The top 0.1%

Just noticed Paul Krugman's recent column, in which he suggests that OWS has set the bar too low, by focusing on the top 1% instead of the top 0.1%.  I don't think so. 

Here's what he says:

"If anything, the protesters are setting the cutoff too low. The recent budget office report doesn’t look inside the top 1 percent, but an earlier report, which only went up to 2005, found that almost two-thirds of the rising share of the top percentile in income actually went to the top 0.1 percent — the richest thousandth of Americans, who saw their real incomes rise more than 400 percent over the period from 1979 to 2005.
Who’s in that top 0.1 percent? Are they heroic entrepreneurs creating jobs? No, for the most part, they’re corporate executives. Recent research shows that around 60 percent of the top 0.1 percent either are executives in nonfinancial companies or make their money in finance, i.e., Wall Street broadly defined. Add in lawyers and people in real estate, and we’re talking about more than 70 percent of the lucky one-thousandth."

So this gives us some more rough statistics:

Top 0.1% (by income)
 
60%: "executives in nonfinancial companies or make their money in finance"
10%: lawyers and people in real estate
30%: who knows?

This actually isn't all that different from what we saw before, where 31% were probably the same non-financial executives, and 14% were in finance, for a total of 45% in the "class" that is now 60%.  Lawyers still seem to command about the same share, although we don't know what kind of lawyers we're talking about.  No info on doctors.  Krugman also doesn't tell us what the "floor" for the top 0.1% is, so we can't try to translate that to an hourly rate.

He makes essentially the same point about this group that I made about the 1% -- very few of them seem to be job creators.  Presumably, some percentage of the top 1% or top 0.1% are people who have created jobs.  How hard can it be to determine who those people are, what their incomes are, how many jobs they have created, and what percent of the top 1% or (0.1%) they make up?  If someone would just do that, we could probably figure out a way to give THAT class of useful citizens incentives to keep doing what they are doing, while allowing us to tax the rest of the 1% (or 0.1%) that are more parasitical than productive.

Do the 1% deserve it, part III

Of course, you might say that we need to pay top dollar to talent in order to keep our corporations competitive with other corporations.  But in our society, that sort of "top dollar" might well just be the first, relatively low-taxed $500 K.  After that, you start giving back to the society that made your first 500K possible.

Will this result in a "brain drain" as corporate executives move overseas and start managing the businesses from over there?  Perhaps that's a risk we're willing to take. 

A word about stock options.  I don't mind at all if executives are paid in stock options, and I find it misleading when people talk about executive compensation in terms of how much money the executives made off of their stock options.  True stock options have a value on the day they are "issued."  That's the only value that's relevant when determining what executive compensation was.  The amount an executive makes off of exercising an option should not count as income for purposes of the "cap."

Of course, there have been instances when executives have been compensated by backdated stock options.  That's different, and that's straight compensation.  For tax purposes, we obviously need mechanisms to distinguish backdated options from real options.

 

Try a Financial Transactions Tax

A financial transactions tax would impose a small tax on certain financial transactions.  The main idea is to reduce the sort of unproductive speculation that resulted in the partial destruction of the world economy, the loss of hundreds of thousands of jobs, the loss of any realistic expectation of a comfortable retirement for millions of people (due to the low interest rates and uncertain stock market caused by the continuing crisis), and the loss of homes for thousands of families.

There are some very smart people on both sides of this issue.  Keynes proposed it in 1936.  Joseph Stiglitz (Nobel Laureate) is for it.  Kenneth Rogoff (Harvard Economist and International Chess Grandmaster) says it might do more harm than good.  Larry Summers was for it (1984) until he started making tons of money by being against it (see Summers, L. H. and V. P. Summers, 1989. When financial markets work too well: a cautious case for a securities transactions tax, Journal of Financial Services Research 3, 163–188).  President Obama was for it until he was against it.  James Tobin (Nobel Laureate who came up with one form of the idea, a tax on currency speculation) recanted, at least for a while.

Interestingly, Wikipedia discusses various flavors of the tax at length, and talks about experiences in different countries, without once mentioning that a form of it was in effect in the U.S. from 1914 to 1966.  According to the Center for Economic and Policy Research:

"The FST is not a new idea. The U.S. had a transfer tax from 1914 to 1966 which levied a 0.02% tax on all sales or transfers of stock. In 1932, Congress more than doubled the tax to help financial recovery and job creation during the Great Depression. Transactions taxes were imposed in most financial markets until the last two decades, and there still is a 0.5% stamp tax imposed on each trade on the London Stock Exchange. The U.S. already has a very modest FST, which is used to finance the Securities and Exchange Commission and the Commodity Futures Trading Commission."


See http://www.cepr.net/documents/fst-facts-myths-12-10.pdf

Note:  I saw at least one site that purported to quote this paragraph but gave 0.2% instead of 0.02%.  I haven't done any double-checking.


I personally have not analyzed any of the proposals closely. There are clearly a lot of questions:  will it harm liquidity?  Will it decrease or increase volatility?  Can it be implemented in only one country or does it need to be implemented the world over?  Will it really rake in the projected $100 billion per year in revenue?

