Stumbling and Mumbling

Taxes, norms & belief equilibria

Here's another recent finding in experimental economics:

We analyze how tax evasion is affected when the same income is earned without any effort, or with a moderate or high level of effort.We find that subjects who have invested high levels of time and effort evade significantly more taxes.

In other words, people who feel more entitled to their income, by virtue of sweating for it, are more likely to try to keep it.

You might think this unsurprising .But I think it highlights something I've said before - that neoliberalism is performative; it doesn't just describe the world, but creates it.

One claim of neoliberalism is that individuals are entitled to their incomes, as these are the result of work and contribution to society rather than to, say, luck or accidents of history. If people believe this, then they will have lower tax morale, and so will try to dodge taxes either legally or not. The neoliberal claim that higher tax rates reduce revenues will therefore be true. But this will be only so by virtue of people believing they are entitled to their incomes. Neoliberalism then becomes a self-fulfilling belief equilibrium*.

But we can imagine an alternative equilibrium - in fact we don't need to imagine it, as it has existed in some social democratic societies. In this, people regard their high incomes as a product of good luck, and feel obliged to share this fortune. As a result, they tolerate high taxes. In this world, the social democratic claim that high taxes don't reduce effort is true - but, again, only by virtue of people's prior beliefs.

This poses the questions: is it possible to shift the belief equilibrium away from the neoliberal to the social democratic one, and if so how?

It's in this context that we should interpret MPs' haranguing of companies for "immoral" but legal tax-dodging.

From one perspective, such finger-pointing makes no sense; if Labour MPs think companies should pay more tax, they should have changed the law during the 13 years they were in office. However, what they are trying to do is change social norms by stigmatizing tax dodging. This is more than reasonable. It is only by having norms which raise tax morale that higher tax rates can be reconciled with economic efficiency.

Whether MPs alone have the power to change norms is, however, another matter.

* The same might be true for corporate taxes. In a neoliberal world where managers' duty to maximize "shareholder value" is interpreted as narrow short-term profit maximization, we'll see more corporate tax dodging than we would in a world where social norms frown upon agressive tax planning with the result that companies who engage in it alienate customers and so suffer a loss of business.

The hollowed middle

What has happened to inequality in recent years? By one standard, it's increased; the share of pre-tax incomes going to the top 1% has rose from 10.4% in 1993 to 13.9% in 2010. By another standard, though, it hasn't much changed lately. Gini coefficients rose sharply between the mid-70s and early 90s but have since moved more or less sideways (figure 5 here).

There's no inconsistency between these two facts. The Gini coefficient measures all inequalities whilst the top 1% ratio measures just one. It's possible, then, for the top 1% to pull away from everyone else without increasing the Gini, as long as inequalities elsewhere in the income distribution are falling.

Which poses the question: if inequality between the top 1% and the rest has risen, in what offsetting sense has inequality fallen?

My table helps answer this. It shows ratios of income to the bottom decile for three years: 1977 (when current data began); 1993, when the Gini peaked; and 2010-11, the latest year available. I'm using two measures of income: original, which is pre-tax incomes from wages, savings and suchlike; and disposable, which are after directs taxes and benefits*.

This shows that between 1977 and 1993 all income deciles pulled away from the bottom two deciles. In 1977, the top decile's disposable income was 5.23x that of the bottom, but in 1993 it was 9.2x.

However, since 1993 these trends have greatly slowed, and in some cases reversed; I'm not sure how far what matters is the level of relative income rather than the rate of change. In terms of original incomes, the top deciles have lost relative to the bottom two. And because the top 1% has gained, we can say that they have also lost relative to the very rich.

Take, for example, the 6th decile.Since 1993, it's disposable income has barely changed relative to the bottom decile, and it has fallen relative to both the second and top deciles. Much the same is true for the surrounding deciles.

In other words. what we've seen is a squeezed middle, with median earners losing out relative to the poor and very rich. This, I suspect, is due in part to job polarization - the fact that technical change has reduced demand for what used to be moderately well-paid routineish white-collar jobs.

