The Becker-Posner Blog

Wealth and Income Taxes on the Rich-Becker

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The Occupy Wall Street movement has not expressed clear goals, but it does want higher taxes on the “rich”. President Obama agreed in his State of the Union address, and proposed that the rich-in his case, anyone with an annual income of at least $1 million- pay no less than 30% of their income in federal taxes. Others have proposed to add annual taxes on household wealth, in addition to taxes on income. The fact is that Obama’s tax goal is already being met by the complicated American tax code, while even a small wealth tax would discourage savings and create other problems.

According to a 2010 study by the Congressional Budget Office, the effective federal tax rate on the top 1 percent of households has already been about 30%. This might seem to be a misprint since very wealthy persons like Warren Buffet and Mitt Romney report that they pay only about 15% of their income in taxes. However, much of their incomes come from investments that are first taxed at the corporate tax rate of 35%, and then the after-corporate tax income is taxed again when paid out as corporate dividends, or when capital gains are realized.

According to the same CBO study, federal taxes on the middle classes comprise on average only about 15% of their incomes, This disparity in tax rates indicates that the American tax system is already quite progressive when corporate income taxes are combined with personal income and capital gains taxes. To be sure, it is inefficient to have such high tax rates on corporate incomes. Eliminating the corporate income tax, and then taxing personal incomes, capital gains, and dividends at the same rate would go a long way to both simplifying the tax code and to improving its efficiency.

Better still would be to scrap entirely the income tax, and substitute a consumption (i.e. sales or value added) tax instead (see the more extended discussion of a general consumption tax in my post on 8/29/11). Even if consumption of the poor were taxed at lower rates, the current bloated level of federal spending could be financed with a consumption tax on the great majority of households of no more than 25%. The effective tax rate does not have to be high because a generally flat consumption tax would be far more efficient, in particular, it would be more encouraging to investments, than the present complicated personal and corporate income tax system.

An income tax is an indirect tax on wealth because it lowers the value of the assets that produced the taxable income. Nevertheless, support has recently emerged for a direct tax on wealth to go along with taxes on incomes. Some forms of wealth are already directly taxed, such as property taxes levied by most local governments, and taxes on estates of deceased individuals. Henry George in his book Progress and Poverty (1879) made a famous proposal for a wealth tax in the form of a 100% tax on increases in the value of land. This single tax, he believed, could replace all other taxes. George argued that a land tax was a good tax because, so he claimed erroneously, the value of land did not depend on what landowners did, but rather depended only on forces like population growth that were beyond their control.

Current proposals for a wealth tax go beyond taxes on particular assets, like land or housing, and envisage a much broader tax that includes financial wealth, like stocks and bonds. I only say “broader” since a viable wealth tax would still exclude wealth in the form of human capital, the most important form of capital in modern economies, and the source of wage and salary incomes. Since the richest one percent of households on average get about half their incomes from wages and salaries (the remaining 99% get almost all their income from human capital), much of the true wealth of the rich would escape a wealth tax.

Another major problem with even a small tax rate on wealth is that it implies a very high tax rate on savings. Consider a constant 2 percent tax on wealth, and suppose that a household saves $10,000 out of its income to raise its future wealth. A one year 5% return on these savings would increase its before tax wealth next period by  $10,500. Since a 2 % wealth tax on $10,500 would leave an after-tax value of just $10, 290, such a wealth tax would reduce the after-tax return form 5% to only 3%, a 40% reduction.

So what seems like a small tax on wealth of only 2% is the equivalent of an income tax on savings of 40%. Presumably, this would discourage savings and increase consumption, whereas sustained higher long-term growth in GDP requires greater, not lesser, savings. As I mentioned earlier, the discouragement to savings of an income (or wealth) tax is a major reason why consumption taxes are better.

Wealth taxes have several other serious problems in addition to their negative effects on savings. It is almost impossible to value accurately many sources of tangible wealth, such as the value of privately owned businesses, so that an actual wealth tax would be rather narrow. Moreover, forms of wealth that can be most easily valued because they have good asset markets, such as stocks and bonds, can be moved across countries, and hidden through complex arrangements of assets.

Therefore, I conclude that a general tax on wealth is undesirable because it is both inefficient and ineffective. A feasible wealth tax is dominated by consumption taxes, including even progressive consumption taxes, and by inclusive income taxes.

