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Democracy’s Last Period Problem

The budget deal last December was notable for its neglect of any reform to entitlements. The Obama years will likely be remembered for the utter failure to come to grips with our burgeoning unfunded obligations, which remain the greatest threat to our future. But don’t take my word for it. Here is the eloquent economist Caroline Hoxby:

         Programs such as Social Security, Medicare and disability have needed reform for many years because they are not fiscally sound. They will predictably impose an increasing burden on the economy. Today’s young Americans will have to be heavily taxed when they are adults to pay for benefits mainly enjoyed by previous generations. This will discourage them from working and upgrading their skills, causing future growth to slow. Most economists have agreed year after year that these programs need attention, yet reforming them always takes a back seat to agonizing about the latest crisis—even when we know that such agonizing cannot help much and that we must let the economy re-equilibrate.

Sadly, reform seems further away than ever, as Republican presidential candidates are largely silent about the issue and Democratic candidates want to add to entitlements by increasing social security benefits. One reason for less serious talk about reform, let alone action, is simple: the baby boomers are either now collecting old-age entitlements or getting ever closer to the day they will do so. Politicians are leery of annoying this massive, aging voting bloc.

This issue highlights a little discussed danger for democracy—its last period problem. When people are young they have an interest in the nation’s long term future. But as they age, many become less concerned, because they will not be part of that  future. This problem is not unique to democracy but besets any enterprise where some decision makers have shorter term horizons than the beneficiaries. Faculties are a case in point: I have long wondered whether the voting rights of professors should be whittled away as they approach retirement.

But democracy itself exacerbates its last-period problem. Older people vote in much greater percentages than the young. Voting is costly, and older people have less to do and less exciting ways to spend their time. The aged would thus turn out more, even if their benefits were not at stake.

And it is also exacerbated by modernity. Having children tempers the psychology of the last period, as children are a bridge to the future. But more people are childless and most have fewer children than in past centuries. And children tend to live farther away, reminding their parents less of their presence.

The last period problem of democracy has a variety of implications. First, it highlights the fact that democracy is no substitute for other restraints on government—restraints that have been eroded by progressivism. Second, it suggests the need for new restraints: a balanced budget amendment, for instance, might help prevent the old from sloughing off debts onto the young. Finally, it shows the folly of proposals to increase rather than pare back entitlements. Such profligacy will saddle the unborn with even greater impositions from which it will be difficult to escape.

Reader Discussion

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on January 10, 2016 at 13:04:14 pm

It's worth remembering President Obama offered Republicans a deal of significant entitlement cuts for small tax increases. They turned him down.

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Aaron J
on January 11, 2016 at 09:03:37 am

Programs such as Social Security, Medicare and disability have needed reform for many years because they are not fiscally sound. They will predictably impose an increasing burden on the economy. Today’s young Americans will have to be heavily taxed when they are adults to pay for benefits mainly enjoyed by previous generations. This will discourage them from working and upgrading their skills, causing future growth to slow.

Yup. But, of course, this dynamic arises from any marginal taxation.

Is it true that today’s young Americans would have been better off if their parents had been poorer – receiving low transfers, or being taxed more, spending more of their resources caring for their own parents – and if the economy throughout their youth had lacked the stimulative effects of these transfers? Perhaps, but this strikes me as a far more complicated question than set forth here.

Moreover, arguably people are motivated to work based on after-tax marginal income. If we’re concerned about how taxes might discourage marginal productivity, we should target the taxes to people with the highest after-tax marginal income. Since per capita GDP has never been greater, that shouldn’t be so hard to do.

The last period problem of democracy has a variety of implications. First, it highlights the fact that democracy is no substitute for other restraints on government—restraints that have been eroded by progressivism. Second, it suggests the need for new restraints: a balanced budget amendment, for instance, might help prevent the old from sloughing off debts onto the young. Finally, it shows the folly of proposals to increase rather than pare back entitlements. Such profligacy will saddle the unborn with even greater impositions from which it will be difficult to escape.

