Robert Reich joins the pod people
The Economist has a new podcast up with Robert Reich, the former Clinton Secretary of Labor, discussing income inequality.
Income and poverty Archives
October 23, 2007
September 19, 2007
Feel that earning power
I'll have more on the Obama tax plan sometime in the next week; I'm trying to go through and look at the sum total spending and tax proposals by the candidates, which takes time.
Meanwhile, one proposal I'm surprised not to find being talked up is the Earned Income Tax Credit, a variation on Milton Friedman's famed negative income tax proposal that is very well regarded by Democrats and Republicans alike. Defying the aphorism that "a program for the poor is a poor program", the EITC has been expanded in every major tax package in the last two decades, and with good reason: it helps out marginal members of the labor force, while still encouraging work.
But this Raj Chetty profile suggests that it may not work as well as it could:
Chetty is drawn to the psychological underpinnings of economic theory. Before deciding on a change to the tax code, he argues, politicians should study how consumers think about taxes. With that in mind, he created an experiment to determine whether separately labeling the sales tax on an item would affect a shopper’s behavior. He persuaded a large grocery chain to allow him to post tags next to 750 of their products for three weeks, showing how much the item would cost after sales tax was added. Fearing the experiment would result in lower sales, the chain did not allow Chetty to post signs on its most popular items.The store management’s fears were well founded. When consumers knew just how much more taxes would cost them, they reduced their purchases of the items by about 7 percent. As part of the working paper—titled “Salience and Taxation: Theory and Evidence,” coauthored by Adam Looney of the Federal Reserve Board and Kory Kroft of Berkeley’s economics department—Chetty surveyed customers entering the store to determine whether they knew which goods were taxed and which ones weren’t. They were generally able to distinguish the two categories. In other words, they knew that an item was taxable, but actually seeing the total cost—including the tax—at the time of a potential purchase discouraged them from buying it.
“It may not sound unusual. But in economics, most people don’t do experiments. They’re happy to take the data as they find it. They don’t create novel experiments to understand the way the world works,” Feldstein says. “It was a very ingenious way of showing how taxes actually affect shopping behavior—that people actually shopped less when they recognized the full cost of what they were doing.”
Given that consumers seem to weigh taxes more heavily when they are reminded of the burden, Chetty wondered whether Americans understand the implications of the Earned Income Tax Credit, a program meant to motivate low-income people to work by subsidizing their wages. Enacted in 1975, the program was expanded in 1986, 1990, 1993, and 2001. It is considered one of the government’s central anti-poverty policies. Under the program, those who earn, say, $10,000 a year might be given a credit once a year for $4,000, or 40 percent of their salary. But after surveying some of the beneficiaries of the EITC , Chetty found that most people who get it don’t understand how it works.
“They just know that after they file their taxes, they get a big check,” Chetty said. “That is seriously problematic for public policy, because the whole point of the program is to give people an incentive to work. To give them an incentive to work, they really need to understand that they’re really being paid $14 an hour, not $10 an hour.”
The EITC seems to function less as a wage boost than as a system of forced savings for the poor. That's not a perjorative, either; forced savings are popular even with the forcees. Witness the number of (middle class) people I used to work with who would overwithhold in order to experience the joy of getting a check back from the IRS. When I tried to explain that they were essentially making an interest-free loan to the government, they countered that they liked having a big check they could spend on something memorable, like a vacation or a downpayment on a car. The EITC beneficiaries I've known seemed to view it much the same way.
But how to make it work more like a direct wage subsidy? Refunding the money in each paycheck would be outrageously expensive to administer, and poor people who were overpaid the credits in the beginning of the year are vanishingly unlikely to have the money to cover a shortage at year's end. Moreover, the forced savings aspect can be a real benefit; money that would otherwise trickle away on small sundries can instead be put towards a reliable car to get to work, a rental deposit, or something else that measurably improves their lives. Perhaps a statement issued with each paycheck, showing the accumulated EITC?
