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Rawls, Cohen and the Laffer Hypothesis

March 30th, 2009

I was in Sydney for a fascinating conference on Evidence, Science And Public Policy. It was worth the trip just to hear John Worrall on evidence-based medicine point out this paper on remote retroactive intercessory prayer [1]. Assuming, as appears to be the case, that the study was totally legit (no data mining etc), the obvious question for me was why anyone would think it worthwhile (ex ante) to test this out.

But that’s not the subject of this post.

In discussion at the conference, some reference was made to Rawls, Cohen and incentives, the subject of quite a bit of discussion at Crooked Timber. Rawls and Cohen (and those of us following them) spend a lot of time on the question of whether it is just/desirable to adopt policies that increase the income of the well-off relative to that of the poor, assuming that the result is a Pareto-improvement (everyone is better off, even if the rich gain more). That’s an important question if you want to think about an ideal social order, or to clarify concepts of justice, but there’s a big risk (evident in some of the discussion at the conference) of sliding into the assumption that this question is politically relevant right now. To put it another way, this question is politically relevant only if you accept something very clsoe the Laffer Hypothesis[2], that a reduction in tax rates will, under current circumstances, produce an increase in revenue. Chris Bertram made much the same point in relation to the banking crisis a while back. The term “trickle-down economics” describes the general form of the claim.

There’s very little reason to believe the Laffer hypothesis or equivalent claims about the banks. The reason tax rates aren’t higher and bankers are getting bailed out on hugely generous terms isn’t because Rawlsians have outvoted Cohenites behind the veil of ignorance, or even because lots of economists believe the Laffer hypothesis. It’s because the rich and powerful are, well, rich and powerful. Not only can they promote ideas, however dubious, that serve their cause, they can bring powerful force to bear against any government or political movement that threatens their interest. All of this is obvious enough, but after thirty years in which any mention of these facts has been shouted down as the “politics of envy” or “class hatred”, it may be necessary to restate the obvious.

Again, that’s not a reason not to talk about whether Pareto improvements are (necessarily) desirable and just. I only want to remind everyone to mention, from time to time, that we’ve got a long way to go before we need to worry about this in practice. At the moment, the relevant version of the question is how the left can regain some of the ground lost over the last thirty years, now that the trickle-down theory has failed so spectacularly and obviously.

fn1. Paywalled, sorry. The authors of the study took records of people who had been treated for blood infections some years previously, randomly assigned them to two groups and got a volunteer to read a brief, non-specific prayer for the recovery of the test group, while holding the list of names. It turned out that the prayed-for group had had significantly better outcomes. John Worrall presented it as an data point against believing in randomised trials as the gold standard of evidence based medicine. As I said, my main puzzle is, assuming that the results were just a 100-1 fluke, why the authors thought of doing this in the first place, given the low probability of a publishable result.

fn2. Laffer didn’t invent the curve to which his name is commonly attached, but he can reasonably claim responsibility for the hypothesis that the US in the 1980s was on the declining part of the curve.

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  1. Martin
    March 30th, 2009 at 21:53 | #1

    You are assuming, John, that negative results are unpublishable. For all I know that might be true, but, if so, it would be unfortunate.

    But perhaps demonstrating that intercessory prayer did not work would be a valid research outcome?

  2. Joseph Clark
    March 30th, 2009 at 22:08 | #2

    Pareto improvements are good by definition so there is no need to postpone a discussion of them.

  3. SJ
    March 30th, 2009 at 22:35 | #3

    Joseph Clark Says:

    Pareto improvements are good by definition so there is no need to postpone a discussion of them.

    That’s not what welfare economics is about. Pareto efficiency is separable from equity only to a small extent in theoretical models that largely have bugger all to do with realty.

    Assuming zero transaction costs, complete markets and symmetric information…

  4. Joseph Clark
    March 30th, 2009 at 22:45 | #4

    What you say makes no sense.

  5. SJ
    March 30th, 2009 at 22:50 | #5

    What you say makes no sense.

    Well, to you, maybe, but that’s not really surprising.

  6. March 30th, 2009 at 23:09 | #6

    “we’ve got a long way to go before we need to worry about this in practice….now that the trickle-down theory has failed so spectacularly and obviously.”

    Isn’t that a contradiction?

    And, so sorry, where’s the obvious and spectacular failure?

  7. Ikonoclast
    March 30th, 2009 at 23:10 | #7

    Responses to the GFC so far have not convinced me that neoliberalism has lost any power at all. The neoliberals are still running the show. The bailouts seem to be tailored to save the rich for the most part.

    Honesty forces me to admit the middle class are getting help too. I guess the rich figure they still need the middle class who are essentially the servants who run everything for the rich.

  8. wilful
    March 31st, 2009 at 09:18 | #8

    Maybe we need some intercessory prayer for neoliberalism.

  9. O6
    March 31st, 2009 at 10:31 | #9

    Cochrane reviews are the ‘gold standard’ for assessing clinical trials. Unfortunately there isn’t a recent one on prayer, but here is how prayer looked a decade ago:
    http://www3.cochrane.org/reviews/en/ab000368.html .
    Publication bias is almost certainly one reason for the paucity of reported trials, given the low cost of prayer.

  10. Alice
    March 31st, 2009 at 10:33 | #10

    SJ#3

    You make sense to me.

    Transaction costs are everywhere….complete markets and symmetric information???. Hello? Its a chaotic jumble of dodgy information out there.

    I just love these theories where you note shaky assumptions in the fine print. Bit like an insurance contract.

  11. Jim Birch
    March 31st, 2009 at 11:05 | #11

    Jarrah @6: The obvious and spectacular failure is that it hasn’t happened.

    Real income at the bottom end, and the middle pretty much too, has been more-or-less static for a few decades. If it’s trickling down somewhere, then where? Meanwhile a number of undesirable social indices have increased, eg, rates of clinical depression. We all love simple explanations – biologically, these are low energy computations that feel good – but apparently there’s some complexity out there fouling our pristine insights.

