Any number of slow-moving factors could have caused this erosion of the well-being of less-educated Americans. Every single one of these cohorts was also less likely than the preceding one to be in the labor force. For those who worked, their real wages were no higher than those of previous cohorts, and sometimes lower, and they were less likely to have a strong attachment to a particular job or company. They were less likely to be married or in stable relationships. All in all, the white non-college-educated working class collapsed after the 1970s, and this was probably a product of the specific kind of unequal economic growth the country experienced.
RAGING AGAINST THE WORLD
The alternative to despair is anger.
Becoming aware of the lack of social mobility does not necessarily make people more willing to support redistribution. In the study we discussed above, after eliciting the views of Americans, the researchers presented some of them with an infographic suggesting mobility was much lower than they thought (and the others with another infographic showing the same data, but with a rosier angle). For respondents who originally identified with the Republican Party, this made them even less likely to agree that the government could be part of the solution.85
An alternative is to rebel against the system, potentially at great personal cost. In an experiment in Odisha, India, when employees in a firm felt the pay varied arbitrarily, they rebelled by working less hard, and being absent more often, than in comparable firms where the wage was kept constant, and since they were paid a fixed salary for every day they came to work, they hurt themselves by doing so. Workers in firms with unequal pay were also less likely to cooperate to achieve a collective goal tied to a reward. Workers were willing to tolerate pay inequality, but only when it was clearly tied to performance.86
In the United States, there is another possible reaction. Because many believe the American market system is fundamentally fair, they must then find something else to blame. If they don’t get that job, it must be because the elites have somehow conspired to give it to an African American, a Hispanic, or at one remove, to a Chinese worker. Why would I trust the government of those elites to redistribute to me? More money for the government is more money for “those other guys.”
Therefore, when growth either fails or fails to benefit the average guy, a scapegoat is needed. This is particularly true in the United States, but is happening in Europe as well. The natural foils are immigrants and trade. Behind the anti-immigrant views, as we argued in chapter 2, are two misconceptions: an exaggeration of how many migrants are coming in, or about to come in, and a belief in the nonfact that low-skilled immigrants depress wages.
More international trade, as we saw in chapter 3, hurts the poor in rich countries. This has provoked a backlash not only against trade, but also against the existing “system” and the elites. Autor, Dorn, and Hanson found that in US electoral districts more affected by the China shock, moderate politicians were replaced by more extreme ones. In counties originally leaning Democratic, centrist Democrats were replaced by more liberal ones. In counties originally leaning Republican, moderate Republicans were replaced by conservative Republicans. Counties highly affected by trade tended to be in traditionally Republican states, and therefore the overall effect of this was to push many districts toward more conservative candidates. This trend started well before the 2016 elections.87 The problem of course is that since conservative candidates tend to be against any form of government intervention (and redistribution in particular), they then exacerbated the problem that little was done to compensate those hurt by trade. For example, many trade-affected states governed by conservative Republicans refused federal funds to expand Medicare expansion. And this in turn fueled the resentment against trade.
A similar negative cycle may emerge as people gradually understand that they live in a society that has much more inequality and much fewer opportunities than they previous believed. As in the study mentioned above, they may become even more upset with the government and even less likely to believe it can do something to help them.
This has two implications. First, the obsession with growth at the root of the Reagan-Thatcher revolution, and that no subsequent president has taken issue with, has caused lasting damage. When the benefits of economic growth are largely captured by a small elite, growth can be a recipe for a social disaster (like the one we are currently experiencing). We argued before that we should be wary of any policy sold in the name of growth because it is likely to be bogus. Perhaps we should be even more scared if we think that such a policy might work, because growth will benefit only the happy few.
The second implication is that if collectively we as a society do not manage to act now to design policies that will help people survive and hold on to their dignity in this world of high inequality, citizens’ confidence in society’s ability to deal with this issue might be permanently undermined. This underscores the urgency of designing, and adequately funding, an effective social policy.
CHAPTER 8
LEGIT.GOV
A RECURRING THEME of this book is that it is unreasonable to expect markets to always deliver outcomes that are just, acceptable, or even efficient. For example, in the sticky economy, government intervention is necessary to help people move when it makes sense, but also sometimes to remain in place without having to give up their livelihood and their dignity. More generally, in a world of skyrocketing inequalities and “winner take all,” the lives of the poor and the rich are diverging wildly and will become irremediably different if we allow markets to drive all social outcomes.
As we saw, taxation can be used to rein in inequality at the top of income and wealth distribution. But abolishing the one percent cannot be the end-all of social policy. We also need to find out how to help the rest.
