Coyote Blog

James Bessen has a terrific article in the Harvard Business Review on the estimated contribution to corporate profits of rent-seeking, or the acquisition of special favors, subsidies, and protections from the government that shelter a company from the normal competition of a free market.  Bessen argues that such rent-seeking is major explanatory factor for recent rises in corporate profits.

This topic will be a familiar one to Coyoteblog readers.   Show me a regulation and I will show you the large corporation that is able to use it to throttle competition.  I remember when everyone claimed the retail minimum wage was going to hurt Wal-Mart, but in fact Wal-Mart actually supported it because it was paying a higher wage than its smaller upstart competitors and thus the minimum wage would tend to hurt Wal-Mart's competition worse than it would be hurt.  Taxi service is one of the most regulated businesses in the country (at least in relation to the complexity of the business) and we are seeing just how much these regulations have supported taxi profits as we watch the taxi companies use the regulations to try to hammer Uber and Lyft.

According to Bessen, the effect is both large and on the rise:

I find that investments in conventional capital assets like machinery and spending on R&D together account for a substantial part of the rise in valuations and profits, especially during the 1990s. However, since 2000, political activity and regulation account for a surprisingly large share of the increase....

The pattern around the 1992 Cable Act is representative: I find that firms experiencing major regulatory change see their valuations rise 12% compared to closely matched control groups. Smaller regulatory changes are also associated with a subsequent rise in firm market values and profits.

This research supports the view that political rent seeking is responsible for a significant portion of the rise in profits. Firms influence the legislative and regulatory process and they engage in a wide range of activity to profit from regulatory changes, with significant success. Without further research, we cannot say for sure whether this activity is making the economy less dynamic and more unequal, but the magnitude of this effect certainly heightens those concerns.

Two characteristics make these changes particularly worrisome. First, the link between regulation and profits is highly concentrated in a small number of politically influential industries. Among non-financial corporations, most of the effect is accounted for by just five industries: pharmaceuticals/chemicals, petroleum refining, transportation equipment/defense, utilities, and communications. These industries comprise, in effect, a “rent seeking sector.” Concentration of political influence among a narrow group of firms means that those firms may skew policy for the entire economy. For example, the pharmaceutical industry has actively stymied efforts to address problems of patent trolls that affect many other industries.

I would add two other industries to this list -- medicine and legal.  The reason it likely does not show up in his study is that the returns in these businesses show up to individuals or small private firms.  But heavy regulation, and in particular a licensing process wherein one must get permission from the incumbents in order to compete with them, has always kept prices and returns in these businesses artificially high.

Note by the way that the breakpoint year of 2000 makes this a bipartisan issue, occurring in equal measure in Republican and Democratic Congresses and Presidencies.

And I don't think I need to remind folks, but both of our Presidential candidates are absolutely steeped in and committed to this cronyist, corporatist system

Earlier this week I posted my thoughts on taxation, which included thoughts on taxation and class warfare and linked this recent WSJ editorial on tax shares paid by the rich.

Today, Kevin Drum rebuts the WSJ editorial with a post of his own.  Though I find Mr. Drum's consistent socialism and the-rich-will-be-first-against-the-wall rhetoric tedious, he is a smart guy and does have a point.  There is, as usual, a mixed message in the data.  However, this also means, as I will point out in a second, that Drum is guilty of picking and choosing his data points just as much as does the WSJ.

Drum points out, rightly, that while the share of taxes paid by the "super rich" (his term for the top .5% of income earners) has increased, their share of income has increased faster, such that their rates have gone down (god forbid that anyone violate the left's rule of the tax ratchet that says that tax rates may always go up but can never ever come down).  Using the same study as the WSJ, he rebuts this table of share of tax burden...

