Monthly Archives: January 2017

Where do the rich come from?

Were you not born into a rich family? Never mind, your chances to become a billionaire have never been better.

Steven Kaplan and Joshua Rauh (both from the University of Chicago) conducted one of the less typical academic researches when they studied characteristics of the richest Americans. Using the Forbes ranking which lists the top 400 wealthiest individuals in the US economy, the authors explored three simple questions: whether wealth is self-made or inherited; in what industrial activities the firms of the rich operate and to what extent technology plays a role in their business activity; and whether the Forbes 400 members have graduated from college or not.

To provide a bigger picture, they analysed four years with approximately 10-year gaps between them. Starting with 1982 and finishing with 2011’s issue they described the dynamics of the changes. The study reveals that nowadays the Forbes 400 are more likely to run their own business rather than a business established by their ancestors. In 1982 only 40 percent of the Forbes 400 members started their own business, compared to almost 70 percent in 2011. The effect of family’s wealth has also become smaller within the group of self-made billionaires. While in 1982, roughly 60 percent of Forbes 400 members grew up in rich families, nowadays, it is only around 20 percent. Equally interestingly, the share of Forbes 400 members from poor families has remained constant, around 20 percent. The figure below provides more details.

2017-01-13

The data further indicate increasing importance of education. In particular, the percentage of college graduates among the 400 richest businessmen has grown by 10 percentage points, to 87 percent. Similarly, the rate of dropouts has increased as well. Naturally, the number of those who did not attend college at all has decreased. Considering the industry of the businesses, there are several trends worth attention. In the last 20 years, retail, technology-based industries and financial firms (hedge funds, private equity) have become more represented in the Forbes 400, whereas real estate, energy and media have experienced a decline. Overall, the structure of Forbes 400 has changed dramatically since 1982 and the position of the wealthiest individuals seems to be more open for those with no business to inherit.

Reference: Kaplan, S. N., & Rauh, J. D. (2013). Family, education, and sources of wealth among the richest Americans, 1982–2012. The American Economic Review103(3), 158-162. Available here

Why do some people oppose international trade deals?

Towards a more informed view on what’s hidden under the veil of aggregated data

The current level of economic well-being is largely to be thanked to increased specialization in the economy, which was enabled by international trade and integration of regional and national markets. Although international trade is not a zero-sum game, even the most vocal proponents of openness to trade admit there are businesses finding themselves on the losing side of the bargain. Yet we know surprisingly little about the adverse effects of international trade exposure, especially on the micro level. David Autor, David Dorn, and Gordon Hanson made the first step into these unchartered lands and provide grounds for a more informed discussion about international trade.

Their great contribution stems from using regional instead of national data and also from distinguished use of econometric methods. Commuting zones in the US serve as a smart proxy of local labor markets. Labor mobility and spillovers from dynamic regions are often not able to compensate for losses caused by increased competition. Disaggregation of the data at the local labor market level enables a closer look at this issue. To avoid endogeneity, they use data on other advanced countries’ imports from China. The original US data could be endogenous; import intensity is not caused only by supply but by demand as well. However, by using import data of a similar country (actually a composite index of several ones), one can isolate only the supply effect and thus avoid the endogeneity trap.

The results prove Chinese import competition negatively affects labor markets. Even a brief look at the data shows clear negative correlation between manufacturing employment and Chinese import penetration in the US (see figure below). More advanced analysis shows import penetration indeed reduces the number of employees working in manufacturing, but also shrinks the total labor force (as many people prematurely retire or apply for disability benefits), pushes down wages in non-manufacturing, and increases government transfer receipts. Trade exposure thus affects the whole labor force: manufacturing through employment and non-manufacturing through wages. There is also already a mechanism in place compensating for losses caused by trade – unemployment, retirement, disability and other welfare benefits serve as an insurance against trade shocks. Unfortunately, looking at regions formerly known for booming manufacturing, such mechanism does not compensate for the contemporary economic dynamic.

Autor graph

Although trade with China most likely benefits the US economy in the aggregate terms, there are regions losing out in the short term. This could partly explain the widely spread disenchantment with new trade agreements all around the developed world (be it TPP or TTIP). However, for those working in the service sector in major cities, it is tempting to focus only on the upside of international trade. The newly acquired insights should not serve as an argument against openness to trade; instead, it should make the discussion more informed and make us all think of how to kick-start regions lagging behind.

Reference: Autor, D. H., Dorn, D., & Hanson, G. H. (2013). The China Syndrome: Local Labor Market Effects of Import Competition in the United States. American Economic Review, 103(6), 2121–2168. Available here

Should tall people pay more taxes?

Do you think that’s absurd? Keep reading.

Tax systems of most developed countries are astonishingly complex. Depending on your country, factors such as your income, consumption, wealth, number of children, charitable contributions, mortgage payments, health insurance expenditures, or whether you donate blood may all influence your tax liability, i.e. the total amount of tax due each year. The ultimate aim of designing a tax system is fairness, although the concept is rather subjective. There are multiple plausible, yet very different views on what is fair. One view (very rare, luckily) is that a flat tax would be the most fair tax, as everybody would just pay the same amount. In practice, two main principles are used to argue which taxes are considered fair – the ability-to-pay principle and the benefits principle. While income tax or wealth tax are prominent examples of taxes we deem fair based on the ability-to-pay principle (you pay as much as your financial situation allows you to), consumption tax or highway tolls are typical taxes based on the idea of the benefits principle (you pay as much as you use a certain good or public service). The framework for optimal taxation which remains a centerpiece in modern public finance was laid out by James A. Mirrlees (of Mirrlees Review) and William Vickrey, for which they jointly received a Nobel Prize in 1996.

As argued by Nicholas Gregory Mankiw and Matthew Weinzierl (both from Harvard), based on this theory, a surprisingly suitable choice could be taxing people’s height, or more precisely, providing a tax credit to short people and imposing a tax surcharge for tall people. Before you discard the idea as nonsense and stop reading this article, think about the reasons not to tax height. In short, the optimal taxation theory as it stands today defines an ideal characteristic based on which to tax as:

  1. exogenous, meaning that the tax does not distort incentives as there is no way to change this characteristic,
  2. easily observable, meaning that it is easy to see what the value of this characteristic is for every person,
  3. positively correlated with ability, so that the ability-to-pay principle is satisfied.

Income, which is currently the most important characteristic of people for tax purposes in most countries, does not do too well in (1) because of deadweight loss and in (2) as documented by relatively high shares of the shadow economy throughout the world. Income does pretty well in (3); in fact, it is probably the best indicator of ability we have at this time.

But how about height? While the first two requirements are clearly met for height, the third one might raise questions. However, previous research (see, for example, here, here or here, and figure below) convincingly shows that taller people make more money – on average by between 1 and 2 percents per additional inch of height – and, assuming correlation between ability and income, a potential height tax would also be correlated with ability. Starting from here, the authors rigorously show in their article that the current theory suggests that we should indeed impose a height tax, and moreover, the optimal level of such tax is substantial. The fact that in practice, we do not impose such a tax and that most people think it absurd suggests that the current optimal taxation theory must in some way fail to capture our intuitive notions of distributive justice.

article_figure

Reference: Mankiw, N. G., & Weinzierl, M. (2010). The optimal taxation of height: A case study of utilitarian income redistribution. American Economic Journal: Economic Policy, 2(1), 155-176. Available here, working paper version available here.