Who Pays Taxes?
The debate rages on as we go to press with candidates taking sides on the issue of taxes. Tax cuts and who gets them are hot issues with many Americans. Few would argue with the need to collect taxes to pay for public goods such as national defense, basic research, and other items the private sector would be unwilling or unable to provide. However, exactly how much from whom is a highly charged question.
One of the most overlooked aspects of this entire can of worms is consideration of where the tax burden currently falls. It is meaningless rhetoric, for example, to discuss lowering tax rates for people who are not paying taxes anyway because of their income levels. It is also nonsensical to lament tax cuts for the rich without explaining such specifics as (1) what is meant by “rich,” (2) what is actually cut—rates or levels or deductions or any number of other possibilities, and (3) what benefits for lower-income groups are incorporated in the tax policy changes.
In 2001, the bottom 50% of earners paid a tax share of just 4.0%, down slightly over the past decade. By contrast, families in the top 20% of the income scale pay more than 80% of all income taxes while earning less than half of all the income. In 2001, the income tax share of the top 50%, which includes those individuals or couples filing jointly earning $26,000 and above, was 96% of all federal income taxes paid.
The top 25% of income earners shouldered some 83% of the tax burden in 2001, and the top 1% paid 34%. In terms of sheer dollars, it is only natural (and appropriate) that tax relief is more heavily weighted toward those paying the highest shares. In fact, it would be difficult to design any type of meaningful tax cut otherwise. In terms of income, the only group receiving a larger share of income than their share of taxes paid was the bottom 50%.
Another distinction lost in many sound bites regarding taxes is that they are driven by income, not wealth. While wealth can generate substantial income, simply having a high current income does not imply wealth. Wealth is the accumulated savings of prior income (or the assets inherited or otherwise acquired). Consider the situation of a person with a huge portfolio of stocks, real estate, or other assets. These may or may not generate current income and, thus, may or may not lead to a large tax bill. On the other hand, it’s possible to have a high income without much wealth.
The key point is that many of the most productive Americans, those in high-demand jobs offering the highest salaries, are the ones who shoulder the largest tax burden. The very wealthy, by contrast, may pay a lower effective rate depending on the assets they own. The oft-cited stories of the “rich” avoiding taxes are most often a case of confusing wealth (which is not the basis of most federal taxes) with current income (which is).
Sound bites about tax cuts for the rich can be very misleading. In fact, recent tax “cuts” are actually expected to increase the share paid by high-income earners. The US Treasury’s Office of Tax Analysis estimates that the net effect of President Bush’s tax cuts will be to shift a larger share of individual income taxes paid to higher income taxpayers. Thanks to various credits (such as the $1,000 child credit and marriage penalty relief), lower-income Americans see notable gains.
All of these numbers, of course, beg the question of whether or not tax cuts are advisable at all given present fiscal circumstances. They are almost always good politics, but not necessarily good economics. Some of us (including me) would prefer to see any tax relief directed toward investment and research and development, thus expanding long-range opportunities for all. The basic lesson here is simply that, although adequate tax receipts are certainly necessary for the well-being of all Americans, it is a far more complex issue than can be meaningfully addressed in a typical campaign slogan or media sound bite. Both sides will give you plenty of those, but real answers are far more elusive.
posted @ 07:55 AM CST [link]
Friday, October 15, 2004
An Antidote to Arrogance
Back in the 1950s and 1960s, the economy generally percolated along without major bumps and bruises. This long period of relative calm, coupled with the post-war conversion to the theories attributed to John Maynard Keynes, led many to believe that business cycles could be managed and were pretty much a thing of the past.
When I took my first economics classes in the early 1970s, textbooks, articles, and even senior government officials spoke of “setting the dials,” and “fine tuning” policy to achieve desired outcomes. It was as if you could turn a few knobs and change the growth rate from 3.5% to 3.7% or 3.8%. (As an aside, Keynes never said anything like that. His zealous disciples did, but he was far too smart for that.)
Then, along came the energy crisis, and for the past three decades, things have been a bit more chaotic. We have seen Nixon’s wage and price controls, the misery index, several oil shocks, corporate scandals, terrorists’ attacks, and a war. No one would remotely suggest in these turbulent times that we can set the dials and make the economy whatever we want it to be. Not even close.