August 29, 2007
The economics of despair
This is the second piece that I've read on Charles Karelis' new book, The Persistence of Poverty. Steven Pearlstein describes it thus:
The reason the poor are poor is that they are more likely to not finish school, not work, not save, and get hooked on drugs and alcohol and run afoul of the law. Liberals tend to blame it on history (slavery) or lack of opportunity (poor schools, discrimination), while conservatives blame government (welfare) and personal failings (lack of discipline), but both sides agree that these behaviors are so contrary to self-interest that they must be irrational.After all, the reason we study, work, save and generally behave ourselves is that these behaviors allow us to earn more money, and more money will improve our lives. And, by logic, that must be particularly true of the poor, for whom each extra dollar to be earned or saved for a rainy day is surely more valuable than it is for, say, Bill Gates.
In economics, this insight -- that the fifth ice cream sundae is less valuable than the first one -- is enshrined in the law of diminishing marginal utility.
But what if this iron law of economics is wrong? What if it doesn't apply at every point along the income scale? If you and everyone around you are desperately poor, maybe it's perfectly rational to think that an extra dollar or two won't make much of a difference in reducing your misery. Or that you won't be able to "study" your way out of the ghetto. Or that if you find a $100 bill on the street, maybe it's logical to blow it on one great night on the town rather than portion it out a dollar a day for 100 days.
Tyler Cowen's description is a little more pithy:
If your car has lots of scratches and dents, getting rid of just one doesn't help much either.
There's a lot of interesting literature on the bad incentives faced by the poor. They often have punitively high marginal tax rates, because of the lost benefits; they also face a high personal "tax" in the form of poor relatives and friends, since earning additional money makes it very likely that they will be tapped for loans and other forms of financial help. This already explains a lot of the behavior that Pearlstein describes, as do various sociological phenomena.
But I find this thesis intriguing. One way to think about it is that the poor face a lot of problems with threshold effects. If I need an apartment and a car, and I have the down payment for a Hyundai and a basement efficiency, each additional dollar improves my lot. If I need an apartment and a car, and I have $30, I might as well spend that $30 on dinner and a movie, because I'm going to end up on Mom's couch tonight either way. Once you reach the threshhold, it's easy to make a straight tradeoff between two forms of utility. But if it's going to take you nine months to save the cash you need, your choice right now becomes fun, or none.
Another way to think about it is that if you are living on the edge, this lowers, rather than raises, the returns to planning. If there's a 50% chance that an unforeseen expense will force you into bankruptcy, why not load up on some credit card debt and have fun while you can?
I'm not convinced . . . but I've added it to my Amazon queue.
The good old days
Brad DeLong is absolutely stunning when he writes about economic history:
A quarter of American households in 1900 had boarders or lodgers (compared to two percent today). Half of American households in 1900 had fewer rooms than persons (compared to five percent today). A quarter of American households in 1900 had running water (compared to ninety-nine percent today). An eighth of American households in 1900 had flush toilets (compared to ninety-eight percent today). Less than a fifth had refrigerators, less than one-twelfth had gas or electric lights, less than one-twentieth had telephones or washing machines, and of course there were no radios or televisions or vacuum cleaners or central heating, to list just those major appliances that have greater than ninety percent coverage today.And even if you did have a four room house, could you afford to heat more than one room of it? Many Homestead four-room houses became two-room houses--the kitchen and the bedroom--in the depths of the western Pennsylvania winter.
The diets of workers in Homestead, Pennsylvania at the turn of the century were composed primarily of meat of widely variable quality, bread, butter, potatoes, oatmeal, and tea and milk–with luxuries such as sweets added in more or less regularly. We would find the diet somewhat monotonous (however, a lot of time and effort went into Þnding different ways to make potatoes). Almost always the first luxury that a working-class family moving up would purchase would be the services of a laundress: since laundry was expensive and difficult, few working-class families could maintain upper-middle-class standards of cleanliness. How often would you take baths if the water had to brought in from an outside pump, and then heated on the stove? How often would you wash your clothes if everything had to be washed out in the sink, if the fabrics were three times as heavy and the detergents one-third as powerful as the ones available today, and if as a result the laundry was a full day’s chore? Hand laundry was not a two hour a week task. Those who could afford the resources to maintain bourgeois styles of cleanliness flaunted it. White shirts, white dresses, white gloves are all powerful indications of wealth in turn of the century America. They said "I don't have to do my own laundry and ," and they said it loudly.