Yes, most people are better off in absolute terms than they were 20 years ago. But we don't compare our incomes merely to those of our 1993 selves. We compare them to our contemporaries. And these comparisons show that the improvement relative to the poor for the middle deciles has more or less ceased since the 1980s, and in some ways it has gone into reverse.

I suspect this is important socially and politically. Politically, it might explain the the increased hostility towards the poor, whom the middling sorts perceive to be a greater threat to their relative position; envy, remember, isn't always directed towards those better off than us. And it might also explain resentment towards the "political class" which has failed to improve the relative position of median earners.

But I have a sense that it's worrying at a broader, social level. Is it really healthy for a society to see a hollowing out of its middle class, with those who are in it feeling threatened by and resentful towards both the poor and the rich?

* Taken from table 16 here, for non-retired households; the disposable incomes are equivalized - that is, they take account of differences in the size of households.

On within-class envy

One of the great failures of classical Marxism has been the lack of development of class solidarity. Marx expected the working class to become more conscious of its common interests and thus develop into a powerful political force.But this never happened to the extent that Marxists hoped.

Why not? One possible reason lies in reference group theory. This says that individuals compare themselves to their own social circle rather than to everyone, with the result that we envy colleagues and former classmates who have done slightly better than us rather than the super-rich. This erodes class solidarity.

Some laboratory experiments (pdf) by Philip Grossman and Mana Komai have shown how common such in-group envy is, and how damaging it can be.

They split subjects randomly into two groups - rich and poor, with the rich given a higher endowment and the chance to invest at higher returns than the poor. After a while of investing, and increasing class inequality, subjects were then given the opportunity to spend some money in order to destroy part of another's wealth.

If people were free of envy, they'd never take up this offer as it always impoverished them. But in fact, such choices were quite common. In total, subjects chose to destroy part of another's wealth in almost a quarter of the instances in which they could; 2346 times out of 9600 choices.

However, attacks by the poor on the rich were only a minority of all attacks - 619 of the 2346. Almost as often (509 times), the poor class attacked their fellow poor, with most of those attacks being upon people poorer than themselves. And most of the attacks upon the rich came from other rich folk.

This tells us that there is indeed some inequality aversion; people will pay money to reduce inequality. But this is only part of the story. Folk are also concerned with their individual relative status. So they'll pay money to hold down people who are slightly worse off than themselves, and to bring those slightly above them down a peg or two.

Of course, there are countless real world analogies to this behaviour. Old money sneering at new money, the rich complaining about the super-rich, "white trash" being racist and "strivers" attacking "shirkers" are all examples of within-class conflict. What's striking about this experiment is that such behaviour emerges so easily, without the aid of ideology or media manipulation.This suggests that the lack of development of class solidarity has some deeper-rooted causes than ideology alone.

For a Marxist, this is depressing stuff. But it should also concern any liberal or democrat.It suggests that people might support policies that hurt other poor people - for example, welfare cuts or immigration controls - even if they themselves are harmed by such policies. In this sense, people's preferences aren't necessarily the same as their narrow material interests.

What Eton knows

Some people are unhappy that an Eton entrance exam asked candidates to write a speech justifying the shooting of protestors. Their disquiet reflects the discomfort the soft-headed left feels when confronted with the cold hard facts of life.

It is no accident that the question follows a passage from Machiavelli. What we're seeing here is that Eton - the training ground for our future leaders rulers - instinctively understands the nature of power, whereas its soft left critics have always been simperingly naive about it. I mean this in five senses:

1. Political power rests, ultimately, upon force and violence. Plan A for the ruling class is to govern by consent. But there is a plan B.

2. Power comes with risks. If you give bosses power over companies, there's a danger they'll extract wealth for themselves at others' expense. If you give bankers' power over the economy there's a danger of damaging financial crises. And if you give guns to some people and not others, there's a danger people will be killed*. This is something New Labour never really understood. In creating so many new criminal offences and bolstering the power and self-importance of the police, it thought it was acting out of good intentions but was - to take only the latest example of many - merely giving them licence to bully old ladies.Good intentions are not enough.

