12 Responses to “Harness market forces to share prosperity”

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1. Martin Weale: Tony Atkinson has suggested that a basic indicator of welfare would be median household income. The OECD could tabulate this country by country alongside GDP figures so as to show whether the economic success stories are as good as we are told. At the moment people are too ready to rely on GDP figures as performance indicators, leading to substantial distortions, like the suggestion that the Irish Republic is one of the most successful economies in Europe.

   Posted by: Martin Weale | June 25th, 2007 at 3:40 pm | Report this comment
   

2. Adrian Wood: An incisive description of the problem and of the non-solutions, but more on the right solutions would have been welcome. Progressive taxation of incomes seems to me to be the key ingredient, but the article mentions taxes only in passing at two points and not at all in the final discussion of market-friendly responses. I wondered why. Is it that Professor Summers doesn’t believe progressive taxation to be appropriate? Or is it, as I am coming to suspect, that FT editorial policy, for fear of offending customers, prohibits the publication of anything supportive of progressive taxation (though it is ok to slag it off, as Martin appeared to do in the title of his article on happiness three weeks ago)?

   As I have argued before in this space, a serious problem in levying more progressive taxation is that the world does not have a unified tax authority, and that no one national tax authority dares raise taxes on internationally mobile people. Getting national tax authorities to cooperate, moreover, would be a major administrative and political challenge, but it is a challenge which I believe should be addressed.

   Posted by: Adrian Wood | June 25th, 2007 at 5:29 pm | Report this comment
   

3. Allan Meltzer: Discussion of static measures of income distribution leaves me puzzled. Poverty is a social problem. As Hayek taught decades ago, large productivity changes quickly reward some and more slowly reward others. Politicians feel the need to make noise about stratic measures of income distribution. Economists should direct their concerns to poverty alleviation.

   Posted by: Allan Meltzer | June 25th, 2007 at 7:01 pm | Report this comment
   

4. Willem Buiter: Larry ought not to get away with the statement that “by definition what one group gains from changes in the distribution of income another group must lose. The lower 80 per cent of families are $664bn poorer than they would be with a static income distribution…” The statement that is true by definition is not Larry’s but Larry’s immediately followed by: “and with the same aggregate (or average) income”.

   The 64 trillion dollar question is whether there exist ways of making the before-tax or after-tax distributions of income more equal without a significant loss in average income. Are there administratively and politically feasible interventions that make the distribution of the cake more equal without shrinking the size of the cake too much?

   While there may be regulatory and similar interventions that make the before-tax distribution of income more equal, those who are concerned about growing inequality in the distribution of income and wealth should get serious about redistributive taxation. Higher aggregate tax receipts can fund increased public expenditure on education, health, child care and long-term care that can address key inequalities in economic well-being, including some not captured by conventional income measures. In addition, they can be directly redistributive, financing cash transfers to poorer citizens, including social security.

   Seriously redistributive taxation will, inevitably, have to be progressive. Even the flattest of flat taxes will in fact have (at least) two marginal rates: a zero rate for low levels of income and a constant marginal rate beyond some threshold level. For incentive/efficiency reasons, it is key that the unavoidable progressivity (in the sense of increasing average tax-net-of-benefit-witdrawal rates) of a redistributive tax-transfer system be achieved with the lowest possible marginal tax-net-of-benefit-withdrawal rates for the largest number of people.

   If the tax authorities are not to be taken to the cleaners by the rich and their legions of tax advisers and accountants, it is key that all forms of capital income (interest, dividends and capital gains) be taxed at the same rate (or using the same rate schedule). It is just too easy to transform one form of capital income into any other one: unless all capital income is taxed the same way, the capital income tax base will be seriously undermined. The argument that risk-capital will dry up unless capital gains are taxed at a rate not exceeding ten percent does not have an empirical leg to stand on.

   Not only can dividend income be turned into interest income or capital gains (& vice versa), capital income of any kind can be turned into labour income (or vice versa) with surprising ease. In small partnerships and unlisted incorporated enterprises, the shareholders and their close relatives can also masquerade as employees. Each tax year, the directors (who are also the shareholders and employees) decide with their tax advisers and accountants whether they will be paid dividends or wages. So preservation of the income tax base (or consumption tax base) in practice will require both labour and capital income to be taxed the same way. Combine this will an end to deductions and exemptions, and the tax system can play a significant role in limiting inequality.

   Adrian Wood is right that international tax cooperation is essential. Exchange of information is probably the best place to start. Next comes a common line towards tax-havens and off-shore entities involved in tax evasion and avoidance. Then common definitions of tax bases and for taxes on mobile factors, and common definitions of domicile for mobile owners. Last come common rates.