Taxing Wealthy People More Heavily—Posner

Inequality in income and wealth has grown very substantially in the United States in recent decades, and appears to be at a historical high. That would hardly be noticed, in a society such as ours that is strikingly free of envy, were it not for the last almost three and a half years of economic distress. The distress is not felt by the wealthy; this is noticed, and angers the nonwealthy, who are naturally inclined to think that the distress should be shared, and that increasing the progressivity of the tax system would be a step in that direction, and should be taken. Many people are worried by the nation’s huge public debt, and it is natural to think that raising taxes on the wealthy would reduce that debt by reducing the gap between government revenue and government spending. Furthermore, Federal Reserve and other regulatory officials, who I believe were (with a helping hand from many academic economists) primarily responsible for the economic distress because of unsound interest-rate and regulatory policies, and regulatory laxness, and general cluelessness, have managed to shift the blame, in the mind of the public, for the economic distress to the financial industry. Markets are Darwinian, and the industry’s reliance on short-term capital, both financial and human, compels risk taking to the farthest degree that the government will allow, and the Greenspan-Bernanke Fed and its staff and the entire financial regulatory establishment allowed too much risk taking. But this is not widely understood; the reappointment of Bernanke as Chairman of the Federal Reserve helped to conceal recognition of the point. 

But as long as a substantial segment of the public blames the wealthy, the pressure for making the tax system more progressive presents a political as well as an economic issue. An increase in progressivity that does little economic harm would be a low-cost response to the political pressure, though the President’s recent proposal to tax people who earn more than $1 million at a rate that will make them pay 30 percent of their income in federal income tax carries symbolism too far. If a person who earns $1 million a year and is taxed at an effective rate of 25 percent is subjected to such an imposition, instead of paying $250,000 in taxes he will have to pay $300,000, and he will therefore do whatever it takes to reduce his income from $1 million to $999,999, as that will save him $49,999. 

Marginal income tax rates can be increased slightly, deductions trimmed slightly, the budget of the Internal Revenue Service increased so that the tax laws are enforced more effectively, and income tax forms simplified, and the result of these modest measures would be a small increase in government revenues at a small—I would guess a negligible—cost in economic growth. Anything  more ambitious in the way of tax reform probably is politically infeasible, given our disordered political system, and, more interesting, probably economically infeasible as well. While there are good theoretical arguments for replacing income with consumption taxes, as discussed by Becker, the administrative and transitional costs would be staggering; and so with any effort to overhaul the federal income tax system rather than just tinker at the edges of it. 

Grandstand gestures like the proposed millionaire tax would have only the slighest effect in alleviating resentment at the rich, and should be understood as campaign documents rather than serious proposals. 

As for a tax on wealth as distinct from income, I agree with Becker that it is an uncommonly silly idea. I would again stress issues of implementation, rather than theoretical objections (for example that the wealth tax would necessarily exclude human capital from taxable wealth, despite its importance). It would be an enormous undertaking to compel everyone in the United States (for one cannot identify who is wealthy by income alone, since one can have great wealth but a small income, depending on the form the wealth takes) to value his entire wealth honestly. Would everyone who owns a home have to submit an appraiser’s evaluation? And who would pick the appraiser?

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Does America Imprison Too Many People? Posner

A society can be thought of as a collection of private and public systems. At present a number of these systems in American society are under stress: the medical system, the educational system (other than elite private schooling and elite university education), the political system (especially at the legislative level), the finance industry, the fiscal system (including taxation, borrowing, and spending at all levels of government), transportation infrastructure, the regulation and assimilation of immigrants, and perhaps others. In contrast, foreign affairs, the military (and national security generally), and industries such as retailing, the production of intellectual property, computer technology, and the production of pharmaceuticals and medical technology are areas of great national strength. 

Another troubled American system is that of criminal justice, with particular emphasis on the astrounding growth and level of imprisonment. Some statistics: the incarceration rate had been 118 per 100,000 in 1950, and actually fell in 1972 to 93 per 100,00. By 2000 it had reached 469 and only since the advent of the economic crisis has it begun to decline as states try to reduce expenditures. Between 1950 and 2000 the white imprisonment rate increased by 184 percent and the black imprisonment rate by 355 percent; today 40 percent of prison and jail inmates are black, although blacks are only 13 percent of the overall population. Even though the U.S. crime rate fell by a third in the 1990s (and by two-thirds in many large cities)— the murder rate by more than 40 percent—the inmate population continued growing during this period, an increase that cannot be explained by population growth, since the population grew by much less than a third in the 1990s. 

