2017-04-06

The Fairy Tale of Capitalism: Supercompensation, Income and The Exchange

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A mythology, such as FTC the Fairy Tale of Capitalism, provides explanations and justifications for the norms of society, inspiration and justification for our actions, a narrative of transformation, and no small portion of entertainment.



Sculpture: Brenda Putnam, "Solon" (1950)
Once upon a time, a small, small number of people in the Society received a large, large amount of pay for their work. So large an amount did this small number of people receive that it accounted for a significant part of the National Income.

In those days, there was a young man who received a good education and became an employee receiving $55,000/yr of pay. His colleagues liked him and regarded him highly. He reliably exceeded short-term goals while remaining consistent with the long-term plan. He worked with versatility and insight. He was diligent, clever, persistent, adaptable, creative and quite productive. He worked with devotion to customers, colleagues, Society and the Shareholders. He never wasted the Firm’s resources, though he didn’t shirk from taking a calculated business risk. His work advanced long-term strategic growth and drove strong results. He embraced change, improved product quality, focused on the customer and led his colleagues in grasping new challenges. His Managers observed his consistently superior performance. Each year, he received an increase of 10% in his rate of pay, a reward for good work and an implied incentive to perform well in the future. After 30 years of superior performance, no longer young, with promotions to new responsibilities and the 10% increase each year, he received nearly $1m/yr of pay.

The CEO Chief Executive Officer of the same Firm received Supercompensation of about $8m/yr of pay.

We'll return to the excellent worker and the CEO in a minute, but first, what is this thing called National Income? And for that matter, what is Income?

The Economists calculated National Income as GDP Gross Domestic Product minus depreciation of capital plus or minus some relatively minor adjustments, mostly for transactions with foreign parties.

United States 2016
$ trillions
GDP Gross Domestic Product
19
Less: Depreciation
-3
Equals: National Income
16
The Aristocracy got about 20%, or $3t, of National Income. Of that, about 2/3 was Capital Income, and the remaining 1/3, or about $1t, was Labor Income for the Aristocracy. The Aristocracy were One Percent of the households in the Society. Those of them who got Labor Income were the small, small number who received a large, large amount of pay.

Customarily, in those days, nearly everyone received money, called “pay” in exchange for the Labor of some members of their household. The people could exchange the money for the necessities of life and a degree of personal indulgence. Some of the people saved a part of their pay for future use.

A different arrangement called “slavery” prevailed in earlier times, but most of the people had forgotten it. Slavery enabled some people to force Labor from Workers. If these Workers got pay, they rarely got much of it, but that is a different story.

Another arrangement sometimes called “debt slavery” wasn’t uncommon in earlier times, but most of the people had forgotten it. Even though Solon of Athens had prohibited some forms of debt slavery, the arrangement persisted elsewhere even 2,500 years later, the time of the great wars. In one form, an employer paid Workers cash insufficient for bare subsistence, and lent money to the Workers for house rent in housing the employer owned and for food from a store the employer owned. With loan payments deducted from their pay, Workers borrowed even more, and so remained under perpetual obligation to the employer. But that too is a different story.
However, the Workers, in this (longish) story of Supercompensation, Income and The Exchange, didn’t live in the time of slavery. For the most part, and like nearly all of the 99 Percent, the Workers were employees of Firms. Around 9/10ths of their Income came from exchanging their Labor for money. If you didn't have Capital Income, then you had to give up Labor to get Income.

The Society (with some exceptions in this immense population, of course) believed that without the principle of Labor for Income, civilization would be lost. Maybe it didn't have to be that way, but that's how it was.


The Income of the median household was about $55,000/yr. Many Workers got pay of about that much, which was nearly all of their income. A Worker with 5 times that pay was quite well paid and characteristic of the upper reaches of the 99 Percent and the less wealthy Aristocrats. Aristocratic Income came mostly from ownership of Firms and the lending of money, which the Economists called Capital Income, and about ⅓ from Labor Income, as we mentioned earlier. Supercompensation, a form of Labor Income, became a more important component of Aristocratic Income following the great wars then tapered off.

As we said earlier, in those days, there was a man whose excellent work brought him, after 30 years of superior performance, nearly $1m/yr of pay. And you remember the CEO of the same Firm who received Supercompensation of about $8m/yr of pay.

comic: Scott Adams http://amzn.to/2nC642w  © 1993 United Features Syndicate

The Firm’s shares were traded at the Exchange, a big granite building where representatives of people who wanted to own part of the Firm would buy shares from representatives of Shareholders of the Firm who wanted to sell some of their shares. The Exchange was also an association of members, like a club, that met every day at the big granite building. They never ran on the floor of the Exchange. The members were the representatives who bought and sold shares of various Firms. They would buy or sell shares for you, if you paid them their fee. Their revenues came from their fees, and from buying shares for a few pennies less than the price for which they immediately sold them. They bore the costs of trading paperwork and of the Exchange membership, which they had bought from someone else. Like all other businesses, the Incomes of the members were their revenues less their costs.

The Exchange’s members had rules limiting the character of the shares they traded. They had created many of these rules at the insistence of Government, which usually allowed the members to pretend the rules were voluntary. The historical reason for this custom of pretending the voluntary was lost even to the Old Ones, most of whom had been dead a long time. The Society kept the custom for the same reason they placed the forks on the left sides of their plates.

One set of Exchange rules required Firms, with shares traded on the Exchange, to make public the amounts paid to the most highly paid employees every year with explanation for why they paid $8m/yr.

Chart: Daniel Brockman
To explain why they paid $8m/yr, the Board of the Firm appointed a Committee of Compensation of three of their members, who were 2 CEOs and 1 Executive from other Firms. First, they hired a consultancy, a kind of organization that provides Staff on demand. The Staff so hired researched the matter carefully. After several months, they provided two or three dozen pages of intensely boring prose for inclusion, with approval of the Committee of Compensation, in the Notice to Shareholders of Annual Meeting and Proxy Statement.

