Problems with Other Countries’ GDP Data

I’m going to start with a digression.

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Most students don’t know the difference between a country, a nation, and a state.

A country is the physical space. It’s what you see borders of in an atlas.

A nation is a set of people with a cohesive culture tying them together.

A state is a government that has “standing”: basically, other states admit that it’s worth engaging with. An effective state is sometimes described as “sovereign” (even though that word applies to royalty, and we don’t have much of that anymore), in that it acts as if someone is in charge of the whole thing.

For most of us, a country, a nation, and a state roughly coincide.

Through this lens, we can see the overarching position that Trumpers share: a sense that the immigration is making the U.S. less of a nation, and a sense that our state no longer controls the entire country.

Most of our problems around the world crop up in places where there’s a worse mismatch between these three ideas. 

Iraq has had problems spanning decades because there’s a country on the map, and a state run out of Baghdad that tries to control the whole country, but there isn’t much of a nation of Iraqis: citizens are Arab or Kurd, or Sunni or Shia.

Somalia is a country on the map, and a nation of people who identify as Somalis. But there hasn’t been a viable state running the place from Mogadishu for about 25 years. This country is the source of the term “failed state” that is tossed around in the media.

And what we roughly call Kurdistan is a nation of people who think of themselves as Kurds, with a state that effectively runs the region and defends itself … but there’s no country on the map.

Now I’m going to take you back to the Thirty Years War. Remember that? Probably not. Anyway, it was a nasty continental war fought in Europe in the 17th century. One thing that came out of it was the idea of Westphalian Sovereignty (because the treaty that ended the war was signed in Westphalia).

Briefly, Westphalian Sovereignty means that other states can either accept you as a state or not. If they do, it means that they respect your state’s decisions regarding everything that goes on inside the borders of your country. For example, this is why the Palestinian Authority makes the case so strongly that they need a Palestinian state.

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The problem with Westphalian sovereignty for macroeconomics is that it suggests that if a country produces data about itself for public consumption, other countries should accept that data at face value. Except some governments lie.

The classic example of this is CIA estimates of the size of the economy of the Soviet Union, which were largely based on data provided by the Soviets. Officially, in 1990, the CIA said the Soviet economy was about half the size of the U.S. Critics that were friendly to the CIA marked this down to 40%, those unfriendly to it down to 35%, and an influential Soviet economist estimated 28%. Admittedly, the remnants of the Soviet Union have not had an easy time over the last generation, but the current (overstated) PPP estimates for the region are about 25% of the U.S., and the current (understated) exchange rate based estimates are at about 10%.

Problems with GDP measurement around the world are kept track of by a private consulting firm called World Economics. Their Data Quality Index allows ranking of countries by probable inaccuracy (but you have to pay real money to get their actual GDP estimates). They also have some tough reading there (not required) detailing about a dozen ways in which states fail to accurately track their country’s GDP. Here’s the skinny on the problems:

• Base years need to be updated periodically, and many countries don’t do this very often.
• The UN has pushed out 4 increasingly refined systems for counting economies over the last 80 years. But countries are not required to switch to the most recent/best system.
• Informal economies are tough to count, and are bigger in countries with weaker states.
• Poor countries have trouble affording better GDP measurement.
• Government’s interfere in the calculations.
• Much of what government’s purchase has a much bigger divergence between price and value than consumer goods do, so countries with big government sectors are probably measured more poorly.
• Financial sectors are tough to measure, which is a problem for richer countries with generally thicker financial sectors.

Economists are particularly concerned about China’s GDP numbers. China may be the second biggest economy in the world, but it ranks around the middle in accuracy of GDP. In fact, World Economics devotes an entire section to China in its discussion of Asian economies — they have all the problems list above, plus these:

• China produces its GDP estimates much more quickly than other countries.
• China never revises its announced GDP figures.
• The variability of reported GDP is far lower for China than any other country.
• China has an uncanny ability to announce targets for GDP growth rates, often years in advance, and then hit them time after time.
• State-owned enterprises (SOE’s) report their output data directly to the state, which assigns values to it, rather than allowing it to be traded on the open market
• Chinese provinces appear to report a lot of GDP to Beijing that is systematically pared back by Beijing due to overstatements.
• Double counting of transactions that cross provincial borders seems to be a big problem.
• Much of the world is aware of the high prices and rental rates for real estate in coastal China. This is absent from Chinese inflation statistics, suggesting that real GDP growth rates are overestimated.

