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Monday, October 27, 2008

Greg Mankiw threatens work stoppage if Obama is elected

From Greg Mankiw's blog:

Here is a question that you may have been thinking about: How do the different candidates' tax plans affect Greg Mankiw's incentive to work?

* * *

Let me start with my personal situation: I am a pretty lucky guy. I have a comfortable, upper middle class life style that includes one house, two cars, three kids, a wife, and a dog. I am fortunate enough that I don't have trouble keeping that going. I am also fortunate enough that I don't crave much more than I already have. I don't particularly want to own multiple houses or drive a Ferrari or wear Armani suits. You might say that I am close to being sated.

On a regular basis, I am offered opportunities to make some extra money. It could be giving a talk, writing an article [ed. note - !], editing a journal, and so on. What incentive is there to put forward that extra work effort?

To a large extent, the beneficiaries of that extra effort are my kids. My lifestyle is, as a first approximation, invariant to my income. But if I make an extra few dollars today, I will leave more to my kids when I move on. I won't leave them enough so they can lead lives of leisure, but perhaps I will leave them enough so they won't have to struggle too much to afford a downpayment on their houses or to send their own kids to college.

Do you notice a rather big part of Mankiw's income that isn't discussed here?  Isn't he a professor somewhere?  I imagine if the H decided to cut all professors' income by half or decided to fire the good professor, he would find that his "lifestyle" is perhaps not so " invariant to [his] income."  But that couldn't happen, could it?  He's tenured at a very wealthy university.  The chances that this economic downturn will affect him directly are pretty slim.  Nice!

Anyway, he continues.

Let me try to put each tax plan into a single number. Let's suppose Greg Mankiw takes on an incremental job today and earns a dollar. How much, as a result, will he leave his kids in T years?

The answer depends on four tax rates. First, I pay the combined income and payroll tax on the dollar earned. Second, I pay the corporate tax rate while the money is invested in a firm. Third, I pay the dividend and capital gains rate as I receive that return. And fourth, I pay the estate tax when I leave what has accumulated to my kids.

Notice how he slips the corporate tax rate in there, because he assumes that he will invest all of his children's future money in stocks.  T-bills too safe, huh?

Let t1 be the combined income and payroll tax rate, t2 be the corporate tax rate, t3 be the dividend and capital gains tax rate, and t4 be the estate tax rate. And let r be the before-tax rate of return on corporate capital. Then one dollar I earn today will yield my kids:

(1-t1){[1+r(1-t2)(1-t3)]^T}(1-t4).

I guess he assumes that he'll do no estate planning. 

For my illustrative calculations, let me take r to be 10 percent and my remaining life expectancy T to be 35 years.

If there were no taxes, so t1=t2=t3=t4=0, then $1 earned today would yield my kids $28. That is simply the miracle of compounding.

Ah, yes.  They should really get the $28.  Anything less is socialism.

Under the McCain plan, t1=.35, t2=.25, t3=.15, and t4=.15. In this case, a dollar earned today yields my kids $4.81. That is, even under the low-tax McCain plan, my incentive to work is cut by 83 percent compared to the situation without taxes.

Under the Obama plan, t1=.43, t2=.35, t3=.2, and t4=.45. In this case, a dollar earned today yields my kids $1.85. That is, Obama's proposed tax hikes reduce my incentive to work by 62 percent compared to the McCain plan and by 93 percent compared to the no-tax scenario. In a sense, putting the various pieces of the tax system together, I would be facing a marginal tax rate of 93 percent.

The bottom line: If you are one of those people out there trying to induce me to do some work for you, there is a good chance I will turn you down. And the likelihood will go up after President Obama puts his tax plan in place. I expect to spend more time playing with my kids. They will be poorer when they grow up, but perhaps they will have a few more happy memories.

Is this tongue-in-cheek?  I hope so.  The fact that he's writing this on a blog that has no advertising only increases the sense of irony.  (Perhaps his blog header should be: "I'M BLOGGING AWAY MY CHILDREN'S INHERITANCE.")  But if this is all a joke, apparently Instapundit isn't in on it.

Posted by Matt Bodie on October 27, 2008 at 12:15 PM in Corporate | Permalink

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Comments

Wow. Just, wow.

Posted by: Daniel S. Goldberg | Oct 27, 2008 1:43:46 PM

"They will be poorer when they grow up, but perhaps they will have a few more happy memories." Yes, and perhaps their happy memories will include memories of living in a country where respect, equal treatment, and integrity aren't just hollow words used to prop up a kleptocracy, but actually reflect values that are visibly embraced and promoted. So, maybe their rich dad's failure to earn a few more marginal bucks to pass along won't be such a big deal, when you do the cost-benefit analysis.

Posted by: pizaz | Oct 27, 2008 3:35:36 PM

I don't think I understand the incentive structure implicit in Mankiw's post. Is he making a threat, or a promise?

Posted by: Anon | Oct 27, 2008 3:44:58 PM

Nothing like a supply-sider to ruffle some liberal feathers. Whaddya mean you won't work! How are we supposed to get your income if you don't work! Let's see how smart he is when he's conscripted into the Peace Corps.

Posted by: BHO | Oct 27, 2008 5:52:06 PM

I don't understand your issue with it. Professor Mankiw is engaging in a little thought experiment. Taxes affect incentives, and people respond to incentives. So what?

Posted by: humblelawstudent | Oct 27, 2008 9:44:03 PM

One of the the insidious things about Mankiw's "simple math" is how big an effect the estate tax makes in the calculation. Mankiw treats both candidates as if their estate tax rate reaches each dollar he intends to leave for his kids.

But the reality is that even Obama is proposing a $7 million per couple exemption from the estate tax. Since Mankiw said his goal is to "leave them enough so they won't have to struggle too much to afford a downpayment on their houses or to send their own kids to college," I'm surprised that he doesn't think $7M is enough. That money, by the way, is not just transfer-tax free, but (at least some of it) may be free from capital gains also, so he could avoid not just the 45% on the transfer, but also the 20% on the gains from earnings. If he's already amassed his $7 million nestegg, I say, go ahead and stop taking paying work (or work, earn money, and give it away to charity, getting a big fat tax deduction). Surely, at a certain point, one's self-interst must give way to one's concern for the rest of society, some members of which have not been so fortunate as you.

Posted by: benleff | Oct 28, 2008 11:06:31 AM

One other small but related point -- Mankiw assumes that McCain or Obama's inhertance tax rate will still apply 35 years from now (his remaining life expectancy). Do you think folks in 1972 could have predicted their inheritance tax rate based on the Nixon-McGovern contest?

Posted by: Matt Bodie | Oct 28, 2008 6:55:58 PM

Incredible ignorance in this post.
Mankiw's blog is about one thing: the effective rate of tax. It's difficult to calculate and understand how to approximate the deliberately complex tax system with a single effective rate of tax, and so the post was useful. The rate will depend on the individual, his wealth and motives. So Mankiw calculates it for himself as an example. It's suprisingly high.
Yes for others it will be lower, for example if inheritance tax won't kick in. But you can use the same methods to calculate the effective marginal tax rate in other cases too.

Aside from not understanding this, all the points (except inheritance tax) made in the post display a lack of understanding of economics. 100% is not a large proportion to have in risky assets e.g. equities - look up the equity premium puzzle. Mankiw does not make any assertions about socialism or morality in his post; it is a quantitative question. And he also does not quantify the effect on his level of work, apart from saying that there is an effect.

Posted by: CR | Nov 12, 2008 5:47:39 PM

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