Chris Dillow's Blog, page 183

How a mansion tax helps the rich

Supporters of a mansion tax seem to have overlooked something - that such a tax would not be a tax upon the rich so much as upon the older rich.

I say this for a simple reason. The price of any asset should be equal to the discounted present value of the net benefits from it. Because a tax reduces the net benefits of a mansion, prices of them should thus fall. In other words, the tax should get capitalized into prices.

History suggests this is just what happens. Some research (pdf) at the IFS found that the replacement of rates by the poll tax in 1989 -  the abolition of a tax on housing - caused a big rise in house prices. In inner London, an anticipated  saving of £471 per year on rates added almost £6000 to the price of an average house (in 1985 prices).

That was not by any means full capitalization; the capitalization rate was only around one-third. But there are two good reasons why the capitalization rate might be higher for a mansion tax:

- In the late 80s there were doubts as to whether the shift from rates to poll tax would persist, given the unpopularity of the latter; such doubts were of course wholly correct. The risk of a reversion to property taxes would have dampened the boost to house prices. Because there's more chance of the mansion tax persisting - especially if it gets cross-party support - it should be more fully capitalized.

- There's more substitutability for mansions than for housing generally. A £1.9m house is a decent substitute for a £2m-plus one, whereas there are fewer close substitutes for home ownership generally. This means that potential buyers of mansions have the bargaining power to bid their prices down.

Insofar as the mansion tax is capitalized, it is present owners of them who lose two-fold; they have to pay the tax, but also see the value of their asset depreciate.

But house prices are not net wealth. A falling price of mansions is a benefit for those who would like to buy them. If the tax were 100% capitalized, the effect upon future buyers would be zero. Yes, they'd face a tax on their purchase, but they'd also pay a lower price for the Mansion. The two would net out.

And who are future buyers of mansions? They are the younger, slightly less rich - those who might well already own houses in the £1-2 million bracket. Indeed, some of these could even benefit from such a tax. This would happen if the price of their desired house falls to just below £2m, or if prospective buyers shift from £2m to sub-£2m-priced houses, thus bidding up the price of the latter.

Now, I don't think all this is a clinching argument against a mansion tax. I favour it, insofar as it is a slippery slope towards a fuller, more intelligent, land value tax. But let's not kid ourselves that a Mansion tax is hitting the rich. Some of the rich might even gain from it.

Inequality & the crisis

Was inequality to blame for the financial crisis? A paper (pdf) by Michael Bordo and Christopher Meissner suggests not. They point out that, in developed countries since the 1920s, the sort of credit booms that lead to crises have not generally been associated with rising inequality. This casts doubt upon Raghuram Rajan's idea that rising inequality led to the crisis by encouraging lax regulation of lending to low-income households; though he is not alone (pdf) in suggesting such a link.

One can question the relevance of Bordo and Meissner's evidence. The fact that crises are not often preceded by rising inequality does not disprove that inequality - along with other mechanisms - had a role in this particular crisis.

And there are two other mechanisms through which inequality might have precipitated the crisis:

- Insofar as rising inequality in the 00s was correlated with a rise in wages in the financial sector relative to other industries, it attracted "talent" into banking. And this contributed to its downfall, because "talent" produces not stability but rent-seeking and overconfidence. Remember - banks survived for decades by employing doddering Captain Mainwarings but collapsed soon after hiring physics PhDs.

 - One contributor to bank collapses was inequality of power. Top-down management structures produce bosses who combine domineering arrogance with ignorance. As Julian Birkinshaw has said (pdf), the management model in investment banks was one in which "Aggressive and intimidating behaviour is tolerated; effective teamwork and sharing of ideas are rare."

And even if inequality did not cause the crisis, it is correlated with it. The same growth (pdf) of Asian economies that gave us an excess supply of cheap labour which depressed unskilled wages in the west also gave us the savings glut that produced the housing boom and malinvestments in mortgage derivatives.

But does it much matter whether income inequality contributed to the crisis or not? The Left argued that high inequality was a bad thing long before the crisis, for intrinsic as well as instrumental reasons. Those arguments are as strong (or as weak!) as they ever have been.

The power of prosocial motivation

"Incentive pay" can backfire, according to some new research. Margaret Lee and Ye Li at Columbia University got people to find as many words as they could in four minutes from the letters "a d e r s t w". Some solvers were not paid at all. Others were paid per word they found. And others were told that their performance would determine the pay of the next participant.

They found that when people were paid per word, they actually found fewer words than people who weren't paid: an average of 25.6 compared to 29. This confirms Daniel Pink's argument that extrinsic rewards can actually crowd out intrinsic motivation.