Do note that you can test forensically for data falsification. Researchers looking at this do not find much evidence for this in China. Instead, the evidence for pervasive “guesstimation” seems more convincing.

A Wikileak showed that China’s current Premier, Li Keqiang, described his country’s GDP as “man made”. The Economist went far enough to construct an index of Keqiang’s personal favorite economic indicators — rail volume, electricity consumption, and loan disbursement — as an alternative to official GDP statistics. A good source for analysis and data on China’s economy is Balding’s World (Balding is an economics professor working in Beijing).

Some Terminology Notes for Cross-Sectional Comparisons of GDP

In class I recommended that Wikipedia is a good source for information on GDP across countries.

I agree with that, but I do want to give you some pointers.

First off, start with this Wikipedia page. It’s actually a list of lists: kind of a table of contents. There are a number of different ways to rank countries.

Secondly, the word “nominal” is one of those that is used to mean different things in different contexts. It does not just mean “in terms of some paper currency” as I use it in class. Instead, it’s more along the lines of “initial” or “untreated” or “unadjusted”.

This brings up a problem with these lists in Wikipedia. These are a great way to make cross-sectional comparisons. But a problem with making cross-sectional comparisons across countries is that it requires us to adjust for differences in exchange rates and purchasing power (PPP).

This is where Wikipedia creates a problem for student. On this page, when they use nominal what they mean is adjusted by exchange rates rather than by PPP. They do not mean that the link goes to a list of countries GDP which has not been adjusted for inflation. Every link on this page goes to a list of countries ranked by real GDP. Using nominal here is a big problem because it steers users towards the tables using PPP.

Third, always keep in mind that ranking by PPP tends to make poorer countries look richer than they are, and richer countries poorer than they are. Using exchange rates has the opposite effect. As always, these are indexes, so there is no right answer. Be aware of both.

Fourth, keep politics in mind. Some countries GDP measurements are better than others. Also, for international agencies, decisions are often made by votes where each country gets a single vote. If the issue is bragging rights about who is bigger, poorer countries will often vote in a way that makes them look larger than they are. However, if the issue is about how much aid to transfer from rich to poor, the poor countries will often vote in a way that makes them look smaller.

Fifth, growth rates should always be higher for poorer countries. If it isn’t, they won’t catch up to the richer countries. We have a lot of evidence that many poorer countries do catch up (but not all of them). Generally, rich countries never grow really fast. But, it does happen that poor countries do sometimes grow slowly: this is a huge failure and should always draw your attention.

Sixth, consider the sources. I think the IMF and World Bank publish reputable data. I am less sure about the UN: it is more of a political rather than an economic institution, so I worry a little about their economic data. The CIA keeps track of economic data for security reasons, but has a history of overstating the size of the economy’s of America’s “enemies”. The Conference Board is a private think tank in New York with an excellent reputation. Eurostat is the official statistical agency of the European Union: the quality of their data is usually excellent, but there is some political influence there that economists worry about.

Lastly, this is a list of ranked lists. There are a lot of choices. If a journalist or politician wants to push a particular point, they can cherry-pick the ranking that makes their position look the strongest. It’s the economists job to look past that and dig deeper.

The Republican Tax Reform: Part 11—The Corporate Income Tax Rate Reduction

This post is not done yet, but this is what I’m working on for after the long weekend.

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I think control issues are a general problem with politicians and bureaucrats. I’m speculating, but I think that jobs where you can conceivably control some things attract people who believe controlling things is important.

A problem with that is if controllers believe they can control something that they can’t.

This comes up a lot in tax policy. There’s a real economic problem with tax labeling and tax incidence that no one should ignore. But political processes often focus on labeling exclusively, or as a matter of convenience. There’s also an issue that you can target a certain tax base, but you always need some element of buy-in from the parties being taxed. It’s perfectly legal for people to avoid being included in the tax base, and if buy-in is weak you may get some tax cheating on top of the avoidance.