All of these are fair questions.  But we can sit around and theorize about them ad nauseam without ever knowing the answer.  Why not show some leadership on this issue?  It was OUR banks that plunged the world economy into financial crisis.  Why don't we try a bold solution like this and see what happens?

A couple of years ago, we pumped $700 billion of hard earned tax dollars into the economy, without any appreciable effect (well, except to enable a few upper middle class families to trade in their rusting minivans for a $5000 discount on Japanese-made Priuses (Prii?), and to feather the nests of replacement windows contractors who rely on cheap if not illegal itinerant labor to do the real work).  Why not see if we can make some of that back, while imposing a tax on the kind of reckless behavior that got us here to start with?

If it works, great.  If it doesn't work, we can always repeal it -- it's hard to imagine that it would cost us more than the $700 billion we've already spent on one try.

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?

Do the top 1% "deserve" it?

Yes, I know the title is ambiguous. I'm talking about whether they "deserve" their wealth and/or income.  Again, from before, there are no good statistics on who the top 1% are. But let's use the third-hand income statistics that David Brooks used:


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

According to CNN Money, that first 31% is "executives, managers and supervisors."  In other words, people who "started" nonfinancial businesses are probably a very small fraction of this 31%; we're mostly talking about  people who have done well enough in the corporate hierarchy to get a paycheck in the $500K range.  And as previously observed, these numbers add up to 76%, so there are 24% of "earners" that no one wants to put a label on.  As previously suggested, a good chunk of these may well be people living off of inherited wealth.  But I don't know.

Remember again that we are looking at income here.  The top 1% by net worth is going to be a different, though doubtless overlapping, group of people.  We don't have any information (at least I haven't found any) that attempts to break that group down in terms of profession.

Before we go through each one, let's get a sense of how much these people are making per hour.

The $516K floor for the top 1 percent is household income.  Let's just assume that typically, this means that at least one of the earners is making at least $400K.  Not always true, but 400K is a nice round number.  Let's say that these people work 2000 hours per year (that's 40 hours a week plus two weeks vacation).  That means that for every hour they put in, they are making $200.  Not bad for an hour's work, even better if you get that for every hour you work.

The question is whether that is a "real wage" that somehow reflects the person's just deserts, or whether it represents something else.  In the old, pre-industrial revolution days, you could judge most workers by the hour -- they would be able to "earn" whatever they could make in an hour, minus the material costs of making it.  I.e. a shoemaker starts with some leather and some metal parts and makes a shoe.  His hourly wage depends on how fast he can make shoes and how much he can sell them for, minus the cost of materials.

Even in the pre-industrial age we had bankers and merchants.  These were people who dealt in large sums of money -- and often large numbers of people, or a few very rich people -- and paid themselves by skimming something off the top.  Already, one can ask the question whether they "deserved" that money.  Yes, they had the drive and the initiative to set up the bank or the business, and that should be encouraged.  That's capitalism.  But we can observe that the rewards were not really related to the effort or time put in.  Instead, the rewards derived from an imperfection in the market -- the merchants and bankers were able to sell their goods or services to a lot of people, while paying themselves a "percentage" as opposed to an hourly wage.

I'm leaving the hereditary aristocracy out of the analysis for now, on the assumption that nearly everyone can now agree that their gains were "ill-gotten."


With the industrial age came industrialists, who were able to put people to work on assembly lines, and then simply "skim" off the profits of the enterprise.  In other words, if the industrialist was able to get ten people together to make 100 shoes per hour, it was no longer the case that those "shoemakers" would get the benefit of their labor in the sense that the old shoemaker did.  How much the shoemakers now made depended solely on the labor market -- how little could the capitalist get away with paying his shoemakers?  That number -- labor cost -- now simply became another input (along with raw materials and rent) into the shoe production business.  The capitalist is now the shoemaker, and he gets to keep for himself the differential between the costs of production (materials, labor, and rent) and the sales.  Of course, he also makes decisions on whether investing in marketing will result in the ability to sell more shoes or charge higher prices for the shoes he sells.

For shoes, this is not necessarily a bad thing.  The capitalist provides cheap shoes (by the miracle of the assembly line) and provides jobs to people who otherwise might not be able to get them.  The capitalist is also taking risks, although nowadays, you can buy insurance to cover any risk, so that's theoretically just another cost of production.
 
So we can agree that we need a capitalist to manage the risks.  But that only really means we need one person per business, right?  Not anymore.  As the business grows, we need more and more "managers" to deal with all the decisions that have to be made in all of the aspects of the business.  While these people get paid salaries, and thus might seem to be "wage earners" in the sense that the assembly line workers are, there is an important distinction.  They are not actually producing the product.  They are reacting to market conditions and making decisions that presumably help the business stay competitive and maximize profits, but their "hourly" output is not shoes, it's "profit."  In other words, these people contribute to the enterprise's ability to maintain a high differential between costs of production and sales.  They are partaking in the capitalists profits.