Oh, so close. McGinnis walks right up to the edge of condemning politicians who promise tax cuts without specifying corresponding expenditure reductions -- but somehow can't bring himself to acknowledge the implications of his own argument.

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nobody.really
on January 11, 2016 at 13:21:18 pm

"Yup. But, of course, this dynamic arises from any marginal taxation."

- Yup - but the dynamic is incorrect. It is unclear, at best, that higher marginal rates will deter the INDIVIDUAL worker from gainful employment or cause that worker to a) work fewer hours or b0 decide to not increase their skills / marketable attributes. No, faced with a fairly constant need for some level of income to meet family needs, it is somewhat counter-intuitive to believe that the worker will simply withdraw from the economic sphere. That some few may do so is not indicative of a general trend or a marked alteration of the motivations of most workers.
If i don't work how can i possibly afford my Seahawk tickets, etc. etc.
Rather, the effect of higher rates may best be seen in the corporate sphere where the incentives for investment may change - NUT not the motivations of the principal actors. I may chose to defer investment in the face of higher corporate tax rates as I do not wish to be removed by the Board of Directors after profit margins have fallen if i invest AND pay higher tax rates. My motivation is to continue to exercise corporate power and influence and still receive very adequate compensation. That remains the same - only the corporate tactics are different.
As a consequence, many workers may either a) lose employment or b) not be hired.
The worker still desires to work (at least those previously disposed to do so); the worker still desires to feed his / her family and may recognize that $0.75 on the earned dollar is till better than 100% of no earned dollars.

As for the high earner - very gracious of you, once again, to offer up their pocketbooks to the public trough!
Interestingly enough, they may not object too strongly in their INDIVIDUAL persona ; it is in their corporate persona where the objection will arise. Again, look to their motivations (and in practice, the pronouncement of many 1%-ers). The exercise of corporate power / influence is not necessarily diminished by a higher personal tax rate - but it may very well be affected by a higher corporate rate - as well as the continued tenure of the incumbent. In short, the well to do CAN survive the higher personal rate - but perhaps not the higher corporate rate - at least not without adversely affecting the livelihoods of many of their employees.
Outsourcing anyone??????
Again, in the outsourcing instance, we see a change in *incentives* but not in *motivations* - the incentives to use certain instruments (doemestic or international production mechanisms) to achieve my own motivations have bee

A slightly different dynamic than the one you argue is what is altered by government action.

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gabe
on January 11, 2016 at 13:23:23 pm

Should read: " to achieve my own motivations have bee(n) altered by government."

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gabe
on January 11, 2016 at 17:14:15 pm

You’re raising issues of 1) marginal taxation, 2) the price mechanism and economic rents, and 3) the backwards-bending labor curve. I don’t have anything new to say, so I’ll recycle some old stuff.

To rationalize high returns to superstar executives, we need to postulate 1) that they actually produce enough to justify their compensation, and 2) they are sufficient scarce that they can keep the firm from appropriating the profits of their labor. After all, today’s average US worker is vastly more productive than yesterday’s – yet she extracts a much smaller share of her productivity in compensation, because today’s firms can produce more with less labor, and because labor unions no longer serve to artificially constrict the labor supply in order to reallocate the benefits of productivity to labor. Relative to yesterday, labor just isn’t very scarce.

Taxation generally deters the thing that gets taxed. If we tax marginal income, it will tend to deter earning at the margins. After all, people have no incentive to pay Kobe Bryant even one cent more than necessary in order to induce him to work for them – ergo it follows that if we raise taxes on him by even one cent on his $61.9 million earnings, he’d quit. To draw any other conclusion would be to impugn the efficiency of the market, right?