With this text, the Proxy Statement explained how the CEO upheld the Firm’s devotion to customers, employees, Society and the Shareholders. It explained how the CEO exceeded short-term goals while remaining consistent with the long-term plan (except for a pesky little legal problem), advanced long-term strategic growth drivers, drove strong results in all parts of the Firm, and got general concurrence from the Shareholders on pay in the previous year. The Proxy Statement also gives great detail on the competition with other Firms to pay up for CEO talent, the extensive industry experience of the CEO, levels of pay (without giving specific numbers) at other Firms of similar size and complexity, various Staff-concocted methods of pay and executive benefits, and an abundance of other detail.

The Shareholders who paid any attention ignored most of the detail, looked quickly at the total in the Summary Compensation Table part of the Proxy Statement, then voted yes. And that’s why the CEO got $8m/yr.

The Economist Thomas Piketty (2014, p.510) said the CEOs exercised “bargaining power” to extract the higher rates of pay. The Economists Piketty, Emmanuel Saez and Stefanie Stantcheva (2014, p.231) attributed an aggressive bargaining response to reduced top marginal income taxation as a possible cause of Supercompensation. They said on the other hand that the CEOs might have been paid for luck. On yet another hand, they said that CEOs might indeed merit their Supercompensation.

The Economist Dean Baker said that the CEOs collected rents (2016, p.18), unless the value the Firm received was about equal to the money paid to the CEO. CEOs receiving Supercompensation, he wrote, got money that could only have been taken from funds that the Firm otherwise would have paid to other employees or to Shareholders or as reductions in prices for customers.

“Rents” was a word Economists liked to use to describe money a person could get simply because she or he was in a circumstance to demand it. They picked it up from the writings of David Ricardo, one of the Old Ones. Ricardo described how the value of older agricultural land increased when farmers cultivated new lands nearby. But that is another story.

Two verses of the Professors’ song “Market Value” described how the CEOs’ Supercompensation fully reflected the CEOs’ value, because it was tempered by the competition of many buyers and sellers. Customarily, when a CEO recognized the wisdom of the Professors, as often happened, the CEO would endow a chair in Economics at a University.    

Some Workers wondered why the excellent employee of 30 years topped out at $1m/yr when the CEO got $8m/yr. But most Workers knew the song “Market Value” had the right idea, more or less. They taught their children that good children, with hard work, would deserve Supercompensation when they grew up.



I’m grateful to my friends who reviewed a prepublication draft and offered helpful corrections and advice.


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Sources

Alphabet, “Notice of 2016 Annual Meeting of Stockholders and Proxy Statement” (Apr 2016) https://abc.xyz/investor/pdf/2016_alphabet_proxy_statement.pdf

Dean Baker, “Rigged” (Center for Economic and Policy Research, 2016) http://deanbaker.net/images/stories/documents/Rigged.pdf

Daniel Brockman, “Critique of GOP Tax Plan” (Mar 2, 2017) https://daniel-brockman.blogspot.com/2017/03/critique-of-gop-tax-plan.html

Daniel Brockman, “The Fairy Tale of Capitalism: The Buyer of Labor and the Nine Percent” (Mar 11, 2017) https://daniel-brockman.blogspot.com/2017/03/the-fairy-tale-of-capitalism-buyer-of.html

Daniel Brockman, “The Fairy Tale of Capitalism: Workers, GDP and Economists” (Mar 17, 2017) https://daniel-brockman.blogspot.com/2017/03/the-fairy-tale-of-capitalism-workers.html

Bureau of Economic Analysis, “Selected NIPA Tables: Table 1.7.5. Relation of Gross Domestic Product, Gross National Product, Net National Product, National Income, and Personal Income” (Mar 30, 2017) https://www.bea.gov/national/pdf/SNTables.pdf

Johnson & Johnson, “Notice of Annual Meeting and Proxy Statement” (Mar 2017) http://www.investor.jnj.com/secfiling.cfm?filingID=200406-17-15&CIK=200406

Thomas Piketty, “Capital in the Twenty-First Century” (2014, English translation) http://amzn.to/2fJg7Oi

Thomas Piketty, Emmanuel Saez, Stefanie Stantcheva, “Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities” (2014) https://eml.berkeley.edu/~saez/piketty-saez-stantchevaAEJ14.pdf

Thomas Piketty, Emmanuel Saez, Gabriel Zucman “Distributional National Accounts: Methods and Estimates for the United States” (Dec 2016, NBER Working Paper No. 22945) https://eml.berkeley.edu/~saez/PSZ2016Slides.pdf https://eml.berkeley.edu/~saez/Piketty-Saez-ZucmanNBER16.pdf

United States Census Bureau, “Median Household Income in the United States: 2015” (Sep 2016) https://www.census.gov/library/visualizations/2016/comm/cb16-158_median_hh_income_map.html


2017-03-31

The Fairy Tale of Capitalism: CEOs, Growth and Prosperity of Society

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The Fairy Tale of Capitalism, or FTC, is a mythology, as is the Wild West, portrayed in thousands of movies, radio and television programs.



Once upon a time, Growth measured Prosperity in the Society. “Growth of GDP”, the kind of Growth they had in mind, was perhaps the Professors’ favorite hymn. In “Growth of GDP”, sung often, Growth led and Prosperity followed. Some listeners envisioned enlarging the Aristocrats' wealth and letting the Downward Trickle distribute the Prosperity to the 99 Percent. But that is another story.