Which brings us to the problem of multinational corporations. These don’t face one corporate tax rate. They face a bunch. And it’s reasonable and legal to expect them to pick and choose where to place the tax base they create.†

Here’s how that might work out. Country A has a corporate income tax rate of 10% and country B has a corporate income tax rate of 20%. Multinational firms from both countries then do everything they can to shift costs to country B (as a practical matter of tax planning, if not so much an ethical one, costs you measure internally are easier to move around than revenues that others might be able to measure externally to the firm) . Income is revenue minus costs, so the goal is to cancel out all the revenue from country B with costs from country B but also costs from country A that have been shifted over. If they do this perfectly, they end up with their income all taxed at 10%. This makes good financial sense, and going further, it is the fiduciary duty of corporate officers to make sure this happens. Now suppose the politicians in country B want to increase taxes. They raise their rate to 21%, and still collect nothing. Even worse, they may not be able to admit how it is possible for country A to raise their rates even more, say to 12%, and have their tax revenue go up by 20%.

Part of me does not believe that politicians can be that dumb.

But a different part of me is certain that they are that dumb. Here’s why. If country B really wants to increase tax revenues (instead of just labeling themselves as tough on business) they should undercut country A’s rate. Perhaps country B should try 9%. But if they do country A should try 8%. That game ends with both of them charging a 0% rate. At first glance, this outcome might seem implausible, but governments do this all the time when they compete with each other to offer tax breaks to get first to locate within their jurisdiction. In public finance there’s actually evidence of governments going past zero and offering packages that amount to negative tax rates on net. That’s what can happen if governments are not that dumb. If they are dumb, they might not go that far, and end up with a positive rate, but one that is different from other countries. This is actually what we observe in the real world, which makes me thing there are a lot of politicians who really don’t get the economics.

Which brings us to the U.S. corporate tax rate. The OECD says that, yes, the U.S. did have the highest statutory corporate tax rate (the right column at this site). Those are marginal rates, so there will be some weirdness to judging our system when all we’ll have is average rates from the data. Also, when we talk about the statutory rate, this is before deductions, exemptions, credits and so on. The effective tax rate might be much lower. The Congressional Budget Office (CBO) researched that for G-20 countries, and found that in 2012 … our marginal corporate rate was the highest, our average corporate tax rates were still the third highest, and our effective corporate rate was the fourth highest (see Table I here). That’s better, but not good. The change in positions also indicates that our system has a lot of complexity to it.

So yes, it is reasonable to think that high U.S. corporate tax rates were causing multinational firms to shift their costs around the world. How recent a phenomenon is that? Well, historical panel data sets on that are both complex and sketchy, but the OECD data for earlier periods shows the U.S. did not used to be at the top of the list. What’s happened is that many other large and/or rich countries have reduced their corporate tax rates over the last generation or so. This is because the wave towards lower tax rates that hit the U.S. starting in the 1980’s was a global phenomenon. It just did not hit our corporate income tax rate.

After all this, the U.S. was doing one more dumb thing. Well, smart from the perspective of collecting revenue, but dumb from the perspective of reducing tax distortions. The U.S. had been running a non-territorial tax system. In a territorial tax system, a U.S. multinational would pay tax on its income in each country that it operates, at the tax rate for that country … and then you were done. But this is not the system the U.S. had. Instead, if the tax owed in the foreign country was lower than what would have been paid if that operation was in the U.S., the firm owed the different too. Except that a U.S. firm could claim that the foreign income on which that extra tax was owed was still needed or active in that foreign country, say for future investments. In this case, that tax liability could be deferred indefinitely. And obviously, it could be invested in financial investments from the foreign country and earn even more income that could also be deferred.

But wait! There’s one more big distortion. The “Americanness” of a firm was judged on the basis of its headquarters’ location. And some countries had territorial tax systems in place. This led to inversions: move the headquarters to a lower tax country with a territorial tax system and completely avoid rather than defer some U.S. corporate taxes.

† Thomas Piketty’s Capital in the 21st Century made a big splash a few years ago. There’s evidence that many non-economists didn’t read much past the first chapter. But economists did (Piketty is a big name guy on our field’s political left). Piketty wants big government. He doesn’t hide that. But big government requires big taxes. Multi-national corporations can short-circuit that by moving their income around to lower tax jurisdictions. Not surprisingly, Piketty suggested that we need a single global tax system and rate to apply to corporations, with a bureaucracy to distribute the proceeds down to individual countries.

