(Based on the Chapter LEGIT.GOV of the GOOD ECONOMICS FOR HARD TIME)
ONE CONCEQUENCE OF MARKET. INEQULITY
A RECURRING THEME of this book is that it is unreasonable to expect markets to always deliver outcomes that are just, acceptable, or even efficient. For example, in the sticky economy, government intervention is necessary to help people move when it makes sense, but also sometimes to remain in place without having to give up their livelihood and their dignity.More generally, in a world of skyrocketing inequalities and “winner take all,” the lives of the poor and the rich are diverging wildly and will become irremediably different if we allow markets to drive all social outcomes.
ONE REMEDY IS TAXATION
As we saw, taxation can be used to rein in inequality at the top of income and wealth distribution. But abolishing the one percent cannot be the end-all of social policy. We also need to find out how to help the rest.
OTHER MEANS(POLICIY INTERVENTIONS) ARE REQUIRED
Any innovation in social policy is likely to require new resources. The ultra-rich will probably not be rich enough to finance the entire government, especially if pre-tax inequality goes down, as we hope. Moreover, if history is any guide, they will resist, probably with some success. Others will also need to pay; the experience of many countries shows this is perfectly feasible. The challenge is political. The problem is the eroding legitimacy of the state. The state is perceived as unreliable, or worse, by an increasing majority of the electorate. How can that legitimacy be restored?
TAX AND SPEND?
TAX RAISING HAS A LIMITED EFFECT
Democracies raise money through taxation. The overall tax revenues (taking together all levels of government) in the United States in 2017 was just 27 percent of GDP. This is seven points lower than the average in the OECD. The United States was tied with South Korea, and only four other countries in the OECD have lower tax revenues (Mexico, Ireland, Turkey, and Chile).1 Any significant public policy effort would require more funding. Even if the United States raises its taxes on the rich to match Denmark’s, the overall tax revenue as a share of US GDP will still be much lower than what it was in 2017 in Denmark (46 percent), France (46 percent), Belgium (45 percent), Sweden (44 percent), and Finland (43 percent). One reason is that if US tax rates were raised to those levels, it is possible top incomes would go down a lot because companies would move away from paying astronomical salaries; this might be desirable in itself but would defeat the purpose of raising revenue. In other words, although it might be desirable in terms of limiting inequality, the current proposal to raise income tax rates above 70 percent is unlikely to deliver so much new money to the state. A wealth tax would raise more revenue as long as steps were taken to reduce evasion. Saez and Zucman estimate that a 2 percent wealth tax on Americans with assets above $50 million (this would affect about seventyfive thousand people), as well as a 3 percent wealth tax on those who have more than $1 billion would raise $2.75 trillion over ten years, or 1 percent of GDP.2 As we saw, 2 percent wealth tax for those worth more than $50 million is actually more popular than an increase in the marginal income taxrate.3 But even at the proposed level, it still raises just 1 percent of GDP. Even in the European countries with high top rates and a wealth tax, the majority of the government’s revenues come from taxes on average earners. In other words, the dream of a tax reform that leaves “99 percent of the taxpayers with a lower tax bill” would guarantee that the United States continues to be unable to redistribute much to those falling behind.
Tax reform needs to apply not solely to the ultra-rich, but also the merely rich
and even the middle class. As things stand, this is a no-fly zone for US politicians on the left and the right. Proposing to raise taxes on (almost) everyone is not popular. In our survey, 48 percent of respondents thought small business owners paid too much in taxes, and less than 5 percent thought they paid too little. The same was true for salaried workers.4 The hardest part may be to persuade the average taxpayer in the United States to pay more and get more public services.
WHAT CAN HAPPEN IF TAX RATES CHANGED
We suspect economists are partly responsible for people’s reluctance to pay taxes, in more than one way.
