Policy bubbles alert: most innovation is not about R&D (and boffins in lab coats)

The fire of truth: the relationship between inequality and economic prosperity in New Zealand since the 1970s

Figure 1: Before Housing Costs Gini coefficient, New Zealand, 1982 – 2013

closertogether.org.nz/nzs-income-inequality-problem claims that NZ income inequality increased very rapidly in the late 1980s and 1990s — faster than in any other wealthy country.

Figure 2 shows that this rapid rise in inequality coincided with the resumption of economic growth after two lost decades: next to no increase in real GDP per working age New Zealander from 1974 to 1992.

Figure 2: Real GDP per New Zealander and Australian aged 15-64, converted to 2013 price level with updated 2005 EKS purchasing power parities, 1956-2012

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Source: Source: Computed from OECD Stat Extract and The Conference Board, Total Database, January 2014, http://www.conference-board.org/economics

Perry (2014) found that:

  • Income inequality in New Zealand is at a similar level to Australia, Canada, Italy and Japan (Ginis of 32-33) and a little lower than the UK (34). Countries such as Denmark, Norway, Finland and Belgium have lower than average inequality (Ginis of 25-26). The US and Israel have higher scores of 39.
  • The top 1% in New Zealand received around 8% of all taxable income in 2010 and 2011 (before tax), similar to Norway, Finland and Australia, lower than Ireland and Switzerland (11%) and much lower than the UK and Canada (13%) and the US (18%).
  • The trend for the New Zealand share has been steady at around 8-9% since the mid 1990s, with perhaps a slight fall in the last few years. Many OECD countries saw small rises in the period, and in the USA the top 1% share continued to rise strongly, from 13% to 19%.

Perry (2014) concluded that:

Overall, there is no evidence of any sustained rise or fall in inequality in the last two decades. The level of household disposable income inequality in New Zealand is a little above the OECD median. The share of total income received by the top 1% of individuals is at the low end of the OECD rankings.

This remark by Parry that there is no evidence of any sustained rise or fall in inequality in New Zealand in the last 20 years  is very much at odds with the claim of Closer Together New Zealand that income inequality inequality increased rapidly in the late 1980s and 1990s.

The increase in inequality in New Zealand  was in the late 1980s  and early 1990s. In the early 1990s, a long economic boom started that lasted until the global financial crisis.

Figure 3 : Income Inequality in New Zealand as Assessed by the Gini Coefficient

Source: Perry 2014 derived from Statistics NZ Household Economic Survey (HES) 1982–2012.

Figure 4: Income Inequality in New Zealand as Assessed by the P80/P20 Ratio

Source: Perry 2014 derived from Statistics NZ Household Economic Survey (HES) 1982–2012.

Figures 3 and 4 both show that after housing costs inequality in New Zealand is higher, but has been pretty stable for 20 years as measured by the Gini coefficient and by the P80/P20  ratio. (When individuals are ranked by equivalised household income and then divided into 100 equal groups, each group is called a percentile. If the ranking starts with the lowest income, then the income at the top of the 20th percentile is denoted P20; the income at the top of the 80th percentile is called P80. The ratio of the value at the top of the 80th percentile to the value at the top of the 20th percentile is called the P80/20 ratio and is often used as a measure of income inequality).

Figure 5: Proportion of HHs with housing cost outgoings to income of greater than 30%, by income quintile

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Source: Perry (2014); OTI = outgoings to income

Figure 5 shows that

  • for the bottom quintile (Q1), the proportion with high outgoings to income (OTI) steadily reduced from 48% in 1994 to 34% in 2004, as unemployment fell, employment and income rose, and income-related rental policies were introduced in 2000 for those in HNZC houses. From HES 2009 to HES 2013 the proportion rose strongly from 33% to 42%, the highest it has been in the last 25 years except for the peak of 48% in 1994.
  • For households with incomes in the second quintile (Q2) there was a strong rise from the 1980s through to the mid 1990s, followed by a relatively flat trend to 2004. Since 2004, the proportion with high OTIs has risen strongly from 27% to 36%.
  • For the third quintile (Q3) the proportion with high OTIs settled at around 30% for 2007 to 2013, up from 21% in 2004 and 10% in 1988.

Rising housing costs in New Zealand have one explanation, which is restrictions on the supply of land under the Resource Management Act.

HT: nzchildren.co.nz/income_inequality for figures 3 and 4.

