Arnold Kling  

Work Choices, Money, and Status

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If Greg Mankiw did not know that his latest column on the incentive effects (on Greg) of higher marginal tax rats would be ill-received, then he is somewhere along the autism spectrum. Tyler Cowen tries to return the discussion to issues of status. Let me make a few points.

1. Sometimes, pay conveys status. To the extent that this is true, the marginal tax rate could be greater than 100 percent without affecting behavior. For example, if you want to be the highest-paid person in your field, then you can enjoy that status benefit no matter how high the marginal tax rate.

2. People often care more about status than pay. Most college-educated parents would rather see their offspring work for $40,000 a year at a "professional" job than earn $60,000 a year as an air conditioning repairperson.

3. Perhaps one reason for the steep decline in the employment/population ratio this century is that people are reluctant to search for lower-status jobs. It could be that, at the margin, the value of income is not as high as it once was, but the importance of status remains high.

4. It is possible to increase public school teacher pay relative to that of other occupations and yet not raise the status benefits of teaching. I suspect this has happened over the past thirty years.

5. As the time horizon gets long, the effects of monetary incentives and status motives may be hard to disentangle. In the short run, you raise marginal tax rates, and few people reduce work effort, because the status of being "employed" is much higher than the status of being a homebody. However, once a few people decide to become homebodies, the status of being a homebody goes up enough that many people choose not to work. So the long run effect of the higher marginal tax rate is much higher than anything you might have predicted, because it has affected cultural norms. I worry about this much more near the median of the income distribution than at the very high end.



COMMENTS (31 to date)
liberty writes:

For #2, I am not sure that's usually about status. I would think for most people the reason they would prefer their kid make less at a "professional" job is that they would expect their kid to enjoy it more, for it to be intellectually stimulating, or meaningful, for it to lead to other things, etc.

For example, a parent might prefer to see their kid work at a non-profit or as a teacher, although they don't pay well - but this is not about status, it is about having a "meaningful" career.

cephalic furrow writes:

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GU writes:

@liberty,

Imagine this conversation between two mothers in a tony suburb:

Mom1: I'm so proud of my son, he just obtained a master's degree in public policy and is working for a non-profit in the city that helps children with oppositional defiant disorder.

Mom2: Wow! My son is a plumber.

I think the big question is, would Mom1 respond with "I'm so sorry," or compose herself and ask "Is that what he really wanted to do"?

RPLong writes:

Very impressive points.

Joshua W. Scott writes:

As any HVAC technician in New York (or any plumber anywhere) will tell you, their jobs save lives. Any arguments about meaningfullness seem to reduce back to questions of status. The guy that fixes my toilet is much more meaningful to me than the one that writes the software to test the performance of my networking equipment. The latter gets more accolades at the family reunion, even though he's probably making less money.

GU writes:
I worry about this much more near the median of the income distribution than at the very high end.

Very interesting post. I think you're on to something re: status and labor market decisions. But regarding the quoted material above, this assumes that the median taxpayer is facing a fairly substantial burden already, so that raising marginal rates would push such a person over the edge to homebodyism. The median taxpayer pays little to nothing in federal income taxes though, and most conceive of their payroll taxes as equivalent to forced saving, not taxed dollars lost forever. To make your scenario more likely, the middle-class would have to first be burdened by taxes, a situation that, despite all the rhetoric, is simply untrue.

Upper-middles get it the worst, usually facing the highest average tax rates b/c they can't plan their way out of taxes. Uppers can engage in such planning, but they still pay a lot of taxes in absolute terms.

JKB writes:

"Meaningful" is a bit subjective and elitist. I haven't seen it confirmed but it was reported that a lowly plumber was the person who came up with the way to shut off the oil in the GOMEX. Not, I might add the high government officials and academics, Nobel prizes providing no advantage.