   Posted by: Willem H. Buiter | June 25th, 2007 at 7:17 pm | Report this comment
   

5. Larry Summers: Adrian Wood will I think be satisfied by the perspective taken in the next column which will emphasize (along the lines of the Hamilton Project paper referenced in my column) the importance of progressive taxation and of addressing the international mobility aspect that is essential for its success. The US, by taxing the worldwide income of its citizens, addresses this issue to an important extent. I also believe that financing healthcare with taxes is much more progressive than assuring it with mandates which is equivalent to using a head tax to finance it.

   Posted by: Larry Summers | June 25th, 2007 at 9:53 pm | Report this comment
   

6. Guillermo de la Dehesa: Larry has written an excellent piece to start the debate to try to explain the long trend in increasing inequality in the US and other Anglo-American countries and what to do to reduce it.

   The main issue in this inequality trend in the US is that it has been going on for more than two decades. In mature democracies this can be considered as an exception to the rule, by which some social and political forces start moving to reverse it.

   When inequality grows as fast as in the US and there is not some kind of reversal after some time it means that it is not a question of globalisation and a simple skilled/unskilled dichotomy of the labour force, because not only the unskilled have lost relative to the median but also the median has lost relative to the high earners.

   It may rather be more a question of a shift in the social preferences of the median voter towards accepting a higher degree of income inequality, as Atkinson, Alesina, Glaesser and others have been pointing out since almost a decade ago. The next US election campaign may provide a good evidence about this issue by showing if this important issue overtakes others, such as the war in Iraq and terrorism, as the centre of the agenda.

   The issue of progressive taxation on income is becoming increasingly difficult due to the much higher mobility of capital income than of labour income, due to financial globalisation. But, in the US it is also a question of enlarging the welfare state and increase redistribution. A country as rich as the US cannot dare to have almost 25 per cent of households outside medical insurance. It was a time in which equality of opportunity gave the US an edge over old Europe, where due to being a more stratified society, equal opportunity was more difficult to achieve and upward mobility was low, so the welfare state had to be more generous. Nevertheless, the problem today is that the then famous equal opportunity in the US is fading away. Today, there is very little upward social mobility among income quintils in the US and the number of working poor keeps growing. Therefore, a much larger effort need to be made in the US in terms of redistribution through enlarging its welfare state.

   Posted by: guillermo de la dehesa | June 26th, 2007 at 12:24 pm | Report this comment
   

7. John Williamson: In his reply of June 25, Larry suggests that the US practice of taxing the worldwide income of US citizens addresses the problem of international mobility of where income is earned to an important extent. This is half-true: legislating taxation of worldwide income is a necessary condition for being able to avoid taxes by expatriating income-earning assets. But it is only half the solution, because it is also necessary that the tax authority have access to reliable information about earnings to avoid a legislated tax being essentially voluntary. That is why Willem Buiter is right to say that information exchange, followed by joint action against tax havens, are the ways to start international tax cooperation. It never ceases to amaze me that so obvious a need for international cooperation is so neglected.

   Posted by: John Williamson | June 29th, 2007 at 2:47 pm | Report this comment
   

8. Lawrence Summers: Willem Buiter is technically correct that my calculation about transfers assumes no change in total income - a point I thought was clear in context.

   I used to have more sympathy for Allan Meltzer’s view than I do today. Poverty is indeed a problem and probably a more serious distributional issue than others. But I think most thoughtful people will care about the distribution of income as between the richest 1 per cent or 0.1 perc ent of the population and its average member. And the case for caring is magnified when it is recognized how strongly inequality is transmitted from generation to generation.

   I agree with all the comments about the importance of progressive taxation and the issues around international cooperation. Indeed during my time as Secretary of the Treasury we launched a number of initiatives directed at what might be called the “dark side of capital mobility” - tax evasion, money laundering and regulatory arbitrage. Most of this was dropped by the Bush administration.
   I have come to think that the international problem of taxing capital income may be exaggerated for the United States since we tax our citizens on their worldwide income - wherever they may go. There is of course the question of enforcement where we could do much more and also the question of whether foreign taxes should be deducted or credited?

   Did any of the other participants in this forum share my surprise at Clive Crook’s last FT column that seemed to deny that there was a need for a progressive taxation response to the distributional changes associated with globalization? If globalization is taken to mean a combination of more openness and growth of developing countries it is not even altogether clear that it benefits America in aggregate. To see this suppose that the developing world suddenly became a clone of the US - gains from trading arising from comparative advantage which presumably exist today would vanish. (Essentially this is Paul Samuelson’s recent point about trade). It is even less clear it seems to me that the US middle class gains from increases in the economic capacity of our trading partners so I would have thought that progressive taxation was natural concomitant of openness. Crook also seems to me to go wrong in suggesting that if globalization did in fact hurt the middle class then the right thing to do would be to try to shut it off. Leaving aside questions of feasiblity such a strategy of stifling the growth of emerging market countries would court geopolitical disaster.

