Sunday, March 4, 2012

I’m grateful for the thoughtful criticisms of my essay. The responses suggest three areas in which my argument could be clearer: the proper role of tax-based redistribution, the effectiveness of institutional reform, and the need for an expanded understanding of rent. I’ll proceed by taking them on in turn.

Tax-based redistribution: The critics have made much of my worry that reformers, responding to OWS, too quickly fixated on tax policy. Although I’m concerned that we haven’t fully examined our options, no one should misunderstand my essay as an argument against tax-based redistribution. I agree with Susan Mayer that tax reform can make real headway in reducing inequality. I also agree with Thomas Piketty, Emmanuel Saez, and Stefanie Stantcheva that increasing the tax rate for the rich is especially attractive if it discourages rent-seeking but not legitimate economic activity. And I agree with Ruy Teixeira that new taxes should be “part of the solution” and that the additional revenues can and should be used to pursue institutional reform.

But there’s nothing in these critiques that implies that all reform must rely on the tax instrument. Because so much inequality is generated by rent, we need to focus at least some of our efforts on repairing the institutions that allow it to be collected. This approach has an OWS pedigree because it recognizes that the rules of the game typically benefit the well off.

How should we deal with the rent that remains even after our best effort at institutional reform? There’s an especially compelling rationale for stripping off, via taxation, any income in excess of the worker’s true economic contribution. The conventional justification for taxation is a hard sell because it amounts to instructing the rich that they should contribute more of their legitimately earned money for the collective enterprise. If instead the rich are understood to be rich because of rent, then it’s no longer their money that’s being taken. It’s rather like taxing the Mafia because they’re stealing and extorting. It would be far better to stop them from stealing and extorting, but if we haven’t the capacity to do so then there’s no disputing the legitimacy of resorting to taxes to recoup illicit gains. It’s difficult to calibrate taxes to the amount of rent being extracted, but a rent-based rationale can at least help to make a rough-and-ready case for raising tax rates at the top.

The effectiveness of reform: The rationale for raising taxes thus relies, in part, on the challenge of making the necessary institutional reforms. This is a non-trivial challenge. Although some of the critics are open to institutional reform, they are worried that the suggested reforms are unlikely to bring about the desired effect. In this vein, Anne Alstott suggests that a rent-reduction project might help “more people climb the economic ladder,” but it wouldn’t assist those who don’t go on to college. Likewise, Barbara Bergmann wonders how increasing the number of college slots will help those who remain in the working class, a line of reasoning that leads her to conclude that there’s no good alternative to protectionism and an improved safety net.

These critiques fail to appreciate that unskilled labor is poorly paid precisely because market failure has bloated its ranks. If overcrowding at the bottom were eased by making education more widely available, the earnings of unskilled workers would increase because new opportunities for upward mobility would siphon off some of the competition at the bottom. The best way to raise wages for the working class is to trim the size of the reserve army and thereby limit the number of workers chasing after the shrinking supply of low-skill jobs.

The other big winners, in addition to the working class, are the many who would benefit from a larger national income. By increasing the size of the educated class, we’ll finally reduce its outsized wages and allow the country to build a high-road economy that rests on a reasonably priced supply of well-trained, creative labor. We’ve been priced out of our natural niche in the global economy by rationing education and thus driving up its payoff. If instead we were to follow Bergmann’s advice and simply “deliver benefits” to the bottom, we would forego this boost to national income.

This is not to deny that an opportunity-expanding program will create some losers. I’m sympathetic to Rick Perlstein’s concern that the college-educated will lose out, at least in the short run, when opportunities for higher education are opened up. If labor increasingly migrates from the uneducated to the educated sector, the wages of uneducated labor will increase and those of educated labor will decrease, precisely the zero-sum dynamic that Shikha Dalmia calls into question. Although no one should wish a loss on anyone, the fact is that inequality is partly generated by outsized returns to the college-educated. We can’t address the sources of inequality without taking on the bottlenecks that deliver those outsized returns.

There are any number of ways to provide the additional training and education that’s needed. As Neal McCluskey notes, a major educational ramp-up will likely require heavy public investments, given that education in the United States is principally a public-sector good. How this ramp-up occurs is immaterial from my point of view. What matters is that it happens. If education is no longer rationed to the lucky few, the price of educated labor will drop and the United States will finally be able to become the high-road economy it’s meant to be.

The legitimacy of levying taxes to recoup illicit gains is beyond dispute.

A full-throated critique: I’m naturally more sympathetic to those critics who suggest that a rent-based analysis could be up to the task if only it were developed more aggressively. My two examples of rent-seeking are intended as illustrations and admittedly don’t deliver a comprehensive account of how our institutions protect and favor the well off.

What would a comprehensive analysis of rent look like? At minimum it would feature a fuller account of supply-side barriers to equal opportunity. As both Alstott and Glenn Loury stress, poor children don’t typically have access to high-quality primary and secondary schooling, since their parents can’t afford private tuition or to live in expensive residential neighborhoods with the best schools. These are the supply-side bottlenecks that I refer to but do not stress because they are the stuff of everyday critique.

But we must go further and address other forms of rent that aren’t as well appreciated. The sources of rent are many, but some of the more prominent include occupational barriers to entry (e.g., the bar exam), the legal right to inherit capital (which can only be exploited by children with an estate to inherit), and the incomplete development of capital markets. These institutions prevent labor from freely flowing to positions that provide unusually high returns. Although Susan Mayer is right that inequality would hardly be eliminated by addressing education rent alone, we don’t know how far a more substantial attack on rent would take us.

I don’t mean to imply that the institutional critique is reducible to a narrative about rent. In focusing on rent, my objective is not to characterize the entirety of the institutional critique, but to highlight that portion most relevant to understanding the rise in inequality. As Mike Konczal points out, those concerned about inequality have developed a broader indictment of “gerrymandered capitalism,” an indictment that challenges the breathtakingly naïve view that our market institutions are a thin set of rules guaranteeing fair exchange.

Does this message have legs? Understandably, Teixeira and others are skeptical, but the message does resonate well with our country’s most cherished commitments to equal opportunity and fair return, principles that we want to be real and meaningful rather than hollow. There are few moments in history when our institutions have been understood for what they are rather than what we’d like them to be. When such a moment presents itself, as it has now, it’s our obligation to exploit the newly created potential for fundamental reform.