The free market and working people

Left wingers have an awfully perverse way of helping workers. Their primary means of doing so is to call for higher minimum wages and more labor unions.

The raising the minimum wage is a proven way to kill jobs since workers who don't produce revenues equal or greater than the minimum wage become costs to their employers. In fact, 85% of the most credible studies on minimum wage laws find that they create unemployment among low skilled workers [1].

Unions on the other hand are labor cartels which the number of workers in a company in order to boost the remaining workers wages, a scheme which is great for unionized workers but detrimental to non-unionized workers and the economy as a whole.

According to economists Richard K. Vedder and Lowell E. Gallaway, unions have cost the US economy $50 trillion between 1947 and 2000 [2]. Unions have been found to increase unemployment and lower investment, in fact, unionized industries tend to grow the slowest [3].

All that left wingers have to offer workers is benefits for some at the expense of others. Free market policies on the other hand attempt to raise worker's wages (at no one else's expense) by increasing their productivity (since wages are a function of productivity [4]).

According to the Free Marteteer, taxes which reduce the incentive to work or invest in capital will harm worker productivity growth and thus slow the growth of worker's wages. In fact, the marketeer acknowledges that restraining government spending, increasing economic freedom, and pro-growth tax reform are the best ways to boost workers wages. Consider the the following:

- Empirical research on the size of government consistently finds that government spending is significantly negatively correlated with economic growth (even when controlling for numerous other confounding variables) [5].

- "If government expenditures as a share of GDP in the United States had remained at their 1960 level, real GDP in 1996 would have been $9.16 trillion instead of $7.64 trillion, and the average income for a family of four would have been $23,440 higher." [6]

- "[T]he average income of the poorest 10% [of income earners in the most economically free countries] was $10,556, compared
to $932 [for the poorest 10% of income earners in the least economically free countries] in 2011US (PPP) dollars" [7]

- Abolishing the current federal tax system and replacing it with a progressive sales tax would increase worker's real (inflation adjusted) wages by around 10%  and increase employment between 5-10% over the current system according to several studies. [8]

- Abolishing the corporate income tax would raise worker's wages by 12-13% thanks to increased investment in capital and correspondingly higher worker productivity according to a recent study [9].

Ultimately, the free marketer is the realist who acknowledges that wages cannot simply be raised according to the will of politicians. Rather, raising worker's wages is best done by instituting pro-growth policies which encourage work, investment, and growing worker productivity. Lastly, unlike the policies of the left winger, those advocated by the marketeer raise wages at no one's else's expense. As Milton Friedman once noted:

“When unions get higher wages for their members by restricting entry into an occupation, those higher wages are at the expense of other workers who find their opportunities reduced. When government pays its employees higher wages, those higher wages are at the expense of the taxpayer. But when workers get higher wages and better working conditions through the free market, when they get raises by firm competing with one another for the best workers, by workers competing with one another for the best jobs, those higher wages are at nobody's expense. They can only come from higher productivity, greater capital investment, more widely diffused skills. The whole pie is bigger - there's more for the worker, but there's also more for the employer, the investor, the consumer, and even the tax collector.

That's the way the free market system distributes the fruits of economic progress among all people. That's the secret of the enormous improvements in the conditions of the working person over the past two centuries.”

Citations:
[1] http://www.socsci.uci.edu/~dneumark/min_wage_review.pdf
[2] http://www.ncpa.org/sub/dpd/index.php?Article_ID=5589
[3] http://www.heritage.org/research/reports/2009/05/what-unions-do-how-labor-unions-affect-jobs-and-the-economy
[4] http://www.sparknotes.com/economics/micro/labormarkets/labordemand/section1.rhtml
[5] http://www.ifn.se/wfiles/wp/wp858.pdf
[6] http://frihetspartiet.net/function.pdf
[7] http://www.freetheworld.com/2013/EFW2013-complete.pdf
[8] http://being-classical-liberal.blogspot.com/2014/03/its-no-secret-that-our-current-federal.html
[9] http://www.kotlikoff.net/sites/default/files/Corporate%20Income%20Tax%20NBER%20WP%2019757.pdf

The Optimal Size of Government

I generally analyze how government actions affect economic growth. In this post I will go through some of the empirical evidence on the optimal size of government. In the following studies, the optimal size of government is measured by government spending (as a % of GDP) which maximizes economic growth.