Any innovation in social policy is likely to require new resources. The ultra-rich will probably not be rich enough to finance the entire government, especially if pre-tax inequality goes down, as we hope. Moreover, if history is any guide, they will resist, probably with some success. Others will also need to pay; the experience of many countries shows this is perfectly feasible. The challenge is political. The problem is the eroding legitimacy of the state. The state is perceived as unreliable, or worse, by an increasing majority of the electorate. How can that legitimacy be restored?
TAX AND SPEND?
Democracies raise money through taxation. The overall tax revenues (taking together all levels of government) in the United States in 2017 was just 27 percent of GDP. This is seven points lower than the average in the OECD. The United States was tied with South Korea, and only four other countries in the OECD have lower tax revenues (Mexico, Ireland, Turkey, and Chile).1
Any significant public policy effort would require more funding. Even if the United States raises its taxes on the rich to match Denmark’s, the overall tax revenue as a share of US GDP will still be much lower than what it was in 2017 in Denmark (46 percent), France (46 percent), Belgium (45 percent), Sweden (44 percent), and Finland (43 percent). One reason is that if US tax rates were raised to those levels, it is possible top incomes would go down a lot because companies would move away from paying astronomical salaries; this might be desirable in itself but would defeat the purpose of raising revenue. In other words, although it might be desirable in terms of limiting inequality, the current proposal to raise income tax rates above 70 percent is unlikely to deliver so much new money to the state.
A wealth tax would raise more revenue as long as steps were taken to reduce evasion. Saez and Zucman estimate that a 2 percent wealth tax on Americans with assets above $50 million (this would affect about seventy-five thousand people), as well as a 3 percent wealth tax on those who have more than $1 billion would raise $2.75 trillion over ten years, or 1 percent of GDP.2 As we saw, 2 percent wealth tax for those worth more than $50 million is actually more popular than an increase in the marginal income tax rate.3 But even at the proposed level, it still raises just 1 percent of GDP.
As things stand, this is a no-fly zone for US politicians on the left and the right. Proposing to raise taxes on (almost) everyone is not popular. In our survey, 48 percent of respondents thought small business owners paid too much in taxes, and less than 5 percent thought they paid too little. The same was true for salaried workers.4 The hardest part may be to persuade the average taxpayer in the United States to pay more and get more public services. We suspect economists are partly responsible for people’s reluctance to pay taxes, in more than one way.
First, many prominent economists have raised the specter that people will stop working if taxes go up. For example, Milton Friedman, who famously declared: “I am in favor of cutting taxes under any circumstances and for any excuse, for any reason, whenever it’s possible.”5 They maintain that high taxes kill initiative and stop growth, even in the face of data that says nothing of the sort. We have already seen that the rich do not stop working when taxes go up. How about the other 99 percent though? Would they retire to the countryside? There is also a voluminous economic literature on the subject that makes it clear they won’t.6
One of the best examples is from Switzerland. In the late 1990s and early 2000s, Switzerland converted from a system where people paid taxes on the previous two years of income to a more standard “pay as you earn” system. In the old system, taxes due in 1997 and 1998 were based on income earned in 1995 and 1996, taxes due in 1999 and 2000 were based on income earned in 1997 and 1998, and so on. The new system works like that of the United States: estimated taxes due, say, for 2000 are collected throughout the year, then in early 2001 the taxpayer fills out an income tax return and the tax liability is adjusted. To transition to the new system in Switzerland, there had to be a tax holiday. The canton of Thurgau transitioned in 1999. In 1997 and in 1998, taxpayers paid taxes on the income earned in 1995 and 1996. In 1999, they started paying taxes based on income in 1999. To avoid taxing people twice, no taxes were ever levied on the income earned in 1997 and 1998: those were the tax holiday years. Swiss cantons transitioned in different years between 1999 and 2001, so different people got their tax holidays in different years, depending on where they lived. The rebate was temporary and widely known in advance. So while people decided whether (and how much) to work for the year, they already knew they would pay no taxes. This was a perfect opportunity to see whether lowering tax rates made a difference to people’s willingness to work; we can just compare labor supply before, during, and after the tax holiday. The answer is it changed not at all. There was absolutely no impact on whether people decided to work or not, and no effect on hours worked either.7
While the Swiss example is particularly stark, the result is more general. Taxes do not seem to discourage people from working.8 However, voters may still oppose taxation if they think others would stop working if taxes went up. In our survey we asked some of the respondents whether they would stop working, or work less, if taxes were higher. Seventy-two percent said they would absolutely not stop working, and 60 percent said they would work just as much as before. This is very consistent with the data. We also asked the other respondents how they thought the average person in the middle class would respond. In that case, only 35 percent of respondents believed the average middle-class person would work as much as before, and 50 percent believed they would stop working.9 Thus, when judging themselves, Americans are about right, but when they anticipate the behavior of their friends and neighbors, they are much too pessimistic.