  12. Monkey’s Uncle
    March 31st, 2009 at 11:31 | #12

    As for the so-called Laffer curve effect, although it has become somewhat fashionable to mock this there is plenty of evidence to support this thesis.

    Again, it must be stressed that the Laffer curve does not posit that lower taxes will always yield higher revenues. It merely posits that in some situations lower taxes will actually yield higher revenues.

    During the 1980s Australia reduced the top marginal tax rate from 60% to 47%. What was the result of that? Did government revenues decline heavily? Did the budget deficit increase? Was the government sheepishly forced to hike the tax rate back to 60% in order to avoid financial ruin? No no no.

    In New Zealand the top tax rate was reduced from 66% to 33% during the 1980s. Given that public finances were already in bad shape, why didn’t this massive tax break for the rich bankrupt the country?

    Of course, the obvious question is: if a government could raise more revenue through a lower tax rate, why would anyone in their right mind set the tax rate higher?
    There are a couple of reasons:
    - the electorate doesn’t understand economics, so it is harder to explain these arguments. It is much easier to resort to populist arguments and exploit the politics of envy by complaining about excessive breaks for the rich
    - if higher tax rates lead to more evasion and less revenue collected, why should the wealthy or influential care less?
    A perfect combination of cynicism and naivete.

  13. jquiggin
    March 31st, 2009 at 11:42 | #13

    During the 1980s Australia reduced the top marginal tax rate from 60% to 47%. What was the result of that? Did government revenues decline heavily?

    They declined by around 13 per cent of the amount of income subject to the top marginal tax rate. That is, any Laffer-type effects were negligible, which is consistent with US experience.

    Of course, the loss due to the cuts was offset by bracket creep and by the introduction of the capital gains tax, so total revenue kept rising.

  14. Alice
    March 31st, 2009 at 12:56 | #14

    Monkey’s Uncle says

    “During the 1980s Australia reduced the top marginal tax rate from 60% to 47%.Did government revenues decline heavily? Did the budget deficit increase? ”

    Funny you should mention that Monkey’s Uncle. Inequality has been rising ever since (in actual tax incomes, in taxable tax incomes and a a range of other inequality measures).

    The Budget also went into surplus because successive governments ironically since the 1980s alo, flogged a whole pile of capital, land and other assets under the sun our government once owned, and where is it now ??

    Nothing quite like drawing your attention to privatisations which you seem to completely overlook making the comment you made above. Where exactly would the Budget have been without all those asset sales (after giving the rich an almighty tax cut in the early 1980s?? It was a huge reduction by any standards and tax measures made for everyone else came nowhere near offsetting the gain by top tax incomes).

    That, in short, was a stupid and destabilising move.

  15. Jim Birch
    March 31st, 2009 at 13:26 | #15

    It merely posits that in some situations lower taxes will actually yield higher revenues.

    Yeah, but under exactly what conditions? Have they ever actually occurred in the real world? It appears to me that you’re extrapolating actual public policy – with real effects – from some kind of two bob theory. Sure, there must be some hypothetical situation where reducing taxation might actually raise revenues, but does that mean we should do anything? Because if it does, I’ve got lots of great policy ideas that should definitely be implemented, eg, my No Tax for B Surnames policy is a ripper.

  16. Ernestine Gross
    March 31st, 2009 at 16:24 | #16

    Pareto efficiency and Pareto improvement.

    While the definitions of the above concepts are sometimes introduced in conjunction with the first fundamental welfare theorem (pertaining to a Walras equilibrium), it is not true (contrary to the content of at least two comments) that the definition depends on the conditions of a Walras equilibrium (see for example second fundamental welfare theorem).

  17. Ernestine Gross
    March 31st, 2009 at 16:34 | #17

    “Rawls and Cohen … spend a lot of time on the question of whether it is just/desirable to adopt policies that increase the income of the well-off relative to that of the poor, assuming that the result is a Pareto-improvement (everyone is better off, even if the rich gain more). ….”To put it another way, this question is politically relevant only if you accept something very close to the Laffer Hypothesis[2], that a reduction in tax rates will, under current circumstances, produce an increase in revenue.”

    I accept the opinion of our host on what is politically relevant under current circumstances. However, I am not prepared to accept that the Verbal-theoretiker (eg Austrians, supply-siders, ….) should have so much influence on policies.

    There are several versions of Pareto-improvement. One is the requirement that at least one person is made better off (in terms of consumption of commodities) without anybody else being made worse off. Given a top marginal tax rate of say 67% (something like this before the Verbal-theoretiker gained the ears of Reagan and Thatcher and a few others) then a lowering of this top marginal tax rate to say 45% makes those in this tax bracket better off without ensuring that the remaining members of the society are not made worse off. The Verbal-theoretiker people ask us to believe that a Pareto improvement has occurred. I don’t believe it because they don’t have as much as one theorem which gives conditions under which it is conceivable that it could work. By now there is ample empirical evidence that it did not work. And on this point the dreaded neoclassical mathematical economic models do give some insights as to why it didn’t work. Two give only two examples: 1) The minimum wealth condition (related to income distribution) has been neglected. 2) The conditions on risk aversion in financial markets have been ignored.

  18. Ernestine Gross
    March 31st, 2009 at 16:41 | #18

    “All of this is obvious enough, but after thirty years in which any mention of these facts has been shouted down as the “politics of envy” or “class hatred”, it may be necessary to restate the obvious”

    And this is another reason why the Verbal-theoretiker’s influence on policies should be curtailed. These people come up with phrases or sentences that can be copied by non-economists who then proffer psychological (maybe I should say pseudo-psychological so as not to offend the serious people in this area)phrases such as “politics of envry” and “class hatred”.

  19. Joseph Clark
    March 31st, 2009 at 16:46 | #19

    Ernestine,
    As always I appreciate your ability to take a simple point and make it incomprehensible to ordinary people. You’ll make a fine economist some day!

