Worthwhile Canadian Initiative

Why do we care about the labour share of income?

And by 'we', I mean 'Canadians'.

A lot has been said and written about the decline in the labour share of income, usually calculated as total employee compensation divided by nominal GDP. This decline is generally regarded as a negative development: the reduction in the share of income going to workers is interpreted as a symptom of suppressed wage growth and of increased income inequality.

I don't doubt that this is a useful narrative for understanding what has been happening in many countries, the US in particular. But I can't see how it fits the Canadian experience. Movements in the Canadian ratio of wages to national income  appear to be a story of the denominator, not the numerator.

Some basic facts about the distribution of sex

The Canadian Community Health Survey is an annual voluntary survey, carried out by Statistics Canada, that collects information about a wide range of health outcomes and risk factors. As part of the 2013-14 survey, 47,764  Canadians between the ages of 15 and 49 were asked about their sexual activity - whether or not they have ever had sex, and if they have had sex in the past year.

The majority of those surveyed reported being sexually active, as shown in the graph below. For example, about 88 percent of 18-19 year old women surveyed in 2013-14 (or 0.88) reported having sex in the last year.  For women, the probability of having had sex in the past year peaks at age 25-29. For men, it peaks 10 years later at ages 35-39. 

These estimates, because they are based on survey data, are subject to some margin of error. The vertical bars represent 95 percent confidence intervals - the true population mean will lie within that confidence interval 19 times out of 20. When there is little to no overlap between two confidence intervals, it is fairly certain that one group of people is having more sex than another group of people. So it is possible to say, with a high degree of confidence, that 18-19 year old girls are more likely to be sexually active than 18-19 year old boys, and 45-49 year old men are more likely to be sexually active than 45-49 year old women.

Natural Resources, Living Standards and Inequality

Kevin Milligan had an op-ed in the Globe and Mail a few days ago drawing the link between natural resource development, middle class incomes and inequality.  The point essentially was: “Without income derived from the resource boom, Canadian inequality and the well-being of the Canadian middle class would be much worse than we’ve experienced.”  The point was being made with reference to the current pipeline debate and the consequences of erecting barriers to the transportation of resources to market.  Erecting barriers in the end would result in less resource development and by extension fewer good jobs that would diminish “the income source that has best shielded the Canadian middle class from the harsh economic forces that are increasing inequality in other countries. For Canadians concerned with inequality, the equalizing effect of resource development on our economy is too strong to ignore.”

Seeing through Sovereign Wealth Funds?

In the first country, the government imposes a 50% flat tax on each individual's income, and uses the proceeds from that tax to finance an annual $10,000 transfer payment to each individual. The government has zero debt.

In an otherwise identical second country, the government has a sovereign wealth fund that owns a 50% non-voting equity share of each individual's personal business, and each individual owns a government bond that pays an annual $10,000 dividend. The government has zero net debt.

In an otherwise identical third country, the government imposes a 50% flat tax on each individual's income, and each individual owns a government bond that pays an annual $10,000 dividend. The government has positive net debt.

In an otherwise identical fourth country, the government has a sovereign wealth fund that owns a 50% non-voting equity share of each individual's personal business, and uses the proceeds to finance an annual $10,000 transfer payment to each individual. The government has negative net debt.

What is the difference between the four countries?

Remember that each individual can borrow or lend to other individuals. An individual in the second or third country can sell his government bonds, but an individual in the first or fourth country can borrow against his future transfer payments.

And each individual can buy or sell shares to other individuals. But there might be a non-negativity constraint here, that I can't quite get my head around. An individual can always issue more than 50% shares in his own business. But I can't figure out how an individual can issue negative shares to bring the total down to 40% if the government insists on owning a 50% share in his business.

Liquidity and risk of default might make a difference. And I haven't said what happens when individuals die or emigrate and new individuals are born or immigrate (things that might make Ricardian Equivalence false). But distorting "taxes" are already in the "model".