The inmate population started its rapid growth in the early 1970s, largely in response to sharply rising crimes rates in the 1960s, a decade of domestic unrest. In 1960 the homicide rate was 4.6 per 100,000 persons; in 1970, 7.9; in 1980, 10.2; in 1990, 9.4—but by 2000 it had dropped 5.5 and it is about the same today, which is to say that it is almost back to where it was in 1960, before crime became a big issue. Crime rates are higher than they were in the 1950s but they are tolerable, yet the incarcerated percentage of the population remains much higher now than then. 

The economist Steven Levitt, after correcting for other factors that have been proposed as explanations for the decline in crime rates since 1980, has attributed the leveling of and then decline in those rates to the increase in the prison population, along with increases in the number of police, a decline (largely, it seems, independently of law enforcement) in the consumption of crack cocaine, and the legalization of abortion in the early 1970s. Legalization resulted (Levitt argues, though his statistical evidence has been questioned) in a decline in crime rates twenty years later; unwanted children are more likely to be neglected, brought up badly, and as a result get into trouble as young adults than wanted children. 

The striking thing is that although the criminal sentences are considerably more severe in the United States than in our peer countries, which one expect to have a substantial deterrent effect, the percentage of the American population that is incarcerated is the highest of any country in the world—at 2.3 million, it is about .8 percent (eight-tenths of 1 percent), which is 4 to 7 times the percentage of any of our peer countries—and our crime rates are generally no lower than in those countries and our murder rate is much higher. Although we have a larger black population than those countries, and our blacks are disproportionately engaged in crime, as noted earlier, even if their crime rate were no higher than that of the rest of the population our overall crime rate would still greatly exceed that of the other countries, because it would fall by only 27 percent from its present level, or to about 1.8 million, which is .6 percent of the population, compared to its current level of.8 percent. 

Long prison sentences should deter crime, or if not deter then incapacitate the criminals and thus prevent them from committing crimes (outside the prison itself) for a long period of time. We might therefore expect to have lower crime rates than our peer countries, and, given the deterrent effect of heavy sentences, lower rates of imprisonment. The fact that instead the U.S. imprison more persons in prison than foreign countries do, yet has no lower a crime rate, calls for explanation. If the demand for crime in the U.S. were no higher than in those countries, and the supply price no lower, we would expect the the United States to have a lower crime rate if it imprisons more persons. So the fact that our crime rate isn't lower requires investigation. The investigation might show for example that we criminalize more activity, which is the equivalent of increasing the demand for crime. If an activity is criminalized, this increases the amount of crime unless the criminalization of the activity drives its level to zero. 

There are a number of other possible explanations for the conjunction of a high rate of imprisonment with a high crime rate. One is not enough police, or intelligent enough police, to prevent and detect crime effectively. Another is a high elasticity of supply for criminal activity, so that discouraging or preventing one person from committing crimes induces someone else to enter the crime industry. Another (suggested above) is that we define crime too broadly, criminalizing activities that in other countries are lawful; our high rate of sexual offenses against minors is a function in part of a high age of consent (18). Or we may make too little use of fines, and of regulatory and private-litigation alternatives to criminal punishment. The prevalence of gun ownership may be a factor, along with the proximity to the United States of countries in Latin America that are large producers of illegal drugs. And finally crime rates are particularly high in the southern states of the United States, and that may have deep cultural roots. 

Reform is difficult when the causes of a problem are multiple or unknown. And because the direct monetary costs of the criminal justice system are not very great by current standards (only about $40 billion a year), and there is strong hostility among the general public to criminals (another cultural fact, perhaps), and because our huge prison system provides a great deal of employment, there is no pressure for reform. Yet the indirect costs of high levels of incarceration must be very great, in the form of the lost output of the large number of prisoners, most of whom are of working age.

Does America Imprison Too Many People? Becker

 

My discussion of this important subject will elaborate answers to the following questions:

1) Does imprisonment reduce crime? Yes.