A Mildly Technical List of the Bad Policy Choices that Make the U.S. Healthcare System What It Is

In class I refer to the U.S. healthcare system as a Frankenstein monster: every time something doesn’t work properly, we add something new that usually doesn’t work properly either.

Dawn Smit, writing at The EclectiSite has put together a nice summary of the big issues, where they came from, and how they went wrong. Click through and read “Health Care: How In the World Did We Get Here?”

It’s not perfect or completely unbiased, but this is the best quick-read summary of all the issues that I’ve ever seen.

New Research on the Gender Pay Gap

It may not seem that way, but any gender pay gap is a macroeconomic issue. This is because we mostly measure that gap with average national statistics, and most policy approaches that begin with the assertion that this is evidence of discrimination are at the national level as well.

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Jordan Peterson is the public intellectual of the season. In one of his many videos he notes at the 6:00 mark that “Like if you’re a social scientist, worth your salt, you never do a univariate analysis”.† Hold that thought.

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In general discussion, the factoid that most people know about the gender pay gap is that women are paid some percentage less than men. Sometimes that’s derived from averages across the gender, and sometime from medians. The current best estimate is 12%, although politicians and advocates prefer older estimates with larger values.

Either way, that factoid is evidence of univariate analysis, because the only variable used to generate the difference is gender.

Economists have had trouble with this for a long time because when you start including other variables into the analysis, you find out that most/all of the pay gap is explained by variables that have little to do with discrimination. If that’s the case, then the discrimination explanation is a “Just-so Story”. Peterson and others make this point.

Economists don’t have a problem addressing discrimination through non-market measures. But they definitely do not want a market modified by such a measure when the market is not the source of the discrimination. That’s the problem with these results and the typical responses to the possibility of discrimination. In this case, this often amounts to some policy to extract money out of employers to transfer to the disadvantaged group (good economics students will recognize that there’s an incidence problem there, since firms may be able to pass some or all of that along to their customers). It’s OK to have a policy to divert some money from owners and customers provided that the owners and customers are the source of the problem. If they’re not, it’s not efficient for the economy as a whole, and we should be looking harder for other forms of redress.

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So there’s a new working paper by Cook, Diamond, Hall, List and Oyer entitled “The Gender Earnings Gap In the Gig Economy: Evidence from Over a Million Rideshare Drivers”.‡ They studied Uber.

Uber has done a lot to design a system in which men and women should be compensated equally. And yet … they’re not.

Prior to this paper, the primary explanation for the remaining 12% gap is that women prefer more flexible scheduling. To the extent that employers are unwilling to work around that preference, it would constitute a solid motivation for regulatory redress from the employers.

But that’s not what this new paper finds. Uber’s system applies the same pay formula regardless of gender, without negotiations, or role for tenure or work intensity. Customers might be discriminating against women, but this doesn’t show up in the data. What they’re left with is a 7% pay gap that does not seem to involved employer discrimination. (Do note that doesn’t mean that the other 5% of the measured gap is not from discrimination).

Also note that assertion of the authors “… We know of no prior work that fully decomposes the gender earnings gap in any setting”, and “… We are not aware of prior cross-sectional wage regressions that have precisely and entirely eliminated the gender pay gap in virtually any context”. Those are fairly bald claim that they’ve accounted for more sources of the gap than previous authors.

What they did find was 3 factors that can explain the pay gap. Now, these could reflect differences in preferences between men and women. And you can argue that those differences in preferences are driven by social conditioning. Even so, that implies that redress should not come from employers and customers, but rather from some other broader section of society.

So what are those 3 factors?

First, men drive faster. Half of the gender pay gap is men putting in more trips in the same period of time. What’s really interesting about this cause is that the private sector has already compensated for this by charging higher auto insurance rates to men.

Also, it’s not a factor that would be relevant in most professions. So what we’re seeing is a 12% univariate pay gap, reduced to 7% by a firm’s compensation system, further reduced to 3% due to a job-related skill that’s already compensated for.

Second, male drivers make more trips with Uber. They demonstrate there is a learning curve associated with Uber driving, that is persists for years, and that men climb it faster by taking more trips. This gap opens up quite early in a worker’s tenure with Uber, and still persists two years after hire: it takes women 16 months to accumulate the same experience that men do in a year.