Soldiers of Fortune goes to Hollywood

There are six identical men, who must choose one of them to do an unpleasant job. They could hold an auction and pay one of them to volunteer to do the job. But if they have diminishing marginal utility of consumption, they will prefer instead to roll a die to decide which one of them does the job. Their expected utility is higher. If the job is unpleasant because it has a risk of death, then state-contingent preferences (the marginal utility of consumption when dead is zero) strengthen the argument for a lottery.

That's the intuition behind a paper I read 25 years ago, about lotteries and the draft for the Confederate Army. I think the title was "Soldiers of Fortune", but I don't remember the author, and I can't find it on the internet. Sorry. by Ted Bergstrom.

Now imagine that a seventh man controls the die, and can offer deals to the other six. He can collect rents in exchange for tilting the die. But there is a limit to how much rent he can collect, or the six will instead auction the job among themselves.

Now change the model, reversing the sign, so the job that one of them will do becomes pleasant. One of them will become a movie star. With diminishing marginal utility of consumption, they will prefer to roll a die to decide who gets to be the star. And with state-contingent preferences (being a star increases the marginal utility of consumption) that strengthens the argument for a lottery.

And again, if a seventh man controls the die, he can collect rents. But there's a difference, because in this case the seventh man need only make a deal with one of the six, not with five of the six. If the other five don't know about the secret deal, they won't revert to the auction.

[Trying to answer a question raised by Steve Randy Waldman's tweet.]

Overselling faded dreams?

The April, 2017, issue of Science has a paper by Chetty, Grusky, Hell, Hendren, Manduca, and Narang on "The Fading American Dream" (ungated here). The paper documents falling income mobility. In particular, Chetty et al claim that, "the fraction of children earning more than their parents fell from 92% in the 1940 birth cohort to 50% in the 1984 birth cohort."

 There is something odd about Chetty et al's results. Women born in 1940 typically had children young, had fairly high fertility levels, and often did not participate in the labour force while they were raising children.  Many women in this generation had no earnings of their own. So how could they have earned more than their parents?  Given that women comprise half of the 1940 cohort, how could 90 percent of the cohort have earned more than their parents? 

A composition effect in earnings growth and education attainment levels in Canada

I came across this post by Mickey Kaus a while ago, on trends in US earnings broken down by education attainment levels. From about the mid-70s to the mid-90s, earnings growth diverged sharply: increasing strongly for those with high levels of education, and falling for people with lower levels of education. Earnings growth has been more balanced since then, but the gaps carved out by this divergence have not been filled in.

This isn't an exercise we can repeat for Canada; this kind of earnings data only start in 1997. But I was curious to see what it would look like, and I found as neat an example of composition effects as you'll ever see.

Tony

Tony Atkinson died January 1, 2017. He was my PhD supervisor when I was at LSE in the 1980s, and we kept in touch occasionally afterwards. What follows are some personal reflections on his life and his work.

In his youth, Tony hitchhiked around Europe. In his later years, he would give lifts to Oxford students thumbing their way into town - and delight in the surprise of those who discovered they were being chauffeured by no less a personage than Sir Anthony Barnes Atkinson, warden of Nuffield College.

Hitchhiking is a fitting metaphor for Tony's attitude to life. It captures his commitment to the practical achievement of a just society. Some people have no access to transport. Others have unused room in their vehicles. Behind the elegant formality of his work on taxation and inequality is a simple idea: if those who have plenty share with those who have less, everyone can get where they want to go.

Staghunt and (the) IRS

"IRS" stands for "Increasing Returns to Scale". It means if you double all the inputs, you more than double the output.

I first worried that US readers might think "IRS" stands for Internal Revenue Service (the US tax people). Then I realised that I want it to stand for that too.

Staghunt is a simple game with two players. Each player alone can catch one hare each; both players together can catch one stag, which they share. Staghunt has two Nash Equilibria: both hunt hare alone; both hunt stag together. (If the other hunts hare you want to hunt hare too, because you can't catch a stag alone; if the other hunts stag you want to hunt stag too, because half a stag is better than one hare.)