First, many prominent economists have raised the specter that people will stop working if taxes go up. For example, Milton Friedman, who famously declared: “I am in favor of cutting taxes under any circumstances and for any excuse, for any reason, whenever it’s possible.”5 They maintain that high taxes kill initiative and stop growth, even in the face of data that says nothing of the sort. We have already seen that the rich do not stop working when taxes go up. How about the other 99 percent though? Would they retire to the countryside? There is also a voluminous economic literature on the subject that makes it clear they won’t.6
EXAMPLE OF SWITZERLAND
One of the best examples is from Switzerland. In the late 1990s and early 2000s, Switzerland converted from a system where people paid taxes on the previous two years of income to a more standard “pay as you earn” system. In the old system, taxes due in 1997 and 1998 were based on income earned in 1995 and 1996, taxes due in 1999 and 2000 were based on income earned in 1997 and 1998, and so on. The new system works like that of the United States: estimated taxes due, say, for 2000 are collected throughout the year, then in early 2001 the taxpayer fills out an income tax return and the tax liability is adjusted. To transition to the new system in Switzerland, there had to be a tax holiday. The canton of Thurgau transitioned in 1999. In 1997 and in 1998, taxpayers paid taxes on the income earned in 1995 and 1996. In 1999, they started paying taxes based on income in 1999. To avoid taxing people twice, no taxes were ever levied on the income earned in 1997 and 1998: those were the tax holiday years. Swiss cantons transitioned in different years between 1999 and 2001, so different people got their tax holidays in different years, depending on where they lived. The rebate was temporary and widely known in advance. So while people decided whether (and how much) to work for the year, they already knew they would pay no taxes. This was a perfect opportunity to see whether lowering tax rates made a difference to people’s willingness to work; we can just compare labor supply before, during, and after the tax holiday. The answer is it changed not at all. There was absolutely no impact on whether people decided to work or not, and no effect on hours worked either.7
SUREVY IN THE USA
While the Swiss example is particularly stark, the result is more general. Taxes do not seem to discourage people from working.8 However, voters may still oppose taxation if they think others would stop working if taxes went up. In our survey we asked some of the respondents whether they would stop working, or work less, if taxes were higher. Seventy-two percent said they would absolutely not stop working, and 60 percent said they would work just as much as before. This is very consistent with the data. We also asked the other respondents how they thought the average person in the middle class would respond. In that case, only 35 percent of respondents believed the average middle-class person would work as much as before, and 50 percent believed they would stop working.9 Thus, when judging themselves, Americans are about right, but when they anticipate the behavior of their friends and neighbors, they are much too pessimistic.
IS GOVERNMENT THE PROBLEM?
Another reason why people are reluctant to raise more taxes to get more services is that many people in the United States (but also in the UK and in many developing countries) are skeptical of any intervention by the state. At least since Reagan, we have been fed the mantra that “in this present crisis, government is not the solution to our problem, government IS the problem.”10 In 2015, only 23 percent of Americans thought they could trust the government “always” or “most of the time.” Fifty-nine percent had a negative opinion of the government. Twenty percent thought the government had no tools to improve equality of opportunities between the rich and the poor, and 32 percent thought lowering taxes on wealthy people and corporations to encourage investment would be a better way to improve equality of opportunities than increasing taxes to finance more programs for the poor.11
INDIA This radical skepticism about government action may be the single biggest constraint on helping those who need it most, paradoxically because many of those people themselves hold precisely these views. Manpreet Singh Badal, a bright young minister in the Indian state of Punjab, saw his political career stumble over just this issue. Farmers in Punjab get free electricity, and groundwater is free, with the result that everyone overirrigates their land with the consequence that the water table is falling so fast that in a few years there will be no water to pump out. It is in everybody’s interest to reduce water consumption now. Badal’s solution was to give everyone a fixed sum of money to compensate them, and then charge them for the electricity so they would not pump any more water than they needed, because the cost would act as a deterrent against excess pumping. From the point of view of economic logic, this is a no-brainer. But it was political suicide. The measure, introduced in January 2010, had to be removed ten months later, and Badal lost his job as finance minister and eventually had to leave his political party. Farmers simply did not trust they would get any money, and the powerful farmers’ associations radically opposed the measures. Remarkably, in 2018 Badal, back in government, decided to try again. This time the plan was to first give a direct transfer of Rs 48,000 (equivalent to $2823, accounting for purchasing power parity differences) to all farmers directly into their bank accounts, before charging them for electricity by deducting from this same account. The subsidy has been calculated such that at the going rate, a farmer consuming less than 9,000 units of power would come out ahead (the state estimates the average consumption is between 8,000 and 9,000 units). The idea was to make it absolutely clear that this is not a tax in disguise, a sly way to raise money from the farmers. And this time the government moved slowly. They began with a small pilot program, and are now planning a larger RCT to evaluate the impact of this scheme on water consumption and farmers’ welfare. Still, farmers remain suspicious. The farmers’ union continues to claim that “their real agenda is to discontinue the power subsidy for agriculture.”12 Why are people so suspicious of the government? A part of it, no doubt, is historical. In India, people have seen too many instances where the government reneged on a pledge.