  20. Bruce Littleboy
    March 31st, 2009 at 17:06 | #20

    Joseph #2
    Perhaps I’m reading less into what you said than what you meant.
    A Pareto improvement is only ‘better’ if you assume that ‘more is better than less’ and argue successfully that our preferences are independent (or should be). Economists have regarded these as the safest minimum value judgements they could make that would permit useful policy advice while being as scientific as possible.

    They may have been wrong, and the problem may have started at step 1. It seemed a good idea at the time. As ‘more’ can be quantified, it permits measurement and other scientific-looking stuff.

    Efficiency (Paretian or any other kind) does not mean good. A fact does not imply a value. We *assume* that more is preferred to less and pretend that people in fact have no preferences about the distribution of these goods, and clearly this latter assumption is factually false.

    At best, PE means potentially good in a narrow but mildly interesting sense: if there is more output then some new allocation exists can make everybody better off. (The only exception is if an improvement in A’s welfare in terms of getting more of good X causes B enough disutility to override the gain in X (s)he obtained.)

    I vaguely recall a diagram with goods on one axis and equity (!) on the other, with an indifference curve on it: there was a tradeoff between goods and equity and some supposed ‘optimal’ outcome. Interesting, but equity involves more than “equality”.

    What matters more to me than how much you have is how you obtained it. This is qualitative in the light of all the relevant circumstances, not quantitative — and not capable of being reduced to any formula or slogan (e.g., Rawlsian).

  21. Ernestine Gross
    March 31st, 2009 at 17:24 | #21

    Joseph Clark, it seems to me you underestimate the abilities of “ordinary people”.

  22. Joseph Clark
    March 31st, 2009 at 17:31 | #22

    Bruce,
    Pareto improvements are defined in terms of preference not quantity. Unless people prefer less preferred commodity bundles Pareto improvements are just plain good. Pareto optimality is another matter.

  23. Monkey’s Uncle
    March 31st, 2009 at 18:05 | #23

    Jim Birch at 15 “Yeah, but under exactly what conditions? Have they ever actually occurred in the real world? It appears to me that you’re extrapolating actual public policy – with real effects – from some kind of two bob theory.”

    Jim, I cited two “real world” examples in my post you refer to. I could probably cite many more examples if I had more time. Such as the constant increases in federal government revenues over the past several years despite successive tax cuts.

  24. Monkey’s Uncle
    March 31st, 2009 at 18:10 | #24

    Alice @ 14, regarding privatisation I don’t think the Hawke-Keating governments began selling major assets until the late 1980s or early 1990s.

    The period I was referring to regarding the adjusting of tax scales and the budget was around the mid 1980s. So it has little relevance to the comparison I was making.

  25. Alice
    March 31st, 2009 at 18:53 | #25

    #24Actually it does have a lot of relevance Monkey’s Uncle.

    You didnt specify what years the budget was presumably unaffected but lets look at it?. I am copying two links for you. Most privatisations were carried out the 90s, I agree – so what happened before (in the 1980s after that nice tax cut was delivered to the already rich?). See below

    http://www.rba.gov.au/PublicationsAndResearch/Bulletin/bu_dec97/bu_1297_2.pdf

    Here is a quote from another source

    http://www.treasury.gov.au/documents/1496/PDF/01_Debt.pdf

    “There were two further episodes of debt accumulation, and subsequent reduction, during the 1980s and early 1990s driven by periods of weak economic growth and associated budget deficits. From the mid-1990s, as the Australian Government’s fiscal position improved, gross debt declined steadily as a share of GDP.”

    So clearly debt accummulated in the 1980s after that very accommodating tax cut was delivered to the already rich in the early 1980s. From 1990 we started selling off public assets which would have masked any rising deficit nicely.

  26. Alice
    March 31st, 2009 at 19:03 | #26

    Monkey’s Uncle #12 -
    your precise comment was

    “During the 1980s Australia reduced the top marginal tax rate from 60% to 47%. What was the result of that? Did government revenues decline heavily? Did the budget deficit increase?

    From the source I have given you at 25 (RBA source)

    “During the early 1970s net debt was mainly negative and reached lows of -3.1 per cent of GDP. During the first half of the 1970s budget surpluses averaged 1.7 per cent of GDP, while in the second half, there were budget deficits averaging around — 1.6 per cent of GDP. By 1979-80, net debt was around 4.7 per cent of GDP.

    Net debt reached 10.4 per cent of GDP in 1985-86. It took only three years (from 1986-87 to 1989-90) to reduce net debt by around 6 percentage points of GDP. Across those same years, the underlying cash balance averaged around 0.6 per cent of GDP.”

    So yes, then government budget deficit did indeed increase in the 1980s (seeing as you wanted to narrow your argument to that decade later in your comment at #24).

  27. Alice
    March 31st, 2009 at 19:13 | #27

    Monkeys Uncle at 12 and 25

    Furthermore – the speculative bubble in the 1980s (the first of these damn things in decades) was likely to have poured cash in to the governments budget (once more dangerously seductive to governments).

    I dont see the period 1986 – 1989 as being particularly productive or any sound measure of underlying government budget strength …after all, that period spawned Skase, Bond, Jodie Rich (1st time around), Rivken, Adler and a host of others and then the market crashed. “Greed is good” ran away to Spain before it could get put in jail.

    Its just like now – JHs “magnificent surplus” (irony and sarcasm) evaporated.

    We need to get the effect of volatility through poor economic management out of the picture. The tax cut to the rich in the early to mid 80s was very much part of that poor economic managment. Poor fools, what were they thinking? The rich just did even better out of the next boom and gambled to even greater heights. I dont need to suggest that it wasnt sustainable either. I think most people know that now.

  28. Alice
    March 31st, 2009 at 19:30 | #28

    # re 17 and 19. I fully agree with Ernestines two final points in the last para made at #17 and had Joseph #19 half the knowledge of economics that Ernestine does he might not have found those comments incomprehensible (19).

    Greenspan has acknowledged a “flaw” in his models and to date I have heard nothing on Greenspans versions of the “flaw” or exactly what the “flaw” is in neoclassical economic models of self regulated markets. Id like to hear more on the flaw and its time some discussion of the weaknesses occurred.