Ali Amir Beg (ca. 1558),  image: Wikimedia.org
Society, of course, was all the people, the Aristocrats, the Nine Percent, the 90 Percent, everyone. The Society organized itself into groups called Firms to find, gather, produce and distribute stuff.

A CEO Chief Executive Officer, sometimes called the President, was the Manager who outranked all other Managers in a Firm. The CEO could tell any of the Workers or other Managers what to do. By hiring appropriate Staff, the CEO worked to improve the Shareholders’ part of GDP10, and incidentally the CEO’s part.  

There were many kinds of CEOs. Some founded the Firm, the usual case with the smaller Firms. Many were Managers who had pleased the previous CEO, often by their performance at other Firms. For older or larger Firms, especially those in which the previous CEO was Aristocratic, the CEO was an Aristocrat from birth. Sometimes a Board selected for CEO a Worker who had become a Manager and who had shown talent.

The Staffs did not include the CEOs. But not uncommonly a member of the Staff was chosen for CEO. Some of the Staffs became CEOs when an Aristocrat wanted a person of demonstrated talent, instead of a son or niece or paramour of presumed talent, to manage a Firm, reminiscent of the Ottomans.

GDP50 grew slowly then shrank.

People understood the Economist Piketty only slightly better than other Economists, because he presented many pictures. The pictures showed the Prosperity wasn’t evenly shared among the Society. GDP01 was not much smaller than GDP90. Piketty’s pictures showed GDP50 grew ever more slowly as the years had passed and then shrank. GDP90 slowed to nearly nothing. GDP10 grew nicely, though ever more slowly. In later years, overall GDP growth sometimes outpaced GDP10. GDP01 grew rapidly over the years, though with variability. 

Responding to the unsettling conflict between Piketty’s pictures and their favorite song, some Professors added a few verses to “Growth of GDP” describing how even though redistribution allocated much Growth to the Ten Percent, that was necessary if the Ninety Percent were to get any. But most continued to sing the classic form, which members of Government understood well, owing to their frequent discussions with the Staffs, who the Professors educated. 

The Economists held Economist Saez in high regard for the arcane mathematical runes with which he always punctuated his expressions. Saez, a frequent collaborator with Piketty, had unusual talent for pictures among Economists. Saez described how the Supercompensation that the Boards paid the CEOs in the period following the great wars grew to about 40% of the aggregate incomes of the Aristocracy. But that’s another story.




I’m grateful to my friends who reviewed a prepublication draft and offered helpful comments.



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Sources


Ali Amir Beg, “Janissary Recruitment in the Balkans” (1558, Wikimedia) https://commons.wikimedia.org/w/index.php?curid=22361418

Daniel Brockman, “The Fairy Tale of Capitalism: Workers, GDP and Economists” (Mar 17, 2017) https://daniel-brockman.blogspot.com/2017/03/the-fairy-tale-of-capitalism-workers.html

“Koprulu Mehmed Pasha” (Wikipedia) https://en.wikipedia.org/wiki/K%C3%B6pr%C3%BCl%C3%BC_Mehmed_Pasha

Thomas Piketty, “Capital in the Twenty-First Century” (2014, English translation) http://amzn.to/2fJg7Oi

Saez, Piketty and Zucman, "Distributional National Accounts: Methods and Estimates for the United States" (NBER Working Paper NO. 22945, Dec 2016) https://eml.berkeley.edu/~saez/PSZ2016Slides.pdf

Emmanuel Saez, https://eml.berkeley.edu/~saez/





2017-03-17

The Fairy Tale of Capitalism: Workers, GDP and Economists

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The Fairy Tale of Capitalism, or FTC, is a mythology, a collection of villains, heroes, morals, all of which participate from time to time.




Once upon a time, the Composers of Tales were known as Economists, but most people thought the Economists were unintelligible. Sometimes the Professors created tales, and sometimes other members of Society created tales, but Economists originated most of the Tales. The ancient economists, to whom all turned for their original and enduring wisdom, were called the Old Ones, but that’s another story.

Workers were the people who got most of their income from their personal Labor. Sometimes the Economists simply called them Labor. The 90 Percent included almost all Workers. Of the Workers, none were Aristocrats, or if there was an Aristocrat among them, it was most often a scion sent to work in a factory for a summer, or an Aristocrat in disguise, like a monarch or a president of a Federal Reserve Bank who wanted to learn about the life of a Worker. 



The Economists often told of GDP Gross Domestic Product as the fundamental measure of social well being. GDP in the United States was mainly National Income plus depreciation of Capital. Depreciation of Capital was a relatively small and predictable amount compared with National Income. A few relatively minor adjustments wrapped up the calculation. So GDP was pretty much the same as National Income. Changes in the GDP level would reflect significant change in National Income.

Almost nobody understood the Economists. The Professors studied the Economists carefully, and sang songs of the Tales. Many people could understand the songs. They repeated some of the catchier songs to their friends. That was how most of the people learned of the Tales. “Growth of GDP” was perhaps the Professors’ favorite hymn. They sang it again and again. 

For a few years following the great wars of the 20th century, many Economists believed that Aristocrats, Nine Percent and Ninety Percent shared, more or less evenly, the growth of GDP. But in the 21st century, Piketty and a few other Economists told of GDP01, the Aristocrats’ share of GDP, of GDP09, the share collected by the Nine Percent, and GDP90, everyone else’s share. According to their Tale, from 1977 to 2007, growth of GDP10 (=GDP01+GDP09) was three-fourths of the growth of GDP. Even when GDP grew nicely, GDP90 grew very little from year to year. At the same time, GDP09 grew fast, and GDP01 grew very fast indeed. GDP growth wasn’t distributed evenly at all. The Ten Percent got most of GDP growth.