3. Power depends upon mechanisms. The question rulers must ask is: what tools do we have to exercise our will? Eton knows that one such mechanism is force. Again, though, social democrats have long been naive here. One reason why New Labour was cringingly deferential towards bosses was that it thought that "leadership" was a magic which enabled things to get done, and that the secrets of such ju-ju were known by a priestly elite of "business leaders". But that naivete was nothing new. Back in 1931 a Labour government was replaced by a coalition government which promptly left the gold standard, prompting one Labour politician to bewail "Nobody told us we could do that." Both episodes betray social democrats' ignorance of the tools of power. But Eton's examiners know what the tools are.

4. The role of bad faith. The examiners are not asking for a philosophical defence of killing protestors, but for a speech. The difference is that political speeches need not be true or sincere. The legitimation of power rests partly upon lies and half-truths.

5. Who, whom? Lenin got it right. Power is about who does what to whom? Eton's examiners know that their charges will be the "who" and the rest of us the "whom."

A great thinker - well, greater than most on the non-Marxist left - once asked: "what chance have you got against a tie and a crest?" None at all, given that they know what power is whilst the soft left is just wimperingly emotive. 

* I nearly wrote here that there's a risk that power will be abused. But when people speak of the "abuse of power" they often mean what they mean when they speak of "drug abuse" - the routine use of it.

On terrorist probabilities

Why aren't the Scots doing more to combat their culture of violence? Why aren't its community leaders doing more to rein in their violent minority? Don't we need tougher laws to protect us from the threat posed by men of Scottish appearance?

You might think I've lost my mind. From a statistical point of view, though, I haven't.

According to table 1.18 of this pdf, there were 89 Muslims in prison for terrorist offences in March 2012 . As there are 2.7 million Muslims, this is 33 per million.

By contrast, there were at the latest count 2382 people imprisoned in Scotland for assault or murder. That's 449 per million.

The prevalence of violent people in Scotland is therefore 13.6 times that of terrorists among Muslims. In fact, this is an understatement. A Scotsman who has committed a violent crime is more likely to be out of prison than a Muslim terrorist, either because he's more likely to have gotten away with his crime or because he's more likely to have finished his sentence.

If it is reasonable to speak of a problem of Muslim terrorism, it is therefore an order of magnitude more reasonable to speak of a problem of Scottish violence.

I anticipate two objections here.

One is that terrorism is nastier than street fights. True.But we must distinguish between the cost of an event and it's probability; I'm talking about the latter.

Secondly, the prevalence of terrorism is greater among Muslims than non-Muslims; Nick Cohen is correct to point out that popular culture misrepresents terrorism in this regard. We can quantify this. There are 29 non-Muslims in prison for terrorist offences. That's a rate of 0.5 per million non-Muslims in the population generally. So, Muslims are more likely to be terrorists than non-Muslims. Coincidentally, the difference between the two groups is about the same (pdf) as that between the prevalence of assault in Scotland and New Zealand - so my analogy holds.

But of course, P(A|B) is not the same as P(B|A). The fact that a terrorist is likely to be a Muslim does not mean a Muslim is likely to be a terrorist. Even if we assume that there are ten terrorists walking the streets for every one inside, then 99.988% of Muslims are not terrorists. To put this another way, there's only around a one in 8000 chance of a Muslim being a terrorist; it's 16 times more likely that the Duke and Duchess of Cambridge will name their child Wayne.

Given all this, why does anyone think terrorism is a Muslim problem? There are several biases at work:

1. The out-group homogeneity bias. Will Davies tweeted that "in my day, a bloke who stabs a random stranger then rants about the government was called 'insane'". This is true if the bloke is one of "us". If, however, he is one of "them" then he is more representative of "them".

2. The narrative fallacy. We love to tell stories and read messages into things, and thus underweight the significance of random nuttery. Frank Furedi says:      

One problem with the construction of the random fanatic, is that virtually any form of incomphrehensible act of violence – a school shooting, a crazed knife attack – can be redefined as an act of political terrorism. That is why far too many people cannot resist the temptation of defining the tragedy in Woolwich as an act of political terrorism.

