Friday, September 08, 2006

Income Distribution and Monopoly Rents

Maybe I am a lefty. In any case I find this discussion of income distribution (by Maynard of Creative Destruction) rather compelling:
I think one thing that's going on with the income distribution is this. With the development of communication and computer technology and the greater reach of large corporations in the last several decades, our productive technology is increasingly characterized by scale economies (I haven't read Rosen's Economics of Superstars, AER 1981, in awhile, but I think my argument is related to his). Two examples. Microsoft dominates the "market" for operating systems because of network effects: the more people who use Windows, the more valuable it becomes for the marginal user. Tom Hanks gets paid an outrageous amount of money because the distribution of his movies has become so sophisticated. It costs next to nothing at the margin to distribute one more copy of the same movie, so he is able by dint of a slight advantage in talent over a performer that no one has ever heard of to dominate the market. This means that there are huge monopoly rents that are up for grabs across huge swaths of the American economy. In the old days when the economy was insulated to some extent from the rest of the world and workers were represented by strong unions, you might have seen workers take a big chunk of these rents. But in the present environment, the rents go to those in the strongest bargaining position, namely the executives at large corporations and institutions and the performers who always have the recourse to walk away from the next film (or music, or sports) deal. So Brooks is right that our "meritocracy" is rewarding people based on individual talents, those who are organized, self-motivated, and socially adept. But the talent that is being rewarded is the talent to extract rents, not the talent to produce a higher quality product than the competition. Rewarding that particular talent produces no benefits for society; there is no economic argument to justify such a meritocracy, no economic basis for opposing, say, a steeply progressive tax system that would counteract some of the forces pushing us toward greater income inequality.
In fact, progressive taxation is more efficient. People in the bottom half of the income distribution aren’t getting much of the rents. They’re being paid roughly their marginal product, and taxes would distort their labor/leisure decision. People near the top of the distribution are the ones who have succeeded in capturing rents. They are being paid much more than their marginal product, and taxes actually correct a distortion in their labor/leisure decision.

Note, however, that these arguments don’t apply to capital taxation. (Maybe I’m not a lefty, after all.) If an individual has a lot of capital income, it is probably because that individual had a lot of capital to invest, not because she is capturing a disproportionate amount of rents in her capital income. So there is no efficiency justification for progressive taxes on capital income.

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15 Comments:

Anonymous happyjuggler0 said...

As a libertarian I'd like to see all taxes go lower, and with it government's size. Besides mere principles of liberty, I also think government is much less efficient than individuals at maximizing returns on those dollars. Just to highlight my bias going in....

If I had to make a priority on what taxes to cut or abolish, I'd pick some sort of investment tax. Cutting, or abolishing, an investment tax implies that a much larger proportion of the gains by the would be payer of investment taxes would then be reinvested, at least in the short and medium term. This contrasted with some sort of consumption tax like gas taxes or tobacco taxes. A cut in income tax that was viewed as permanent would likely be used virtually the same way as it is now, mostly for connsumption with some much smaller amount for investing.

The social upside of this investing of course is increased demand for labor. I don't know that this will reduce inequality, and it may increase it, but some of this increased demand for labor will be for low skill/low wage labor, and an increase in demand (all other things being equal) for something does what to its price?

This brings up another thought. Targeting investment tax cuts for employing the bottom of the wage barrel.

I've long been puzzled/disturbed by Germany's approach to reunification of the low skill east with the high skill West. They demanded equal wages, thus choking off any rationale for investing in the East. They thus had a large migration to the West where the jobs are.

What I would have done, and would still do, is allow market prices for wages to clear by taking away government reg's on East labor, at least as much as possible, especially in terms of minimum wages, but other things like ease of firing redundant or bad workers too.

I also would've, and still would, massively slash corporate tax rates in the East, making them much more attractive than both the West and also at the very least no higher than in Estonia, Hungary etc. I'd also decimate payroll taxes for workers in the East. Cutting payroll taxes is essentially the same as cutting income taxes, but it is invisible to workers, so cutting them doesn't create perverse incentives for workers to move to the East the way that an income tax cut would.

Switching to the US, we ought to target areas where we have large pockets of unemployment and large pockets of poverty in much the same way. From an efficency point of view this is not ideal, but if the goal is to raise the bottom of the ladder....

Yes, this is basically empowerment zones again, but with some real teeth, at least in its ideal theoretical form before the political process distorts it.

