Friday, September 24, 2004

Things that'll drive economists around the bend, part II 

Arnold Kling has an excellent post the debunks a WaPo article with data contained in the article.

The article emphasizes that the middle has shrunk, from 22.3 percent of households to 15.0 percent. What it does not point out is that the two categories below the middle also have shrunk, from 52.8 percent of households to 40.9 percent. Adjusting for inflation, the percentage of households with incomes over $50,000 has climbed from 24.9 percent in 1967 to 44.1 percent in 2003.

The article's claim that it has become harder to stay in the income range of $35,000 to $50,000 is correct, if what you mean by "harder to stay" is that it has become difficult to avoid being squeezed up into a higher category.

One of the commenters to Kling suggests that we should adjust for the fact that people work more hours or that more people are participating in the labor force. I recall when some of the early work came out on increased labor hours in America, there were discussions of how overworked Americans were. One of my graduate school professors, Craig Stubblebine, remarked one day how absurd this was. "If real wages are going up, what should we expect to find for hours worked and labor force participation?" he asked, with eyes rolling to suggest the answer. Of course, economists will debate about income versus substitution effects, but the notion that workers respond to increased wages by working less is not well supported. (See Stefan Karlsson for more.)

And the main difference, according to Ed Prescott in this new article from the Minneapolis Federal Reserve, is taxes. His model shows not so much that the U.S. induced more work with lower taxes, but that Europe has reduced work effort in their countries through tax rates that permit workers to keep only forty euros of every 100 euros earned (including indirect taxation.) Since changes in labor taxation change the price of an hour of leisure, the tax cuts of the last 25 years have induced greater participation as well as greater hours. That shift can be seen in a companion paper from the MinneFed.