Harvard economics professor Greg Mankiw has written a paper called "Defending the One Percent" which makes the case against reducing inequality as an economic policy goal. Mankiw was a top advisor to Mitt Romney, who said during the 2012 campaign that inequality ought to be discussed in "quiet rooms" but was being oversold by the Obama campaign.
Like Jonathan Chait, I'm not impressed by Mankiw's paper. In particular, Mankiw totally brushes past the strongest argument for income redistribution—wealthy people have a lower marginal utility of money than poorer people, meaning they get less happiness out of an added dollar of consumption.
But Mankiw made one observation that, unintentionally, got at how economists are looking at tax policy in an outdated way. Today's rich are very different from the rich in previous decades. They produce different kinds of things and probably respond differently to taxes.
[I]t seems that changes in technology have allowed a small number of highly educated and exceptionally talented individuals to command superstar incomes in ways that were not possible a generation ago. Erik Brynjolfsson and Andrew McAfee (2011) advance this thesis forcefully in their book Race Against the Machine. They write (p. 44), "Aided by digital technologies, entrepreneurs, CEOs, entertainment stars, and financial executives have been able to leverage their talents across global markets and capture reward that would have been unimaginable in earlier times."
Paul Krugman addressed a related matter on his blog last week:
[T]here is at least one important respect in which the 21st-century economy is different in a way that ought to have a significant effect on macroeconomics: the much larger role of rents on intangible assets...
Consider the changing identity of the most valuable company in America ... The reality is that [Apple] is basically built around technology, design, and a brand identity.
There are a couple of obvious implications from this change in the nature of corporate success. One is that profits are no longer anything remotely resembling a “natural” aspect of the economy; they’re very much an artifact of antitrust policy or the lack thereof, intellectual property policy, etc. Another is that a lot of what we consider output is “produced” at low or zero marginal cost.
In this environment, the traditional way in which economists estimate the economic effects of taxes does not look apt.
Normally, economists model labor as something that employees sell to employers. Raise income taxes and you cut the price received by the employee, so he works less. Cut taxes and he works more.
A cardiologist might behave exactly like that, doing more procedures if his taxes are cut. But Lady Gaga can't very easily decide to produce twice as many hit songs. She might only have so many good ideas.
And unlike the cardiologist, producers of ideas have had big, positive pre-tax shocks to their income. Being able to sell into a global market and scale up quickly means a great idea is worth a lot more than it used to be. Even if the share of that value that is captured by the idea generator gets cut—whether through a tax increase or a weakening of intellectual property protections—creating great ideas should be more appealing than ever.
This is more or less what is happening in creative industries. Piracy has undercut royalties to artists. The ease of generating cheap internet content has cut payments to writers. People who work in these industries talk about these phenomena like they are crises. But content keeps getting both better and more plentiful.
Musicians and writers have gone, over the last 10 years, though shifts in their sectors that look an awful lot like big income tax increases. And it's been bad for workers in those sectors. But it's not at all clear that it's been bad for the economy or for consumers—in fact, it's probably been good.
One possible lesson here is that economic shifts raising the value of ideas have made it possible and desirable to cut the share of the value from idea generation that goes to idea generators. That is, idea generators are less sensitive to taxes than they used to be.
In the case of superstar high earners, we could do that by raising taxes at the top, or we could do it by directly attacking the rents and intellectual property protections that Krugman identifies.
Or maybe this isn't the right approach. Maybe great ideas have become so valuable that disincentives to their creation have become drastically more costly.
But that's the discussion that needs to be had—do "superstars" really need to get such a large fraction of the surplus they produce lest they slack off? Or, like rank and file musicians and writers, can we cut their earnings with near impunity?
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