Policy bubbles alert: the R&D fetish is a major threat to innovation and economic growth

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John Rawls and are the super-rich unjustly over-taxed?

John Rawls is often put forward by political progressives as the starting point for political philosophy. Rawls pointed out that behind the veil of ignorance, people will agree to inequality as long as it is to everyone’s advantage.

Rawls was attuned to the importance of incentives in a just and prosperous society. If unequal incomes are allowed, this might turn out to be to the advantage of everyone.

Rawls lent qualified support to the idea of a flat-rate consumption tax (see A Theory of Justice, pp. 278-79). He said that:

A proportional expenditure tax may be part of the best scheme [and that adding such tax] can contain all the usual exemptions.

The reason why Rawls lent qualified support to the idea of a flat-rate consumption tax was because these taxes:

impose a levy according to how much a person takes out of the common store of goods and not according to how much he contributes.

A simple way to have a progressive consumption tax is to exempt all savings from taxation. Taxable consumption is calculated as income minus savings minus a large standard deduction. Different countries use different terms to describe the minimum amount that must be earned before any taxes are paid.

Income tax must be opposed on social justice grounds, but not progressive consumption taxes.

Given that the super-rich – the top 0.1% of income earners – do not spend much of their incomes, especially on the way up building their businesses, they could be rather over-taxed!

Steven Kaplan and Joshua Rauh’s “It’s the Market: The Broad-Based Rise in the Return to Top Talent”, Journal of Economic Perspectives (2013) found that:

  • Rising inequality is due to technical changes that allow highly talented individuals or “superstars” to manage or perform on a much larger scale.
  • These superstars can now apply their talents to greater pools of resources and reach larger numbers of people and markets at home and abroad. They thus became more productive, and higher paid.
  • Those in the Forbes 400 richest are less likely to have inherited their wealth or have grown up wealthy.
  • Today’s rich are working rich who accessed education in their youth and then applied their natural talents and acquired skills to the most scalable industries such as ICT, finance, entertainment, sport and mass retailing.
  • The U.S. evidence on income and wealth shares for the top 1% is most consistent with a “superstar” explanation. This evidence is less consistent with the gains in earnings of the top 1% coming from greater managerial power over the determination of their own pay in the corporate world, or changes in social norms about what managers could earn.

Today’s super-rich are highly productive because they produce new and better products and services that people want and are willing to pay for. These rewards for entrepreneurship and hard work guide people of different talents and skills into the occupations and industries where their talents are valued the most. The efficient allocation of talent and income maximising occupational choices were important to Rawls’ framework.

Another important role for incentives is it rewards entrepreneurial alertness. People will look for and take advantage of hitherto unnoticed business opportunities if they are rewarded for doing so. These private rewards for greater effort, excellence and superior alertness are the driving force of the market. Most of the innovation that drives modern prosperity would not have occurred but for the lure of profit.

Rawls was keen on stiff inheritance taxes to prevent the “large-scale private concentrations of capital from coming to have a dominant role in economic and political life”. His support for inheritance taxes was out of concern with a concentration of political power rather than improving incentives.

Rawls overrated the power of the rich to buy political influence as do many on the Left. They do not understand Director’s law of public expenditure and the theories of the median voter and the expressive voter. The major political parties all chase the swinging voter in the middle class.

Rawls’ views on incomes taxes and the rich are rather under-discussed among his champions on the progressive Left. Google John Rawls and income taxes and you do not get many hits or papers of any substance.

With his emphasis on fair distribution of income, Rawls’ initial appeal was to the Left, but left-wing thinkers started to dislike his acceptance of capitalism and tolerance of large discrepancies in income. Many moved on. Rawls excluded envy from deliberations behind the veil of ignorance. This may be why he lost some of his initial appeal to some.

You must admire his consistency. Rawls was happy for people to be super-rich as long as they saved and invested their resources. Everyone in society gains from those investments and is better off.

Robert Lucas (1990) estimated that a revenue neutral elimination of all taxes on income from capital and on capital gains would increase the U.S. capital stock by about 35% and consumption by 7%. Hans Fehr, Sabine Jokisch, Ashwin Kambhampati, and Laurence J. Kotlikoff (2014) found that eliminating the corporate income tax would raise the U.S capital stock (machines and buildings) by 23%, output by 8% and the real wages of unskilled and skilled workers by 12%. Is taxing the rich worth this large a lost wage rise?

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