Third, this learning curve appears to be related to the choice between agreeing to make a distant pick-up and rejecting it in the hope something nearby shows up. So, if men drive more often, they establish this skill earlier and better than women do. The authors provide evidence that men and women learn this skill at the same rate.

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Do note that none of this implies that there is not a problem. It just says that the source of the problem may be in the personal preferences of men and women. There may be a role for social policy to alleviate that, but it’s hard to see one. Think about what’s going on here: Uber has done a lot to make the job as flexible as possible, but the flexibility that women seem to care about the most is not in how to do the job day-to-day but rather whether to do the job at all on a given day.

However, there is also a perception that women work more than men “because they work two jobs”. The American Time Use Survey data from the Bureau of Labor Statistics suggest that the difference is only … about 18 minutes per day. That’s not nothing, but on the other hand, it’s 2% of the day, and there is little basis for arguing that the elasticity of pay with respect to time is around 6 (the value needed to convert a 2% difference in time into a 12% difference in pay). Could it explain the 5% difference between the nationwide gap and Uber’s gap? Maybe.

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† Do note that when we get into the time series section of the class (towards the end of the month) it may appear that we are doing univariate analysis, when in fact we are doing indirect multivariate analysis. The reason is that if a variable depends on many other variables, and we relate that variable to its own lags, we are indirectly relating it to all those other variables. Basically, it’s a short cut.

‡ John List is a good role model for the SUU economics student. His vita is huge, and he has tons of heavily cited papers rather than just a few big ones. Best of all, he went to the University of Wisconsin at Stevens Point (an SUU sized, rural, school) as an undergraduate, and the University of Wyoming for graduate school. That’s a path comparable to the one you’re on right now.

Two for the Price of One

It’s February 9th. In class this week I spent two days talking about stocks and flows, and how policy analysts need to pay more attention to this distinction.

In today’s issue of The Wall Street Journal there are two articles, on the same page, illustrating the right way and the wrong way.

The right way is in a piece by David Henderson. He’s a well-known economist at the Naval Postgraduate School who writes occasional op-ed pieces for a variety of publications. In this case, he’s writing about how Oxfam, an NGO that advocates on behalf of the global poor, does not make the stock-flow distinction. The result is a comparison that looks persuasive but is in fact not a comparison … at all.

The report also compares the income of the poor with the wealth of the rich. For instance: “Between 2006 and 2015, ordinary workers saw their incomes rise by an average of just 2% a year, while billionaire wealth rose by nearly 13% a year.” But it’s a false comparison: one person’s paycheck versus another’s net worth.

To get the story right, you need to compare income for both groups. Two economists, Tomas Hellebrandt and Paolo Mauro, studied this and concluded, in a 2015 paper published by the Peterson Institute for International Economics, that global income inequality declined between 2003 and 2013 due to rapid economic growth in poor nations.

This is even more impressive than it sounds, given the math involved. Say that wages in a developing country rose by 10%, and in the U.S. by only 1%. For a family in the poor country earning $2,000, that would mean an extra $200. But for a family in the U.S. making $50,000, it would equate to $500. In other words, income inequality would increase, even though wages grew 10 times as fast for the poor family.

You might want to do the math. In this case inequality will continue to get worse for about 15 years, but within 40 years the poor will have more income than the rich.

The wrong way is in a piece by Peggy Noonan. She’s a Pulitzer Prize winning columnist and writer today, who’s best know for being one of President Reagan’s speechwriters.† She’s a Republican, but not a Trump fan, who lately writes a lot about what people see or infer about Trump. This is from a section about three current events from the week, including the declining stock market:

… I would add the big secret everyone knows both here and abroad and that occasionally springs to the forefront of the mind: A fundamental is unsound. Compared with other countries we look good, but compared with ourselves we do not. Our ratio of total debt to gross domestic product has grown to more than 100% and can’t keep growing forever. Because of it, no matter how high the market goes it will never feel sound. There is no congressional appetite for spending control because there is no public appetite for it.

No one in Washington is forging a plausible solution to the problem.

Noonan can be forgiven for not knowing better. But … she also seems super-bright and well-informed, so I find it hard to believe she hasn’t digested that this statistic isn’t an answer to a question bright and informed people ask.