2) Do many crimes cause considerable harm and hardships to victims? Yes.

3) Does America imprison too many people?  In light of my answers to 1) and 2) you might expect my answer to this question to be “no”, but it is a strong “yes”.

Imprisonment reduces crimes against the general public if only because of the incapacitation effect; that is, person in prison cannot commit crimes against the public-they can and do commit many crimes against other prisoners. For certain crimes, imprisonment also has a deterrent effect, so that potential offenders are deterred from committing crimes by the prospects of prison terms, especially when the probability of apprehension is not negligible.

This conclusion does not deny that imprisonment raises the likelihood that some prisoners will commit crimes when they are released because their skills at legal employment eroded while in prisons, or they learned in prison how to be better criminals, or they become blacklisted for certain jobs, or for other reasons. Nevertheless, Levitt’s study cited by Posner and other studies find that on balance imprisonment reduces crime. The main disagreement is over whether the whole effect of imprisonment on crimes comes from the incapacitation effect, or whether some is also due to deterrence. I believe deterrence is also at work.

That some crimes cause a large amount of both direct and indirect harm is obvious. In high crime neighborhoods, men, and especially women, are afraid to go out alone at night because of fears about being assaulted. Some men in these neighborhoods carry guns, knives, or other weapons as protection against crimes. Children cannot relax at school because they fear robberies, assaults, and bullying from gang members. Many decisions are made primarily with regard to concern and fears about the likelihood of becoming victims of crime. Economic studies confirm this conclusion since they show that property values are significantly lower when crime in a neighborhood is much larger.

Unquestionably, the decline in crime over time in the US has had a noticeable effect on wellbeing and behavior, especially in large cities that have had high crime rates. Crime was the main topic of discussion aside from intellectual subjects when I moved in 1970 to the Hyde Park neighborhood around the University of Chicago located on the South Side of Chicago. Nowadays residents seldom discuss crime, and people feel a lot freer, although not yet completely free, to walk around when it is dark, or to attend evening seminars.

Since I argued both that imprisonment reduces crime, and many crimes cause immense pain and other costs to victims, readers might expect me to conclude that America does not imprison too many offenders. But I believe just the opposite. For whatever reasons, such as higher school dropout rates or more dysfunctional families, the propensity to commit violent crimes is much greater in America than in Europe or Asia. As a result, it is rational for America to imprison a larger fraction of its population, especially for violent crimes. Unfortunately, American prison policies go beyond this point, and America imprisons far too many men and women for nonviolent crimes.

Imprisonment is the right policy for anyone committing heinous crimes like rape, assaults, robbery at gunpoint, and many other crimes where victims are badly harmed both physically and mentally. Imprisonment is the wrong punishment for crimes without victims, or where other punishments are more effective. The sale of drugs is the prime example of a “victimless” crime for understanding the data on imprisonment. Buyers of drugs for the most part enter into voluntary transactions with sellers. Yet almost one quarter of all persons in US prisons are there on drug-related charges. In addition, studies indicate that many others are there because they committed crimes to finance their expensive drug habits since drug prices are kept artificially high by US drug policy.

Elsewhere I have discuss why the US should decriminalize and legalize drugs (see, for example, my post on 3/20/2005 called “The Failure of the War on Drugs”). If the US were to do that, the prison population would eventually fall by over 30%. The imprisonment of blacks and women would fall by even larger percentages since these groups are more likely to be in prison on drug-related charges. Such a policy change would also release police and other resources that have been used to catch and punish drug dealers to concentrate on crimes where victims suffer great harm. These crimes would then fall, perhaps because more offenders would be caught and imprisoned. The US might still imprison a larger fraction of its population than peer countries, but the differences would become much smaller than at present.

Imprisonment should be rarely used also for other victimless crimes, for crimes that do not greatly harm victims, and for crimes where victims can be adequately compensated by fines and other monetary punishments. In these cases, punishment should consist of fines, probation, and other ways that do not require imprisonment. Eliminating imprisonment for drugs and other victimless crimes,and for many other crimes would cut greatly the US’ bloated prison population,reduce the spending on prisoners, and cut down the depreciation of the market skills of offenders who did not commit serious crimes.