But let's compare the impact with the accolades afforded contemporaries from the 19th century. Namely, the Honorable William Gladstone and Sir Henry Bessemer. Gladstone had a 50-yr career in British politics and was the off and on Chancellor of the Exchequer during the height of the British Empire. An admirable career, perhaps still known to those with economic educations and one many a parent would wish for their child.

Bessemer was a simple inventor, who, at the same time Gladstone was beginning his career at the Treasury, invented himself out of a job at Treasury with a new stamp design. But twenty-two years later, he transformed the world by inventing a steel making process that reduced the cost of steel to that of iron, yet the steel was twenty times more durable, and ushered in the age of steel for the world.

Although, Bessemer's work was far more meaningful in retrospect, how many parents hope their child will follow his path over that of the statesman?

mark writes:

Good post. I just want to point out the hypocrisy of those who argue that Mankiw has failed to account for the nonmonetary benefits in his analysis, when they do the same when they bleat about income inequality.

Steve writes:

I agree with him, but I don't like Mankiw's 90% marginal rate calculation. If your taxes are paid in the future, you shouldn't use the present value of that future tax base as the denominator. Taken to the extreme, this calculation method could lead to a calculated marginal tax rate of greater than 100% when in fact the economic impact of earning the money was to leave you with more money than you otherwise would have.

For example, suppose there is no income tax, but there is a 10% capital gains tax and a 90% estate tax. Suppose also, as Mankiw does, that any marginal dollar you earn will be bequeathed to your heirs. Then, if you earn $100 and put it into savings for several years and it doubles and then you die, what would your marginal rate be for the $100? First, you'd be taxed $10 on your capital gains. Then, you'd be taxed 90% on the remaining $190, which equals $171. So, on your $100 in earnings you pay $181 in taxes. But you shouldn't call this a 181% marginal tax rate because your kids have $29 more than they would have if you had not earned the money. A 181% marginal tax rate should only be stated if your kids would lose $81 as a result of you earning $100.

Yancey Ward writes:

Steve,

I don't follow you. Didn't Mankiw use as the base the future value of his $1000 to calculate that 90% rate?

AaronG writes:

GU said

The median taxpayer pays little to nothing in federal income taxes though, and most conceive of their payroll taxes as equivalent to forced saving, not taxed dollars lost forever.

I doubt it is true that the median worker pays little to no taxes. My wife made about $45,000 a year which isn't too far above the median income for a full-time worker. Added to my income of about $100,000, most of her income was taxed at a marginal rate pretty close to 40% - 25% federal, 7.65% payroll, 7% state, plus a bit more because phaseouts of some deductions and credits.

When we had our first child, we quickly found out that after paying for daycare and taxes, we weren't getting much financial boost out of her continuing to work. Now she stays home (This decision is even more clear cut now that we have two children). The story would be somewhat different, but still not great for a family of two median earners.

Silas Barta writes:

@Arnold_Kling: While Mankiw might be an uncharitable example, marginal tax rates basically eliminate my financial incentive, as a middle-class engineer, to put my tutoring services on the market. It would be nice if that second job would be counted as starting from a separate "income" so it's not taxed at my marginal rate until it *independently* makes that much income, but obviously they're not going to introduce that kind of complication to the tax code because of potential for abuse. ("I have 40 one-hour jobs a week!")

@GU and liberty: Parents would probably be *wrong* to think that the plumbing job is less intellectually stimulating than that credential-driven, lower-paying "professional" job at a non-profit. The plumber will enhance his knowledge every day and have to tackle various different problems, and get to see real, immediate results. All of this is very stimulating.

In contrast, the worker at the non-profit will be doing the same, boring things all day, without developing a real craft, a base of knowledge. They'll probably just end up dawdling the day away.

And I seem to recall a philosophy PhD who recently wrote a book about the relative joys of Harley repair over white-collar work.

(As an engineer, I will say that my kind of white collar work is, in fact, very intellectually stimulating.)