David Henderson’s piece is entitled “A War on the Rich Won’t Help the Poor”. Peggy Noonan’s piece is entitled “I Love a Parade, but Not This One”. Both appeared on the op-ed page in the February 9, 2018 issue of The Wall Street Journal.

† Two of her speeches are ranked in the top 100 speeches of the 20th century. She’s also known for the Bush I phrases “kinder, gentler nation”, “thousand points of light”, and “read my lips, no new taxes”.

Two for the Price of One

It’s February 9th. In class this week I spent two days talking about stocks and flows, and how policy analysts need to pay more attention to this distinction.

In today’s issue of The Wall Street Journal there are two articles, on the same page, illustrating the right way and the wrong way.

The right way is in a piece by David Henderson. He’s a well-known economist at the Naval Postgraduate School who writes occasional op-ed pieces for a variety of publications. In this case, he’s writing about how Oxfam, an NGO that advocates on behalf of the global poor, does not make the stock-flow distinction. The result is a comparison that looks persuasive but is in fact not a comparison … at all.

The report also compares the income of the poor with the wealth of the rich. For instance: “Between 2006 and 2015, ordinary workers saw their incomes rise by an average of just 2% a year, while billionaire wealth rose by nearly 13% a year.” But it’s a false comparison: one person’s paycheck versus another’s net worth.

To get the story right, you need to compare income for both groups. Two economists, Tomas Hellebrandt and Paolo Mauro, studied this and concluded, in a 2015 paper published by the Peterson Institute for International Economics, that global income inequality declined between 2003 and 2013 due to rapid economic growth in poor nations.

This is even more impressive than it sounds, given the math involved. Say that wages in a developing country rose by 10%, and in the U.S. by only 1%. For a family in the poor country earning $2,000, that would mean an extra $200. But for a family in the U.S. making $50,000, it would equate to $500. In other words, income inequality would increase, even though wages grew 10 times as fast for the poor family.

You might want to do the math. In this case inequality will continue to get worse for about 15 years, but within 40 years the poor will have more income than the rich.

The wrong way is in a piece by Peggy Noonan. She’s a columnist and writer today, who’s best know for being President Reagan’s speechwriter. She’s a Republican, but not a Trump fan, who lately writes a lot about what people see or infer about Trump. This is from a section about three current events from the week, including the declining stock market:

… I would add the big secret everyone knows both here and abroad and that occasionally springs to the forefront of the mind: A fundamental is unsound. Compared with other countries we look good, but compared with ourselves we do not. Our ratio of total debt to gross domestic product has grown to more than 100% and can’t keep growing forever. Because of it, no matter how high the market goes it will never feel sound. There is no congressional appetite for spending control because there is no public appetite for it.

No one in Washington is forging a plausible solution to the problem.

Noonan can be forgiven for not knowing better. But … she also seems super-bright and well-informed, so I find it hard to believe she hasn’t digested that this statistic isn’t an answer to a question bright and informed people ask.

David Henderson’s piece is entitled “A War on the Rich Won’t Help the Poor”. Peggy Noonan’s piece is entitled “I Love a Parade, but Not This One”. Both appeared on the op-ed page in the February 9, 2018 issue of The Wall Street Journal.

The Republican Tax Reform: Part 10—Average/Mean vs. Median Outcomes

Here’s something to watch out for (in the sense that it’s a hazard you need be aware of).

It’s a very common technique when trying to justify positions going towards both ends of the political spectrum to be selective about using the mean and median.

Typically this takes the form of citing a mean and then comparing it to a median. Casual readers and the innumerate can get fooled by this.

First, a little statistics review. One of the first things taught in statistics is to determine whether the data are (roughly) symmetrical or not. This is usually discussed before the calculation of simple statistics. After that, you’re introduced to measure of central location of data distributions: the mean (average), median, and mode(s).

You all know how to calculate a mean: sum the values, and divide by the number of observations.

The median sounds easier, but ends up being more work: rank the observations from smallest to largest, and find the one that’s in the middle so that half are larger and half are smaller.

One of the reasons we have more than one measure is asymmetry. If your data is symmetric, the mean and median are the same. If it is asymmetric, it’s very likely that they are different.

For example, if my distribution contains the observations 1, 2, and 3, the mean is 2, and so it the median. But if my distribution contains the observations 1, 2, and 9, the mean is now 4, but the median is still 2.