  29. Joseph Clark
    March 31st, 2009 at 19:55 | #29

    Alice,
    I’m just stating definitions. Let’s not get into childish contests about who knows more economics.

  30. Alice
    March 31st, 2009 at 19:56 | #30

    29# Joseph referring to comment at 19 Im not sure who is being childish here…

  31. March 31st, 2009 at 20:28 | #31

    Pr Q says:

    It’s because the rich and powerful are, well, rich and powerful. Not only can they promote ideas, however dubious, that serve their cause, they can bring powerful force to bear against any government or political movement that threatens their interest.

    All of this is obvious enough, but after thirty years in which any mention of these facts has been shouted down as the “politics of envy” or “class hatred”, it may be necessary to restate the obvious.

    My general rule to predict the behaviour of a progressive democratic polity in a regressive catallactic economy is that our elite representatives tend to take the path of least resistance between:

    the populace’s…Left-leaning political opinions and elites…Right-leaning policy interests.

    The only exception to the elites Right-wing tendency is the Culture War where most elites sympathise with the Left-liberal position. But this exception proves the “anti-populace elitist” rule, since the populace is well to the Right of the elites in cultural identity matters. It was only a major Right-wing populist backlash from Hansonites that policy to move in line with public sympathy on this issue.

    So we have an elite dominated polity – Quelle Surprise.

    The only thing that will arrest this regressive elitist tendency is counter-valing power from populist organizations such as unions, churches and community groups. Certainly exquisitely argued points between dead philosophers wont prise certain peoples fingers off the loot.

  32. Alice
    March 31st, 2009 at 21:11 | #32

    Strocchi – you are droll (and funny)! I agree but the elites really dont want to push people too far (only as far as they can get away with and they have been pushing too far..they need to stop the campaigns of misinformation and shonky economics (good for the few and not the economy) and reign themselves in. You can wake up a sleeping but cranky bear like that.

    AIG telling its staff to wear no company logos and plain clothes while G20 is on. Demonstrators outside execs houses smashing their cars and windows (ex CEO Bank of Scotland)? They may be elites and able to command resources but being merely elite has not protected some elites in history has it? Its no guarantee they can avoid an angry mob.

  33. Joseph Clark
    March 31st, 2009 at 21:20 | #33

    Alice,
    Having bizarre conspiracy theories about ‘elites’ is one thing. Supporting violence against people is quite another. Is that what you’re doing?

  34. Alister
    March 31st, 2009 at 22:26 | #34

    Monkey’s Uncle @ 23, you have not taken into account the various other tax increases while income tax was being reduced. FBT was only one. The Medicare Levy was introduced in 1986, along with FBT. Capital gains tax was introduced in 1985. HECS was introduced in the late 1980s, and the HEAC preceded it. It’s a little disingenuous to claim that the cuts in income tax only lead to a mild decline in consolidated revenue without reference to the other taxes that were introduced at the same time.

  35. TerjeP (say tay-a)
    March 31st, 2009 at 22:48 | #35

    So do we admit there have not been any real tax cuts.

  36. March 31st, 2009 at 23:43 | #36

    # 33 Joseph Clark Says: March 31st, 2009 at 9:20 pm

    Alice, Having bizarre conspiracy theories about ‘elites’ is one thing.

    One does not have to rely on conspiracy theory to believe that economic elites have gone to extraordinary organizational lengths to further their own interests. This sort of thing has been done in plain view.

    Financial markets until recently were full of boutique hedge funds, tax-efficient accountants, HVI wealth managers and so on. All designed to concentrate wealth amongst those with institutional privilege. Similar schemes operated at a higher political level to crony capitalists to sell off public property at cheap rates to insiders and to offer tenders on contracts at exorbitant rates.

    And of course we then had on top of this the financial pump-priming by central bankers to support financial agents gross leveraging of securitised assets. Which in turn validated the high-powered hustling of usurious credit instruments by unscrupulous hustlers in minority neighbourhoods. (I call this the “debtquity and diversity” play).

    More to the point, as Pr Q points out, there has been a massive concentration of financial players in densely populated financial precincts in all the great metros of the Northern Hemisphere. This is not what we would expext given that financial activity could be easily and cheaply disaggregated using computer networks.

    The obvious inference is that the social concentration facilitates face-to-face interaction, OTR with no paper or pixel trail. Quo Buono is not a “bizarre” hypothesis, but its a conspiracy, alright.

  37. Joseph Clark
    April 1st, 2009 at 00:33 | #37

    jack,
    It’s all true. Us capitalists have been running the scam for centuries. First we steal all the money from the workers by exploiting them then we finance right wing think tanks to brainwash the portion of the population that hasn’t been pacified by consumerism (us again!). Sure, there’s a few loudmouths who have us figured out but we can easily shout them down as cranks using our media mouthpieces.

  38. jquiggin
    April 1st, 2009 at 05:02 | #38

    #35 “Admit” suggests a previous denial. Not here, as indicated by this post, on which you commented

    http://johnquiggin.com/index.php/archives/2006/05/17/budget-manages-to-hold-the-line/

  39. Alice
    April 1st, 2009 at 07:21 | #39

    33#Joseph – says
    “Alice
    “Having bizarre conspiracy theories about ‘elites’ is one thing. Supporting violence against people is quite another. Is that what you’re doing?”

    Well Joesph, I dont see much evidence above that I was “supporting violence” but its an interesting twist youve thrown in here (and it is a royal twist). I will say that political instability can and does arise from underlying economic instability (everywhere in the history books Joseph – not me “supporting violence”).

    If I think that elites are running the show I certainly wouldnt be alone. Roosevelt complained of the very same thing after the crash of 29 where he complained about the magnitude of surpluses that were extracted by the few who had the power to manipulate markets that it became top heavy and fell on itself (the US top 50 families at that time controlled extraordinary wealth and market power). The US did not implement the Sherman anti trust laws for no reason. I dont see much difference between the CEOS and executives at Merryll Lynch, AIG, Goldman Sachs or Lehman except time Joseph. Same modus opernadi. Surpluses of the magnitude these executives have been extracting for their own private benefit, I would call the excessive and unrestrained behaviour of an elite oligarchy.