Steve writes:

Yancey,

Mankiw calculates the taxes paid on his base $1,000 in the future (at the point when it has accumulated to more than $1,000) to generate the gross dollars paid in taxes in total. He adds up some taxes that are paid immediately upon earning the $1,000 and some taxes that are paid years later, and lumps them all together in a numerator without making any adjustments for timing. He then uses the initial $1,000 earned as his denominator. Going through with the division yields his calculated marginal tax rate.

GU writes:

@AaronG

Good point, married (joint-filing) couples complicate this issue. You and your wife fell victim to the "marriage penalty." However, many other couples get a "marriage bonus" from joint filing (typically, one high earner and one low earner see a penalty, whereas two similar earners see a bonus)*. I don't know of any data showing whether penalty, neutral, or bonus is the typical outcome of joint filing (not saying there are no studies).

Another point is that the trend in the U.S. is lower rates of marriage, and thus fewer joint filers. Admittedly I was analyzing the situation in an "all single filers" world, but I think for the two reasons posted here, that it is not a bad approximation for assessing the aggregate situation.

*no general solution to this problem exists where there's mandated a progressive rate structure and a joint filing system.

Matt Flipago writes:

Steve, Mankiw calculates that if he had no taxes and earned a 1,000 dollars, he could pass of 10,000 to his children. With taxes 1,000. Since the gov't is taking 90% of his money, or he only can pass on 10% of what he would without taxes, he faces a marginal tax rate of 90%.

Peter Finch writes:

My wife became a SAHM, largely because of taxes. We had a child and then twins in quick succession, and were looking at a mid-five-figure daycare bill and a somewhat larger tax bill on her income. So we let her engineering degrees and MBA go idle. We have since discovered a lot of advantages to this new life, but they weren't obvious before we got into it.

At the time, we thought we were giving up status, not that we were really consciously worrying about it. Her career was high-status to her young-woman peers. But it turns out that working 60 hour weeks and traveling to Asia once a month is not as high-status to her 30-something peers. I'm not sure if this is because her peer group has changed, or gotten older, or because of societal drift over the last 15 years or so; it's probably a bit of all these. She became a homebody, and maybe her status has gone up.

I guess I think becoming a SAHM is becoming more high-status, and that taxes had something to do with making that possible.

Yancey Ward writes:

Steve,

Mankiw takes the $1000 he earns today, and invests it at 8% in the absence of all taxes, and in 30 years, it grows to $10,000 which he will leave to his children (his stated preference). He then re-does the calculations using the tax system as it is most likely to stand as of 2013, and that money then grows, in 30 years, to $1700 dollars, of which thinks the estate tax will take $700 off, so that his children get $1000 in inheritance. He is claiming the marginal rate is 10000-1000/10000. Breaking this down, he is claiming the tax rate is $10,000 (the future value of $1000 today in the absence of all taxes) minus $1000 (the future value of $523 he earns today with various taxes- or the money he leaves to his children) divided by $10000 (again, the future value of $1000 earned today and invested in the absence of all taxes).

I think you are being confused by the coincidental use of $1000 to describe two different values- the first is the gross pay for the assignment today, while the other is the future value of the $523 he actually retains after taxes for taking the assignment. Is this clear?

Steve writes:

Yancey,

You're right, and thanks for walking me through that. I'm still uneasy about one aspect of it though: the marginal tax result is sensitive not only to the various rates prescribed by Congress on ordinary income, capital gains, and inheritance, but it is also sensitive to how long the investment compounds.

For example, assume we use Mankiw's calculus but for simplicity we have 0% income tax, 0% estate tax, 50% corporate tax, 0% capital gains tax. Then, without taxes $1,000 at 8% grows to $10,000. With taxes, it grows instead to $3,000. This gives us a 70% marginal rate.

Now, instead suppose we hold the investment for only 10 years. Without taxes, it grows to $2,000. With taxes, it grows to $1500. Now our marginal rate is only 25%.

As the length of time investment is held approaches infinity, the marginal tax rate approaches 100% under this method. This seems more like an arithmetic quirk than an economically relevant number.