   Posted by: Lawrence Summers | July 1st, 2007 at 11:17 pm | Report this comment
   

9. Willem Buiter: In support of his claim that “If globalization is taken to mean a combination of more openness and growth of developing countries it is not even altogether clear that it benefits America in aggregate”, Larry invokes Paul Samuelson’s elegant paper on the welfare effects on a nation of growth abroad. The appeal to Samuelson’s (correct) analysis should, however, be taken with a pinch of salt.

   Samuelson’s paper deals with the effect of growth abroad on home country welfare in a world with two countries (or regions) that have fully integrated (free, competitive) trade in goods and services throughout (both before and after growth abroad takes place). There is no capital mobility or labour mobility. Samuelson’s analysis is intuitive: if growth abroad (whether through total factor productivity growth or the hard way) is concentrated in sectors where the home country used to have a comparative advantage, the terms of trade may turn so badly against the home country that everyone in the home country is worse off. A nation of candle-makers and candle-exporters who don’t have many productive alternative uses for their labour and capital resources may well be worse off when the rest of the world starts producing cheap gas lamps.

   However, despite getting clobbered by this technological change abroad, the candle-makers’ nation can do no better for itself than imposing the optimal tariff and trading away. This was true also before the rest of the world invented and produced the gas lamp. Even with the optimal tariff, the candle-makers’ nation can be worse off than before. ‘Shutting off’ globalisation does not mean reducing openness in the sense of reducing trade. The only way to restore the status quo ante is to stop the rest of the world from producing gas lamps.

   Back in the real world, the analogue would be to stop India from producing software, operating call centres and providing back office functions to the world at large. It would mean to stop China from acquiring or re-inventing and then using modern technological and managerial know-how to create a mighty manufacturing machine. You would have to stop both technology transfer and internal R&D and other knowledge creation in the Chindias of this world. This, fortunately, is as impossible as it would be immoral. The genie is out of the bottle.

   Given that China, India, the other BRICS and ultimately most other emerging markets and developing countries will acquire modern technology, management techniques and governance institutions, the best response of the old industrial countries (the OECD countries, say) is to trade freely, with just the optimal tariff separating them from truly free trade. Even if the old industrial countries were to be worse off as a result of the growth of the emerging markets and developing countries (a theoretical but not a practical possibility for most countries, although individual groups of workers and owners of capital could well be worse off), they would minimize the extent of the welfare loss by optimal tariff-qualified free trade. Going self-sufficient would mean that the candlemakers would have to eat their own candles.

   The optimal tariffs are optimal only from the perspective of the countries setting them. Globally they are welfare-reducing. Intelligent bargaining-with-side- payments at the level of the WTO should ensure that the optimal response of the old industrial countries to the rise of the new giants is unqualified free trade.

   Whatever happens, the candle-makers can never get their export markets back. Living with it and trading despite it, is the only efficient policy. Using domestic distributional instruments to meet domestic distributional objectives is the other blade of the policy scissors.

   Posted by: Willem H. Buiter | July 3rd, 2007 at 1:53 am | Report this comment
   

10. Clive Crook: Larry says he found my column on middle-class economic anxiety surprising “because it seemed to deny that there was a need for a progressive taxation response to the distributional changes associated with globalisation”. As I indicated in the article, I’m in favour of making American taxes more progressive. Relieving people on low earnings of payroll taxes seems eminently desirable, for instance; and at current rates, I also agree that US taxes on capital income are too low.

    Mainly, though, my column tries to pose a different question — one which Larry seems reluctant to engage with, much to my own surprise. Just how far is liberal trade to blame for recent trends in inequality in the US and elsewhere?

    As Larry knows, the recent increases in American inequality are concentrated at the very top of the income distribution: the ratio of lowest incomes to middle incomes is little changed. (The same is true in other rich countries). So we are not mainly seeing a shift of income from unskilled workers to skilled workers, which one might attribute to cheap imported manufactures, and hence to globalisation. Especially in the US, the striking movement in inequality is at the very top of the distribution. Are we to believe that cheap imports of goods and services are holding down real wages for the great majority of Americans, and concentrating the benefits of growth on the top few percentiles? I find that extremely implausible — and I have seen no evidence to support it. Other factors are surely at work and, unlike Larry, I want to know what they are before I start advocating policies (even if they are desirable in their own right) as remedies for globalisation’s ills.