    Of course the elites have been engaged in conspitaorial activities Joesph and its naive to imagine otherwisse. Those “conspiratorial activities” (the closed shop that is their self remuneration process and the market power which they can exercise to manipulate share prices up or down) have been against the best interests of employees, creditors and shareholders as well as the healthy functioning of a multitude of economies.

    Its about balance in your agruments Joseph – and that doesnt include false accusations of “carrying conspiracy theories” or “supporting violence.”

    These are naive comments you make.

  40. Socrates
    April 1st, 2009 at 09:35 | #40

    Is it possible for people to stop using the term “elites” whether left-wing or right-wing? I think it is now quite outdated and inaccurate. A more accurate term for the wealthy and powerful who dominate our society would be “power cliques”.

    Webster’s dictionary defines “elites” as being “a group of persons who by virtue of position or education exercise much power or influence”. It seems to me that many of our most powerful are not intellectual and influential – we don’t believe a word they say – but they are powerful and get their way with government. Academics are not elites either. Sadly, they have declined greatly in influence in my lifetime. One media shock-jock has more power than 100 academics. Needlesss to say, its unlikley the shock-jock will have a PhD.

    Second, I agree with Bruce @ 20 on Pareto Optimality – who cares about it? It guarantees neither efficiency nor equity. The more I study philosophy and realise just how many different views exist on distributive justice, the less I pay attention to Pareto. Plus, it is so easy to cheat Pareto in any analysis by only considering the short term. You can even get a change that makes everyone worse off in the long term to look Pareto optimal in the short term. Pointless.

  41. Socrates
    April 1st, 2009 at 09:50 | #41

    I should add that in other respects I strongly agree with Alice above; I just don’t like this term “elite”.

  42. TerjeP (say tay-a)
    April 1st, 2009 at 10:34 | #42

    #38. I was just making sure. And I wasn’t specifically refering to you John. However can I take it as given that in your book the neoliberal project that has supposedly brought the global economy to ruin has nothing at all to do with tax cuts. The latter having never happened. In other words we might blame deregulation (if we must call it that depite some apparent absurdity) and privatisation but we can’t blame tax cuts that didn’t happen. And of course can I take it as given that you accept that we have never really tested the laffer curve hypothesis because we never actually had cut taxes.

  43. April 1st, 2009 at 12:16 | #43

    # 37 Joseph Clark Says: April 1st, 2009 at 12:33 am

    jack, It’s all true. Us capitalists have been running the scam for centuries. First we steal all the money from the workers by exploiting them then we finance right wing think tanks to brainwash the portion of the population that hasn’t been pacified by consumerism (us again!).

    Joseph,

    I am no way opposed to industrial capitalists who do their job to maximise corporate profits. Even if that means sacking workers en masse. Shedding labour allows companies to move operations overseas or substitute machinery. The former raises global living standards, the latter raised national productivity.

    For a while back in the nineties I was the brother-in-law of Sue Morphett. She struck me as being a perfectly decent person and a top-notch professional businessperson.

    My beef is with financial capitalists who, in Warren Buffet’s memorable formulation, “make money off, rather than for, investors”. Financial capitalists by and large do not produce wealth. They are engaged in a struggle to re-distribute wealth, away from industrial capitalists and political statists.

    This form of capitalism is like a virus that parasticially infects and infests the Body Catallactic, filling the subject with a phony euphoria which ultimately leaves him feeling listless and apathetic.

    I am also a big fan of Right-wing think tanks that keep an eye on government waste, inefficiency and corruption. Governments are just resource-acqusitive firms constituted by men who are not angels. So they need to be watched and be held accountable.

    In AUS, the CIS perform this function admirably. Andrew Norton is pretty close to being the best academic blogger in Australia. They were well ahead of the curve in bringing out Friedman and Hayek. Its just that they have treaded a lot of water ideologically speaking ever since.

    Undoubtedly the onward march of statism means that there will be a big need for Right-wing economists to monitor dysfunctional state apparatus. Just imagine if the kind of people now hanging onto the NSW ALP were suddenly put in charge of your business. Scary thought.

  44. April 1st, 2009 at 12:53 | #44

    Socrates Says: April 1st, 2009 at 9:50 am

    I should add that in other respects I strongly agree with Alice above; I just don’t like this term “elite”.

    The term “elite” is indispensable for the analysis of institutions in the post-modern age. Once upon a time, in the “good old days” of “old school tie” the elites were very conservative and traditional. That has completely changed now.

    This is because of the pervasive and perpetual influence of tertiary universities in meritocratically selecting and sorting the managerial and professional personnel who staff major institutions. And the inevitable proliferation of incomprehensible jargon that accompanies their rule. Think MBAs.

    Virtually all contemporary elites subscribe to some form of post-sixties post-modern liberalism. This liberalism can be cultural Left-liberalism or financial Right-liberalism or sometimes both, as in the case of libertarians. One noticeable exception is technical elites, who still have a tendency to be boring nerdy “organizational men”.

    Post-modernist liberalism (c ~1970-~20??) is quite distinct from the modernist liberalism (c ~1770-~1970). The latter sought to develop individual self-government, the former seeks to escape institutional accountability.

    Post-modern liberalism is very convenient for uni-educated elites as it it tends to be sold as a technical doctrine laid out by the experts. “Just give us, or our ‘clients’, a free hand and we will do the job and society will be better off”. But in fact “a free hand” variously translated into “self-regulation”, “risk-management” or “harm-minimization”, “self-determination” turns out to be a licence for free-for-all.

    This suits the elites and their clients in the uber- or unter-classes who are free to “clean up” by appropriations from the wealthfare or welfare state. And if the thing degenerates into a mess then there is always a federal bail-out or intervention.

