Wednesday, October 01, 2014

The Leadership Implications of "Too Big To Fail"

This month, The New York Times in Leadership will be featuring a short post from me with some reflections on what we have learned about leadership in the six years since the onset of the financial crisis. It is based on a session I have done a couple of times for the Rockefeller Leadership Fellows program at Dartmouth. Here's the conclusion:

Ironically, the leadership lesson of “Too Big to Fail” is that we must lead proactively before a crisis so that leaders can remain comfortably on the sidelines when a large financial institution works its way into trouble.

Read the whole thing.

Friday, September 19, 2014

Income Tax Changes and Economic Growth

Policy makers and researchers have long been interested in how potential changes to the personal income tax system affect the size of the overall economy. Earlier this year, for example, Representative Dave Camp (R-MI) proposed a sweeping reform to the income tax system that would reduce rates, greatly pare back subsidies in the tax code, and maintain revenue- and distributional-neutrality.

In a recently released paper, Bill Gale and I examine how tax changes can affect economic growth. We analyze two types of tax changes — reductions in individual income tax rates without any offsetting tax increases or spending cuts — and income tax reform that broadens the income tax base and reduces statutory income tax rates, while maintaining overall revenue levels and the distribution of tax burdens. We do not consider reforms to the corporate income tax (see Eric Toder and Alan Viard’s recent paper) or reforms that would substitute consumption taxes for all or part of the income tax.

We examine impacts on the expansion of the supply side of the economy and of potential Gross Domestic Product (GDP). This expansion could come in the form of a permanent increase in the annual growth rate, a one-time increase in the size of the economy that does not affect the future growth but raises economic output permanently, or both. Our focus on the supply side of the economy and the long run is in contrast to the short-term phenomenon, also sometimes called “economic growth,” by which a boost in aggregate demand in a slack economy can close the gap between actual and potential GDP.

While there is no doubt that tax policy influences economic choices, it is by no means obvious on an ex ante basis that tax rate cuts will ultimately lead to a larger economy. While rate cuts would raise the after-tax return to additional work, saving, and investment, they would also raise the after-tax income people receive from their current level of activities, which lessens their need to work, save, and invest more. The first effect (the so-called “substitution effect”) normally raises economic activity, while the second effect (the “income effect”) normally reduces it. In addition, tax cuts that are not financed by spending cuts or offsetting tax increases raise federal debt, which reduces long-term growth. The historical evidence and simulation analysis are consistent with the idea that tax cuts that are not financed by immediate spending cuts will have little positive impact on growth. In contrast, tax rate cuts financed by immediate cuts in unproductive spending will raise long-term output, but so would cuts in unproductive spending that are not accompanied by tax cuts.

Tax reform is more complex, as it involves both tax rate cuts and base-broadening. In theory, such changes could raise the overall size of the economy in the long-term, although it is unclear how much. One fact that often escapes notice is that broadening the tax base by reducing or eliminating tax expenditures raises the effective tax rate that people and firms face on returns from additional work, saving, and investing, thereby offsetting some of the benefits of statutory tax rate cuts. But base-broadening has the additional benefit of reallocating resources from sectors that are currently tax-preferred to sectors that have higher economic (pre-tax) returns, which should raise the overall size of the economy.

Well designed tax policies may raise economic growth, but there are many stumbling blocks along the way and no guarantee that all tax changes will improve economic performance. Given the various channels through which tax policy affects growth, a growth-inducing tax policy would require (i) the presence of large positive incentive (substitution) effects that encourage work, saving, and investment; (ii) the presence of income effects that are not large enough to offset the substitution effects, (iii) a careful targeting of tax cuts toward new economic activity, rather than providing windfall gains for previous activities; (ivi) a reduction in distortions across economic sectors and across different types of income and types of consumption; and (v) little or no increase in the budget deficit.

Few if any tax real-world tax changes are likely to satisfy all of those conditions. Thus, the justification for sweeping income tax reform changes must rest primarily on objectives other than economic growth.

Cross-posted by Bill Gale at TaxVox. 
Tax Policy Center event video from September 9. 
 Media References:
"Tax Cuts Can Do More Harm than Good," David Cay Johnston, Aljazeera America, September 18.
"Can Income Tax Reform Spur Economic Growth," APPAM, September 15.
"Taxes and Growth," Dietz Vollrath, The Growth Economics Blog, September 12.
"Don't Count on Much Economic Growth from Individual Tax Reform ... Or From Rate Cuts," Howard Gleckman, Forbes, September 10.