First it's worth noting that the majority of the empirical literature on the relationship between government size and growth finds that government spending is contractionary (meaning it decreases economic growth). Consider a recent survey of the literature which states:

"The most recent studies [on the relationship between government size and growth] find a significant negative correlation: An increase in government size by 10 percentage points is associated with a 0.5 to 1 percent lower annual growth rate." [1]

Keep in mind the studies surveyed controlled for many others variables such as population, lagged per capita GDP, net debt to GDP ratios, institutional factors, economic freedom, regional variations, etc in order to isolate the affect government spending has on economic growth.

Using evidence provided by studies like the one previously mentioned, researchers have been able to predict the optimal (growth maximizing) size of government. For example:

Chobanov and Mladenova (2009) finds:

"The evidence indicates that the optimum size of government, e.g. the share of overall government spending that maximizes economic growth, is no greater than 25% of GDP (at a 95% confidence level) based on data from the OECD countries." [2]

Di Matteo of the Fraser Institute concludes:

"All other things given, annual per capita GDP growth is maximized at 3.1 percent at a government expenditure to GDP ratio of 26 percent (of GDP); beyond this ratio, economic growth rates decline." [3]

Our friends over at Unbiased America have provided more studies:

16% +/- 3% of GDP.
Karras, G. (1997). “On the Optimal Government Size in Europe: Theory and Empirical Evidence,” The Manchester School of Economic & Social Studies

17.3% +/- 3% of GDP.
Gunalp, B. and Dincer, O. (2005). “The Optimal Government Size in Transition Countries,” Department of Economics, Hacettepe University Beytepe, Ankara and Department of Commerce, Massey University, Auckland

17% to 20% of GNP.
Peden, E. (1991). “Productivity in the United States and its relationship to government activity: An analysis of 57 years, 1929-1986,”

The average rate of federal, state and local taxes combined should be between 21.5 and 22.9% of GNP.
Scully, G. (1994). “What is the optimal size of government in the US?,” National Center for Policy Analysis, Policy Report No. 188

28.9% of GDP
Vedder, R. and Gallaway, L. (1998). “Government Size and Economic Growth,” Joint Economic Committee, Washington D.C., p. 5

14.7% of GDP
Davies, A. (2008). “Human Development and the Optimal Size of Government,” Journal of Socioeconomics, forthcoming

NOTE: There are even more studies than these, the highest estimates I've seen is 37% for European Countries. Almost all studies purport that the optimal size of government is 30% or less, with the majority finding it to be between 15-25%.

Citations:

[1] http://www.ifn.se/wfiles/wp/wp858.pdf
[2] http://ime.bg/uploads/335309_OptimalSizeOfGovernment.pdf
[3] https://www.fraserinstitute.org/uploadedFiles/fraser-ca/Content/research-news/research/publications/measuring-government-in-the-21st-century.pdf

Corporate taxation and economic growth aren't friends.

This post is dedicated to all the people who know nothing about economics and want the government to force corporations to "pay their fair share".

The corporate tax is probably the most harmful tax on economic growth since it discourages investment and thus productivity growth (as well as encouraging hiding income over seas).