 

The Euro Crisis and Euro Bonds-Becker

After the financial crisis erupted in 2008, continental Europe on the whole appeared to be in better shape than the US. The main reason was that the big EU banks held smaller amounts of questionable mortgage-backed securities than did American (and British) banks. The housing markets in Germany, France, Italy, and most other member countries-Spain and Ireland are two exceptions- had not boomed as much as the American and British markets.

Unfortunately, the apparent more solid position of EU banks has turned out to be an illusion because these banks held large amounts of euro-denominated sovereign debt of Greece, Portugal, Italy, and other economically weak members of the EU. The presumption of EU banks in holdong so much sovereign debt of weak members was that the strong members would not allow defaults on any sovereign debts issued in Euros. This same presumption led the now bankrupt American fund, MF Global Holdings, to bet billions of dollars on the expectation that sovereign debt of all members of the euro-zone would be paid off in full.

This same expectation explains why initially the weaker “Mediterranean” countries were the most eager to join the euro bloc. They anticipated much lower interest costs on their sovereign debt because they expected the strong EU nations to provide a guarantee of their debt. These countries also expected that the Maastricht Treaty and other fiscal rules would prevent their governments from running up large deficits. At first, these expectations were met, as interest rates on the sovereign debt of weaker countries fell to levels not much above that of Germany’s, the strongest member of the EU. The significant fiscal deficits of the weaker EU members did not seem important in a world with booming EU and world economies.

All these expectations crashed with the onset of the Great Recession, and the resulting decline in government revenues, and the retreat by banks and other investors from risky assets. As a result, interest rate spreads between sovereign debt of Germany and France and countries like Greece, Portugal, and Italy have soared, and some direct or indirect default on the sovereign debt of these weak countries seems highly likely- which is why they are being forced to pay higher interest rates on new debt.

What can be done now to prevent a catastrophe in the EU that would plunge Europe into another recession, and hurt badly the world economy as well? I opposed the formation of a common European currency because it did not allow weaker members enough levers to adjust to various idiosyncratic shocks they would inevitably face. This view has turned out to be correct, but a return to separate currencies in the middle of the crisis is likely to be highly disruptive.

At the opposite extreme of a break-up of the euro are proposals for some or all of the sovereign debts of individual member countries to be replaced by euro bonds guaranteed by the EU community as a whole (read mainly Germany and France). One recent idea advanced by Germany’s Council of Economic Experts is to have joint liability for all euro-zone debt above 60% of a country’s GDP, while each country would still have to manage payments on the rest of its debt. Even with high interest rates of 7% or more, weaker countries might be able to manage interest payments on debt equal to 60% of its GDP. Presumably, moreover, these interest rates will fall when the EU is guaranteeing a good portion of the total debt. The EU share of the debt would be paid off over a 25-year time period through tax revenues set aside for this purpose.

In the short run this is likely to reduce significantly the crisis. This is especially so if taxpayers in Germany and elsewhere do not rebel either at the additional taxes they will have to pay to fund the sovereign debts of weak members, or if banks get off lightly despite their risky investments in sovereign debt. In the longer run, this plan for euro bonds backed by joint liability of EU countries would require joint control over issue of debt above the 60% mark since that debt would be the obligation of all euro-zone countries. This would necessarily lead to some type of at least temporary fiscal union regarding sovereign debt issue.

Many have recognized that fiscal union is a necessary part of any long-term solution to maintaining the euro. The euro bond approach set out in the previous paragraph is an indirect way to achieve at least partial fiscal union. It will be helpful in the short run, but I doubt if fiscal union alone will preserve the euro in the long run. Weaker member nations will continue to be stressed by shocks to their economy and to their fiscal balance sheets, with many of these shocks not easy to anticipate in advance. The crisis helps demonstrate that a common currency makes adjustment to individual country shocks far more difficult than when countries can devalue their own currencies. This will continue to be a devastating weakness of the euro unless labor and product markets became much more flexible in the euro-zone, and unless labor mobility across member nations increases greatly.

 

The Question of Eurobonds—Posner

Several countries that belong to the Eurozone and thus use the euro as their currency are in peril of defaulting on their sovereign debt. (In fact Greece is certain to default.) If they default it will probably alleviate their economic woes, because their sovereign debt will (in a total default) be wiped out. They may not even have to pay high interest rates to borrow more money, because with their existing debt wiped out their ability to pay interest on new debt will be greater. Nations have defaulted in the past without terrible consequences; and the deeper the economic hole a nation finds itself in, the less costly default is. 