Wednesday, June 25, 2014

A Quick Reaction to More Minimum Wage Nonsense

Danielle Kurtzleben of Vox has an interview with Gap's Vice President of Stores Lynn Albright about the company's decision to phase in higher wages for its lowest paid workers. The claim being made is that this decision is good for the Gap, as it will reduce employee turnover (which is costly) and attract higher skilled workers. I have two reactions.

First, good for the Gap for figuring out that it can raise profits by changing a labor practice. Also, good for the higher skilled workers who now have more opportunities in the labor market.

Second, this policy change at one company has absolutely nothing to do with the case for raising the minimum wage in the economy as specified by law. Such legislation affects the opposite labor practice -- when a company figures out that it can raise profits by offering lower wages, acknowledging that it will suffer higher turnover costs and that it will attract less skilled workers. With that labor practice forbidden by law, companies with that production model and the less skilled workers, who now have fewer opportunities in the labor market, are worse off.

The problem that we should be addressing is that low-skilled workers have low skills, not that there are labor market opportunities that pay them in accordance with their low level of productivity.

Wednesday, June 11, 2014

The End of Tenure in California Public Schools?

Judge Rolf M. Treu of the Los Angeles Superior Court has ruled in Vergara v. California that tenure and other job protections for teachers in primary and secondary public schools are unconstitutional. I think this is a clear case of judicial overreach -- legislating from the bench.

I don't think it is a hard case to make that the implementation of employment protections in many public school systems is bad policy. However, bad implementation of the policy does not mean that the policy is unconstitutional. The ruling pays lip service to this distinction, but that seems to be all. The key excerpt from the ruling in this case is:

Substantial evidence presented makes it clear to this court that the challenged statutes disproportionately affect poor and/or minority students.

Any policy under the purview of the public sector in which the benefits and costs fall unevenly by race would be deemed to violate the civil rights of the disadvantaged group. It is interesting to me that almost all of the tentative decision focuses on how bad the Challenged Statutes are at their worst, only two paragraphs focus on the effect on low-income and minority students in particular, and none of it discusses potential advantages of the job protections in the Challenged Statutes.

Even if those two paragraphs are the essential part of the ruling, the remedy is to ensure that the policy is implemented better, not necessarily to declare the policy unconstitutional. For example, based on what is presented in the ruling, consider a system in which:

  1. The Permanent Employment Statute had a 3-5 year evaluation period (as a defense witness suggested and as is found in most other states), 
  2. The Dismissal Statute had protections only at the level described in the Skelly v. State Personnel Board case cited in the ruling, 
  3. The "Last In, First Out" Statute were relaxed to having seniority considered as one among many factors rather than the only factor (as the ruling notes is the case in 20 other states), and
  4. The State could establish that there was no correlation between a school's incidence of low-income or minority students and the presence of ineffective teachers (where the latter was measured based on performance facing a standardized classroom).

This system would appear to violate no principle identified in the ruling. I don't expect this ruling to survive on appeal. I expect a higher court to require the State to implement a system like what I have outlined here.

Wednesday, April 23, 2014

College Admissions in Michigan, Again and Again

Supreme Court Justice Sonia Sotomayor's dissent in the Schuette v. Coalition to Defend Affirmative Action case is puzzling to me. She accuses her colleagues in the 6-2 majority of "trying to wish away racial inequality." They do nothing of the kind. It seems very hard to believe that there is anything in the Constitution or judicial precedent that would deny the citizens of Michigan the prerogative to affirm that a public university they support will be constrained to not treat applicants differently based on their race. This says nothing about whether the Michigan policy is a good one -- only that it is within the purview of the citizens to make this requirement. It does not say that every state must affirm such a policy. Is Sotomayor really saying that there is a Constitutional requirement that public universities must treat applicants differently based on race?

In the context of figuring out what is an equitable policy, we often hear questions about non-racial preferences in admissions, like athletes and legacies. Given the racial composition of profit-sport athletes relative to the student body, I don't expect the coalition that is pushing for Sotomayor's worldview to challenge those preferences. But it would not surprise me to see, and I think the day is coming when we will see, a legal challenge to legacy preferences at public institutions based on the claim that they discriminate against racial minorities. Legacy preferences perpetuate a legacy of discriminatory admissions standards (or simply unequal college preparation) that may have existed years ago. I doubt it would be too hard to show that the potential pool of legacy applications to any flagship state university is tilted away from racial minorities relative to the potential pool of applicants statewide. It would also not surprise me if Michigan was once again the battleground for this challenge.