    If it turns out that globalisation really is skewing incomes in so extreme a fashion, then it would be perverse — not to mention politically unsustainable — to argue that we must have unimpeded globalisation regardless. Citing Samuelson, Larry goes further than this. He says, “If globalization is taken to mean a combination of more openness and growth of developing countries it is not even altogether clear that it benefits America in aggregate.” Well, as we know, few things in economics are ever “altogether clear”. Usually we have to settle for a balance of the evidence. If I believed that, on a balance of the evidence, globalisation was not good for America in the aggregate, then I would ask myself whether America should defend it. Larry doesn’t even blink. As a matter of geopolitical prudence, he says we should support it anyway, because it raises aggregate income in the developing world. One wonders, though, what would be the prospects of sustaining such a policy in the US? “We keep our markets open even though it makes us poorer, because we want to spur growth in China and India.” Good luck to the politician who adopts that position.

    We know that many Americans associate globalisation with growing inequality and stagnant living standards. The crucial question is, are they right to? If Larry really does believe that globalisation is an immiserizing process for most Americans — and maybe even for the country as a whole — then that surely ought to cool his enthusiasm for liberal trade. If, on the other hand, he still believes that liberal trade is good for most Americans (even without further redistribution), then why not just say so? Is the point unworthy of emphasis? The case for redistribution can fend for itself: it does not need to be based on the supposed failures of globalisation.

    One more thing. While I agree that we need to think harder about how to share the benefits of growth more widel, it is not enough just to say, “make taxes more progressive”. A tax reform that shifted more of the burden from the lowest–paid to those on middle and upper-middle incomes would be progressive, but (desirable as it might be on other grounds) would do nothing to support middle incomes, or to incline middle-earners to favour globalisation. Piling more of the burden on the very top makes better sense in this regard, though one wonders whether it is feasible. Collecting vastly higher taxes from the very rich (and they would need to be vastly higher, to pay for meaningful relief for the great lagging majority) will be easier said than done. And of course, if liberal trade hurts narrower groups of workers in particular industries or sectors, rather than almost everybody, then making taxes more progressive is again a badly targeted response.

    My guess, in any case, is that worries over health insurance, over the costs of a college education, over rising indebtedness and other specifically US factors are adding at least as much to middle America’s economic anxiety as trends in pay. Fixing healthcare would be my own top priority — and, unless I’m missing something, that problem has nothing to do with globalisation.

    Posted by: Clive Crook | July 3rd, 2007 at 8:45 am | Report this comment
    

11. Martin Wolf: Let me add a few comments to this discussion on Larry’s interesting column, albeit one that was short on concrete answers. (I am waiting for the next columns.)

    I am intrigued by Martin Weale’s suggestion that we look at median incomes, as well as GDP (or, presumably, average GDP). I think that would be useful. Of course, an economy with a faster growth of average than median GDP has, in addition to becoming more unequal over time, the opportunity to redistribute more income and improve the provision of public goods. Both of these are valuable.

    Adrian Wood is far too suspicious. The FT has no editorial policy opposed to mentioning progressive taxation, even though he is right that I mentioned it in a recent column only to oppose the idea that it is an obvious route to greater happiness. (Incidentally, I thank Adrian for recommending Daniel Gilbert’s book, Stumbling on Happiness, which I found very entertaining, though it did not make me reconsider my views on the impossibility of making gross national happiness a policy goal.)

    My reluctance to support more progressive taxation than we already have (in the UK) is mainly that I fear this would reduce people’s willingness to embrace entrepreneurial careers, while not improving the welfare of society. But my position is not an absolute one. Progressivity is inherent in any imaginable tax system (as Willem notes). This is even true of a flat tax with tax-free allowances. So we are always talking about degrees of progressivity.

    If I were asked why I care about inequality, however, it would not be because of differential access to goods and services, provided everyone is ensured reasonable (socially determined) minima. Do I care that Bill Gates is many orders of magnitude richer than I am? Not at all, would be my answer. I do care about access to opportunity, though I recognise that equality of opportunity is never attainable.

    What worries me most, however. is the political power that vast wealth creates. The arrival of a predatory plutocracy is extremely undesirable. This has already happened in a large number of emerging countries where a small handful of people enjoy not just enormous, but politically decisive, wealth. When dominating oligarchies emerge, democracy is undermined and so, ultimately, is the openness of the economic system: the super-rich come to own politicians and so ensure that competition is suppressed. In the long run, such a plutocratic elite means the end of the liberal and open political and economic systems I prefer. That is also likely to produce repression, or revolution, or a cycle between the two.