USA In the United States, there is clearly an ideology of self-reliance, even though for many years it has been based, to a significant extent, on a fantasy—the states in the US where people take the most pride in their autonomy are also the ones most dependent on federal subsidies (Mississippi, Louisiana, Tennessee, and Montana top the list by federal aid as fraction of revenue).13 In part also, as we suggested earlier, it relates to a distrust of the elite. Government programs are seen as the elite’s way of subsidizing everyone but hard-working white (males?). But it doesn’t help that there is a background of economist-inspired chatter about waste in government. Mention a government intervention in a roomful of economists and you will hear an unmistakable snicker. Many, perhaps even most, economists believe incentives in government are always messed up, and as a result government interventions, while often necessary, tend to be ham-handed or corrupt.14
IS THE PRIVATIZATION A PANACEA?
But bad relative to what? The problem is that there is no substitute for a lot of things the government does (although of course many governments do more things than they should, like running an airline in India or a cement plant in China). When a tornado strikes, when an indigent needs healthcare, or when an industry shuts down, there is usually no “market solution.” The government exists in part to solve problems no other institution can realistically tackle. To demonstrate waste in government, one needs to show there is an alternative way of organizing the same activity that works better.
There is no doubt waste in governments in most countries. A number of studies from countries like India, Indonesia, Mexico, and Uganda have found that changes in the way governments do things can lead to substantial improvements. For example, in Indonesia simply distributing a card indicating someone was eligible for a program increased the amount of subsidies the poor got by 26 percent. Once they found out what they were eligible for, people were able to better advocate for themselves.15 On the other hand, as we noted in chapter 5, there is also enormous waste inside private firms, so perhaps good management of resources is harder than we think. Consistent with this, figuring out how to reduce waste in government turns out to be more difficult than it seems. Simple formulae do not work; privatization, for example, is not a panacea. The limited evidence comparing private and public provision of the same service turns out to be very mixed. Private schools in India are cheaper, but children randomly assigned to a private school have the same low test scores as those who stayed in public schools.16 Private placement services for the long-term unemployed in France work less well than their public equivalents.17 In 2016, the Liberian government transferred the responsibility of running ninety-three government schools to eight different organizations (some NGOs and some for-profit operators) and, remarkably, ran an RCT to evaluate the impact. The results were mixed. Students’ results in those schools were somewhat better on average, but the private schools also spent a lot more money per pupil (double what the normal students got), so the playing field wasn’t quite level. Moreover, four of the eight organizations did little better than public schools. Bridge Academy, the star provider, had good scores, but only after receiving considerable outside money and dropping all students in excess of their class size cap.18 Another provider, the US charity More Than Me, got itself embroiled in an egregious sexual abuse scandal.19 There was no miracle cure.
THE CORRUPTION OBSESSION
Part of the root of the skepticism of government is a widely shared obsession with corruption in government across the world. Perhaps it is because the idea of government officials living the easy life on taxpayers’ money offends people, and therefore is often at the heart of political campaigns.