However, people whose performance determined the pay of the next participant actually found more words than either - an average of 30. Prosocial motivations, then, can be more powerful than selfish ones.

In another experiment, Li and Lee discovered why. It is not because people are purely altruistic, but rather because they are conditional reciprocators. They'll work hard for others as long as they expect others to work hard in turn. If this expectation is not fulfilled, prosocial motivation doesn't work any better than flat-rate pay.

In a third experiment, Li and Lee found that such reciprocity was especially powerful if people expected to be accountable for their actions. They got random pairs of people to type the letters F and J alternatively for 15 minutes, with payment if more than 400 pairs were typed. Some were paid for their own performance, and some for their partners. They found that people working for their partner typed almost 10% more letters if they knew they would meet their partner afterwards than if they didn't. Such people also typed slightly more letters than those paid for their own performance.

This result might generalize. Most of us see our co-workers every day. If we know their pay depends on our efforts and vice versa, we might therefore be pressurized into working harder. And such pro-social pay gives workers an incentive to monitor each other and so reduce shirking.

Now, it doesn't follow from this that all firms should adopt "payment for others" - type incentives. I suspect that the power of prosocial motivations depends a lot upon detailed context.

What this research does do, though, is further undermine the notion that high-powered selfish incentives are the best way of motivating people. This belief probably rests more upon a desire to justify inequality than it does upon a basis of empirical evidence.

Tax the (middlingly) rich

The coalition's confusion over its plan to remove child benefit from people in the 40% tax band raises an issue that all politicians would rather ignore: namely, the structure of marginal taxes.

The problem with withdrawing child benefit is that someone earning just under £42,745 faces a massive marginal tax rate because she would lose child benefit if she gets a pay rise.

Of course, marginal deduction rates of several hundred per cent are undesireable. The best way to demonstrate that we're "all in this together" is not to remove child benefit from the rich, but to tax them more heavily.

And this is where economics and politics collide violently, because there is a sound economic case for having higher marginal tax rates on the middlingly rich - those in the current 40% tax band - than on the super-rich.

This is because the super-rich are more likely to reduce their taxable income in response to higher marginal rates than the middling sorts. And as Greg Mankiw wrote in his nice survey (pdf) of optimal tax theory:

If high-income workers are particularly elastic in how their taxable income decreases with higher tax rates, this would imply lower optimal marginal tax rates on high incomes

Empirical work (pdf) in the US by Gruber and Saez has demonstrated just this - that there's a case for lower marginal taxes on very high incomes than on slightly lower ones.

There are (at least) four reasons why the super-rich are more likely to be on the "wrong" side of the Laffer curve than the middling sorts:

1. They are footloose. A hedge fund manager can move to Switzerland more easily than can a head teacher.

2. There are deadweight costs of dodging taxes. Paying fancy accountants and lawyers is not worth the effort for a middling earner aiming to save a few hundred quid, but it for someone aiming to save a few thousands.

3. The very rich can afford to retire if they think the government is ripping them off. Those of us on middling incomes cannot.

4. The super rich might have lower tax morale than others. The very fact that they are rich is evidence that they are more motivated by money than the rest of us, which suggests they might resent higher marginal taxes more. And this, combined with points 1 -3, might lead them to cut their taxable income in response to high marginal taxes. It more efficient to tax the compliant than the non-compliant.

These points all argue for lower marginal taxes on the very rich than the middlingly so - though whether this points to a 40%-10% structure or a 60%-50% is a separate issue.

Such a structure is, however, politically infeasible.  But it needn't be.

This is because low marginal taxes on the rich are quite consistent with progressive average taxes. Imagine an income tax system in which the first £10k is tax-free, the next £30k is taxed at 20%, the next £110k at 60% and incomes above £150k are taxed at 30%. Then someone on £25k faces an average tax rate of 12%. This is only one-fourth the average rate paid on £150k, and one-third that paid on £200k. Over most incomes - 99% - the tax system is progressive. Yes, average tax rates fall as incomes rise beyond £150k. The guy at the bottom of the top percentile might complain. But so what?

What's more, income tax is not the only redistributive tool. I'd like to see it accompanied by: land value tax; worker democracy to rein in bosses' rent-seeking; and a culture war against managerialist ideology.

Lower marginal rates on the rich, then, might be consistent with more egalitarianism than we presently have.

A case for cutting fuel duty?

What, if any, should be the link between the price mechanism and "fairness"? Two issues raise this question.