And it's the higher ranking ones of these that get paid the most.  The bigger the company, the greater the gross sales, and the easier it is to skim hundreds of thousands or millions of dollars here and there to pay these "mini-capitalists."

(I've never read Das Kapital.  I wonder if I am accidentally simply reconstructing it?)

So that's the 31% -- these are people who are skimming corporate profits.  Nice work if you can get it.  And of course, the "invisible hand" may well be determining how much these people take.  Presumably, the capitalists at the very top would like to pay everyone below them as little as possible, but they need good people.  Perhaps these high earners ARE that good, in the sense that they are able, through their good decisions and policies, to cause the company to make additional profits over and above their wages.  Theoretically, if a given company is overpaying these people, or has too many of them on the payroll, its competitors will be able to undercut their prices in the marketplace.

But the question for the rest of us is how much should we tax these people?  I.e. they are big fat targets because of their incomes.  And their incomes are not proportionate to their actual "labor" in any sense; they derive from corporate profits, which in turn, come from us -- the consumers.  Would taxing them somehow distort the economy?  Would they stop doing what they are doing? If they did, would this be a bad thing?

Take marketing, for instance.  If a marketing "whiz" simply won't work if he doesn't get to keep his entire $500K per year, should we the public care?  Maybe not.  Maybe we would actually benefit, if we were free from his manipulations.

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.


To be continued . . . .

David Brooks "The Wrong Inequality"

In my last post, I cited statistics from David Brooks's Oct. 31, 2011 op-ed "The Wrong Inequality."  But the article irritated me enough to cause me to write a separate post about it.

Brooks agrees that "the zooming wealth of the top 1 percent is a problem," but he says:

"it’s not nearly as big a problem as the tens of millions of Americans who have dropped out of high school or college. It’s not nearly as big a problem as the 40 percent of children who are born out of wedlock. It’s not nearly as big a problem as the nation’s stagnant human capital, its stagnant social mobility and the disorganized social fabric for the bottom 50 percent."

He concludes: "If your ultimate goal is to reduce inequality, then you should be furious at the doctors, bankers and C.E.O.’s. If your goal is to expand opportunity, then you have a much bigger and different agenda."

He seems to be hugely missing the point.  It's not that we should be upset about "zooming" incomes of the rich in the abstract.  OWS is upset because of the control over the government that that "zooming" wealth enables the top 1% to exert.  

Yes, there are many problems in this country that can't be directly traced to the excesses of the top 1% (although of course, the current recession and much of the country's crippling debt burden can).  But what are we supposed to do to solve those problems, which have been with us since long before the Occupy Wall Street movement?  Is he proposing we start a "stop having kids out of wedlock movement"?

No, OWS has identified a specific problem that CAN be fixed:  The US government is largely controlled by wealth.  Fixing THAT problem might not immediately solve the other problems that Brooks is talking about, but at least it will align government more closely with the aims and needs of the majority of people, and bring the government back into harmony with its founders' democratic ideals.  That's not a call for big government as opposed to small government -- we just need a government that acts in the interests of the majority, rather than the wealthy minority.  And perhaps if that happens, solutions to the social problems will start to appear. 

Who are the 1%?

The answer seems to be nobody really knows.  But here are some figures:

Numbers from Suzy Khimm in the Oct. 6, 2011Washington post:

By household income:  Any household with total income greater than or equal to $516,633 (2010) (in in 2010 (in 2007 it peaked at $646,195) (adjusted for 2011 dollars, according to calculations by the Tax Policy Center).  This is the minimum; the average income is $1,530,773 (note that "average" income, as Nassim Taleb has explained, is not a particularly helpful concept (unlike, e.g. average height).  When Bill Gates walks into a room, the average person in that room becomes a billionaire).  According to CNN, IRS figures say the top 1% floor for adjusted gross income was $343,927.


By net worth:   average of $14 million in 2009 (per a 2011 report from the Economic Policy Institute) (peaked at $19.2 million in 2007) (not clear if 2011 dollars).  As mentioned above, "average" net worth is not a helpful concept; we'd be much more interested in knowing what the minimum net worth is.  Interestingly, Khimm's post as it reads today is already corrected to fix a misconception about floor vs. average.  But it's still not as helpful as it could be.

By profession:  David Brooks's column today gives the following for top 1% of "earners" (all prefaced by "about"):

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

That adds up to 76% -- one might well ask who are the other 24% (of the top 1%).  I wonder if it's "earnings" off of inherited wealth?  That would be pretty shocking.

Brooks's numbers are consistent with numbers reported in the above-referenced CNN article:

"A separate study found that financial professionals made up about 14% of the top rank in 2005.
Executives, managers and supervisors working outside of finance accounted for 31%, the largest share, according to an analysis by Jon Bakija of Williams College, Adam Cole of the Treasury Department and Bradley Heim of Indiana University. Medical professionals came in at 15.7%, while lawyers made up 8.4%."

So the numbers apparently come from different sources, and people have been lumping them together.