CAUSE OF CORRUPTION IN GOVERNMENT
But the view that all it takes to root out corruption is the will to do it misses the key point about the sources of corruption and our ability to control it. It is often precisely because governments do things the market will not touch that they become susceptible to corruption. Take the example of a fine for polluting. The polluter would gladly pay someone in the pollution control office a portion of the fine to make the evidence go away. But would things improve if a profit-maximizing private firm was collecting fines? Probably not, since they like money at least as much. Moreover, as the history of private tax collection (“tax farming”) tells us, incentivizing private agents to collect taxes (or fines) runs the risk they will extort those who are not liable as well. Or consider a slot in the best public schools. It is very tempting for a school official to accept a payment to open a “side door” for a rich but unqualified student, and it is rumored to be a common practice in China’s top high schools. But this is not about government per se; it is about rationing. Whenever a good is rationed, the temptation to just pay one’s ay in is very strong. This was made abundantly clear by the admission scandals that shook elite private universities such as Stanford and Yale in 2019; parents who were wealthy but not wealthy enough to pay the full “price” of back door entry for their offspring (say, a building for the university) worked with a consultant who offered a more affordable side door (e.g., a bribe to the sports coaches).
The broader point is that our social objectives often push us to not follow the market’s dictates. There is no pure market solution for collecting fines, and the reason why public schools have low fees and private universities do not charge the price the market would bear is because we want poor but talented kids to be able to get the best opportunities. But whenever anyone tries to get in the way of the market there will be a temptation to cheat. Since it is in the nature of the government’s job to interpose itself in front of the market, the fight against corruption in government will be an uphill and continuous battle, even with the best intentions.
Moreover, fighting corruption is by no means costless. In Italy, an umbrella government organization called Consip was set up in reaction to a succession of corruption scandals. Its job was to purchase supplies on behalf of government departments. What it purchased changed from time to time; as a result, sometimes government departments had to provision certain things on their own, while at other times they relied on Consip. When government departments had access to Consip, they used that option most of the time, but it ended up costing the government substantially more for exactly the same products, because usually there was a cheaper version of the product on the market. In other words, the departments could have bought what they needed more cheaply, but they chose not to exercise that option when Consip was available. As a result, on net Consip turned out to be a money loser. Trusting government officials to do what they had always done, without constraining them, would have been a better idea.20 Why did almost everyone use Consip when it was available, even though they knew they could get products cheaper elsewhere? Probably because they knew that this way they were protected from any accusation of corruption. There is nothing special about government officials in their desire to check all the boxes to avoid trouble. Doctors in the United States recommend too many tests to avoid malpractice suits, for example. And large companies that use a single mandated travel agent for all their staff travel almost surely lose money on most tickets, since the agent does not search for the best deal. But this limits the risk that employees make money on the side.
REMEDY
POLITICAL WILL
The presumption is that if there was enough political will, corruption could be made to go away. There is of course a lot of truth to this. How can you expect corruption to go away when heads of governments are themselves up to their elbows in gravy?
TRANSPERANCY
This illustrates a broader point. The current fashion in fighting corruption is transparency, the idea that the workings of governments should be available for scrutiny by outsiders like independent public auditors, the media, and the public. There is solid evidence that in many situations transparency helps. In particular, informing the ultimate beneficiaries about the difference between what they are entitled to and what they are getting is a powerful instrument for fighting corruption.21
However, as the Consip example makes clear, there is also a downside to transparency. Monitoring often relies on outsiders limited in their ability to understand the bigger picture or evaluate how well the overall social objectives are being served; the most they can do is to verify that due process is followed. In turn, this means bureaucrats tend to focus a lot on checking off the right boxes to avoid attracting attention. This creates a specific bias toward following the letter of the law, even when its spirit is somewhere entirely different.