The Workers knew their incomes weren’t growing much. They didn’t understand GDP numbers. They knew GDP growth was a good thing, because they heard the songs. The Workers had faith that disciplined work and a little bit of luck would make them rich as Aristocrats. They didn’t know. 

They would have known had they remembered the songs sung by some of their grandfathers a hundred years earlier. One of the Old Ones had written some Tales that inspired Workers, and there were songs. But that’s another story.




I’m grateful to my friends who reviewed a prepublication draft and offered helpful comments.


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Sources

Daniel Brockman, “The Fairy Tale of Capitalism: The 90 Percent” (Nov 30, 2016) https://daniel-brockman.blogspot.com/2016/11/the-fairy-tale-of-capitalism-90-percent.html 

Daniel Brockman, “The Fairy Tale of Capitalism: The Buyer of Labor and the Nine Percent” (Mar 11, 2017) https://daniel-brockman.blogspot.com/2017/03/the-fairy-tale-of-capitalism-buyer-of.html 

John Royston Coleman, “Blue Collar Journal” (Jan 1974) http://amzn.to/2mQus2k

Kevin J. Lansing and Agnieszka Markiewicz, “Consequences of Rising Income Inequality”, FRBSF Economic Letter (Oct 17, 2016, Federal Reserve Bank of San Francisco) http://www.frbsf.org/economic-research/publications/economic-letter/2016/october/welfare-consequences-of-income-inequality/ 

Robert K. Massie, “Peter the Great” (1980) http://amzn.to/2nu5GTU  






2017-03-11

The Fairy Tale of Capitalism: The Buyer of Labor and the Nine Percent


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FTC, the Fairy Tale of Capitalism is not one story, but a saga reflected in many stories. 





In a trade, at least two people participate, since the robots haven’t taken over yet in our glorious era. A trade could be a bucket of fish given in exchange for the pulling of a tooth by a dentist. If both parties have a wide range of counterparties from whom to choose, and if they both participate freely, without coercion or deception, then we call it a fair trade. 

In a fair trade, both parties benefit. The dentist doesn’t have any fish, and she is hungry. The dentist has plenty of tools and experience for pulling teeth, which she can do easily, and a costly certificate hanging on the wall for which she has no use if she doesn’t pull a few teeth now and then. The fisher has a sore tooth and more fish than he can eat. When the fisher hands over the bucket of fish and the dentist removes the tooth, they have completed the trade. After the trade, the hungry dentist has fish to eat after giving up nothing but 15 minutes of her time. The fisher, who may have been out in a boat hunting fish for the last three days, has a much relieved jaw after giving up a few fish he couldn’t use. Both parties give up something they value relatively less and get something they value relatively more. Both parties benefit.

Clayton Christensen, a Professor, sings of one of the traders, in our case the fisher, as a person with a “job to be done”, a goal to achieve or an obstacle to remove. The song is the “Theory of Jobs to Be Done”. The successful search for a product or person contributes to job creation, not to be confused with the Ingenious Innovative Job Creators, but that’s another story. 

In our advanced era, a trade more often involves money offered in exchange for a good or a service. In these money trades, we call the the two participants the Buyer and the Seller. The Buyer gives money to the Seller, and the Seller gives something to the Buyer. For the fisher and the dentist, the fisher first takes the fish he caught to the fish market, and gives the fish to the Buyer of fish who offers him the highest price. Now the fisher has money and an aching tooth, and he would be glad to give up some of the money to get relief from the pain. The fisher finds the dentist, and feels confident, having seen the certificate on the wall. The dentist removes the tooth in a quick procedure. The fisher hands over some money to the dentist. The hungry dentist is glad to have some money, with which she can buy food, the certificate on the wall having less value as food. With the money, the dentist goes down to the fish market at the wharf and buys a fish sandwich.

In the USA, the Ninety Percent probably includes the fisher. The Ninety Percent are the least wealthy ninety percent of households. They get almost all their income from selling their Labor. They receive about half the national income. 

We will probably find the dentist among the Nine Percent. In 2015, the income of a household in the Nine Percent was between about $125,000 and about $450,000

The Nine Percent, together with the Aristocracy (incomes above $450,000 per household), are the Ten Percent. The Nine Percent get about 30% of national aggregate household incomes. The Aristocracy gets about 20%.

The Ten Percent get about three-quarters of the income growth in the US economy. The Nine Percent get about one-quarter of the total incomes growth. The Aristocracy gets the rest.

Most of the income of the Nine Percent comes from their Labor, but they get about 7% to 10% of their income from ownership of capital (stocks, bonds, etc.) and businesses. The Nine Percent have about 30% of national aggregate capital and business income. 

In the fair trade, a Seller has many potential Buyers. The Seller can accept a trade with the Buyer who offers the highest price or terms most favorable to the Seller. A Buyer has many potential Sellers and can agree to a trade with the Seller who offers the lowest price or terms most favorable to the Buyer.

In our golden era, Sellers of Labor (workers) often contend with many other Sellers for a trade with a small number of Buyers (employers). In some industries and locations, the employers have market dominance. One could count the potential employers for specialized Labor on one hand and have fingers left over. Employers have what we call Monopsony. On the other hand, the employers have many applicants for each job vacancy. The lack of a large number of employers impairs the fairness of trades available in the market for Labor.  The Ninety Percent generally work for companies owned by the Ten Percent.

Some of the Professors once sang that a Free Market is a fair market, naturally correcting itself for imbalances of Buyers and Sellers that may arise from time to time. But that is another story.





I’m grateful to my friends who reviewed a prepublication draft and offered helpful comments.