One is that Royal Mail is planning a scheme to protect the poor from its price rises. The other is FairFuel UK's campaign for a cut in fuel duty to offset rising petrol prices.

Conventional economics says both are bad ideas. It says:

The function of the price mechanism is to signal that some things - such as petrol or stamps - are becoming scarce or expensive and so people should economize upon them. Blunting these signals by tax cuts or subsidies to selected groups results in a misallocation of resources - over-consumption of stamps and petrol and, by implication, under-consumption of other things. 

The best way to protect the worst off from price rises is to raise their incomes, not to tweak prices. The price mechanism and redistribution are analytically (roughly) separate things.

But how strong is the argument now? Three things make me doubt it.

1. At a time of mass unemployment, minor misallocations of resources are very secondary issues; it takes a lot of Harberger triangles to fill an Okun gap. Any boost to spending power, which helps fill that Okun gap, should be welcomed.

2. The rise in oil prices might not entirely reflect the rational working of the price system, but rather speculation triggered by easy money.

3. It could be that lower fuel duty is the simplest and most effective response to the recessionary impact of higher oil prices.

The UK consumes 1.67mbd of oil. The $15pb price rise we've had so far this year would therefore cost consumers £5.8bn - just under 0.4% of GDP - if it persists for 12 months. This is equivalent to an unanticipated tax rise. What should the government do about this?

It is, of course, mere gibber to claim - as Osborne does - that the government can do nothing as it "has run out of money. " In principle, a tax cut or benefit rise that doesn't (greatly) affect relative prices would be a good way of offsetting the recessionary shock. But there are drawbacks to the obvious possibilities:

- An income tax cut might be partially saved, and would not help those who suffer from higher oil prices who aren't in work - such as the unemployed and pensioners facing higher prices generally because of higher transport costs.

- A cut in VAT imposes administrative costs onto firms and does not greatly help those who face higher food prices  because of higher transport costs.

It might, then, be that a cut in fuel duty commends itself not on the grounds of fairness - most of those calling for it simply have an excessive sense of their own entitlements - but because it is one way of mitigating an adverse supply shock. 

The trouble with preferences

The Daily Mail reports that "almost half of young women aged 18 to 25 would prefer to have large breasts than high intelligence." This raises four issues about the role of preferences in the social sciences:

1. Is the survey reliable? It's possible that this number is downwardly biased because some women would not want to admit to being so shallow as to prefer to embiggen their norks than their IQ. This raises a general issue about the usefulness of survey data. Ideally, we would corroborate such data against other evidence. This is why happiness researchers, for example, correlate self-reported well-being against other indicators (pdf), such as the opinion of friends, tendency to smile and vulnerability to mental ill-health or cardiovascular disease.

2. Is this preference irrational? There's some evidence that the returns to ability are low (pdf), especially for a given level of education, and have fallen (pdf) recently. There's also the possibility that there are diminishing returns to IQ; whereas moving from an IQ of 80 to 100 might lift one out of poverty, moving from smart to very smart has less effect. Malcolm Gladwell has written:

The relationship between success and IQ works only up to a point. Once someone has reached an IQ of somewhere around 120, having additional IQ points doesn't seem to translate into any measurable real-world advantage (Outliers, p79)

If this is the case - and it's controversial (pdf) - then it is quite rational for many women to be less keen upon improving their IQ than enlarging their breasts, especially if the latter boosts their confidence.

3. Are pro-social preferences necessarily a good thing? It's highly likely that the returns to IQ, insofar as they exist at all, are appropriated privately; social returns to education are notoriously hard (pdf) to find, and it's reasonable to suppose the same is true for the returns to IQ. But bigger norks have an obviously positive externality.

Women's preference for bigger norks over a higher IQ is, therefore, is a pro-social preference. Which raises a paradox. It's common for the left to believe that pro-social preferences are a good thing - hence their animosity to capitalists' "greed". But in this case, I suspect many do not believe this. There's a reason for this…

4. Does this show the prevalence of endogenous preferences? There are two ways this might be the case. Feminists will allege that the preference for larger norks represents an adaptation to a body image fostered by patriarchal forces. But there's another mechanism too. Embiggening norks can be easily done by surgery, whereas it's much less obvious that IQ can be so malleable in adults. A preference for bigger norks might therefore be an example of how people want what's available.

This matters, because the idea of endogenous preferences undermines a lot of welfare economics and, indeed, the very case for democracy. The issues here, then, are rather important.

"We need smarter people"

My suggestion that the BBC ban politicians has met with one reply I find revealing - that the BBC should instead have smarter interviewers to call them on their lies and errors.