    But elite liberalism of this kind is distrusted if not despised by the general populace. This is comprised of “working familes” who have to work in a lower-level supervised, or middle level supervisory, occupation for a living. They have a much less liberal, more “corporal”, philosophy of government than special elites because they are routinely held accountable for their deeds and mis-deeds.

    They daily see elites and their “clients” getting off scot-free with rip-offs, rorts and rackets. That is why tabloid media aimed at the general public tends to be more oriented towards policing and punishing misbehaviour. Think Daily Telegraph, Sun-Herald, 2UE, 3AW, ACA, Border Security.

    The elite-populace political conflict is endemic given the tendency of post-modern institutions to suffer deformations and degenerations of accountability. I therefore predict that demagogues both Left and Right will continue to tap into latent populism in the general public.

  45. April 1st, 2009 at 14:31 | #45

    Pr Q says:

    As I said, my main puzzle is, assuming that the results were just a 100-1 fluke, why the authors thought of doing this in the first place, given the low probability of a publishable result.

    If the odds on getting such a study published were 10:1 and the odds of getting a signficant result were 100:1 then the overall odds of the hypothesis getting favourable attention was 1000:1.

    Perhaps someones prayers were answered?

  46. Alice
    April 1st, 2009 at 17:19 | #46

    Socrates #41

    If you dont like the term elites I can probably think of better ones like “wealthy industrialists” or something like that.

    However, there are much more appropriate decriptors for the elites right now but I cant tell you here because Id be breaking the no course language rule.

  47. Alice
    April 1st, 2009 at 19:10 | #47

    TerjeP

    ” And of course can I take it as given that you accept that we have never really tested the laffer curve hypothesis because we never actually had cut taxes.”

    What a nonsenese. Did you actually read previous posts? The top marginal rate was cut from 60% to 47 %. No other tax rank got ebenfits that made up for this. Rising inequality all round. If thats what “selectively cutting the tax rate” does Forget trickle down – it trickled alright but not down” In fact it didnt trickle at all – it seeped and banked up like a broken sewerage pipe.”

    If you are still in favour of testing the laffer curve TerjeP – it should be renamed the “laffin stock” curve.

  48. Alice
    April 1st, 2009 at 19:28 | #48

    And forget futher tax cuts Terje P. I dont mind them sacking every middle layer of the public service and above almost, but they can replace that with some teachers, nurses and road builders in my book. Run it on military lines – a damn lot of soldiers but only a few majors and generals.

    Thats why the public sector is wrecked – too many chielf and not enough Indians and all the chiefs are trying to cosy up to PPP deals where the public gets ripped off eg you drive from outer Sydney to Inner Sydney. You drive 10 ks on an overcrowded transit route. You drive two ks on a PPPs road and pay $7 each way for the privilege. How many two k strips of road are there in Sydney to get to work? Who makes the money – no one ut seems or not enough anyway. Who loses – the poor people who have to get to work.
    Hardly useful is it? Hardly helpful to the economy? Another short term vision by government. Oh wow, we might actually make some dosh on this PPS deal”??. Sack the deal makers. They are running us down in every way in terms of infrastructure provision with this short term efficiency from privatisation ethos. Cough up, provide the infrastructure for free with our tax funds directly (not the damn super or trips or benefits) or risk chronic government turnover due to chronic voter dissatisfaction. The public knows what it wants and what infrastructure is needed – politicians should just deliver or leave.

    TerjeP – get I dont mind people in the public sector being sacked but they have been sacking the wrong end and hiring at the wrong end.

  49. April 1st, 2009 at 20:43 | #49

    Alice – As I see it the conversation thus far has run roughly like this.

    JQ (#0): The Laffer hypothesis was proved false because we had tax cuts and we didn’t see revenue rise.

    Monkeys Uncle (#12) Not really disproved because income tax cuts didn’t lead to any decline in revenue.

    JQ (#13): Revenue actually increased. However it increased because we had other new taxes like FBT and capital gains tax.

    TerjeP (#35): So we never actually had tax cuts.

    JQ (#38): Agreed.

    TerjeP (#42): Doesn’t comment #38 contradict #0?

    Alice (#47): You can’t read. Blah, blah, blah.

    If during any historical period we are interest in the effective tax rates were cut but revenue didn’t declined in any sustained way then it seems self evident that either:-

    i) tax cuts were shown to be possible without harming revenues. This is good becaue it means we can have our cake and eat it. A larger private sector income with no harm done to the public sector.

    ii) we never had tax cuts so the hypothesis hasn’t been tested.

  50. Monkey’s Uncle
    April 1st, 2009 at 21:26 | #50

    Sorry, I’ve been MIA on this thread for a bit. Have had to work longer hours. Although once I hit the top marginal tax rate this year, I will start cutting back my hours (thereby further proving the Laffer effect).

    Some posters have brought up the issue of past income tax cuts during the 1980s being accompanied by increase in other taxes (like the introduction of CGT, and increases in consumption taxes).

    Yet this is really a case of dancing around the point. The main reason why governments looking to increase their revenues decided to do so by expanding their revenue base rather than increasing the rate of individual taxes is precisely to avoid any Laffer-type effects of excessive tax rates.

    If there is little Laffer effect on incentives or evasion, it would be much simpler to raise more revenues by raising existing taxes (like income tax) than expanding the revenue base.

  51. Monkey’s Uncle
    April 1st, 2009 at 21:35 | #51

    Alice, I meant to respond to your earlier point regarding tax cuts for high-income earners and the relationship to economic inequality.

    Regardless of what anyone thinks about claims of rising inequality, I believe that most economic modelling has shown that if income inequality has been increasing over the past two decades that inequality in market incomes (before taxes and transfer payments) has increased faster than income inequality after the tax/transfer system is taken into account. If this is true, it shows the net level of government redistribution is if anything greater than in the past.

    If your argument about tax cuts for high-income earners contributing to rising inequality was true, the exact opposite would be the case. That is, income inequality before taxes and transfers would not have risen as fast, but income inequality after taxes and transfers would have risen faster.

    I’d be interested if JQ has any economic modelling to disprove this.