EFFICIENT AND DEDICATED WORKFORCE
Ultimately, the portrayal of bureaucrats and politicians as either bumbling idiots or corrupt sleazeballs, for which economists are probably partly responsible, is deeply damaging. First, it prompts a knee-jerk reaction against all proposals to expand the government, even when government is clearly needed, like in the United States today. In our survey of US respondents, trust in bureaucrats is as low as trust in economists: only 26 percent of our respondents trust civil servants either “somewhat” or “a lot.”22 This probably explains why so few people think government can be part of the solution. Second, it affects who wants to work for the government. Attracting qualified people is essential to a well-functioning government. But to a talented young person in the United States, a career in government, given its reputation, is unappealing. Neither of us has ever had an undergraduate about to receive their diploma tell us they were headed to a career in government. This kind of sorting can turn into a vicious cycle. If only the less able work in government, we get an ineffectual government no one of talent would want to join. In France, on the other hand, there is prestige attached to working for the government, and the best and brightest do so. The image of the government also affects the honesty of those who want to work for it. A study in India replicated the Swiss experiment with bankers we discussed in chapter 4,23 where participants (in this case, college students) were asked to privately roll a die forty-two times and record what numbers they got each time; the reward was half an Indian rupee for a one, one rupee for a two, one and a half rupees for a three, and so on. Students were free to lie about the numbers they rolled, and roughly the same proportion as in Switzerland did. But, just as those who were reminded of their identity as bankers cheated more in Switzerland, in India students planning to work for the government cheated more.24 In contrast, when the study was again replicated in Denmark, which is justifiably proud of its social sector, researchers found the exact opposite as in India: those planning to join the government were much less likely to cheat.25
LESSONING TOO MANY CONSTRAINTS
Third, if it is assumed most people in government are either venal or lazy (or both), it makes sense to try to remove all decision-making power from them (and thereby banish all creativity and all creative people). This has a direct impact on what government officials can do. In a recent experiment in Pakistan, providing a bit more flexibility to the procurement officers of hospitals and schools by giving them some free cash to spend on basic supplies greatly improved their ability to negotiate low prices, leading to big savings for the government.26 Putting too many constraints on government officials and government contracts can discourage talent when it is the most needed.
Despite the fact that the United States is the world leader in computing, none of the big tech firms chose to bid on contracts to set up the computer system supporting Obamacare. The reason was apparently that there were so many boxes to check off to be a government contractor that very few firms were willing to do it. The Federal Acquisition Regulation has eighteen hundred pages. So, in order to win a government contract, it is more important to be good at paperwork than to be able to do the job.27 In the development world, the contractors that systematically bid for and win the USAID contracts are known as “Beltway bandits.” It is very difficult for other organizations to get a piece of that action, even when they have relevant experience on the ground.
HOLDING POLITITICIANS ACCOINTABLE
Finally, and perhaps most importantly, the mantra that government is corrupt and incompetent has produced the kind of jaded citizenry who can react to news of shameless corruption among its elected leaders with a shrug, from Washington, DC, to Jerusalem and Moscow. They basically have learned to expect nothing else, and stop paying attention. Perversely, the obsession with petty corruption is breeding room for venality on a grand scale.
GOVERNMENT- TAX- INEQUALITY
The United States seems to be at an impasse. Forty years of promising that good things are just around the corner have created an environment where too many people trust no one, least of all the government. The growing economic and political influence of the rich, the result of the pursuit of the elusive elixir of growth, has combined with anti-government sentiments the rich carefully have cultivated to head off any attempts to rein in their growing wealth.
The government is chronically broke because it is politically impossible to raise taxes, and even the most socially minded of the young have become convinced that government is terminally uncool, and so head to private foundations if they do not actually give up and join an “impact” fund, or an unabashedly money-making venture. And yet the only possible way out involves a much expanded role for the government. It is possible this is also the shape of the future in many other countries.
While the rise was less spectacular than in the United States, inequality has also increased in France. Between 1983 and 2014, the average income of the richest 1 percent has risen by 100 percent and that of the richest 0.1 percent by 150 percent. Since GDP growth has been slow, standards of living for most people except the rich have tended to stagnate: over the same period, income increased only by 25 percent (less than 1 percent per year) for the remaining 99 percent.28 This has fueled growing mistrust of the elite and the rise of the xenophobic Rassemblement National. The recent round of tax reforms undertaken by the centrist Macron government has made tax less progressive: the flat tax was raised, the wealth tax is gone, and taxes on capital have been pared back. The official justification is that this is necessary to make France able to attract capital away from other countries. It may well be true, but it runs the risk of forcing other countries in Europe to cut taxes as well, prompting a race to the bottom. The American experience warns us this may be very hard to reverse. European countries need to cooperate to hold the line on their taxes.
Developing-country governments raise even less money than the United States. The median low-income country raises less than 15 percent of GDP in taxes as compared to nearly 50 percent in Europe (and 34 percent in the OECD on average). To some extent, the underdevelopment of the taxNsystem is a consequence of the nature of the economy; a large part of the economy is taken up by tiny firms or remote farms whose income is hard to verify. But to a large extent the low level of taxation is a political choice. India and China offer an interesting contrast. Historically, most citizens in both countries had too little income for it to be worth taxing them.