Staghunt exhibits increasing returns to scale technology, because two hunters producing one stag is more than double the meat of one hunter producing one hare.

Staghunt is also a model of society. We gain by cooperating, but it only works if we trust others to join in. It's different from Prisoners' Dilemma, the alternative model of society, because Prisoners' Dilemma has only one (bad) Nash Equilibrium, and so needs a Leviathan (which can be interpreted many ways) to enforce cooperation.

Staghunt is also a model of a "network externality". The individual who joins the network (hunts stag, buys a telephone) creates a positive externality for others already in the network, and increases the incentive for others to join the network. (That second effect should strictly be called "strategic complementarity", or "positive feedback", because it is not an "externality" in the strict sense. See my old post for the distinction.)

So Staghunt is a very good model with which to examine Brad DeLong's recent thought-provoking post.

The Irrelevance of Universal Basic Income

The Modigliani Miller Theorem says that a firm's financing policy is irrelevant. It's wrong of course, but it's a good place to start thinking about firms' financing policies.

It would be presumptuous to talk about an Irrelevance "Theorem" for Basic Income. The math is trivial, and the economics is obvious. (And I hope this is not at all original.) But it might be an equally good place to start thinking about Basic Income.

There is only one assumption needed for the Irrelevance "Theorem": the only thing that matters to individuals and to the government is Net taxes (taxes minus transfer payments).

Let there be an initial net tax function Ni = N(Income of individual i, other stuff). It is possible to define a new net tax function M( ) - C  = N( ), where C is some constant. Interpret C as "Universal Basic Income". Done. An outside observer, who observed only the net taxes each individual paid, would be unable to distinguish between a system with and without a Universal Basic Income.

If we want to argue for or against UBI, we must argue that the assumption is false. For example:

1. Framing Matters. It makes a difference to individual behaviour whether they frame a (say) 50% marginal net tax rate as a 50% clawback of welfare or as a 50% income tax with no clawback. Since the presumably educated chattering classes often can't see through the framing (or I wouldn't need to write this post), this is not implausible.
2. Taxes are an individual obligation and government right, and transfer payments are an individual right and government obligation. If the default option is that neither government nor individual pays the other anything, it might make a difference who has the obligation and who has the right to do what. Sort of like where the Coase Theorem doesn't work because of "transactions costs".
3. ?

Bargaining power and the incidence of taxes on high earners in Canada

Today I'm presenting a paper at the meetings of the Canadian Economics Association: "Bargaining power and the incidence of taxes on high earners in Canada." The bottom line is that once you take into account the fact that high earners have bargaining power - that's why they are high earners in the first place! - then it's by no means clear that increasing the top marginal personal income tax rate will result in a progressive redistribution of after-tax income.

This is a theme I've been pursuing for years. From a post I wrote in November of 2009:

Two Problems with Designing a Basic Income Experiment

WARNING: I don't do (micro) Public Finance. And I don't do experimental economics. Those who have read the literature may tell me they are well aware of these problems, or that I'm wrong about something.

Suppose someone asked me to design an experiment to test whether Basic Income would be a Good thing. (They wouldn't ask me, but let's suppose.) I can see two major problems.

1. Temporary experiment vs permanent policy.

Let us suppose that the worst fears about Basic Income were true. If you gave anyone (say) $10,000 per year whether they worked or not, everyone would stop working. Just suppose. Would the experiment be able to tell you that? Because if the experiment weren't able to tell you that, if it were true, it wouldn't be a very informative experiment.

If the experiment were temporary, and known to be temporary, it probably wouldn't be able to tell you that. Because getting $10,000 per year for one year is very different from getting $10,000 per year for life. (Colby Cosh tells me the Dauphin experiment did run for 4 years.)

If people do spend the extra money on taking time off work, that doesn't mean they spend it all immediately. If the average person in the experiment will work for (say) 20 more years, and people spread their extra time off work evenly over their remaining years ("consumption-smoothing"), the effects of a lifetime of basic income will be 20 times bigger than measured by a one year experiment.