Still, these countries would prefer not to default. They would prefer to borrow at low interest rates. (Who wouldn’t?) They want the European Central Bank to buy their sovereign debt with bonds issued by the bank, bonds that these countries would pay back at their leisure. Naturally the stronger countries of the EU, especially Germany, do not want to throw good money after bad by lending on generous terms to the PIIGS (as they are no longer called in respectable circles—now they are called GIIPS, an acronym that is not be pronounced with a soft g). Instead they want to secure these debts by persuading or coercing the PIIGS to slash their government spending, so that their revenues, diminished by the worldwide depression though they are, will cover their debt service and thus stave off default. 

The PIIGS don’t want to slash their spending, and for good reason; the standard recipe for combating depression is to increase government spending. If consumers are reluctant to consume, and as a result production and employment fall, and with it borrowing and hence interest rates, government can borrow cheaply from the private sector, and it can use the borrowed money to stimulate production and employment. That was Keynes’s recipe for fighting unemployment, and it is a sensible recipe if the stimulus program is timely, well designed, and well executed. That’s a big if, but it’s unclear what alternative the PIIGS have. In the long run they could increase government revenues by a combination of tax reform, more aggressive tax collection, reduction of bureaucratic impediments to the formation and expansion of businesses, deregulation (especially of labor markets) and privatization, reduction of public employment, and shrinkage of entitlements programs. But such reforms would take years to bear fruit, and might be reversed at any time, and their short-term impact on the economies of these countries would probably be negative. The PIIGS, with the exception of Ireland, have very bad political cultures, and bondholders would be unlikely to trust the governments of these countries to make timely and effective reforms. 

At present the European Central Bank and the wealthy northern European EU members are in a game of chicken with the PIIGS. The former want reform and the latter want handouts. Games of chicken can end badly. This one would not, were it not for the fact that all the countries involved share one currency. Indeed, were it not for the single currency there probably wouldn’t be a game of chicken because, as Becker emphasizes, the single currency is preventing the PIIGS from devaluing, and devaluation is the standard solution to depression for a country that has a large external trade. By devaluing it reduces the prices of its exports, increasing demand, which in turn increases domestic employment because exports are domestically produced. At the same time, devaluation increases the price of the country’s imports, which reduces the demand for imports but increases the demand for domestically produced goods and services, as they are substitutes for imported goods and services. (A complication is that imports include inputs into exports, and so an increase in import prices will offset to an extent the reduction in the price of exports brought about by devaluation.) 

A common currency wouldn’t be a problem if it were easy to change currencies, but it is very difficult, especially when the country wanting to change its currency is economically weak. Devaluation by definition reduces the value of a currency, so anticipating that abandoning the euro would result in its replacement (in Greece, say) by a devalued local currency (the drachma), Greek holders of euros would be quick to exchange them for dollars or yen. The rate of exchange would be disadvantageous to them, however, and so there would be a net money flow out of Greece, making the country’s economic state even more desperate than it is. Moreover, the change in currency would affect not only sovereign debt, but all private contracts in euros as well, which would greatly impede the country’s foreign trade. And setting up a new currency takes time and cannot be concealed, so as soon as the setting up began, the run on euros would begin. 

What a mess! Which is why the wealthy eurozone countries are frightened by the prospect of some or all of the PIIGS dropping out of the eurozone and why therefore the PIIGS have some leverage in demanding handouts in exchange for promises (unlikely, in my opinion, to be fulfilled) of austerity and reform.

Occupy Wall Street-Posner



What is one to make of the “Occupy” movement? Is this the return of the turbulent 1960s? Is it the American version of the “Arab Spring”? Of of the French and English riots of recent years?

 

I think only three things are clear: first, human beings are imitative, and the success of the Arab riots that brought down several governments and have shaken others was bound to attract imitation in some form (a necessary qualification: the “Occupy” “occupations” have been minimally violent); second, the social media have reduced the cost of organizing collective activity by strangers; and third, a depression (which we have now been in for more than three years, since the financial crisis of September 2008) gives rise to street demonstrations. (Think of the “Bonus March” on Washington of 1932, broken up by U.S. soldiers under the direct command of General MacArthur, who at the time was the chief of staff ot the Army.)