  52. Alice
    April 2nd, 2009 at 09:40 | #52

    Monkey’s Uncle

    supposes that
    ” if income inequality has been increasing over the past two decades that inequality in market incomes (before taxes and transfer payments) has increased faster than income inequality after the tax/transfer system is taken into account. If this is true, it shows the net level of government redistribution is if anything greater than in the past.”

    Illogical Monkey’s Uncle. If before tax income and after tax income both show inequality rising, it matters little which is rising faster.

    Inequality is still rising.

    Redistribution policies are ineffectual if both the inequality of before tax and after tax incomes are both rising, regardless of which one is rising faster.

  53. April 2nd, 2009 at 10:47 | #53

    # 33 Joseph Clark Says: March 31st, 2009 at 9:20 pm

    Having bizarre conspiracy theories about ‘elites’ is one thing.

    No elite conspiracy? Ever heard of “remuneration committees“?

    Corporate governance has become a shambles since financial free marketeers took over the board-room. Wikipedia summarises results:

    The results of previous research on the relationship between firm performance and executive compensation have failed to find consistent and significant relationships between executives’ remuneration and firm performance. The results suggest that increases in ownership above 20% cause management to become more entrenched, and less interested in the welfare of their shareholders.

    Some argue that firm performance is positively associated with share option plans and that these plans direct managers’ energies and extend their decision horizons toward the long-term, rather than the short-term, performance of the company. However, that point of view came under substantial criticism circa in the wake of various security scandals including mutual fund timing episodes and, in particular, the backdating of option grants.

    Even big businessmen are questioning the value of these sweet-hearted contracts with “welcome aboard” teasers, dodgy stock-optioned bonuses and “golden parachutes”. It just encourages a short-term “pump and dump” attitude amongst management.

  54. Alice
    April 2nd, 2009 at 10:55 | #54

    #53 “No elite conspiracy? Ever heard of “remuneration committees“?”

    Exactly Jack. You can show them the elephant in the room but you still cant convince them its there…

  55. Alice
    April 2nd, 2009 at 11:02 | #55

    Jack – The Age only just archived one of your links after you posted it (the big businessmen link above) – but I know who it is. I think its David Murray? saying that exec remunerations have gotten ridiculous. I read it very recently.

  56. ajwak1
    April 2nd, 2009 at 11:04 | #56

    It seems to me that the statement that “pareto improvements are good by definition” is only true where the improvement is in our ends, and not necissarily true when the improvement is in a means, such as money.
    So whether a pareto improvement in income is always good becomes a question of indirect costs associated with inequality.

  57. Socrates
    April 2nd, 2009 at 13:10 | #57

    Jack 53

    On this we are strongly agreed; BTW terminology aside I never disagreed with you or Alice on the nature of the powerful adn how they operate.

    Regarding remuneration committees, if anything that Wikipedia entry is not strong enough. John Shields did some work a few years ago that showed there WAS a clear relationship between exec pay and corporate performance. Unfortuantely, it was negative – the higher the pay, the worse the return. I suspect now you could establish a similar relationship with the risk of failure.

    Pesonalyl I think “Old Boys Club” is a more accurate term for elites. Either that or “oligarchs”. Anothe hudnred years at this rate adn they will be “overlords” and we their serfs.

  58. nanks
    April 2nd, 2009 at 13:19 | #58

    @ 57 “Anothe hudnred years at this rate adn they will be “overlords” and we their serfs.”

    I hope you are right Socrates – I’ve not been so optimistic.

  59. Joseph Clark
    April 2nd, 2009 at 13:35 | #59

    Jack & Alice,
    Remuneration in publicly listed companies is a matter for shareholders. If management have their snouts in the trough it’s shareholders who suffer and shareholders who need to become more active. It is not a public policy issue.

    This outrage over executive remuneration is truly bizarre. Why do you care? Do you just enjoy being outraged?

  60. Monkey’s Uncle
    April 2nd, 2009 at 14:04 | #60

    Joseph, spot on. If someone owns a business and is paying a worker more than they are worth, why should I care or be outraged by it? Unless I have money invested in the business, or am being somehow forced to pay for it. Otherwise it’s none of my business?

    If taxpayer subsidies or bailouts are used to help fund excessive executive pay, then people have a right to be outraged. But that is the only situation.

    “This outrage over executive remuneration is truly bizarre. Why do you care? Do you just enjoy being outraged?”

    Yes, a lot of people enjoy being outraged.

  61. Socrates
    April 2nd, 2009 at 15:35 | #61

    JC and Monkey

    the trouble is that, to continue the analogy most of us are forced to contribute funds into this business (via super legislation) and have no control over the wages set. Meanwhile those who run the businesses are now taking more out in fees than many of them are making in profits.

    If the Director/Executive relationship in large corporations really was owner/employer then you would be right. The trouble is, its nothing of the sort. You imagine as though votes on execuive remuneration at shareholder meetings are binding. But with 60% or more of shareholdings in the hands of institutions, which are not subject to the same legislation, even that change will not solve the problem.

  62. Socrates
    April 2nd, 2009 at 15:43 | #62

    JC and Monleys Uncle

    Tell me, if you think there is no problem with exec pay, what do you personally think is a reasonable annual pay level for a CEO of an ASX 200 listed company earning average returns? How many hours a week would you expect the CEO to work for it?

    Bear in mind that the Prime Minister has a salary of $330,000 (more like $400,000 with alowances) and there is no shortage of applicants for that job, despite quite long hours.

    Look forward to your answer.

  63. Joseph Clark
    April 2nd, 2009 at 16:46 | #63

    Socrates,
    You can allocate your super to 100% cash or start up your own SMSF. You’ll sleep better at night.

    Minor shareholders who are unhappy with the behavior of major shareholders can take their money elsewhere.

    Executive pay is usually a small portion of a firm’s costs. Shareholders have many more important things to worry about (like the decisions being made) that have a larger impact on profits.