It could be even worse than that, because people tend to bunch their leisure towards the end of their lives. We call it "retirement". Maybe the effect of getting $10,000 per year for one year will be that people will retire one year earlier. In which case, the experiment will show zero effect for everyone, except the small fraction of people who were planning to retire soon. If a one year experiment cuts working life from (say) 40 years to 39 years, the effects of a lifetime of basic income will be 40 times bigger than measured by a one year experiment.

You might need to run the experiment for three score and ten years to get some idea of the life-cycle effects. Which is a bit awkward.

2. Funded experiment vs self-funded policy

It's OK if experiments cost money. It's worth paying (sometimes) to get the information. But a basic income policy needs to be self-funding. Free ponies don't grow on trees. If you simply give everyone in the experiment a free $10,000 per year, then (as Stephen Gordon tweeted) good things will very probably happen. But what we want to know is whether good things will happen if we give a group of people $10,000 per year each and that same group of people have to somehow pay for that $10,000 per year each. What we want is a self-funding or revenue-neutral experiment (except for the cost of paying the researchers). The subjects would have to give up all other forms of support that the basic income is designed to replace, and pay the extra taxes that would be needed to make up the difference. Labour supply is not just about income effects; it's about substitution effects caused by changing the marginal (net) tax rate.

Almost any change in tax/transfer policy creates winners and losers. And with informed consent, the losers won't sign the Consent Form. Which would make it a bit awkward getting it past the Research Ethics Board.

It's the external validity of experiments that matters, not the damned T-statistics.

But, as a (moderate) supporter of Basic Income, I think I might just have a Cunning Plan. Which I will leave till later, if and when my head is clearer. But I think we are thinking about this Basic Income thing the wrong way.

Conceptually costing Basic Income

Micro public finance is not my area, so take this post with a big heap of salt. But:

Q. How much would it cost to implement a Basic Income, where everyone gets (say) $10,000 per year?

The normal way to approach that question is to multiply $10,000 by the population, then subtract the cost of Social Assistance (welfare) that would be eliminated, to get the net cost of implementing Basic Income. Then talk about what increase in tax rates would be needed to fund that net cost. [Do not fuss about picky details like adults vs kids, and other programs that might be eliminated, because that is not what this post is about.]

I think this is how economists normally think about it, though I am not 100% sure about that.

I think there is something conceptually very wrong with that approach. Let me use an example to try to explain why.

Reforming Government: Do We Need a Human Investment Super-Ministry?

From time to time, I like to ruminate on what could be done to better develop or improve the delivery of government services especially given the tendency of government ministries to overlap when providing services. This gets a further push when I am teaching public finance - as I am this term. There is of course not only overlap between federal and provincial governments but within the respective tiers. This is especially the case within provincial governments when it comes to spending on what could broadly be termed the human investment function.

A modest proposal for renewed imperialism

I hear that a lot of people want to migrate to...Finland. I'm pretty sure it's not because they like Finland's climate, or scenery. I don't think it's got anything to do with the physical geography of Finland. I think that they want to move to Finland because they like Finland's political, legal, and social institutions, and all the good things those institutions bring. They want to live somewhere that is ruled by Finns.

There are two ways to satisfy that desire.

1. We can move the people who want to live there to the country they want to live in.

2. We can move the country they want to live in to the people who want to live there.

How much revenue will the Liberals generate with a new tax bracket on high earners?

[I started writing this post in May, but I stopped when it looked like the Liberals were not going to be in a position to implement this measure. Happily, I didn't actually delete it.]

[An earlier version made a stupid mistake; I did everything under tha assumption that the increase was 3 percentage points, and not 4. Gah.] 

The Liberal Party of Canada is proposing to increase the federal tax rate on taxable income above $200,000 from the current rate of 29% to 33%. According to the LPC, this measure will generate $3b in revenues:

Problems with the Fraser Institute inequality study

This post was written by Mike Veall of the Department of Economics at McMaster University.