Zero corporate income taxes for these targeted areas, which would be largely urban and rural, and minimal to nonexistent in suburbia. Zero payroll taxes for these areas, with the "benefits" that these taxes would have been targeted for being paid for by general corporate income taxes, with the first such payments being labeled SS taxes, unemployment taxes etc.).

Abolish the minimum wage in these areas, as well as all union labor laws, as well as prohibitions on firing for any reason. I realize that there would considerable resistance to this from some quarters, but it is consistent with lowering barriers to hiring. It also helps that these areas are likely to be mostly racially homogenous and thus racial firings a nonissue.

The libertarian in me thinks any lost revenues (which are likely to be minimal except in terms of opportunity cost since there isn't a huge amount of tax revenue received from these areas anyway) ought to be "paid" for by lower spending. Of course I think that we ought to be spending less regardless. But if this is not viable politically, then I could live with a tradeoff of higher marginal income tax rates.

It is also worth noting that such reductions in poverty and unemployment would raise income tax revenues, at least in the long term. In the short, medium, and long term this would also cut government redistribution spending to these now emplowed and non-impovershed people, and at the risk of invoking wrath from voodoo economics labelers, Laffer Curve effects here conceivably could end up with a net gain from the point of view of the budget. Again, at worst the losses to the overall budget picture would be minimal if there are any such losses.

Along these lines, the opportunity cost in terms of government revenues (for those who actually want government to have more revenues instead of less) is likely to be less than it might be since at the margin there would be some investments here from both doemstic and foreign companies that would otherwise have located overseas somewhere instead.

If I'm right and this works to lower both poverty and structural unemployment rates, then not only would this be great in and of itself, but this would lower the long term viability of redistributionism. As a libertarian I am all in favor of that long term outcome of course since it is the stalking horse for our ridiculously large government spending.

Fri Sep 08, 01:59:00 PM EDT  
Anonymous Anonymous said...

the scandanavian social-welfare states all have low capital taxes and high consumption taxes. so you're not alone

Fri Sep 08, 02:10:00 PM EDT  
Blogger Gabriel Mihalache said...

People near the top of the distribution are the ones who have succeeded in capturing rents. They are being paid much more than their marginal product, and taxes actually correct a distortion in their labor/leisure decision.

Ha, ha. You say that like it's a problem. Can I have some of that of type distortion too, please?

Any change in the constraints faced by an agent might be/probably is distortionary compare to the previous constraints. Whatever an agent does, it's optimal given the context.

I can't imagine some rich people complaining at dinner parties: Damn it! Why do I have to be so productive? I'm so productive that I end up working more, according to my own preferences, than I would work if I were less productive... Oh, my, the tragedy!

As for statist leftists and rent-seeking, it's the pot calling the kettle black. So, we're quick to blame Microsoft and Tom Hanks, natural monopolies, but never shall we look closer to home, at the political/coercive rents of governmental largess, no?

P.S. I don't think you are a lefty, if I might offer my opinion. I think that you are mostly influenced by a certain kind of reading of utilitarianism, the dominant one in American liberalism, but you don't seem to hate the rich, maybe because you work in the real world and not academia. Also, you seem to be Keynesian not because of the dirigiste implications, which draw in leftists, but because of the actually theory. Just my guess.

Fri Sep 08, 02:24:00 PM EDT  
Anonymous Anonymous said...

Damn it! Why do I have to be so productive? I'm so productive that I end up working more, according to my own preferences, than I would work if I were less productive...

Actually, Knzn's contention is that, in general, high income people are earning monopoly rents rather than being compensated for their productivity. Hence, a steeply progressive income tax approximates a tax on rent, which is of course non-distortionary.

Sat Sep 09, 02:30:00 PM EDT  
Blogger jult52 said...

I've been thinking about this very interesting post for a couple of days now and have decided that a better definition of "monopoly rents" is needed. Could you define what you mean by this phrase?

I'd also like you to address the "efficiency effects" of having a winner-takes-the-monopoly-rents labor structure. I'll put the case briefly: in an information economy, it's hard for managers to really know how hard subordinates in the corporate hierarchy are working. A winner-takes-monopoly-rents structure gives incentives for workers to try their hardest because the rewards are so high. This argument is proposed briefly and, in dishonest fashion, not addressed by Frank and Cook in their book "The Winner-Take-All-Society."

Enjoying your blog and hoping you will address both of these arguments when you have time.

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