I say this is revealing because it is an indicator of a widespread belief - that the solution to incompetence - at the BBC or in politics or in management - is to find cleverer people.

This, of course, is an aspect of managerialist ideology - the idea that things can be run well by really smart people. It serves to justify inequalities of both power and wealth; clever people must be in charge, and  because ability is scarce we must pay a fortune for it. This ideology sustains itself even in the face of widespread (pdf) incompetence in management (pdf); the solution to incompetence is to hire better people, to pay even more.

This belief is not obviously correct. It could be that the reason why so many "top jobs" are done badly is not that second-raters do them, in which case the problem would be solved by hiring the right people. Instead, it could be that the jobs are so demanding that no amount of brains and ability would suffice. In other words, there is what Thomas Homer-Dixon calls an "ingenuity gap" . Humans just lack the skills to do many complex tasks.

So, for example, no TV or radio presenter can possibly be sufficiently expert on so many different things as to be able to expose politicians' lies. And no top manager can have the skills and knowledge to run large, complex organizations.

In such cases, the solution is not to hire better people - a possibility also undermined by the fact that it's difficult to spot talent - but to find ways of avoiding reliance upon frail human intelligence. So in the case of current affairs programmes, the answer is to not have on people who are liable to be wrong or liars - not just politicians but corporate shills and many activists too. And in the case of management, the solution is to break up conglomerates or seek the wisdom of crowds by using market-based management or worker democracy.

This, though, brings me to a depressing thought. The left is especially vulnerable to this managerialist ideology. It has traditionally had faith (the mot juste) that political problems - and by extension other organizational problems  - can be solved by intellect. From Marx's (misinterpreted?) claim that mankind only sets itself such problems as it can solve to Blair's "confidence in our ability not just to promise change but to deliver it", it has thought that brains and effort are enough.

This belief - which is magnified by the optimism bias for which politicians are selected - naturally leads to a deference to those people thought to possess managerial talent. In this sense, the rising inequality and managerialism we saw under New Labour was not an accident, but rather the logical extension of a major strand of leftist thinking.

Traditionally, many of the best challenges to this have come from the "right" - be it Hayek's warning about the impossibility of aggregating dispersed, fragmentary knowledge or Oakeshott's belief that politics cannot be an exercise in using mere "reason" to solve problems.

Paradoxically, therefore, if the Left really wants to overthrow inequalities of wealth and power, it must move to the right*.

* OK, maybe "left" and "right"  aren't meaningful. But don't let this ruin a nice paradox.

A crisis of managerialism or neoliberalism?

Paul asks lefties a question: is the crisis one of managerialism or neoliberalism? I'd answer: both.

The proximate cause of our current troubles is the failure of managerialism. The banking crisis shows not so much that financial markets fail but that organizations do so. There are three (non-exclusive) ways of reading the banking crisis, all of which represent a failure of management in some sense:

- Banks did not understand the risks they were taking in mortgage derivatives, relying upon wholesale finance or taking over ABN Amro.

- There was a principal-agent failure. Either regulation failed, or shareholders failed to rein in CEOs, or CEOs didn't appreciate the dangers their trading risks were taking. 

- Banks' business models failed to adapt to the new conditions of the 00s, in which saving was concentrated among Asians rather than westerners and in which there was a demand for safe securities.

However, you read it, the crisis shows that managerialism - the idea that some people have the capacity to control large organizations for the better - is wrong. Managerialism is an ideology justifying big pay for bosses, not an empirical truth.

However, in two other senses, the highlights a failure of neoliberalism.

First, the deep cause of the banking crisis was a  dearth of capital investment. In a parallel universe, the high Asian savings rate would have had a happy ending. In driving down bond yields, it would have encouraged western firms to invest in new plant and technology thus making us all richer. But it didn't. Because of the lack of investment opportunities, the savings glut was invested in the housing bubble, which burst.

I say this represents a failure of neoliberalism because neoliberalism told us that if only labour and product markets could be deregulated, (some) taxes cut and profits increased, that investment would follow. From the 80s onwards, the UK and US governments followed this advice to some degree - but investment did not follow. Neoliberals had too much faith in entrepreneurial spirits.

Secondly, the banking crisis - and the euro zone debt crises - are crises of risk-bearing. The neoliberal case for financial deregulation was that it allowed risk to be parcelled up and so be bought by those best able to bear the risks. But this was wrong. Risk ended up being concentrated in the hands of a few banks, with the result that quite small losses had terrible macroeconomic effects.