3. The availability heuristic. Dramatic events weigh heavily upon our mind, and this causes us to overweight their probability.  

4. Many groups have an incentive to exaggerate the significance of terrorism, and to reframe insane violence as "terrorism." For the police, such attacks give them a chance to further inflate their sense of self-importance and to seize more powers. And politicians can use the image of grave danger and an evil foe to appear Churchillian.

Some things, however, are less significant than they seem.

Superstars' baleful effects

Do we over-rate the importance of individual talents to organizational performance? I ask because of this finding by Sander Hoogendoorn:

Team performance exhibits an inverse u-shaped relationship with ability dispersion.

This comes from a study of MBA students' collaborations on business projects. But it is consistent with a finding from baseball, that teams with middling levels of ability dispersion do better than those with low or high dispersion.

It's easy to hypothesise why this might be so. Where's there's middling levels of ability dispersion, less able team members can learn from their superiors. But if there's too much dispersion, they might instead rely too much upon their superstar and shirk responsibility themselves.  

Although the only formal study of this hypothesis for football is ambiguous, it is consistent with something Bill Shankly said: "A football team is like a piano. You need eight men to carry it and three who can play the damn thing" - that is, a middling ability distribution. Spurs' sad failure to qualify for the Champions League also corroborates it. They - more than Arsenal or Chelsea - probably have a greater dispersal of ability; the performance gap between Bale and (say) Adebayor is probably larger than than between any two regular Arsenal players*.

All this evidence suggests that relying upon a single superstar is dangerous. There's other evidence for this. Boris Groysberg has shown that the performance of apparently superstar equity analysts declines when they move firm. And many TV shows continue to thrive after the departure of their apparent stars; one of the more significant and forgotten facts of the 1970s was that the Generation Game reached its peak of popularity after Bruce Forsyth left and was replaced by Larry Grayson.

But its not just in important matters such as sport and TV where an excessively lop-sided dispersion of ability can have adverse effects. The same might also be true in politics. The two dominant politicians of our age have been Thatcher and Blair. But under and after their leadership, their parties decayed in both membership, finances and, perhaps, intellectual vigour.

Sure, superstars can sometimes transform a team or organization. But other times, they can serve like Potemkin villages - a healthy facade behind which lies nothing of substance.

* Remember, we're controlling for average ability here.

Why pre-tax inequality matters

Does pre-tax inequality matter? I ask because of a dispute between Aditya and Tim. Aditya says that inequality is back at 1920s levels - which is true if we consider the share of the richest 1% - to which Tim replies that the relevant metric is inequality after taxes and welfare benefits:

What we really want to do is measure the distribution after we’ve changed it. For only after we’ve checked how much we have changed it can we decide whether we want to change it some more.

However, I suspect that pre-redistribution inequality does matter.

For one thing, market rewards are linked to the esteem in which we hold ourselves and others; there's a reason why wages are called "earnings." The rich get respect from others and a sense of self-worth and arrogance, whilst those reliant upon "hand-outs" feel despised; this is why the unemployed are so unhappy, even controlling for (pdf) their low incomes. I would have expected a senior fellow of the Adam Smith Institute such as Tim to know this, as this is what the great man wrote:

This disposition to admire, and almost to worship, the rich and the powerful, and to despise, or, at least, to neglect persons of poor and mean condition...[is] the great and most universal cause of the corruption of our moral sentiments...
We frequently see the respectful attentions of the world more strongly directed towards the rich and the great, than towards the wise and the virtuous. We see frequently the vices and follies of the powerful much less despised than the poverty and weakness of the innocent. (Theory of Moral Sentiments I.III.28)

Mere monetary redistribution doesn't solve this problem. Indeed, it might even exacerbate it, by making the rich feel that they are being deprived of their entitlements in order to support "scroungers". In this sense, inequality can lead to distrust, as Eric Uslaner has written (doc):

When some people have far more than others, neither those at the top nor those at the bottom are likely to consider the other as part of their “moral community.”  They do not perceive a shared fate with others in society.  Hence, they are less likely to trust people who may be different from themselves.