    Larry, in his first reply, mentions the fact that US citizens pay tax on their worldwide income, wherever they live. I presume that the US can do this because American citizenship is very worthwhile. Well, I would have thought British citizenship (which also gives the right to work anywhere in the European Union) is valuable, too. So why don’t the UK authorities do the same thing? And, while we are about it, why do we allow sundry “non-domiciled” billionaires to live in London tax-free? Surely, the least we could do is create a special category of resident permits for rich foreigners, which would be subject to a sizeable annual charge? Alternatively, we could level a special tax on properties owned by people who are not domiciled in the UK. After all, these people are demonstrably benefiting from the amenities both provided and protected by people who do pay taxes in the UK. Some argue that these residents provide special benefits of some kind to the UK. So why don’t we let British billionaires off taxes, too?

    Guillermo is right that taxing capital income is harder nowadays. But, unless owners are prepared to live elsewhere, their consumption will tend to reveal their income as well. I suspect that the ease with which vast amounts of capital income can be hidden by citizens of advanced western democracies is, in fact, exaggerated, unless they never spend it.

    Some argue that the abiding problem of race is the reason the US does not have a welfare state. Would anybody be prepared to comment? I have always been amused that the US even employs two different phrases: “social security” is for hard-working people, “like us”, while “welfare” is for idlers, “like them”.

    Finally, in response to Larry on Clive Crook, if the rest of the world were to become a clone of the US, the latter would still enjoy the benefit of greater economies of scale, more competitors and more product diversity. That might not matter very much for a country as big as the US (though it would still matter a little). But for, say, the UK, the increased output of the rest of the world has been a big boon, in more or less these terms. I agree with Larry that it is incumbent on the rich countries to remain open to exports from poor countries and deal with the internal consequences themselves. The alternative is a form of economic warfare on the poor. That would be intolerable, morally and politically. But, as Clive Crook says, sustaining openness if one believes it harms most Americans is an impossible position. Fortunately, I don’t believe there is any serious evidence to support such an extreme position on the impact of openness to trade and I can’t see how it can possibly explain the huge increases in wealth at the very top of the income distribution.

    Posted by: Martin Wolf | July 3rd, 2007 at 1:07 pm | Report this comment
    

12. Larry Summers: This dialogue gives me much to think about but has not yet altered my views, though I venture what follows with less than complete confidence.

    Willem is right in his explication of the Samuelson theorem and right in his conclusion that no matter what happens free trade with the optimal tariff qualification is best. I did not suggest otherwise. It may nonetheless be the case that the consequences not of open markets but of the rise in the developing world are negative for a significant fraction of the population. How to manage this is a central question where I think progressive taxation along with health care reform have an important role.

    Clive in my view distinguishes insufficiently sharply between the consequences of liberalization and the consequences of the success of our trading partners in growing and this leads us to be talking past each other to some sense. I do not find it nearly as implausible as he does that globalization thought of in a broad way has much to do with the success of the top end of the income distribution. First, the current financial environment is intimately related to globalization and is surely the source of many fortunes at the very high end. Second, to the extent that there is a growing export market for US intellectual property–video entertainment, whatever produces the value from investment banks, software…the narrow group that possesses this stuff will get much richer and as the exchange rate appreciates the result will be negative for most people. Third, as my first column for the FT argued echoing an earlier paper of Adrian Wood’s a greater capacity for capital in high wage countries to combine in production with labor in low wage countries will tend to exacerbate inequality. To be clear again, I believe Americans are better off because our markets are open though compensations are necessary to assure this is as true for all Americans. I think it is much less clear that we are gaining from the spectacular growth success of our trading partners and particularly unclear that this is good middle class workers. That is why I am for free trade not for interfering with globalization but feel that domestic policy measures are necessary.

    A separate issue. I think there is a significant chance that within a half dozen years economists will have decided that an undervalued exchange rate is a development asset for a developing country but that this strategy has negative externalities for other countries. How this should be worked out if it proves to be the case is a hard question not I suspect one that is easily answered by reference to the principle that “free trade is best”.

    I agree in spirit with Martin’s comments on progressive taxation. I am less convinced of what he says about entrepreneurship given that high taxes cushion losses, that entpreneurs have various ways of sheltering income not open to others etc. Indeed I suspect that if top tax rates were higher the likes of Larry Page and Sergey Brin would be no less likely and perhaps a bit more likely to start the next google. I am quite struck by how much of the money invested with venture capital firms comes from tax free sources.

    Posted by: larry summers | July 5th, 2007 at 3:54 am | Report this comment
    

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