This comes up a lot in macroeconomics (and finance) because of the prevalence of variables that begin as counts of stuff. Counts start at zero, so they’ve got a solid end on the lower end of the distribution. But they don’t often have limits at the top end, so the tail on that side of the distribution can be much longer. This tends to make the mean (average) larger than the median.

For example, things like income and home prices have distributions that are asymmetrical in this way. What this means is that someone of average income can afford the median home, but someone of median income can’t afford the average home. Often you see something like the latter case being used as the basis for outrage in the legacy media. But do not that both of those can be true, and in the same situation it can still be true that someone of average income can afford the average home, and someone of median income can afford the median home.

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So how are Republicans and Democrats going to spin this?

Watch out if Republicans say the average tax payer will have their taxes go down. That can be code for taxes were reduced on the top end of the distribution.

Watch out if the Democrats say the median taxpayer is largely unaffected by this reform. In the U.S., the median taxpayer pays close to nothing as it is, so it’s hard to reduce that.

But what if both of those are kinda’ sorta’ correct? Data on this is not easy to come by, but you should focus on stories about households making around, say, $100K per year (which is around the 80th percentile). This is close enough to the top that they’re paying a lot of taxes, yet close enough to the middle that a cut could seriously improve their lives.

The Republican Tax Reform: Part 9–Progressive vs. Regressive

Another dimension along which we evaluate tax policy is whether it is progressive or regressive.

Surprisingly, these ideas do not have solid formal definitions.

Some would argue that a progressive tax system is one in which the rich pay more than the poor. Most would go further and want the rich to pay taxes at a higher rate than the poor.

It’s not clear if that should be measured with average or marginal rates. In practice, progressivity tends to be concerned with taxes that are actually paid, so an average rate tends to be used more commonly.

The idea of progressive taxation goes along with the idea of progressive politics from a century ago (rather than the contemporary usage). A principle of that movement is that redistribution from those doing well to those doing less well is good policy.

If you combine those last two paragraphs, you get to the idea of why the average tax rate is preferred. It is possible to have a system in which the rich face high marginal tax rates, but are able to reduce their tax base so that they don’t actually pay that much. One would hardly call that progressive.

An alternative method would be to start with the evidence that income is distributed unequally. This can be measured with a variety of methods, like Gini coefficients (there are a variety because we’re not very good at measuring this yet). In this sense, a progressive tax system is one that is more unequal than the distribution of income, so that it tends to push the distribution of income towards greater equality (according to an OECD study, all its members have progressive tax systems).

Whatever. Once we settle on a meaning of progressivity for a particular context, then regressivity is the opposite: the poor are paying at a higher rate.

In developed countries, income tax systems tend towards progressivity. However, these countries rely increasingly on more regressive taxes (like sales taxes and FICA in the U.S., or national VATs in Europe).

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At this point it’s not clear if the Republican tax reform will increase or decrease progressivity.

The perception is obviously that the reduction in the corporate tax rate will decrease progressivity. But this is not clear at first glance because the incidence of that cut will all heavily on labor. And at second glance it gets harder to measure: if the tax cut helps workers, and they get paid more, they may be subject to higher (more progressive) income taxes.

The removal of the Obamacare tax penalty will make the tax system more progressive, since it tends to fall most heavily on the poor. Some will argue that it will also make income inequality worse, but this is simply wrong. The usual justification for this is that the poor will be more exposed to risks from healthcare costs, but this ignores the fact that those who did pay the tax were already fully exposed to those risks. This is the point of that tax: it is a penalty for leaving yourself open to potential problems. Not paying the tax anymore does not make their healthcare position worse, and actually increases the income available to pay those bills. Personally, I’m kind of ambivalent about this tax; I think I’ve said is in class that it’s a poor attempt at addressing a tough problem, but that the alternatives aren’t good either. Having said that, I do disagree with people who do not think through the progressivity of this move.

I think the limits on SALT deductions are a move towards a more progressive system. These deductions allows many high income people to reduce their overall tax bill. If the goal is collecting a greater portion from the rich, then this move enhanced progressivity.

Maybe You’ll Learn Something New (Optional)

If you click a link at the Financial Times and the linked file can’t be found, instead of sending you a plain vanilla 404 page, then send you here:

Here’s the link, rather than the image pasted above.