As this unsettling situation unfolded in the early 1970s, my chosen discipline was searching desperately for new ways to look at the world. Among those who stepped into the breach were Norwegian Finn Kydland and American Edward Prescott, two Carnegie Mellon graduates who collaborated to alter our understanding of business fluctuations and the policymaking process. In recognition of their seminal efforts during the late 1970s and early 1980s, they were awarded the 2004 Nobel Memorial Prize in Economics. Since their names are not exactly household words beyond the rarified air of a thin slice of academia, it is worthwhile to pause and briefly explore how they changed our understanding of the complex modern world. (As another brief aside, most of you are no doubt aware that I was recently honored and humbled to be nominated by the International Institute for Advanced Studies for “the Prize” in the year 2005 and beyond—until I win or die! As a practical matter, there is no reason to even be moderately curious about my chances until 2015 or so. Nonetheless, I have received literally thousands of good wishes and kind words from around the world, and thought this might be an appropriate juncture to say how truly grateful I am to all of you.)
In a seminal paper in 1977, Kydland and Prescott pointed out a “time consistency” dilemma in economic policy. The basic idea is that the best long-term ideas can be foiled by short-term considerations (such as politics). For example, suppose the Federal Reserve (Fed) decided that it should keep inflation low once and for all, announced it to the universe, and was believed by all individuals and firms. In anticipation of the outcome, wages would be lower than otherwise (as no one would see the need to hedge against inflation), and interest rates would be high, as the Fed would need to keep the supply of money tight to hold prices down (long-term inflation is caused by “too much money chasing too few goods”). This pattern would, in turn, lead to less investment and, hence, hiring than would occur otherwise. Then, reality sets in. A sluggish job market (possibly accompanied by an impending election) can cause pressure to “loosen up.” The end result may well be that policy is eased, inflation ramps up, and expectations are not realized. Thus, by failing to stick with long-term plans, the good intentions of policymakers can make things worse than ever (remember the days of stagflation?).
A few years later, Kydland and Prescott teamed up again to point out a similar timing problem in short-term and long-term economic analysis that helps us to understand the business cycle. The issue is not unlike that confronting theoretical physics. We have very convincing and rigorous explanations of how the universe works, and equally compelling notions of how miniscule sub-atomic structures behave. The only problem is that the two sets of concepts are fundamentally inconsistent with one another, and ultimately that great big universe is made up of those tiny little gizmos. Traditional economics had a similar dilemma. We explained short-term fluctuations via “demand shocks” such as oil embargoes, wars, or the like. On the other hand, we explained long-term performance through supply side phenomena, such as workforce availability and capital investment. Kydland and Prescott demonstrated that in reality, the two depend on each other, as short-term decisions ultimately are linked to long-term outcomes. As a simple illustration, lower marginal tax rates in the US (a short-term policy decision) are the primary reason that American workers are decidedly more productive than their European counterparts.
These notions may seem obvious, and, in all fairness, I have tried to simplify them from their opaque mathematical derivations. To truly appreciate their significance, you have to consider the context in which they were offered. Economists had just figured out they didn’t have all the answers and were scrambling to again define their relevance (it is no accident that the Nobel Memorial Prize in Economics was initiated in 1968, at the height of the seeming scientific precision). Kydland and Prescott were among the group that essentially said, “If we can’t do everything, let’s at least do something to better understand and contribute to a rapidly changing world.” In so doing, they were both important architects of modern policy and significant forerunners of much of what followed.
posted @ 08:07 AM CST [link]
Friday, October 8, 2004
No Longer Jobless
As the presidential campaign continues, much attention has been focused on jobs and the loss of jobs and how one candidate or the other would create more jobs and on and on. Much of the rhetoric is based in distortions of the underlying trends in the economy. While this argument has become more difficult to support in recent months, the so-called “jobless recovery” garnered more of its fair share of headlines.
As the current recovery cycle began, there was room in the economy for expansion without the creation of additional jobs through improving productivity and efficiencies and more effectively utilizing the existing workforce. Employers were more reluctant to hire than is typical in expansions due to the combined effects of the September 11 attacks, the corporate accounting scandals, and the onset of war. However, this slack has now been absorbed.
Although there was an unusually long lag between the time most indicators of US economic health turned the corner and when hiring began in earnest, the number of jobs has grown in each month of the past year. In fact, March and April of 2004 saw net gains exceeding 300,000 per month. The pace slowed somewhat through the summer, but showed signs of renewed life in August (adding 144,000 jobs) and September.
Evidence of the improving job market was felt on college campuses across the country. Information recently released by the National Association of Colleges and Employers (NACE) indicates employers anticipate hiring 13% more new college grads in 2004-05 than a year prior.