Sources


Daniel Brockman, “The Fairy Tale of Capitalism: The 90 Percent” (Nov 30, 2016)  https://daniel-brockman.blogspot.com/2016/11/the-fairy-tale-of-capitalism-90-percent.html

Congressional Budget Office, “The Distribution of Household Income and Federal Taxes 2013 (June 2016, Congress of the United States) https://www.cbo.gov/sites/default/files/114th-congress-2015-2016/reports/51361-HouseholdIncomeFedTaxes.pdf

Dina Gerdeman, “Clayton Christensen: The Theory of Jobs To Be Done” (Oct 3, 2016, Working Knowledge: Business Research for Business Leaders, Harvard Business School) http://hbswk.hbs.edu/item/clay-christensen-the-theory-of-jobs-to-be-done

Kevin J. Lansing and Agnieszka Markiewicz, “Consequences of Rising Income Inequality”, FRBSF Economic Letter (Oct 17, 2016, Federal Reserve Bank of San Francisco) http://www.frbsf.org/economic-research/publications/economic-letter/2016/october/welfare-consequences-of-income-inequality/ 

Thomas Piketty, “Capital in the Twenty-First Century” (2014, English translation) http://amzn.to/2fJg7Oi

Emmanuel Saez, “Striking it Richer” (June 30, 2016) http://eml.berkeley.edu/~saez/saez-UStopincomes-2015.pdf 



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2017-03-02

Critique of GOP Tax Plan

CONTENTS

Prologue

What’s Good About the GOP Tax Plan

What’s Bad About the GOP Tax Plan

Omissions

Conclusion

Sources


SUMMARY



The Blueprint will redistribute about two percentage points of national income share to the more wealthy households.

The Blueprint provides for large changes in top tax rates from current levels. This table compares the top marginal rates for different kinds of income.


Income type
Current law top marginal rate
GOP Blueprint top marginal rate
Main beneficiary of Blueprint
Individual ordinary income
39.6%
33%
One Percent
Investment income (interest, dividends, realized gains)
25% (approx.)
16.5%
Ten Percent
Small businesses (a.k.a. passthroughs: sole proprietorships, S corporations, partnerships)
39.6%
25%
Ten Percent
Large businesses (C corporations)
35%
20%
Ten Percent


The Blueprint states (on page 5) admirable goals for simplification, fairness, economic growth, stimulation of employment, and sensitivity of the IRS Internal Revenue Service to taxpayer concerns. It emphasizes “And it [the Blueprint] is the beginning of our conversation about how to fix our broken tax code.”


The Blueprint includes some genuine simplifications, including repeal of AMT Alternative Minimum Tax, simple calculation of investment income subject to tax, consolidation of several common deductions and credits, and other improvements.


The Blueprint claims, with little evidence, that tax reductions produce economic growth. To justify tax cuts for businesses and the more wealthy households, the Blueprint relies solely on a single economist whose research findings vary widely from the consensus of his colleagues.


The Blueprint preserves the capital gains (profit on increase in value of property) loophole. It preserves the mortgage interest deduction.


Piketty, Saez & Stantcheva (2014)
Also, the Blueprint ignores the national crisis of disparity of incomes and the extensive research showing that tax cuts for the more wealthy households shift national income to the more wealthy households, exacerbating the disparity.


The Blueprint includes the BAT Border Adjustment Tax regime, combining an export subsidy and an import tax. BAT, a regressive tax regime, weighs more heavily on the less wealthy.


I can’t know with certainty the internal motives of Paul Ryan and other GOP members of Congress, but if they want to shift after-tax income from the less wealthy to the more wealthy, then this Blueprint shows a way.




PROLOGUE


Here are some things to keep in mind, as you read this article.


According to Piketty, Saez & Stantcheva (2014), CEO pay levels go up when top tax rates are lowered. “Top tax rate cuts are associated with top one percent pretax income shares increases but not higher economic growth.”


According to Gale & Samwick (2015), “The argument that income tax cuts raise growth is repeated so often that it is sometimes taken as gospel. However, theory, evidence, and simulation studies tell a different and more complicated story.”


According to Lansing & Markowitz (2016), “From 1977 to 2007 three-fourths of the income growth in the U.S. economy went to the top 10% of households.”

Graph: Brockman (2010), Data: US Treasury


WHAT’S GOOD ABOUT THE GOP TAX PLAN

The Blueprint

Mr. Paul Ryan, Speaker of the House of Representatives, organized a Task Force to construct a “Blueprint” for reforming federal taxation. The Task Force Report, the “Blueprint”, was published June 24, 2016.


The Task Force emphasizes “And it [the Blueprint] is the beginning of our conversation about how to fix our broken tax code.” The GOP seeks discussion, modification and agreement.

Goals and Principles

The Blueprint states (on page 5) admirable goals for simplification, fairness, economic growth, growth of employment, and sensitivity of the IRS Internal Revenue Service to taxpayer concerns.


Also, in their report, the Task Force enumerates the principles that guided their consideration of policies and provisions. They asked two questions about each policy or provision. The first question, “Will this policy reform grow our economy?”, keeps the focus on economic growth. The second question, “Is it worth raising taxes on everyone else to include this provision?”, prevents loopholes. A loophole results when an exception favors some special interest with lower or delayed effective tax, which is quite like taxing everyone else more.


Simplifications

The Blueprint includes some genuine simplifications. It repeals the AMT Alternative Minimum Tax which requires many filers to calculate their tax according to two different rules.


It calculates investment income subject to tax as simply half of interest income, dividends and capital gains, replacing the incomprehensible current calculation.


It consolidates several common deductions and credits. It replaces the current array of education deductions and credits with a single calculation (unspecified). It raises the standard deduction and child & dependent deductions, eliminating itemized deductions for many filers.


IRS Customer Focus

The Blueprint calls for reorganization of the IRS to focus their efforts on “customer service”.


Fraud Prevention

It corrects the process for awarding EITC Earned Income Tax Credit to fix some forms of fraud.



