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Friday, November 4, 2011

Do the top 1% "deserve" it, part II

Starting from where we left off the last time.  To recap, here are the top 1% by income, to the best of anyone's knowledge.

31% "started or manage nonfinancial businesses"
16% doctors
14% "in finance"
8% lawyers
5% engineers
2% sports, entertainment or the media.

Again, there is a missing 24%.  That's everyone else -- hereditary wealth, rich-neighborhood real estate agents, university presidents, successful authors (unless they are counted in entertainment/media), former politicians with fat pensions who command huge speaking fees, etc. -- and it would be interesting to have that broken down too.

The inquiry of this post is whether we should impose higher taxes on these people.  Below I sometimes refer to a "cap".  The most draconian version of this would be to simply confiscate any earnings above a certain amount.  I'm not proposing that.  By "cap," I'm referring to a cap on relatively tax-free income.  I'm using $500K per year as a possible benchmark.  The idea is that you get taxed normally up until you reach that "cap" and then you get taxed more severely for money you make above that "cap."  The basic idea is that $500K per year will still attract competent people into those lines of work, but the "cap" will result in increased tax revenue.  We don't want the "cap" to stop uniquely talented people from applying those talents to the benefit of society.  But as we look at the issue, it's not clear that there are all that many uniquely talented people earning more than $500K who are doing a whole lot of good for society in the first place.  In some cases, the market channels talented, brilliant people into the game of making money for its own sake, which does little good for -- and has done much harm to -- to society.

To recap, we agree that the person who buys some raw materials and makes and sells a pair of shoes should get to keep as much of his profit as possible.  That person is turning his time into useful goods, and that should be encouraged.

We're less sure about the person who hires ten unskilled laborers and pays them peanuts to work on an assembly line.  Yes, we get cheap shoes as a result, and the workers get jobs they might not otherwise have.  But right now we're focusing on whether he should be able to retain ALL of the profits he has made, or whether we -- "the people,"  the government -- should tax some of it.  After all, he wouldn't be able to make that money if "we the people" weren't there buying his shoes and manning his assembly line.

On the one hand, as above, he's doing a social good, and we need people like him.  On the other hand, he has leveraged the labor of others, and he is "skimming" off money based on the volume of his business.  If there were perfect competition, he'd only be able to pay himself a living wage, because that's what all his competitors would be doing.  But he's paying himself much more than that, and that comes at a cost to consumers and his workers.  Either he is charging customers more than necessary, or he's paying his workers less than necessary, or both.

There is no particular reason that he, as opposed to the consumers or the workers, is morally entitled to keep those "golden crumbs" that fall off of the large volume of his business, which we all helped create.  Pure free marketeers think that the "market" somehow ensures the "correct" distribution, and they rather simplistically insist that if we tax the poor capitalist we won't get any shoes or jobs out of him.  But why not say that he can keep the first few 100K at normal tax rates, and then whatever he "skims" over and above that is taxed at higher rates, because we know that it must have been skimmed?

If one of the values of our society is that people's earnings potential should be capped at a certain amount per hour, then maybe we cap him and then take the rest and redistribute it.  Most of us probably wouldn't mind if there were a cap on earnings of $500 per hour -- few of us will ever see that.  If the ability to monetize more than $500 for every hour spent is a result of market imperfections, maybe there's no harm in imposing a cap, or at least imposing a significant tax on earnings above that amount.

On the other hand, we need to be careful.  How does one compensate the capitalist for the risks he takes; the amount of capital he put at risk?  To the extent the income he pulls in is return on capital, that's different again.

So for now, let's give these risk-takers a pass.  They are the "job creators" that the Republicans are so concerned about.  But they are an incredibly small percentage of the people that are in that first 31%.

Let's now think about some of the others in that 31% -- those who, according to Brooks, "started or manage nonfinancial businesses," minus the ones who "start" the businesses.  The job of most of these people is to keep corporate profits at existing corporations as high as possible, and their salaries can be seen as reflecting their cut of those profits, to which they contribute.  These individuals are not taking risks to get products to consumers and provide jobs.  Rather, they have the specific mission of keeping their companies profitable.  And since competition is the enemy of profit, that often means finding ways of selling more products without really competing.

Let's take an extreme example.  At any major pharmaceutical company, there are probably ten or more people making that kind of money, whose sole goal is to work to keep the company's drug prices artificially high.  This can be done by misleading advertising (getting consumers to ask doctors for drugs they don't need), influencing doctors to prescribe the drugs, and playing games with patents (e.g. "evergreening" via Orange Book manipulations, anticompetitive settlements with generics, lobbying for special extensions).  The work of these people does direct harm to consumers and taxpayers.  The drug prices stay high, and consumers and government programs like Medicaid and Medicare) pay more for health care.