This matters, because trust is a significant influence upon economic growth.

Worse still, the high opinion the rich have of themselves tends to be shared by politicians. One of the more unpleasant aspects of New Labour was its deference towards bosses which led Gordon Brown to commission endless policy reviews from them, and in the US there's a revolving door between Washington and Wall Street. In this sense, pre-tax inequality of incomes generates an anti-democratic inequality of influence and political power.

But there's another reason why tax and benefits aren't sufficient to reduce inequality. A tax and benefit system does not distinguish between the sources of incomes. An income that is derived from rent-seeking, exploitation or cronyism is taxed as much as one obtained through talent and effort. James Crosby and J.K. Rowling are taxed similarly. But there's surely a difference between them.

Now, you might read all of this as a criticism of Tim. But that's not my main point. My point instead is addressed to the soft-brained left; higher taxes and more generous welfare benefits are nothing like sufficient to tackle inequality.

"Swivel-eyed loons"

In the row over the "mad, swivel-eyed loons" remarks, something is being missed - that, from an economists' perspective, we'd expect political activists to be disproportionately mad.

By "mad" I do not mean the content of activists' beliefs, but rather the intensity with which they are held; I'm thinking here of fanaticism rather than extremism. I don't think opposition to EU membership or to gay marriage are mad. What is mad is attaching great importance to such views. As Adam Smith said, "there is a great deal of ruin in a nation." We can live well with a lot of suboptimal policies.

But here's the thing. Political activists are selected for passionate intensity. Stuffing envelopes and canvassing often-hostile voters is a dull and unpleasant way of passing the time. So what sort of people would volunteer to do it? The sort who over-rate the importance of politics - who believe their favoured policies will have huge pay-offs and their opponents' will lead to disaster - that's who. As Eugene McCarthy said:

Being in politics is like being a football coach. You have to be smart enough to understand the game, and dumb enough to think it's important.

I suspect there are two other selection effects:

- When the main parties have so much in common - similar managerialist ideologies - a narcissism of small differences emerges, with both sides exaggerating the benefits of their side and costs of their opponents'. In the 70s and 80s, when there really were big differences between Labour and Tory, it was possible for rational people to think that party politics was very important. It is less possible to do so now.

- Party political activism is now a minority activity. This, I fear, creates positive feedback effects. When party membership was a mass activity, peer pressure attracted sensible people to become activism. Now it is regarded as eccentric, only the eccentric are attracted.

All of this applies to both Labour and Tory parties. But there's another mechanism which makes me suspect that Tories (and Ukippers) are more likely to be loons. If you're a middle-aged, moderately wealthy person working in the private sector, then party politics doesn't much affect you personally: a few pounds here or there on tax rates doesn't much affect the middle classes, but changes to benefit rules can make a huge difference to recipients. The typical Tory activist, therefore, is likely to be someone who over-estimates the importance of party politics.

Now, I don't say all this to claim that all party activists are loons. That phrase "from an economists' perspective" is doing some work; I'm speaking here of cost-benefit considerations and abstracting from the crooked timber of humanity which causes some sane people to become activists.However, these thoughts are consistent with a recent empirical finding - that political activism, unusually amongst voluntary activities, does not make people happier.

Adam Smith on immigration

UKIP claims that its tax policies are derived from Adam Smith. But what would the great man make of its anti-immigration policies? I suspect the answer is: not much.

Now, immigration was not much of an issue in Smith's time so he said little about it directly. But he did point out that some forms of migration, such as the settlement of new colonies, greatly increased prosperity. And his argument that import duties encouraged smuggling has an obvious parallel with how immigration controls encourage people traficking.  smuggling.