 

The police I think made a tactical mistake in routing the “Occupiers” from Zuccotti Park near Wall Street. That is the lesson of the 1960s. Arrests, whacking demonstrators with billy clubs, dragging screaming women to paddy wagons, and other police just create anger, martyrdom complexes, and sympathy for the demonstrators. The Occupiers had made the mistake of—occupying urban spaces (in imitation of the Egyptians who occupied Tahrir Square in Cairo), rather than marching in them. The occupations attracted criminals, panhandlers, and lunatics, and created unattractive, unsanitary conditions. Self-destruction impended, which cold weather in most of the country would have accelerated, had not the arrests interrupted the natural process of decay. As a result there is an increased danger that the occupations will be replaced by a movement—how effective a one I do not know. (In January 1969, student radicals occupied the Administration building of the University of Chicago. The police were not summoned, and after two weeks the radicals abandoned the building; almost 100 were then expelled or suspended from the university. The university was largely spared the turmoil that continued for years at other major universities.)

 

The grievances of the “Occupiers” appear to be three: income inequality, lack of jobs, and the baleful influence of the banking industry (“Wall Street”), broadly defined to embrace pretty much the entire financial sector. The three grievances are related, and a skillful leader could make them coherent, as follows. Income inequality had been growing for many years, most rapidly at the top of the income distribution; between 1979 and 2007, the income of the top 1 percent had grown by 275 percent, and the average income by only 18 percent. The income of the top 1 percent has actually declined during the current depression, but the growth of unemployment and underemployment has highlighted the enormous disparity in wealth between top and bottom. Although unemployment is much lower among college graduates than among others, the unemployment rate of young college graduates has increased sharply during this depression, from 2 percent in 2007 to more than 7 percent today. This helps to explain the prominence of college students and young college graduates among the “occupiers” and their emphasis on unemployment and income inequality.

 

Income inequality at the top of the income distribution has been further highlighted by the enormous publicity concerning the extraordinary incomes that continue to be obtained by financial executives despite their role in the current economic distress. Their incomes do appear to be excessive, in the following senses. These incomes are generated to a significant extent by speculation, which has social value in increasing the amount of information about asset values and the speed with which that information is generated, but these social values are smaller than the profits of successful speculators, since those profits consist primarily of gains, often produced by sheer chance, at the expense of the people or firms with whom they are trading. Speculation is not a zero-sum game, because valuable information is generated, but the value is smaller than the gains of the successful speculators. In the case of nonfinancial products and services, the producer is typically unable to capture anywhere near the full value that he creates. Bill Gates is believed to be the wealthiest person in the world, but the business model that he invented, and its implementation by Microsoft under his leadership, have created far more value that he and the other leaders of Microsoft have appropriated.

 

And without government assistance, whereas the incomes of financial executives have been bolstered by the efforts of the government to keep banks from failing.

 

Banking moreover has never been popular. The main reason I think is that banking is one of the few industries that simply refuse to sell to many of their most willing, even desperately willing, customers. For what they are “selling” is loans, and mainline banks won’t lend to people who have poor credit, leaving them to deal with the payday lenders, the car title lenders, and the pawn shops.

 

Because many financial executives have very large incomes, and because banks have huge financial resources, the banking industry has enormous influence on legislation and regulation. In the regime of deregulation and lax regulation of the financial sector that began at the end of the Carter Administration and accelerated in subsequent Administrations (notably Clinton’s and the second Bush’s), bankers were enabled to engage in a variety of risky and sharp practices—and competition forced them to do so. Banks depend mainly on short-term capital, both financial and human, and firms that depend on short-term capital are constrained to compete to the fullests extent allowed by the law and regulatory authorites, or else they lose their capital to their bolder competitors. Competition in such an industry is Darwinian.