    There is no such thing as a fair wage in the same way that there is no such thing as a fair price. The fair price is the traded price. If you think of prices (and wages) in terms of fairness you will spend a lot of your time being unnecessarily outraged.

    If a painting sells for 50m or an actor gets paid 20m to appear in a movie I could prance around whining at the unfairness of it all. I could find people who work harder than the actor and get paid less or things that are more useful than the painting but sold for less. The fact is my view of value is entirely irrelevant to the parties who entered the trade. Things don’t have an objective monetary value: they are worth exactly as much as people are prepared to pay for them, not a penny more or less.

    I don’t think there is a `reasonable’ salary for a CEO for the same reason that I don’t think there’s a reasonable price for a Rembrandt or a reasonable amount of prize money in a sporting competition.

  64. Socrates
    April 2nd, 2009 at 17:13 | #64

    Nicely avoided JC; courageous answer.

    Actors and paintings are non-sequitors – their salaries are set in different ways. If actors don’t generate the ratings they are soon dropped. Rosne’s work on the economics of superstars explained their incomes 20 years ago. This does not explain CEO salaries.

    If you see Bebchuk’s research on this subject you would know that remuneration of the top five execs now averages over 10% of gross profits in top 500 corporations. Hardly a small cost.

  65. Alice
    April 2nd, 2009 at 17:31 | #65

    CEOs value compared to a Rembrandt painting by JC?
    Well we all know they have had had egos as big as the Nightwatch but Rembrandt created something grand, and didnt paint fakes with delusions of grandeur.

  66. SeanG
    April 2nd, 2009 at 23:10 | #66

    Alice,

    And the titans of business never created anything grand?

    So IBM is not grand? Nor is Compaq? The PC you are using has impacted the world just as much a painting has – but you don’t think that the person who managers/owns the business is entitled to a good income?

  67. TerjeP (say tay-a)
    April 3rd, 2009 at 08:00 | #67

    CEO salaries are set by company boards. Company boards are elected by shareholders. The system is an example of representative democracy. Not the finest.

  68. Socrates
    April 3rd, 2009 at 08:04 | #68

    Sean G

    That is another popular non-sequiter argument used to falsely justify execuive pay.

    What does it mean to “create something grand”? If you are Bill Gates or Warren Buffett it may be true. However their wealth doesn’t derive from what they paid themselves as CEO; its from their share of ownership in what they started. But most (still highly paid) CEOs inherit positions of power over organisations that they did NOT create. So why pay them millions for just managing something that someone else built up?

    Even for those who do create “something grand” the main method is by mergers and acquisition, not creating a new product or building up a business from scratch. Does this represent a net icnrease in wealth for the society? Usually not; its mainly financed by borrowing, with many deals now unravelling. No credit for that. The evidence on the success rate of mergers is also very poor, with Citibank being a classic example of its folly.

    They shouldn’t get credit for creating “something grand”. That is an ego trip. They should get credit IF they create something profitable. The flip side of that is that they should be penalised if they destroy something that was previously profitable.

  69. Socrates
    April 3rd, 2009 at 08:08 | #69

    Just to illustrate how much fans of high executive pay have forgotten their theory, here is what Adam Smith said about managerial pay in Wealth of Nations:
    ” “The profits of stock, it may perhaps be thought, are only a different name for the wages of a particular sort of labor, the labor of inspection and direction [leadership]. They are however altogether different, are regulated by quite different principles, and bear no proportion to the quantity, the hardship or the ingenuity of this supposed labor of inspection and direction.”

    I bet the Adam Smith society won’t quote that passage too often.

  70. Alice
    April 3rd, 2009 at 09:34 | #70

    Sean66# says
    “but you don’t think that the person who managers/owns the business is entitled to a good income?”

    Good yes – Im all for “good salaries for managers and owners”, but not ripping the guts out of the company and shareholders returns, just for their own personal use.

    Are you blind Sean? You think Alan Moss was worth 23 mill in one year????? You think any one person is worth that in salary Sean. Thats about 23 times a good salary Sean.

  71. Alice
    April 3rd, 2009 at 09:41 | #71

    Sean –

    what the CEOs of the grand financial institutions created was a grand catastrophe and they will do it again given half a chance if they dont get their hand slammed down by the cookie jar lid (regulators) and they dont get told what to do with their excessive greed in remuneration (listen here boys – you get two cookies after school not the whole jar). I was glad to see Merkel and Sarkovsky telling Obama to listen up. Someone needs to tell the US to listen up with its out of control financial sector and we in Australia need to drop the “we are U.S. grommets” approach to financial de-regulation.

  72. Alice
    April 3rd, 2009 at 09:57 | #72

    Terje says
    “CEO salaries are set by company boards. Company boards are elected by shareholders.”

    Terje forgot to say that massive blocks of shareholders are represented by one like minded institutional fund manager and for all we know he is probably getting a cut…

    No its not ideal.

  73. Alice
    April 3rd, 2009 at 10:00 | #73

    Or the institutional fund manager is probably getting a deal sweetener – how about a company sale of real estate and way below market values…..to one of the funds companies..

    Come now..it goes on all the time. Asset switches with a remunerative sweetener sachet attached.

  74. Bruce Littleboy
    April 3rd, 2009 at 11:34 | #74

    Re Joseph
    “Pareto improvements are defined in terms of preference not quantity. [True (thank you), but I was tacitly talking about goods and ignoring bads so that "more" necessarily would be preferred.] Unless people prefer less preferred commodity bundles Pareto improvements are just plain good. ["Preferred" is factual. "Good" is usually typically used as normative. Maybe one should stick to PI means "preferred", given the preferences that are recognised by the analyst. Do analysts permit individual preferences about distribution to be included? Eg, your improvement makes me feel weaker, exploited, envious or resentful. Typically not. Perhaps you are commendably permitting people to have whatever preferences they like (including interdependent ones), but is this standard practice?] Pareto optimality is another matter.[Indeed, but PO is a choice among P Efficient points. If these PE points are ill-identified, choosing the most 'equitable' among these is an uninteresting exercise.]“

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