As a rule married women did not work outside the home–unless they were African-American, in which case they might well do their own family’s housework and be paid for doing a share of some white family’s housework as well. Meal preparation was not a one-hour-a-day but a four-hour-a-day task. Barring a shift toward larger-scale communal or cooperative living–a shift which simply did not happen even though anticipated, hoped for, and worked for by many feminists–within-the-household production and maintenance soaked up one-third the potential adult work hours. It made it next to impossible for married women (unless they were quite rich, or quite poor) to have independent careers and still fulfill the social expectations of household maintenance.
Infant mortality at the turn of the century was high. One in five babies in Homestead, Pennsylvania died before reaching his or her Þrst birthday. Adult men died, too, like flies (and adult women faced substantial risks in childbirth). Accident rates in the factory were such as to leave 260 injured per year–30 dead–out of a total population of 25,000 and a steel mill working population of 5,000. Each year, five percent were injured enough to miss work for some time (although only one percent per year were permanently disabled), and 1/2 percent per year were killed in factory accidents.
You can do the math. Start to work for U.S. Steel when you are 20. There is one chance in seven that the factory will kill you before you reach 50, and almost one chance in three that the factory will disable you. Is it any wonder that life insurance–disability insurance--group lodges that provide benefits (because the company provides few)--loom so large in American working class consciousness at the turn of the century? And is it any wonder that the Þrst component of the welfare state put into place, in many parts of the United States, was workmen’s compensation? Of course, in 1910 Homestead (or in 1930 Detroit, or in Los Angeles today) the most arduous and difficult jobs were done by minorities and immigrants: in 1910 Homestead by Slavs, in 1930 Detroit by Blacks, and in 2000 Los Angeles by Hispanics. At the micro level, such groups are concentrated in the most arduous and lowest-paid jobs because they are poor, because they have limited other options.
Most of the Homestead workforce only worked six days a week: for four out of five workers, the mill was shut on Sundays. U.S. Steel viewed this--shutting most of the mill on Sundays–as a major concession on their part, a concession that they hoped would produce large public relations benefits. From U.S. Steel’s perspective, each hour that a modern plant like Homestead stood idle was tremendously expensive. Variable costs--wages, raw materials, and transportation--made up perhaps 2/3 of total costs. The remainder were fixed: capital costs on the construction of the plant, and maintenance that had to be performed whether the plant was operating intensively or not.
Were U.S. Steel to move from two 12-hour shifts a day to one 12-hour shift, its output would be halved but its costs would be reduced by only 1/3, so total costs per ton of steel made would rise by 1/3. This was not a margin that U.S. Steel could afford. As long as it could Þnd workers willing to work the night shift, the Homestead mill (depressions and recessions apart) stayed open 24 hours a day on weekdays. And when things did change, they changed all at once-from two 12-hour shifts before and during World War I, to two 8-hour shifts (or three 8-hour shifts) during the 1920s, and during and after World War II. Yet Homestead jobs--at least Homestead jobs taken by native-born Americans--were good jobs by the standards of the United States. As historian Ray Ginger put it:
their expectations were not ours. A man who grew up on a Southern farm did not think it cruel that his sons had to work as bobbin boys [collecting spun thread in a textile mill]. An immigrant living in a tenement and working in a sweatshop yet knew that for the Þrst time in his life he was wearing shoes seven days a week...
And Homestead, Pennsylvania jobs paid well both by the standards of the United States and much more so by the standards of the world economy of the time. White households could make around $900 (of 1910 value) a year, placing them well the upper third of the U.S. population in terms of income per household in 1910. Relative to what could be earned by people of similar skill levels anywhere else in the world, a job in the Homestead mill was a very attractive job. Even the unequal America at the turn of the century was a very attractive place compared to the rest of the world. America was exceptional. In spite of the hours, in spite of the risk of death or injury, in spite of the working conditions, these were very good jobs by international standards: jobs worth moving 7,000 miles for, from Hungary or Lithuania to suburban Pittsburgh. For the economy of the late nineteeth century was for the first time in human history a truly global economy, filled with long-distance trade and migration, so people could take advantage of the opportunities opened up by industrialization.
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