WHAT’S BAD ABOUT THE GOP TAX PLAN

Redistribution of Federal Revenues

The Blueprint will increase the aggregate after-tax household income share of the One Percent by about 2% of total national household income. Given total adjustable gross income of about $9.1t, this is about $150b for the One Percent, far exceeding the benefits for other income levels.


Beneficiaries of Reduction in Top Marginal Tax Rates

The Blueprint provides for large changes in tax rates from current levels. This table compares the top marginal rates for different kinds of income.


Income type
Current law top marginal rate
GOP Blueprint top marginal rate
Main beneficiary of Blueprint
Individual ordinary income
39.6%
33%
One Percent
Investment income (interest, dividends, realized gains)
25% (approx.)
16.5%
Ten Percent
Small businesses (a.k.a. passthroughs: sole proprietorships, S corporations, partnerships)
39.6%
25%
Ten Percent
Large businesses (C corporations)
35%
20%
Ten Percent


For the owners of corporations (the shareholders), and owners of larger “small” businesses, and for the more wealthy households taxed at top rates, the business and investment tax cuts are big cuts amounting to 14% of their taxable business and investment income. The Ten Percent (household incomes greater than roughly $150,000 annually) get nearly all business and investment income. Tax cuts for businesses benefit the incomes of the owners much more than they benefit the incomes of the staff. The One Percent (household incomes greater than roughly $500,000 annually) are taxed at top rates. Thus, the people who benefit most notably from these tax cuts are the more wealthy Ten Percent of households.  


Consider how these changes in top rates affect the most wealthy One Percent of households. Of total national household income, the One Percent collect a share of about 20% to 25%. About one-third of their income is ordinary income, about one-third is investment income, and about one-third is passthroughs. For illustration, let’s think of each of these thirds as about 7% of national household income. With Blueprint, the tax rate on ordinary income will drop 7 percentage points, increasing their aggregate after-tax income by 0.5% of all national household income. Similarly, the lower tax on investment income gives them 0.6%, and the lower tax on small businesses gives them an additional 1.0%. Add these up, and we see that the Blueprint will increase the aggregate after-tax household income share of the One Percent by about 2% of total national household income. This is money that would otherwise be US government revenues. Were it paid instead to the least wealthy Fifty Percent, then it would be called "redistribution".

Windfall Retroactive Tax Reduction on Foreign Income

Under current law, companies doing business in foreign countries are taxed in the U.S. on world-wide operations. Companies that wish to bring foreign earnings to the U.S. (termed “repatriation” for “American” companies) will be taxed at U.S. rates in effect when the income was earned, less the amounts of foreign taxes paid. Many companies in this situation have found it more profitable to invest the money in other countries, rather than transferring it to the U.S. The Blueprint provides for one-time taxation of accumulated foreign earnings at 8.75% (a surprisingly precise number) on cash and 3.5% otherwise, payable over an eight-year period. This is an astonishing loophole granting, in effect, a retroactive tax windfall to the companies that can profit from it. This is a huge giveaway.

The Blueprint says the money will be used to create jobs and grow their U.S. operations, but the Blueprint contains no process to assure that any person will be hired. Nor does it assure expansion of U.S. business operations. Indeed, having taken advantage of this one-time tax dodge, the benefiting corporation could send the money to some foreign country to expand operations that appear more profitable than projects available to them in the U.S. Or the company could pay it to their CEO, with which compensation the CEO might buy a nice villa in the south of France.

Double Taxation

The Task Force Report discusses “double taxation” at length. The government taxes a large corporation, which then pays dividends from its after-tax income, and government taxes the dividends received by the owners. The Task Force says the lower taxes on investment income and corporations will mitigate the double taxation. An alternate way to mitigate double taxation, apparently not considered by the Task Force, would be deducting dividend payments from corporate income, as is done with interest payments, and taxing the receiving owner. Under the Blueprint, an owner can sustain a 20% tax rate via the corporation earning income, then shelter income indefinitely by leaving it invested in a corporation.   

BAT Border Adjustment Tax

On the BAT Border Adjustment Tax, economists working with the Federal Reserve Bank of New York expect that “Both firms and households will be faced with higher prices for imports and domestically produced goods alike."

Overreliance on Outlier Economics

The Task Force Report depends heavily for economic justification on the work of Mr. Kevin Hassett. On Hassett they rely to explain why tax cuts for businesses increase employment and wages. Moore & Wallner assert that “Kevin Hassett has assembled solid evidence showing that business rate reductions primarily benefit the working class through higher wages.” I looked among the documents cited in the Ryan Tax Plan, including those by Kevin Hassett. The evidence is hard to find and hardly conclusive, given the numerous contrary findings by other economists. Even if we grant Hassett’s findings some validity, the incomes of the least wealthy Fifty Percent have not participated in national economic growth since 1980, implying that economic growth hasn’t visited half the population in the wake of the substantial tax cuts that occurred since 1980. If tax cuts didn’t make them prosperous before, then why will tax cuts make them prosperous now?


Gale & Samwick (2015) reviewed numerous studies by CBO Congressional Budget Office, U.S. Treasury, the Congressional JCT Joint Committee on Taxation, and a number of academic economists. They consider empirical evidence from events such as the Reagan tax reform, the Clinton tax increases, the G.W. Bush tax cuts, and the Obama “sequester” and health-care tax increases. They also use mathematically modeled scenarios. Per these researchers, 80% to 95% of the benefit of a reduction in business ("capital") income tax goes to the owners of the business, and the rest goes to the workers ("labor"). That is, for each dollar of ostensible “job creation”, the owners of the business get nine dollars. New jobs and increased pay are incidental, indirect effects, when they occur at all.