Take for example, a series of OECD papers by Johansson et al. that examined 21 OECD (rich) countries between 1971 and 2004 that found corporate taxes were the most harmful to economic growth, followed by income taxes, then consumption taxes, and lastly property taxes. According to the a summary of the study:

"[A] 1 percent shift of tax revenues from income taxes (both personal and corporate) to consumption and property taxes would increase GDP per capita by between 0.25 percent and 1 percent in the long run." [1]

Not only that, but corporate taxes end up hurting workers slow growth in investment results in slower productivity growth, and thus slow growth in wages (since wages are based on worker productivity). In a recent working paper published by the National Bureau for Economic Research, economist Laurence Kotlifoff estimates that abolishing the corporate tax and replacing the lost revenue with higher income or consumption taxes would increase workers wages in the long run by 12-13%. [2]

Here is some more research on corporate taxes:

-Mertens and Ravn examine corporate taxes after WWII in the US and find that "A 1 percentage point cut in the ACITR [average corporate income tax rate]raises real GDP per capita on impact by 0.4 percent and by 0.6 percent after one year." Additionally, they find that a 1 percentage point cut in the APITR [average personal income tax rate] raises real GDP per capita by 1.4 percent on impact and by up to 1.8 percent after three quarters." [3]

-Ferede and Dahlby examine corporate taxes  and their effect on economic growth in the Canadian provinces and conclude by stating: "Our empirical analysis suggests that 1 percentage point cut in the corporate tax rate is related to a 0.1-0.2 percentage point increase in the annual growth rate." [4]

-Economists Young Lee and Roger Gordon examine corporate taxes in 70 countries over 20 years and state: "This paper finds that the corporate tax rate is significantly negatively correlated with economic growth in a cross-section data set of 70 countries during 1970-1997, controlling for many other determinants of economic growth." [5]

-Another study from Johansson et al. found that: "Corporate income taxes can be expected to be the most harmful for growth as they discourage the activities of firms that are most important for growth: investment in capital and in productivity improvements." [6]

-Kevin Hasset and Aparna Mathur of the American Enterprise Institute examined 72 countries over 22 years and found that on average, a 1% increase in the corporate-tax rate is associated with a 0.8% drop in wages over the next five years after controlling for other relevant macroeconomic factors. [7]

These are just some studies which examine how corporate taxes effect wages and economic growth. I think it's safe to safe that the majority of studies find that corporate taxes are harmful to economic growth, with a minority finding is has no effect. Regardless, this research exemplifies how foolish it can be to simply make assumptions that the government can raise taxes on corporations with no adverse consequences.

Citations:
[1] http://www.oecd.org/tax/tax-policy/41000592.pdf
[2] http://www.nber.org/data-appendix/w19757/CorporateTaxPaper.pdf
[3] http://pubs.aeaweb.org/doi/pdfplus/10.1257/aer.103.4.1212
[4] http://ntj.tax.org/wwtax/ntjrec.nsf/175d710dffc186a385256a31007cb40f/d2eeb9d5f1d7f7ea85257a6f00551c60/$FILE/A03_Ferede.pdf
[5] http://www.washingtonpost.com/blogs/wonkblog/wp/2013/06/05/corporate-taxes-dont-cause-recessions-but-they-do-hurt-growth/
[6] https://www.kent.ac.uk/economics/documents/research/papers/2009/0925.pdf
[7] http://www.aei.org/papers/economics/fiscal-policy/taxes-and-wages-paper/

Myth: Gun control in Australia reduced gun homicides and suicides tremendously.

Myth: Gun control in Australia reduced gun homicides and suicides tremendously. 

-Australian gun control and Mass Shootings

In 1996, the Australian government instituted strict gun control measures which made it almost impossible for a civilian to own a semi-automatic rifle or shotgun after a mass shooting which left 35 people dead (the even restricted access to airsoft guns). Since then, Australia hasn't witnessed a mass shooting, leading many gun control advocates crediting the 1996 gun control legislation as the cause of the lack of mass shootings. Are they right? No. 