Now, you might think that one implication of what I'm saying is that the left needs alternatives to both managerialism and neoliberalism. It does. The problem is that the left's alternative to neoliberalism (insofar as it has one) often seems to lie in a call for just a different type of managerialism - top down control by a group of people whose confidence exceeds their ability.

Incentives doublethink

The government's "work experience" programme highlights a widespread doublethink about the role of incentives.

On the one hand, participants in the scheme are threatened with a loss of benefits if they leave after more than a week - presumably to incentivize them to stay on it.

On the other hand, though, the government seems unaware of a perverse incentive in the scheme - that firms have little incentive to hire permanent staff if they know they there's a supply of almost free labour. Iain Duncan Smith says that "of around 1,400 individuals who have taken part in the Work Experience placement at Tesco, more than 300 have been taken on in permanent roles" without telling us how many people Tesco would have employed without the scheme,

What's going on here is a common theme. Whilst plenty of attention is paid to the incentives that the unemployed need to find work - as if poverty and unhappiness were not incentive enough - the incentives that companies and the rich face don't get such scrutiny.

And yet their incentives should come under attention, because there's a decent body of evidence now to suggest that making the rich richer might not work. High pay and bonuses are not just about greed and unfairness, but might also be inefficient. For example:

- Financial incentives can crowd out other, better, forms of motivation such as social norms or professional pride.

- They can encourage short-term target-chasing, which worsens corporate performance.

- Fines can do better at elicting performance than bonuses.

- Bonuses can lead to people free-riding on the efforts of others.

- The Yerkes-Dodson law predicts that high stakes can lead to worse performance - a prediction corroborated by experiments.

Despite all this evidence, the dominant view amongst the managerialist class seems to still be that bosses need high pay to incentivize them. And this claim does not get the scrutiny it should.

In this sense talk of incentives is highly ideological. The managerialist class decides what's efficient. And what's efficient is whatever is in its own interest, regardless of what the science says. As George Carlin said:

Conservatives say if you don't give the rich more money, they will lose their incentive to invest. As for the poor, they tell us they've lost all incentive because we've given them too much money.

Except that it's not just Conservatives who believe this today.

Should the BBC ban politicians?

Should the BBC allow politicians onto its programmes? I'm prompted to ask by Michael Portillo's appearance on Broadcasting House yesterday. He claimed that the fact that 1% of taxpayers pay 28% of income tax is evidence that the tax system is progressive. This is just plain wrong - not as a matter of opinion, but of fact and logic. Yes there's other evidence that income tax is mildly progressive, but the share of tax paid by the top 1% is irrelevant.

But nobody challenged Portillo on this error.

Which is a reason why politicians should not be given airtime. Doing so carries a high risk that they will just spout idiotic untruths; see also Chris Grayling's weird invocation of the SWP or Nadine Dorries, passim. (I'm just giving examples that spring immediately to mind - I don't doubt that Labour politicians are also guilty*.) 

It's not good enough here for the BBC to reply that it usually aims at "balance" by having opposing politicians on. This can lead to what Paul Krugman called "opinions differ on shape of planet" journalism. If one party says the world is flat, and another says it isn't, you do not have a reasoned debate, but just one moron and one non-moron. In this sense, there's a conflict between the BBC's mission to inform and educate on the one hand, and it's aim at impartiality on the other; being impartial between truth and falsehood does not inform or educate.

Take some of the big political issues: could workfare work? Is there a case for reforming the NHS? Is fiscal austerity justified? Any of us could think of a few hypotheses or anecdotes to support either side of these arguments. Having politicians do the same does not add value. What we want to know is the evidence  - and the holes in that evidence. This requires that the BBC have experts on their shows, not politicians**.

Nor am I sure that having politicians appear even does the politicians any favours. On the one hand, the mere exposure effect suggests that their regular appearances garners support. On the other hand, though, because they are usually overconfident about they abilities, they over-estimate the extent to which they can make a favourable impression. In this case, banning politicians from the BBC would protect them from themselves.

One objection to this is that politicians matter not because they inform or educate, but because they represent popular opinion. I'm not convinced. The fact that an opinion is mainstream - and it's questionable whether politicians do represent the mainstream - is a reason for not broadcasting it. We know what we think; what's the point of hearing an echo?

Now, I'm not saying there should be a blanket ban. Where there is a genuine debate about values - for example security vs. freedom or equality vs. incentives - it's reasonable to have politicians' debate them. But when the debate is about issues of social science, the BBC should not waste scarce airtime on them. And many political issues are ones of science rather than values.

* I never watch current affairs programmes on TV - hence my lack of other examples.

** I'm not saying it should have me on. I usually turn down the few invitations I get to appear.