This is obviously antithetical to any free market principle.  It's made possible by the patent system, which (among other things) addresses the "market failure" that suggests that nobody will do certain kinds of research if others could simply free-ride on the results of that research.  But having a valuable patent can cause all kinds of behavior -- like that outlined above -- which is designed to prevent competition even beyond what the patent is supposed to permit.

And then of course, there is the issue of CEO compensation.  Multi-million dollar severance packages for corporate CEOs who have only served a year or two is tantamount to looting the corporation at the expense of the shareholders.  Imposing a big tax on those packages will get revenue for the government, or it will discourage those packages.  What's wrong with that?

So the question for any of the 1% is whether the money these people make reflects the operation of a truly free market, or whether it derives from market perturbations.

31% "started or manage nonfinancial businesses" -- apart from those who actually start the businesses, tax them high on the assumption that they are more concerned with keeping corporate profits high at the expense of labor and consumers, while avoiding free market competition. 

16% doctors -- yes they provide a service, but their ability to charge so much comes from their monopoly status, as well as the insurance industry's grip on healthcare.  Since health insurance is so widespread, consumers don't have incentives to shop around for doctors and doctors simply don't compete with each other on price.  Yes, in one sense insurance operates to keep prices down (because insurance companies negotiate with doctors), but on the other hand, it also causes a lot more people to go to doctors, and a lot more treatments to be ordered, than may be strictly necessary.

14% "in finance" -- it's far from clear what good any of these people do for society, and the harm they have done is self-evident.  What's worse, the ability to make mega-money in this sector siphons off talent (supposedly 43% of Princeton graduates) that could have actually gone to work to solve the world's problems.  Yes, we need banks, we need a stock market, etc.  But the money that falls into the laps of these people is always just a percentage of some huge transaction involving other people's money.  They create nothing.  And the incentives that drive them -- in contrast to invisible hand theory -- are almost always anti-social.  E.g. investment bankers encourage mergers so they can rake in huge fees, regardless of whether the mergers are good for society or not.  There is no reason not to let the tax system "cap" their income.  Cap it at 500K and you'll still attract plenty of "talent."  But you may prevent some of the extreme behavior and market manipulations.

8% lawyers -- these are typically very hard workers, and they come in several flavors, but their compensation typically derives from the amount of money that they are able to save corporations.  Thus, a lawyer who can win a multimillion dollar lawsuit, is going to be worth $800 per hour or more.  Yes, each hour they spend they "produce" something, but the value of what they proof is based solely on what it will do for the bottom line of some corporation somewhere, often at the expense of some other corporation somewhere, or -- in the case of the Federal Government -- at the expense of tax payers.  There doesn't seem to be any "free market" reason to let the market decide how much these people should be paid.  The world won't end if they are taxed on money earned above a few hundred thousand per year.  If they stop working, that just means that more lawyers will be able to get into the game.

Personal injury lawyers are a different sort.  But there's no reason not to tax their recoveries above a certain amount.  I.e. if they recover over 10 million in fees for a few hundred hours of work, then some of that can certainly go back to the people. Let's make every person injury case a kind of qui tam action, where the government gets a cut.

And then consider tax lawyers -- they make their money by saving their clients millions of dollars in taxes that otherwise would go into public coffers.  Why not tax them?
 5% engineers  -- we'd have to know more about who these people are.  If they are really pulling this kind of money in through "engineering" as opposed to managment, then perhaps they deserve it.  I.e. if they are inventing and improving new products that their companies can us to provide jobs and goods, that's fine.  They can keep a lot of the money.  

2% sports, entertainment or the media. -- these people are "skimming" in the sense that movies, sporting events, etc. cost much more than they ought to.  There's obviously some kind of monopolistic/oligopolistic/anti-competitive behavior going on when you can't see a movie anywhere in your area for less than $8 (note that I'm skipping over many interesting questions about film studios vs. cinemas vs. entertainers).

But beyond that, these people are doing essentially the same things as entertainers were doing fifty or a hundred years ago, for a fraction of the return.  Technology, combined with growing populations, growing markets (here and abroad), and growing societal wealth has enabled them to leverage their "talent" to the point that some of them make tens of thousands of dollars per hour.  Bottom line:  Nobody needs to make that much.  That is not a reward for talent; that's skimming. 

And with these people, we can be pretty sure they'd be doing the same thing even if a lot less money were involved -- they have jobs that are mostly fun.  They can afford a pay cut.  I heard Bill O'Reilly recently say that if they start taxing him too much, he'll just stop doing this.  Good riddance, Bill; there are plenty of equally opinionated and equally interesting blowhards out there just waiting in the wings to take your place.  And they'll do it for less.

Ok, so now we've looked at the "rich" 1%.  What's the harm in increasing the taxes on any of these people?  Why not just give it a try and see what happens?

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