But as incomes grew, India kept raising the threshold above which people had to pay income taxes—on budget day, when new tax rates are announced, the raised threshold is often headline news. As a result, the share of the population that paid any income tax remained stable around 2–3 percent.
In China, where the thresholds were not adjusted, the fraction of the population subject to the income tax went up from less than 0.1 percent in 1986 to about 20 percent in 2008. Income tax revenues in China boomed, from less than 0.1 percent of GDP to 2.5 percent in 2008, while in India they have stagnated at around 0.5 percent of GDP. More generally, tax revenues as a share of GDP have been stable at about 15 percent of GDP in India for many years now, while they are above 20 percent in China, giving China the option to invest more and/or carry out more social spending.29
The new Goods and Services Tax in India is supposed to help by making it harder to evade taxes, but being a more or less proportional tax on purchases, it has very little redistributive effect. Moreover, very much like the United States, India has not been very successful in using taxation to limit the ballooning of top-income pre-tax inequality. According to the World Inequality Database, the share of the top 1 percent of income in India’s GDP increased from 7.3 percent in 1980 to more than 20 percent in 2015. In China, where there was a bit more effort, it still went up, but by less, from 6.4 percent to 13.9 percent.30
The interesting counterexample here is Latin America, for many years the example everyone used for growth with exploding inequality (which then turned into inequality with no growth), where the recent decades have seen a significant reduction in inequality. This was partly driven by rising commodity prices, but also in part by policy interventions, higher minimum wages, and large-scale redistribution in particular.31 The way redistribution was expanded in those countries is instructive. The political opposition to transfer programs in Latin America is couched in terms of the moral and psychological consequences of giveaways, much like the US conversation about welfare is dominated by the fear of abuse and laziness. From the beginning, Santiago Levy, an economics professor who played a very important role in setting up Progresa, the transfer program in Mexico that provided the blueprint for many others, was very conscious of the need to get buy-in from the right.32 The program emphasized a social quid pro quo. The transfers were quite explicitly conditional: the families had to take their children to the doctor and send them to school to get the money. A randomized controlled trial proved that those given access to the program had better child outcomes.33 Probably as a result, these programs have proved durable. For decades, successive governments have sometimes changed the name of the program (Progresa became Oportunidades and then Prospera) but not much else. In 2019, the new left-wing Mexican government seems to be on the way to replace the program with a similarly generous program with fewer strings attached. In the meantime, the conditional cash transfer program (CCT) had been imitated all over the region and beyond (all the way to New York City).Originally, most of the programs adopted similar conditionalities, and often paired the programs with RCTs. These series of experiments had two impacts. First, they demonstrated nothing terrible happens when one gives cash to the poor. As we will see in the next chapter, they don’t drink it all and they don’t stop working. This was instrumental in shifting the public perception on redistribution all over the developing world.
In the 2019 elections in India, both major parties, for the first time, made a cash transfer to the poor a central element of their platform. Second, as countries started to experiment with the model and try out variants of it, it became clear the poor don’t need as much handholding as the design of the original CCTs implied. There has been a complete turnaround in the public conversation on redistribution, and the Progresa experiment and its successors contributed a lot to it.
The battle against growing inequality has not been permanently won even in Latin America. The top tax rates remain low and top incomes are not systematically going down (since 2000, in the World Inequality Database, they are completely flat in Chile, rising in Colombia, bouncing all over the place in Brazil).34 But the experience of Progresa highlights the notion that careful program design will be key to breaking open the seeming impasse in the United States and similar issues that might come down the pike elsewhere. Figuring this out may be one of the greatest challenges of our time. Much greater than space travel, perhaps even than curing cancer. After all, what is at stake is the whole idea of the good life as we have known it. We have the resources. What we lack are ideas that will help us jump the wall of disagreement and distrust that divides us. If we can engage the world seriously in this quest, and the best minds in the world to work with governments and NGOs and others to redesign our social programs for effectiveness and political viability, there is a chance history will remember our era with gratitude.
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