...with this chart , including Drum's subtle annotations in red:

His point is that the Super Rich actually pay lower rates now and the middle class pays higher rates, or as he puts it:

So shed no tears for the super rich in America. Their incomes have tripled in
the past couple of decades and at the same time their tax rates have decreased
by 9 percentage points. That's a pretty sweet deal in anybody's book.

Here are some thoughts on Drum's rebuttal:

Drum cherry-picked data too:  I will get back to the folks in the top 1 percentile in a minute.  Leaving them aside for a minute, note that Drum's storyline breaks down for everyone else.  If you compare the merely rich in the 1-20th percentiles, they got a smaller reduction in the Bush tax cuts than anyone in the middle and lower quintiles.  For example (comparing the 1999 before tax cut and 1999 after tax cut lines) the 1-5% richest got a rate reduction of 0.21%, while Kevin's favored group at 40-60% got a 1.45% rate reduction.

Don't blame this administration for previous tax increases:  Drum is correct in saying that the tax rate has risen for the middle class over 20 years, but incredibly disingenuous not to explain why.   Note that the 1 point rise (which presumably Drum wants to hang on the current administration) actually consists of a 2.5 point rise from past tax increases, AMT creep, and payroll tax changes (passed by Democratic Congresses and generally supported by Drum) offset by a 1.5 point cut courtesy of the current administration.  Drum is in fact using data that clearly disproves his ongoing "tax cuts for the rich" mantra.  By the way, it is also interesting to see a good "progressive" ignoring progress on the lower two quintiles to decry higher taxes on the upper middle class -- seems like an interesting shift in focus.

Payroll taxes skew the picture:  Including payroll taxes (social security and Medicare) in these numbers causes funny things to happen.  Why?  Because social security tax is straight-out regressive since it is flat up to about $90,000 in income and then zero after that.  This means that the total tax rate shown for the lower quintiles will include nearly 8% for payroll taxes (if this looks funny to you because it seems to imply that the lowest quintile must be paying negative income taxes, you are right, they are paying negative income taxes via the EITC).  However, as incomes rise above $90,000, taxpayers get an effective total rate reduction.  For an income of $180,000, a taxpayer only is effectively paying 3.1% to Social Security.  At $1 million, they are only paying 0.56%.  So, even if income tax rates were perfectly flat with no deductions for anything, those in the 1% category of richest people would have a total rate including payroll taxes over 5.5% points lower than the middle class.  If you recast the numbers above leaving out payroll taxes, you would not see the decrease in rates into the 1% group, the numbers would continue to increase, as can be seen here (from government data):

So, for income tax rates, there is still progressivity all the way to the top.  If you want to argue Social Security taxes, fine, but don't use Social Security tax effects to make a point about income taxes

By the way, in terms of the regresivity of Social Security, the defenders of that program need to stick with a story - is it a transfer payment or is it a government run insurance program?  If it is a government run insurance program (as defenders want to argue, since that seem more palatable to the public) then the $90,000 income cutoff makes sense:  Since the program does not pay benefits based on any incomes higher than this, "premiums" shouldn't be based on higher incomes.  Update: Kevin Drum says in this post that Social Security is

a modestly progressive social insurance program that's paid for by everyone and
that benefits everyone. If it ever stops being that, if it ever stops being
universal, it will eventually cease to exist.

OK, but stop lumping the "premiums" of this program in with income taxes to try to prove a point about the income tax system.

All that being said, there may be something funny going on in the top 1%:  As pointed out above, a portion of the apparent rate reduction for the top taxpayers is in fact due to the odd math surrounding Social Security taxes.  Any income tax cut, even if it is progressive, can make total taxes more regressive by shifting the mix to the very regressive social security tax. All that being said, the taxes of the very very rich are odd, because their income streams are so very different than those of you and I.   In particular, that weird mess of targeted tax reductions that I have decried on any number of occasions come much more into play in the very rich's tax returns, with results that are almost impossible to understand or forecast.  If Drum wants to use this data to argue for flat taxes and an elimination of deductions, I am all ears.