As further economic justification, the Blueprint cites Hassett to assert that tax cuts stimulate economic growth. The preponderance of research by other economists shows no significant effect, except when budget deficits finance the cut, in which case the cuts produce long-term economic decline, per Gale & Samwick (2015). They also comment “U.S. historical data show huge shifts in taxes with virtually no observable shift in growth rates.” Piketty, Saez & Stantcheva (2014) write that CEO pay levels go up when top tax rates are lowered. “Top tax rate cuts are associated with top one percent pretax income shares increases but not higher economic growth.”

Misapprehending the Benefits of Growth

The Blueprint is intent, ostensibly, on “growth”, which isn’t clearly defined. Usually, they refer to growth of GDP per capita. Growth of GDP per capita is almost exactly mathematically the same as growth of GDP. GDP per capita is total GDP divided by population. This average seems, superficially, very fair and even. However, GDP and GDP per capita aren’t distributed fairly and evenly. The Ten Percent collect three-fourths of the growth of incomes. The least wealthy Fifty Percent of households have experienced almost zero real (adjusted for inflation) growth of incomes since 1980. The 10% of households with the highest incomes, the top Ten Percent, have about 50% of the national income. If the total national GDP per capita increases by 2% and GDP10 the GDP per capita of the top Ten Percent increases by 5%, then GDP90 the GDP per capita of the other Ninety Percent must decrease by 1%.


(Incomes are about 80% to 90% of GDP. While there are some differences, GDP and incomes are roughly equivalent in their year-to-year changes. We can think of GDP10 as the portion of GDP associated with the incomes of the top Ten Percent, and GDP90 as the portion of GDP associated with the incomes of the less wealthy Ninety Percent.)


In some places, the Blueprint refers to growth in size of paychecks, to productivity growth, and to increased employment. If the Task Force's intent is to generate growth, then one would expect they could trace their ideas to the kind of growth they expect to result, but they don’t. If generating growth isn’t their intent, then there’s no need or perhaps there’s no possibility to trace the causes and effects.


Regressive Taxation of Consumption

The Task Force points out that shifting toward a consumption tax, by the combination of reducing taxes on savings and investment and the BAT, will contribute to producing growth. Indeed, Gale & Samwick (2015) say in their conclusion that two of the many studies they surveyed found that corporate and personal income taxes burden GDP growth more than property, value added, or sales taxes. But since the Ten Percent save substantial parts of their income, and the One Percent save the majority of their income, and the Ninety Percent save nearly none of theirs, a consumption tax will fall most heavily on the Ninety Percent. With the Ten Percent taking the majority of the growth, this change to BAT amounts to a transfer of incomes from the Ninety Percent to the Ten Percent. If BAT is adopted, then Congress should adopt a uniform refundable tax credit for each individual aggregating, say, 2% of national income, financed perhaps by top marginal rates of about 40%.

Mortgage Interest Deduction

The Task Force chooses to continue the Mortgage Interest Deduction, which favors the more wealthy households and the banks which receive the mortgage interest. This old loophole needs fixing. The deduction also tends to increase the cost of housing by enabling buyers to bid a little higher than they otherwise could. The Mortgage Interest Deduction contributes significantly to residential real estate booms and busts, inflates the cost of housing, and provides interest income to banks that lend money on mortgages. If the government wishes to encourage privately owned houses, then it should provide direct subsidies to builders of residences, to the suppliers of housing, not the buyers and not the bankers.

Capital Gains

The Blueprint preserves the capital gains loophole, lightly taxing income in this form. The favorable treatment of capital gains is an old loophole, quite eligible for fixing. Capital gains are the difference between the current value and the purchase price of property (principally stock options, stocks, bonds, real estate). The Ten Percent own nearly all property, by value, so the Ninety Percent get little benefit. A suitable reform would assess the change in value each year and tax the unrealized and realized gains at the same tax rates that apply to wages. Some caps or exemptions or phase-outs might apply for primary residences and elderly taxpayers relying on investment income.

R&D Research and Development

The Blueprint provides for a R&D Research and Development credit for businesses. R&D is an ordinary business expense and there is no good reason to provide this old loophole. The loophole is subject to abuse when businesses book unrelated expenses to the research department. Businesses conduct research to generate profits, typically within five years or less. With few exceptions, they ignore the basic research that enables great scientific advances. If the government chooses to encourage R&D, then it should make grants to the National Institutes of Health, the National Aeronautics and Space Administration, other government research organizations and universities, with the proviso that intellectual property developed will immediately enter the public domain.

Propaganda

The entire Task Force Report is burdened with excessive propaganda. Translating the unnecessarily pejorative and eulogistic phrasing into useful thoughts is extremely tedious. For example, the Blueprint conflates “job creator” and “business”. Also, “penalty” and “tax”. Taxes are the price of civilization. Taxes aren’t penalties. Mr. Ryan should object to describing them as such.

Joining an International Race to the Bottom

The Blueprint makes many references to the taxing policies of other countries and alleges that taxes are higher in the U.S. than in other countries, so we should allow decisions in foreign capitals to steer U.S. laws, and we should reduce U.S. income tax rates to be lower than theirs. This race to the bottom will, the Blueprint says, make the U.S. more competitive. The argument is stated without evidence, the statements about foreign countries are cherry-picked, and on this score, the Blueprint simply isn’t convincing.

False Simplification

The Blueprint repeatedly heralds the “postcard” tax form as a great simplification, but it’s a false simplification. It doesn’t simplify. It hides complexity, merely providing a place to write the last lines of tedious calculations done elsewhere. For instance, line 10 says “Subtract earned income credit” without any process for computing it. That computing will occur on an attached page, of course. Anyone with income and deductions more complex than wages received from a single employer will have to attach a set of forms much like the existing attachments to form 1040.