A 2011 study published by the Justice Policy Journal examined the incidence of mass shootings in Australia and New Zealand over a 30 year time period. The results don't provide any evidence in favor of the belief that banning guns reduces mass shootings. According to the authors:

"[The results do]not find support for the hypothesis that Australia’s prohibition of certain types of firearms has prevented mass shootings, with New Zealand not experiencing a mass shooting since 1997 despite the availability in that country of firearms banned in Australia." [1]

- Gun control and firearm homicide and suicide

After the 1996 gun control legislation, firearm homicide declined, leading gun control advocates to credit gun control as the cause of this decline. However, firearm homicides were already declining before the gun control legislation passed. A study published by the University of Melbourne studied the effects of the 1996 gun control legislation on firearms homicide and suicide. The authors report:

"The results of these tests suggest that the NFA [the gun control legislation] did not have any large effects on reducing firearm homicide or suicide rates." [2]

Additionally, a study published in the British Journal of Criminology found that there was no evidence that the NFA [National Firearms Agreement] had any impact on reducing firearm homicide [3]. They did find that it may have helped reduce firearm suicide, but they that societal factors were already reducing suicide rates.

Lastly, a 2009 study the Australian Institute for Suicide research studied how the NFA effected suicide rates and found the following:

"The implemented restrictions may not be responsible for the observed reductions in firearms suicide. Data suggest that a change in social and cultural attitudes could have contributed to the shift in method preference". [4]

So now you have the facts. Do with them as you will. 

Citations:

[1] http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2122854
[2] http://www.melbourneinstitute.com/miaesr/publications/working-paper-series/abstract-178.html
[3] http://bjc.oxfordjournals.org/content/47/3/455.abstract
[4] http://www.biomedexperts.com/Abstract.bme/18839044/Controlling_firearms_use_in_Australia_has_the_1996_gun_law_reform_produced_the_decrease_in_rates_of_suicide_with_this_method

Myth: 90% taxes had no effect on growth in the 1950's

Proponents of high taxes on the wealthy argue that the government used to force the wealthy to pay 90% of their income in taxes and the economy did great. This isn’t exactly true. Here are some reasons why:

-Only a small portion of wealthy people’s income was subject to the 90% tax rate.

Since the US has a progressive income tax, the 90% rate only applied to a person’s income after they reached a certain income level. As you can see in the chart on the left, the top marginal tax rate was over 90% throughout the 40’s and 50’s until 1964, when it was lowered to 77% [1]. However, top tax rates are applicable to different income levels over time. The 90% top tax rate applied to every dollar earned after someone earn $2.3 million during the 40’s and 50’s (in 2011 dollars). In contrast, today’s top tax rate is 40% in applies to every dollar earned after a person earns $388,000 (in 2011 dollars) [1]. It’s also worth noting that the poorest income earners faced income tax rates of 20% in the 40’s and 50’s vs. 10% today [1]. In the end, the 90% tax rate applied to a very small percentage of income to a very small percentage of people.

-During the 40’s and 50’s, rich people didn’t pay the 90% rate.

The statutory tax rate is the legally imposed tax rate. However, most people don’t pay taxes at this rate due to the numerous tax deductions, credits, etc  which they use to reduce their tax liability. Thanks to all these “loopholes” the rich paid a fraction of what the government wanted. The graph on the left compares the top statutory rate to the top effective rate, which is the rate that people actually paid once they hit the top tax bracket. As you can see, top effective rates have remained steady around 25% throughout the 20^th century [2]. The graph on the top right also shows that federal income taxes as a % of the economy have remained relatively constant throughout the 20^th century as well. The middle graph on the right shows that federal revenues as a % of the economy have been steady over US history [3], while the graph on the bottom shows that US federal government spending as a % of the economy has followed a similar trend [4]. (However, total government spending as a % of the economy has risen steadily over time).