But I'm thinking more of a passage in The Theory of Moral Sentiments (III.I.46 here). He acknowledges that we lack sympathy with foreigners. We would, he says, "snore with the most profound security" upon learning of the destruction of an "immense multitude" of Chinese in an earthquake. But this lack of fellow-feeling must be resisted, he continues. The "impartial spectator", or our conscience:

calls to us, with a voice capable of astonishing the most presumptuous of our passions, that we are but one of the multitude, in no respect better than any other in it; and that when we prefer ourselves so shamefully and so blindly to others, we become the proper objects of resentment, abhorrence, and execration...
One individual must never prefer himself so much even to any other individual, as to hurt or injure that other, in order to benefit himself, though the benefit to the one should be much greater than the hurt or injury to the other.

This, I suspect, is an argument for open borders. It tells us that we must not impose harms upon would-be immigrants, even if immigration is costly to us (which it isn't, but let that pass.)

You might object that by "others", Smith means only other members of our society, or fellow nationals. You'd be wrong. Later on, he writes:

Our good-will is circumscribed by no boundary, but may embrace the immensity of the universe...
The wise and virtuous man is at all times willing that his own private interest should be sacrificed to the public interest of his own particular order or society. He is at all times willing, too, that the interest of this order or society should be sacrificed to the greater interest of the state or sovereignty, of which it is only a subordinate part. He should, therefore, be equally willing that all those inferior interests should be sacrificed to the greater interest of the universe, to the interest of that great society of all sensible and intelligent beings (VI.II.44).

We should, then, read Smith as being a cosmopolitan thinker. Samuel Fleischacker, for example, says "there is no question, I think, that Smith aspired to provide...a structure for morality that reaches out across national and cultural borders."

Such an attitude is surely inconsistent with the little Englander anti-immigrant policies of UKIP.

I say this not simply to point out that UKIP's drawing on Adam Smith is rather selective. I do so to remind readers that Smith was a greater moral philosopher than economist;this passage, for example, is just wonderful.

Trends in exploitation

Richard Exell draws attention to figures from the US's BLS, which show that since the early 90s, manufacturing productivity growth in the UK has far outstripped real wage growth. This strikes me as odd. It poses the question: if UK manufacturers have been increasing the rate of exploitation, how come their rate of profit is so low? ONS data show that manufacturers' net return on capital was 4.7% in 2012, way down from 15.8% in 1997, when the ONS's present records began.

One reason is that the capital-output ratio has increased. Another is that manufacturing prices have not risen as much as consumer prices; since 1996 (when ONS records began) producer prices have risen 31.6% whilst the CPI has risen 43.4%. This has driven a wedge between the real wage as experienced by manufacturing employers, and that as experienced by workers.

In fact, there is a different set of data which paints a very different story from the BLS, shown in my chart.

This shows labour productivity for the whole economy - defined as GDP per employee* - and real wages**, as deflated by the GDP deflator at basic prices; this is the real wage as experienced by employers, rather than employees. The data starts in 1992 because that's when ONS data on employees begins.

This shows a cyclical pattern in the rate of exploitation. Productivity rose faster than real wages in the early 90s, more slowly in the late 90s, faster in the early 00s but has since fallen. The rate of exploitation is about the same now as in the early 90s. This is consistent with the trends in wage and profit shares during this time.

This is a very different picture from the BLS's numbers, not least because productivity in the whole economy has grown more slowly than it has in manufacturing - by 37.5% between 1992 and 2011 in my data against 78.7% in the BLS's.

This poses the question: if the rate of exploitation hasn't increased much lately, why are wages squeezed?

Two reasons. One is that productivity has fallen since late 2007, so the pie is smaller for both capital and labour. Another is that, thanks in part to rising VAT, the prices experienced by workers have risen faster than the GDP deflator - by 17.8 per cent between 2007Q4 and 2012Q4 against 9.3% for the deflator.

I do not say all this to deny that workers are exploited. They are; anyone who thinks you have to believe in the labour theory of value in order to claim this should be hit repeatedly with a copy of Roemer's Free to Lose. But we should distinguish between this fact about the general nature of capitalism and the cyclical problem of depressed real wages, which has little to do with an increased degree of exploitation. 

* ONS code identifiers CGCE divided by MGRN

** This is defined as total employees compensation divided by the number of employees: identifiers DTWM and MGRN, divided by CGBV