The 3 tax brackets is another false simplification. Tax brackets aren’t complex in any significant way. People simply read them from a table, if their accountant or computer doesn’t do it for them. This “simplification” is a way for politicians to pretend they’ve done something useful, and that’s all.




OMISSIONS

Optimal Taxation

The GOP Tax Plan should, but doesn’t, increase the top marginal tax rates. Saez & Stantcheva (Sep 2016) identified an optimal maximum income tax rate, for capital (investment and business) income of about 60% and for labor (ordinary) income of about 50%, promoting broad dispersion of income with ample incentive for work and investment. Lower rates promote concentration of income in the more wealthy subsets of the population.

Principles

In addition to the two questions that guided the Task Force in producing the Blueprint, they should have asked two more questions for each provision, “How does this provision affect the less wealthy?” and “How does this provision affect the most wealthy?”



Disparity of Incomes

The Blueprint completely ignores the disparity of incomes. The Blueprint makes no attempt to mitigate the disparity. The Blueprint ignores that extreme disparity of U.S. incomes has created a kind of aristocracy in the United States, with special favorable taxation and access to government officials not enjoyed by the less wealthy.



The Blueprint ostensibly intends to increase “growth”. It ignores that “From 1977 to 2007 three-fourths of the income growth in the U.S. economy went to the top 10% of households.”, per Lansing & Markowitz (2016).




“For households in the top 1 percent of the income distribution, inflation-adjusted after-tax income grew at an average rate of about 3 percent per year, making that income 192 percent higher in 2013 than it was in 1979 for those households. In contrast, households in the bottom quintile experienced an average growth of about 1 percent per year in their inflation-adjusted after-tax income over the same period, making that income 46 percent higher in 2013 than it was in 1979.” -- Congressional Budget Office, “The Distribution of Household Income and Federal Taxes, 2013” (Jun 8, 2016, https://www.cbo.gov/publication/51361)



CONCLUSION

The GOP tax reform proposal called the Blueprint will increase the aggregate after-tax household income share of the One Percent by redistributing federal revenues aggregating about 2% of total national household income, or about $150b per year.

It is unlikely to promote economic growth and employment growth. If we expect the Trump administration’s proposal for increased spending on security, military and infrastructure, then a tax cut like the Blueprint will produce increased fiscal deficit.


Given that the Blueprint ostensibly promises economic growth and employment growth, the most polite word I can find to describe it is “disingenuous”.




SOURCES

“A Better Way: Tax Reform” (2016) http://abetterway.speaker.gov/?page=tax-reform


“A Better Way: Snapshot: A Better Way for Tax Reform” (2016) http://abetterway.speaker.gov/_assets/pdf/ABetterWay-Tax-Snapshot.pdf


“A Better Way: Full Task Force Report: Tax” (Jun 24, 2016) http://abetterway.speaker.gov/_assets/pdf/ABetterWay-Tax-PolicyPaper.pdf


“A Better Way: By the Numbers: A Better Way to Do Tax Reform” (2016) http://abetterway.speaker.gov/_assets/pdf/ABetterWay-Tax-BytheNumbers.pdf


Mary Amiti, Oleg Itshoki & Jozef Konings, “Why the Proposed Border Tax Adjustment is Unlikely to Promote U.S. Exports” (Feb 24, 2017, Federal Reserve Bank of New York) http://libertystreeteconomics.newyorkfed.org/2017/02/why-the-proposed-border-tax-adjustment-is-unlikely-to-promote-us-exports.html

Daniel Brockman, "Income Inequities" (Jun 2010) https://daniel-brockman.blogspot.com/2010/06/income-inequities.html


Daniel Brockman, “Intellectual Property and The King of Denmark’s Rule” (Oct 2016) https://daniel-brockman.blogspot.com/2016/10/intellectual-property-and-king-of.html


Daniel Brockman, “Paul Ryan’s Budget Proposal” (May 2011) https://daniel-brockman.blogspot.com/2011/05/paul-ryans-budget-proposal.html


Congressional Budget Office, “The Distribution of Household Income and Federal Taxes, 2013” (Jun 8, 2016) https://www.cbo.gov/publication/51361


Cronin et al., “Distributing the Corporate Income Tax: Revised U.S. Treasury Methodology,” National Tax Journal (Mar 2013) https://www.ntanet.org/NTJ/66/1/ntj-v66n01p239-62-distributing-corporate-income-tax.pdf


Diana Furchtgott-Roth, “Corporate Tax Reform Is Needed for Economic Growth” (Manhattan Institute, Dec 9, 2016) https://economics21.org/sites/e21/files/DFR.CorporateTaxes.120916.pdf


William Gale and Andrew Samwick, “Effects of Income Tax Changes on Economic Growth” (Nov 2015) http://eml.berkeley.edu/~burch/Gale%20Samwick%2020151105.pdf


Scott Greenberg, “Summary of the Latest Federal Income Tax Data, 2015 Update” (Tax Foundation, Nov 2015) https://taxfoundation.org/summary-latest-federal-income-tax-data-2015-update/


Kevin A. Hassett, “A Pro-Growth Tax Reform” (Feb 6, 2017, National Review) http://www.aei.org/publication/a-pro-growth-tax-reform/


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Internal Revenue Service, “SOI Tax Stats - Individual Statistical Tables by Size of Adjusted Gross Income” https://www.irs.gov/uac/soi-tax-stats-individual-statistical-tables-by-size-of-adjusted-gross-income


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Stephen Moore and James Wallner, “Why the GOP should abandon the border adjustment tax” (Feb 24, 2017, Politico) http://www.politico.com/agenda/story/2017/02/why-republicans-should-abandon-the-border-adjustment-tax-000324




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I want to thank my good friends for the moral support, the thoughtful conversations and their reviews of prepublication drafts, all of which influenced and improved the content of this article.