IS GOVERNMENT THE PROBLEM?
Another reason why people are reluctant to raise more taxes to get more services is that many people in the United States (but also in the UK and in many developing countries) are skeptical of any intervention by the state. At least since Reagan, we have been fed the mantra that “in this present crisis, government is not the solution to our problem, government IS the problem.”10
In 2015, only 23 percent of Americans thought they could trust the government “always” or “most of the time.” Fifty-nine percent had a negative opinion of the government. Twenty percent thought the government had no tools to improve equality of opportunities between the rich and the poor, and 32 percent thought lowering taxes on wealthy people and corporations to encourage investment would be a better way to improve equality of opportunities than increasing taxes to finance more programs for the poor.11
This radical skepticism about government action may be the single biggest constraint on helping those who need it most, paradoxically because many of those people themselves hold precisely these views. Manpreet Singh Badal, a bright young minister in the Indian state of Punjab, saw his political career stumble over just this issue. Farmers in Punjab get free electricity, and groundwater is free, with the result that everyone over-irrigates their land with the consequence that the water table is falling so fast that in a few years there will be no water to pump out. It is in everybody’s interest to reduce water consumption now. Badal’s solution was to give everyone a fixed sum of money to compensate them, and then charge them for the electricity so they would not pump any more water than they needed, because the cost would act as a deterrent against excess pumping. From the point of view of economic logic, this is a no-brainer. But it was political suicide. The measure, introduced in January 2010, had to be removed ten months later, and Badal lost his job as finance minister and eventually had to leave his political party. Farmers simply did not trust they would get any money, and the powerful farmers’ associations radically opposed the measures. Remarkably, in 2018 Badal, back in government, decided to try again. This time the plan was to first give a direct transfer of Rs 48,000 (equivalent to $2823, accounting for purchasing power parity differences) to all farmers directly into their bank accounts, before charging them for electricity by deducting from this same account. The subsidy has been calculated such that at the going rate, a farmer consuming less than 9,000 units of power would come out ahead (the state estimates the average consumption is between 8,000 and 9,000 units). The idea was to make it absolutely clear that this is not a tax in disguise, a sly way to raise money from the farmers. And this time the government moved slowly. They began with a small pilot program, and are now planning a larger RCT to evaluate the impact of this scheme on water consumption and farmers’ welfare. Still, farmers remain suspicious. The farmers’ union continues to claim that “their real agenda is to discontinue the power subsidy for agriculture.”12
Why are people so suspicious of the government? A part of it, no doubt, is historical. In India, people have seen too many instances where the government reneged on a pledge. In the United States, there is clearly an ideology of self-reliance, even though for many years it has been based, to a significant extent, on a fantasy—the states in the US where people take the most pride in their autonomy are also the ones most dependent on federal subsidies (Mississippi, Louisiana, Tennessee, and Montana top the list by federal aid as fraction of revenue).13 In part also, as we suggested earlier, it relates to a distrust of the elite. Government programs are seen as the elite’s way of subsidizing everyone but hard-working white (males?). But it doesn’t help that there is a background of economist-inspired chatter about waste in government. Mention a government intervention in a roomful of economists and you will hear an unmistakable snicker. Many, perhaps even most, economists believe incentives in government are always messed up, and as a result government interventions, while often necessary, tend to be ham-handed or corrupt.14
But bad relative to what? The problem is that there is no substitute for a lot of things the government does (alt
hough of course many governments do more things than they should, like running an airline in India or a cement plant in China). When a tornado strikes, when an indigent needs healthcare, or when an industry shuts down, there is usually no “market solution.” The government exists in part to solve problems no other institution can realistically tackle. To demonstrate waste in government, one needs to show there is an alternative way of organizing the same activity that works better.
There is no doubt waste in governments in most countries. A number of studies from countries like India, Indonesia, Mexico, and Uganda have found that changes in the way governments do things can lead to substantial improvements. For example, in Indonesia simply distributing a card indicating someone was eligible for a program increased the amount of subsidies the poor got by 26 percent. Once they found out what they were eligible for, people were able to better advocate for themselves.15 On the other hand, as we noted in chapter 5, there is also enormous waste inside private firms, so perhaps good management of resources is harder than we think.
Consistent with this, figuring out how to reduce waste in government turns out to be more difficult than it seems. Simple formulae do not work; privatization, for example, is not a panacea. The limited evidence comparing private and public provision of the same service turns out to be very mixed. Private schools in India are cheaper, but children randomly assigned to a private school have the same low test scores as those who stayed in public schools.16 Private placement services for the long-term unemployed in France work less well than their public equivalents.17
Good Economics for Hard Times Page 32