Historically, it appears as though the high statutory tax rates have had no effect on government revenues. Then again, we wouldn’t expect them to for the reasons given above. One thing that is worth noting is that in the early 1980’s, the federal government under Ronald Reagan cut top taxes rates dramatically from 70% to 50% in 1982, then from 50% to 39% in 1987, and from that to 28% in 1988 [1]. Although leftists may attack this as “trickle-down economics”, it should be noted that Reagan cut taxes for everyone and more importantly that the top effective tax rate under Reagan wasn’t significantly different from the top effective tax rates in the 40’s and 50’s, when statutory rates were above 90% [2]. This is because Reagan closed tax loopholes and cut taxes. Reagan’s tax cuts weren’t a giveaway, they were meant to make the tax code more efficient and transparent. According to one person over at EconomicPolicyJournal.com:

“The dishonesty or perhaps ignorance in the tax debate that is going on today is the complete misrepresentation of the pre-TRA86 [Tax Reform Act of 1986] higher marginal rates in the old ’53 code. Sure the marginal rates were insane, but the underlying tax code was rife with loopholes that a good tax planner (I was one) could exploit to get a person’s effective tax rate as low or lower then it is today. Those loopholes are no longer part of the tax code which is a good thing as they encouraged investors to invest in projects that had no economic viability other then the income sheltering effect they created” [5]

-Empirical evidence finds that taxes are incredibly detrimental to growth.

Christina Romer, a leading Keynesian economist behind the 2009 stimulus package, authored an empirical study with her husband titled, “The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks”. In the study, the Romers examine the economic history of the United States and study how changes in tax revenue as a percent of the economy affect economic growth. Their findings are unsurprising to supply side economists, but utterly destructive to the arguments for higher made by those on the left. According to the Romers:
“We then examine the behavior of output following…exogenous legislated [tax] changes. The resulting estimates indicate that tax increases are highly contractionary. The effects are strongly significant, highly robust, and much larger than those obtained using broader measures of tax changes. The large effect stems in considerable part from a powerful negative effect of tax increases on investment.” [6]
When they say highly contractionary, they mean it. According to their research:“[W]e find that a tax increase of one percent of GDP lowers GDP by about 3 percent” [6]It’s worth noting that it’s not just Romer’s study that find that taxes harm growth, the majority of empirical research does. See citation [7]In conclusion, the claim that wealthy people faced over 90% tax rates in the 1950’s is a half-truth. No one actually paid those high rates due to an immeasurable amount of loopholes written into the income tax code. Additionally, empiricists have studied the effects of taxes on economic growth in the United States and the results indicate that tax increases are highly contractionary, much to the dismay of left wingers who promote such tax increases.
Citations:
[1] http://en.wikipedia.org/wiki/Income_tax_in_the_United_States#History_of_top_rates[2] http://blackburn.house.gov/uploadedfiles/jec_republican_staff_analysis_historical_tax_rates_rhetoric_vs_reality.pdf.pdf[3] http://www.usgovernmentrevenue.com/revenue_history[4] http://www.usgovernmentspending.com/past_spending[5] http://tomwoods.com/blog/didnt-we-used-to-have-high-taxes-and-prosperity/[6] http://www.nber.org/papers/w13264.pdf?new_window=1[7] http://taxfoundation.org/article/what-evidence-taxes-and-growth

Myth: Rifles like the AR-15 are extremely dangerous.

Rifles are no more dangerous than hands or feet.

In 2009, there were only 313 unjustifiable homicides committed with any type of rifle [1]. This is out of 110 million rifles in the United States at the time. [2] This implies that of all the rifles in the United States in 2009, 0.00028% were used to commit murders. This means that the homicide rate per 100,000 rifles is 0.28.

That same year, there were 810 unjustifiable homicides committed with hands or feet [1]. The population that year was 305 million, which implies that of the number of pairs of hands and feet in the US (the population), 0.00027% were used to commit murders. This means that the homicide rate per 100,000 pairs of hands/feet is 0.27.

So in 2009, not only were hands and feet used more often to murder people than rifles were (810 vs. 313), but the homicide rate per 100,000 rifles is nearly exactly the same as the homicide rate per 100,000 pairs of hands/feet (0.28 vs 0.27).

These findings indicate that in terms of statistics, rifles are no more deadly than a pair of hands and feet.

Citations:

[1] https://www2.fbi.gov/ucr/cius2009/offenses/expanded_information/data/shrtable_08.html
--See data tables 14 and 15 for justifiable homicide data
[2] http://www.gunpolicy.org/firearms/region/united-states