Justin writes:

GU,

I think the new health care law might raise effective marginal tax rates to such levels on the middle class, at least for middle aged householders without employer provided insurance.

I found this calculator online, and assumed a family of four with a head of household aged 48 in a medium cost area. The primary breadwinner earns $45,000/yr and the spouse earns $30,000/yr.

http://healthreform.kff.org/subsidycalculator.aspx

At $75,000/yr, the family receives an $8,706 tax credit to purchase health care, and might have to pay up to $8,333 in out of pocket costs. At $45,000/yr, the credit is up to $13,106 and the out of pocket maximum is $4,167. Assuming the out of pocket maximum differential of $4,166 is only worth 50 cents on the dollar ($2,083) to the family, the health care subsidies increase by $6,483 if the spouse quits his/her $30,000/yr job.

Throw on FICA ($2,295), local income ($600 at 2%), state income ($1,200 at 4%) and federal income taxes ($6,000 at an average rate of 20%), and $16,578 is lost through implicit or explicit taxes. That's a 55.3% marginal rate, up from 33.7% without the health care subsidies. If the spouse works 2,000 hours a year, he/she earns $15/hr but takes home $6.71/hr.

This problem can be more severe if the head of household is older, if the area has high health care costs, or if the family's extra income pushes it off the 400% FPL cliff where subsidies are abruptly cut off.

Robert writes:

For #2, you are comparing things which go into different utility functions -- the PARENTS' status to the CHILD's cash income. I'd argue that quite often people choose professions in which they make both less income and disappoint their parents -- e.g., the poetry Ph.D. making $13k/year by stringing together a bunch of adjunct-prof jobs, who could have made $40k/year working in an "regular" job not requiring an advanced degree.

To make the status vs. income comparison, you need to compare the status of the person making the income. As in, would the CHILD of the college-educated parents would rather "work for $40,000 a year at a "professional" job than earn $60,000 a year as an air conditioning repairperson"?

Maybe they would, but that's not the question you've asked. And if you did ask that question, I'd say that (a) a lot of air conditioning repairpeople could make $40k/year at an office job, but chose not to because of the money, and (b) if those who have the choice take the office job, it could be due to factors other than status, such as physically easier work, better hours, and the ability to read EconLog at work.

Furthermore, there are a lot of people who do fine at office jobs who would be incompetent and anything mechanical. Not everyone making $40k in an office could make anything at all repairing air conditioners.

In any case, the following is topical:

http://brassmein.com/poppers/jokes/joke_014.htm

A plumber attended to a leaking faucet at the neurosurgeon's house. After a two-minute job the plumber demanded $150.

The neurosurgeon exclaimed, 'I don't charge this amount even though I am a surgeon."

The plumber replied, "I didn't either, when I was a surgeon. That's why I became a plumber."

DavidW writes:

Don't underestimate the ability of today's status conscious, upper middle-class college educated parents to feather the nests of their college educated, under-earning kids. $40,000/year working at the non-profit in a trendy blue state urban area can go a long way if Mom and Dad are going to make the down payment on your house or car, pay for your wedding, take you to Hawaii, let you use the beach house, pay for the grandkids private school tuition, fund the grandkids' 529, and keep you on their medical insurance policy until you hit 26!

Phil writes:

>"Most college-educated parents would rather see their offspring work for $40,000 a year at a "professional" job than earn $60,000 a year as an air conditioning repairperson."

That's because the parents get the status, but it's the offspring who sacrifices the money.

If you want to discover the price of status, look for evidence about which job the *offspring* would rather have.

GU writes:

Just to be clear, I was not advocating for favoring non-profit dwellers over plumbers, just positing what I think is typical of suburban mothers.

MernaMoose writes:

JKB,

Interesting post.

Bessemer was a simple inventor, who....transformed the world by inventing a steel making process that reduced the cost of steel to that of iron.....