Last week the Fraser Institute published a study that one of the co-authors, Christopher Sarlo, summarized in the Globe and Mail (Is the income gap growing? It depends who you measure, Thursday, July 30). This blog expands on my 150 word letter to the Globe criticizing the study. I thank Stephen for hosting me.

Professor Sarlo highlights “a principal finding of the study” that “individual income inequality has actually declined in Canada” over the study period 1982 – 2010.   It is odd to highlight the individual result given that the study argues “that the appropriate recipient unit is the family” and finds that family inequality has increased. But let that pass for the moment, because there are still three red flags.

First, the study’s income definition excludes capital gains but deducts all income taxes, including the income taxes paid on capital gains. Hence the income observation for someone with capital gains will actually be lower than an otherwise identical person with no capital gains. As capital gains mostly occur towards the top end of the income distribution, this reduces the estimate of inequality.

Second, the data source is the Survey of Labour and Income Dynamics (SLID). A 2004 Statistics Canada paper by Frenette, Green and Picot and  a 2007 Canadian Journal of Economics (CJE)paper by Frenette, Green and Milligan show that SLID tends to under-represent individuals in the tails of the distribution and hence underestimates inequality.  (There is an ungated version of the latter paper here, although I prefer the journal version.)  Given it is a direct challenge to its findings, one would expect some comment in the Fraser Institute study, but the paper is not cited.

This connects to the third red flag. The SLID coverage problem means that the top one per cent is underrepresented in the analysis (and does not even get a mention in the paper). Data from Statistics Canada CANSIM table 204-0001 (where I have adjusted for inflation) show why this matters:  The average after-tax income of the top one per cent of taxfilers went from about $200 thousand to about $380 thousand between 1982 and 2010, an increase of about 90 per cent. For the top 0.1 per cent the increase was from about $570 thousand to about $1.4 million (about 140 per cent). 

In sum, the Fraser Institute study uses a flawed income variable and a data set that lacks coverage in the tails, both in ways that lead to underestimated inequality. And it omits discussion of the top one per cent where significant increases in income inequality have occurred.  I noted in my Globe letter that the Fraser Institute study includes this comment: “Too often, improper measures of inequality are used to arrive at results supportive of an advocate’s pre-existing position.”  I wondered whether it had happened again.

The Beer IneQuality Index

The conventional Canadian view is that American beer is bad; watery and weak. Yet American breweries produce some of the world's best beers - superb brews coming out of microbreweries across the country.

What is striking about the United States is the country's level of inequality - or, to be more precise, the beer quality inequality. Countries like Germany, Belgium - the Scandinavian countries in general - have much less variation in the quality of their beer.

The question is: why? Does beer quality inequality result from other forms of inequality, like disparities in income and wealth? Or do the forces that produce income inequality also produce beer quality inequality? Is it a spurious correlation, or is the armchair empiricist's observation that the US has more beer ine-quality simply wrong?

Does capital income exist?

[Ages ago, as a graduate student, I "wasted" my time (when I should have been finishing my thesis) reading capital theory, including the more "heterodox" stuff. My memory is pretty hazy, but I still think about the old questions occasionally. There's nothing really new here for economists familiar with "dated goods".]

1. Suppose I know about a technology that lets me convert 100 apples into 105 bananas. Should we count those extra 5 bananas as part of my income? Of course not. You can't add (or subtract) apples and oranges bananas. They are two different goods. They don't taste the same.

A short history of the Canadian one per cent

Any sensible policy designed to address the concentration of income at the top of the Canadian income distribution over the past thirty years or so has to be based on a working model that explains how and why it happened in the first place. And we still don't have one. We still don't even have a good handle on the basic facts that this model should explain.

I think that one basic fact that such a model should explain is how the composition of the top earners group has evolved over time. So I'm going to present here some numbers from the Public Use Microdata Files for the censuses between 1981 and 2006.