In addition, starting salaries are trending upward. In many disciplines, increases of 3-5% were observed. While initial offers for some degrees (such as engineering) were largely unchanged, few declined. Computer science grads are enjoying a significant boost of more than 4%, and average offers to information sciences graduates were up almost 11% (some of this expansion is making up for lost time—offers were actually smaller last year than in prior years).
Business administration graduates’ initial salaries were up more than 6% on average, and selected other majors are seeing notable gains. English majors, for example, saw offers up more than 8%. Demand for new hires is boosting salaries across a spectrum of occupations, a clear sign of recovery in the job market.
All in all, the US economy is now creating jobs at a healthy pace. Uncertainties remain, such as high energy prices, ongoing military action, and the upcoming elections. As these issues are resolved or stabilize, the pace of hiring will escalate. Occupations expected to see the largest gains in employment include those in healthcare, education, technology-oriented fields, and other services-related areas.
Globalization will continue to contribute to job growth. Although politically charged debates center on the thousands of formerly American jobs now being performed overseas, recent studies have shown that the practice of “offshoring” actually creates more jobs in the US than it costs. Through the enhanced efficiency afforded by offshoring, companies have fared better and expanded (or remained viable) domestically. In addition, the number of jobs with foreign companies held in the US by Americans more than offsets those that have been outsourced. This trend is expected to continue, with some dislocations of workers, but no true threat to overall job creation.
As the economy continues to gain momentum, job growth will also improve. For newly minted college grads, experienced professionals out of work, and all of the job seekers, the tide has clearly turned. This economic recovery is no longer jobless (and hasn’t been for quite some time), which is good news indeed.
posted @ 08:36 AM CST [link]
Friday, October 1, 2004
Metro Mania
Even though Texas encompasses such a large area, the lion’s share of the population, some 85%, resides in just under 27% of it—in areas designated as metropolitan statistical areas (MSAs).
Formal designations of metropolitan areas were initially made in 1949. By definition, they are areas with a substantial population center of at least 50,000 persons and core census tracts or block groups with densities of 1,000 persons per square mile. MSAs are named for the largest city in the area and always follow county lines. Where an MSA contains more than one county, all of the counties have a substantial degree of economic homogeneity and are economically integrated through commuting patterns.
Changes to MSA designations are considered every decade and are determined by the official US Census Bureau figures. Prior to 2004, there were 27 Texas metro areas formed of 58 counties. Those MSAs generated about 92% of the state’s real gross product (RGP or output) in 2003 (up from 90% in 1993). As of this year, the Census Bureau redefined the metro areas and there are now 25 MSAs in the Lone Star State accounting for 77 of the 254 counties in Texas.
These changes resulted in adding 22 counties and dropping three. The San Antonio MSA gained four new counties, the most for any Texas metro thanks to its rapid outward expansion. With the division of the Odessa-Midland metro, there are now nine single-county MSAs. The new Dallas-Fort Worth-Arlington MSA includes the most counties with 12. This metro area is a combination of what used to be two MSAs (Dallas and Fort Worth-Arlington). The area is subdivided into two metropolitan divisions—Dallas-Plano-Irving and Fort Worth-Arlington.
Because of the relative growth rates among cities, six MSAs were given new names by adding or removing the names of cities included in the previous designation. Two were created—Midland and Odessa—in splitting the Odessa-Midland MSA (which were joined together after the 1990 Census). The former Brazoria and Galveston-Texas City MSAs are now included in the Houston-Baytown-Sugar Land MSA.
While the acronym MSA is not a regular part of the vocabulary of many Texans and changes in metro area definitions may appear to be far removed from daily life, they actually influence many business decisions. For example, through the addition of four counties, the reported size of the San Antonio MSA population (and other measures of business activity) will jump significantly. For companies considering corporate locations, these larger numbers may make San Antonio more competitive. For Odessa and Midland, splitting the metro areas leaves us with two small MSAs rather than one that is larger, which may hamper efforts to attract attention in the national scene as a potential place to do business or open a retail establishment.
The fact is, those analyzing economic data are typically doing so using MSA definitions. They don’t always look at a map to recognize that Odessa and Midland, or Tyler and Longview, or Waco and Killeen-Temple, or Brownsville-Harlingen and McAllen-Edinburg-Pharr, are in adjacent counties and have substantial interaction. As evolving demographics lead to shifts in the way the Census Bureau (and all other federal entities) define MSAs and report statistics, the dynamics of cities can change. Adding fast-growing outlying counties, for example, can enhance the perceived prospects of a metro area.
posted @ 08:05 AM CST [link]