Not sure if you know it, but the steel making process was not what Bessemer wanted to accomplish. More than anything else he wanted to sell his new, high powered artillery shell. But the British government refused to ever give him a field trial, so he eventually went to France and got one. But then the French wouldn't buy it either, because it immediately cracked the (then iron) cannons that were commonly available.

To sell his artillery shell, Bessemer needed lots of cheap steel. That is why he went and invented the steel making process.

...Bessemer's work was far more meaningful in retrospect, how many parents hope their child will follow his path over that of the statesman?

I'm an engineer and I agree, Bessemer's work was the more meaningful. Bessemer's is a path that I'd wish on my children.

But like the fiction writer whose personally favorite novel is a market failure, I'm not Bessemer himself (who never sold his beloved artillery shell) was particularly satisfied. And to Bessemer that steel making process was an incidentally motivated outcome.

Meanwhile, the other big message I keep hearing is that the United States is now intent on making sure its people have every incentive to be less productive.

Strange how the world works, isn't it?


Joe Cushing writes:

I read Greg's article. His analysis is grossly exaggerated. Most of his money would grow tax free because he would invest in stocks earning capital gains. Also, the 8% return he could get in stocks is an after corporate income tax rate of return. I suspect Greg faces something closer to a 50% marginal tax rate--not 90%

liberty writes:

I agree with those above who pointed out that the "intellectual stimulation" and "meaningfulness" of each job might be misconceived. Still, I think it is often only partly "status" for both parent and child, and partly about what you are taught you want, and also what you are naturally good at, which we do inherit (by nature and nurture) from our parents.

So, my parents are professor and (college-educated) artist; it is not for "status" that 4 kids ended up in academic-type careers. After trying other things, one wandered into philosophy merely because she could think of nothing else; another wandered into economics for the same reason. As a child of an economist with philosophical-bent, this should not be surprising - just as many sons of plumbers choose plumbing.

On this topic, it is interesting to note that even in the Soviet Union during the period when the Party actively tried to enforce a certain "class mobility" and there were no economic factors which might determine a child's opportunities, the inter-generational mobility remained about the same there as it was in Europe and the US. Most kids still chose their parents' careers. I don't think that was status as much as it was choice.

Yancey Ward writes:

Steve,

If Mankiw put the $1000 in the mattress for 30 years in your hypothetical, what would the tax take have been?

Yancey Ward writes:

Joe Cushing,

I think a number of people have focused too much on details that Mankiw is only putting in to fill out the hypothetical. For example, when he is discussing the investment taxes, all he is really trying to do is to show you that investment returns are taxed at more than one level along the way. Whatever values he picked for a return, he was always going to be open to the charge of exaggerating by someone, so I suspect that he simply picked the number that pension funds typically use as a benchmark for investment returns. I redid Mankiw's calculations allowing for returns a factor of two and a factor of four lower than the 8%, and the marginal rate, at the end, was still above 80% and 70% respectively.

David Friedman writes:

At a slight tangent ... .

I suggest that schoolteachers, or at least moderately competent ones, already have high status, for a reason that has nothing to do with income. They spend a large part of their life in the classroom, where they are the highest status person present. That is one of the payoffs to being a schoolteacher (or, for that matter, a professor).

Hyena writes:

Alternatively, you get much more early retirement because it is both high status and relatively more valuable.

I seriously doubt people would "drop out of the workforce", rather you'd get a lot of high earning people late in their careers retiring earlier rather than making more money or having to be enticed by yet more lucrative prospects.

If those workers are preventing younger people from moving up, then there is likely a slight public good here. If, however, part of the reason these workers commanded such premiums is that the quality of younger cohorts is lower, you're probably looking at a complete disaster.

Tracy W writes:

They spend a large part of their life in the classroom, where they are the highest status person present.

In their eyes, maybe. But I've been a student in classrooms where the students started questioning the teacher's competence, it's not a nice experience for the teacher.

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