Alternatively, we could go back to Micro 101: The price mechanism serves as an incentive to spur production – and also as a mechanism for allocating resources. Where resources are scarce, the allocation function can outstrip the production function. Thus, Bryant’s $61.9 million compensation isn’t required to get him to produce; it’s required to determine for WHOM he will produce. Bryant is scarce, and the price mechanism determines how his talents get allocated.

And the neat thing about this dual role of the price mechanism: Where elasticity of supply is small, suppliers simply earn rents. Thus, you can tax suppliers without deadweight social losses. Think about is: How many people with the potential to do what Kobe Bryant is doing are instead sitting on their hands because the compensation package just isn’t sufficient to motivate them? I suspect none. And what share of Bryant’s compensation could be taxed away before he’d quit? Don’t know – but I suspect quite a bit.
I suspect the same is true of our supermanagers: They command high salaries not because they’d quit producing otherwise, but merely as an artifact of the competition for their services. Thus we could tax them quite a bit before they’d quit.

Yes, supermanagers work hard – but so what? If hard work were the explanatory variable, farm laborers and new moms would be gajillionaires.

That said, there’s one proviso – but it cuts both directions: The backward-bending labor supply curve.
If you Google “backward-bending,” you will find a lot of graphic images – but mostly of actual graphs, plus a lot of fully clothed, not-very-nubile economists discussing the labor supply. Pity.

See, labor has a curious feature of being both a consumer and a producer. As laborers grow richer, they consume more of all normal goods – including leisure. Thus, at some parts of the labor supply curve we observe the normal dynamics of supply curves: the higher the price, the greater the supply. But beyond a certain point you get the OPPOSITE effect: the more you pay, the LESS people work. At some point, Bryant will realize that he’s a gajillionaire and the time he spends hauling his ass up and down the court is cutting into the time he has for sitting on his yacht drinking liquid gold. And he’ll quit.

Supermanagers, having enjoyed years of high compensation, may be on the verge of increasing their consumption of leisure a/k/a quitting. A tax increase might trigger a one-time loss of productivity as they quit or cut back.

But the flip side of the argument arguably holds with greater force: If you want to induce people to keep working, you need to tax away the wealth that might otherwise prompt them to consume more leisure. So the one-time loss of productivity at the top may be offset by an ongoing productivity gain from all the other people – including all future generations of supermanagers -- who would have retired to their yachts but didn’t because they couldn’t yet afford yachts. That’s the lesson of the backward-bending labor supply curve!

So yeah, if you tax away an individual worker’s wages, or a supermanager’s wages, or Kobe Bryant’s wages, you may in fact induce them to work more. Or to work less. It all depends on where they are on their labor supply curves.

If i don’t work how can i possibly afford my Seahawk tickets, etc. etc.

I think tickets to last weekend’s game were pretty cheap. Hell, they would have had to pay me to sit in -6 degree temps to watch a football game with ONE LOUSY TOUCHDOWN.

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nobody.really
on January 11, 2016 at 18:10:48 pm

Yeah, but at least you could have said that you witnessed a MISSED 27 YARD FIELD GOAL!! Now that is worth something, isn't it.

" plus a lot of fully clothed, not-very-nubile economists discussing the labor supply. Pity. -

Well thank goodness, it was not: "not fully clothed backward leaning economists" - that would not be worth the price of admission.

In any event, we may be saying much the same thing: It is unclear to me that substantially raising the marginal (and effective) tax rates on the so-called super-managers will cause them to quit producing. If so, I would guess that the rate would only be marginally higher than the rate at which lower paid employees would quit given similar increase in tax rates.
The motivations remain for each - albeit the motivations may be different in kind and degree for each respective class of producer.

And for the record, I am not enamored of certain highly paid super-managers - having had to clean up after them in the past, about all I can say is that THEIR motivations were apparently more pronounced than mine. Gee, maybe that is why they demanded more money than this ole knucklehead!

No, my real concern is with corporate tax rates as they seem to have a greater and more direct effect upon overall economic activity.

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gabe

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