 

Railing against income inequality, job loss, and banking abuses is thus understandable, but it doesn’t do any good. The “Occupiers” are anarchic and disruptive, and the solid middle of American society, which rejects the Tea Party because of its goofy ideas, is likely to reject the Occupy movement because of its style, while broadly sympathetic to its antipathies. But if the movement attracts charismatic leaders amidst a stagnant or worsening economy, it may become a force in American politics. Already Kalle Lasn and Micah White, who appear to be the nearest thing the movement has to leaders, have published an articulate manifesto, “Why Occupy Wall Street Will Keep Up the Fight,” www.washingtonpost.com/opinions/why-occupy-wall-street-will-keep-up-the-fight/2011/11/17/gIQAn5RJZN_story.html?hpid=z2 (visited Nov. 20, 2011), which reminds me of Tom Hayden’s 1962 “Port Huron Statement of the Students for a Democratic Society,” www.h-net.org/~hst306/documents/huron.html (visited Nov. 20, 2011).

The Occupy Wall Street Movement-Becker

Will the “Occupy” movement develop into a significant political force? I am doubtful: the movement is already losing supporters in most places where it has been active. Cold weather will accelerate the decline. The movement is losing ground not because the issues it raises are unimportant, but rather because the great majority of Americans and those in other countries with Occupy groups do not sympathize with most of the people doing the occupying.

We discussed the unemployment situation in the US last week, and reform of banks in several previous posts, so I concentrate my comments on the inequality issues raised by occupiers. American inequality in the distribution of incomes, and inequality in many other Western nations, has grown a lot since the late 1970s. This growth can be separated into the growth in earnings inequality across education and other skill classes, and the growth in income at the very top of the income distribution. I start with the inequality by skill since that is what most closely affects the vast majority of people.

Many of the Occupy Wall Street participants are college students- it is easy to miss classes at most colleges for a few days and even much longer- and other young persons who had gone to college. They have complained about the ”high” unemployment of college-educated persons, and also about the burden of college loans. Yet the large increase in earnings inequality during past 30 years has mainly taken the form of a growth in the earnings of college graduates and that of others with high levels of skills relative to earnings of high school dropouts, high school graduates, and others with lower skills. Although unemployment grows for all education groups grow during recessions, it has not grown any faster during the Great Recession for college-educated persons than for persons without college, and is still much lower for the college educated. For example, in October of 2011 the unemployment rate for college graduates was under 5% compared to an unemployment rate of almost 14% for high school dropouts.

Nor are the complaints by occupiers about the burden of student loans much better founded for the great majority of graduates. The typical rate of return to a college graduate, especially those with post-graduate degrees, has risen greatly since the late 1970s, certainly high enough to support even sizable student loans with interest payments that are heavily subsidized by the federal government. The real ones with a gripe are high school dropouts who not only have high unemployment rates, but also low real earnings that may have fallen for dropouts during past 30 years, poorer health than others, bad marital prospects, and weak access to home ownership and other consumer luxuries.

The Occupy Movement and everyone else worried about earnings inequality should be emphasizing the need to find ways to encourage more high school dropouts and high school graduates to get the required background and study habits so that they can, and want to, continue on for a college education. A daunting task, but a necessary one in order to respond in an effective way to the anatomy of the large growth in earnings inequality.

The income share of the top 1% in the United States has declined a lot since the onset of the Great Recession, but it is still much higher than it was in the 1970s. Earnings are also an important component of these very high incomes, but these are earnings of top management and executives, including the top earners in banking, and in hedge funds and other managers of money, and including also the top earners in medicine, law, consulting, and some other fields. According to a November 2010 study by Bakija, Cole, and Heim (I am indebted to Steve Kaplan for referring me to this study), more than 60% of the persons in the top 1% of the income distribution in 2005 consisted of (non-finance) executives, managers, and supervisors, medical personnel, lawyers, and non-finance persons doing computing, math, or engineering.

Although, on the whole, I believe that most members of the top 1% provide useful services to society, I share the concern of “occupiers” and Tea Party members about many of the bailouts. The rich bankers and others who took large risks should have taken much larger haircuts. I have also supported from the beginning of the recession higher capital requirements for banks, especially for the large “too big to fail banks” that will be bailed out if they get into financial difficulties. 

Nevertheless, the overall earnings inequality has far greater relevance for the vast majority of occupiers and Tea Party supporters than do the earnings of men and women at the very top of the financial sector. The most effective way for the US to reduce overall inequality that will help the largest number of young persons is by finding ways to bring American high school and college graduation rates up to the levels achieved by the other nations, such as South Korea and some European nations, that have replace the US as worldwide leaders in education achievements.