Mankiw’s marginal tax rate (which declined from 93% to 80% in two years) and the difficulty of microeconomic reasoning

Greg Mankiw writes (link from Tyler Cowen):

Without any taxes, accepting that editor’s assignment would have yielded my children an extra $10,000. With taxes, it yields only $1,000. In effect, once the entire tax system is taken into account, my family’s marginal tax rate is about 90 percent. Is it any wonder that I [Mankiw] turn down most of the money-making opportunities I am offered?

By contrast, without the tax increases advocated by the Obama administration, the numbers would look quite different. I would face a lower income tax rate, a lower Medicare tax rate, and no deduction phaseout or estate tax. Taking that writing assignment would yield my kids about $2,000. I would have twice the incentive to keep working.

First, the good news

Obama’s tax rates are much lower than Mankiw had anticipated! According to the above quote, his marginal tax rate is currently 80% but threatens to rise to 90%.

But, in October 2008, Mankiw calculated that Obama’s would tax his marginal dollar at 93%. What we’re saying, then, is that Mankiw’s marginal tax rate is currently thirteen percentage points lower than he’d anticipated two years ago. In fact, Mankiw’s stated current marginal tax rate of 80% is three points lower than the tax rate he expected to pay under a McCain administration! And if the proposed new tax laws are introduced, Mankiw’s marginal tax rate of 90% is still three percentage points lower than he’d anticipated, back during the 2008 election campaign. I assume that, for whatever reason, Obama did not follow through on all his tax-raising promises.

To frame the numbers more dramatically: According to Mankiw’s calculations, he is currently keeping almost three times the proportion of his income that he was expecting to keep under the Obama administration (and 18% more than he was expecting to keep under a hypothetical McCain administration). If the new tax plans are put into effect, Mankiw will still keep 43% more of his money than he was expecting to keep, only two years ago. (For those following along at home, the calculations are (1-0.80)/(1-0.93)=2.9, (1-0.80)/(1-0.83)=1.18, and (1-0.90)/(1-0.93)=1.43.)

Given that Mankiw currently gets to keep 20% of his money–rather than the measly 7% he was anticipating–it’s no surprise that he’s still working!

Now, the bad news

I don’t think Mankiw has fully thought this through.

He writes as if he’s writing newspaper articles for the money. (“Now you might not care if I supply less of my services to the marketplace–although, because you are reading this article, you are one of my customers.”) I don’t believe it. I think he’s writing the articles because he has views that he thinks are important and he wants to share them with the world. Like blogging, but with more readers. As you all know, we blog for free. And, for people like Mankiw (or even me), when we write newspaper articles it’s pretty much for free too. There are a lot easier ways for us to make $1000 than to write an article for the newspaper. From a financial standpoint, the only reason to do it is that we were already planning to write the article for free.

In which case, the marginal tax rate doesn’t have anything to do with it. Sure, it’s fun to get these little checks–just the other day, I received a bank deposit from the Wall Street Journal for an article they didn’t publish–but let’s not kid ourselves that we’re doing it for the money, or even for our kids (who I think will do just fine without that extra $1000 in their inheritance).

What Mankiw could do with the money

The last time this came up, a couple of years ago, Mankiw wrote the following in response to Obama’s threatened 93% marginal tax rate:

The bottom line: If you are one of those people out there trying to induce me [Mankiw] 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.

And here’s what I wrote at the time:

To start with, it does sound like Mankiw’s kids are already well provided for, and, although I’m sure they’d disagree with me on this, it’s not clear that they would benefit from having more money in the bank when their parents are gone.

So, from that point of view, the question is why Mankiw isn’t already spending more time playing with his kids?

I can’t speak for him, but for me, I have to say that it can be fun to work (or even to write blog entries). But, more than that, I feel a sense of obligation to get things done. At some level, getting paid is part of the motivation, but in any particular example I’m not quite sure how it fits in. I do lots of work things that pay me $0; I think they’re important, so I do them.

When I get extra money, one thing I spend it on is students, assistants, and postdocs. But, for that, the marginal tax rate is nothing close to 90% or even 80%. For Mankiw, I’m not sure; maybe he makes enough from his textbooks that he doesn’t need much of his academic salary and could possibly do more by converting it into postdocs and research assistants. Or maybe he already has more research assistants than he knows what to do with; I don’t know. But his division of waking hours into “working” or “playing with kids” is, I would guess, not very sensitive to the marginal tax rate.

Back to taxes

In writing the above, I’m not trying to suggest that the tax rate be X% or Y% or Z%. I don’t know anything about macroeconomics and have nothing to offer you, the readers, on this topic.

My real point: economics is hard. Greg Mankiw is one of the world’s experts on macroeconomics, but when it comes to a seemingly simple problem in micro–anticipating his personal reactions to taxation–he messes it up, making the classic error of considering only monetary motivations and, bizarrely, suggesting that he’s not out playing with his kids because he’d rather make a thousand bucks writing a newspaper article. It’s not that I think Mankiw is insincere; I think he just underestimates the difficulty of thinking clearly about decision making. (I know much much much less than Mankiw about economics, but I’ve done enough research in decision analysis to know the challenges that arise in analyzing even the simplest decisions.)

The irony of hard-headedness

The irony is that Mankiw (like so many people, particularly economists!) is conditioned to be hard-headed and think that it’s all about the benjamins, when, really, he’s writing newspaper articles for the completely sane reason that he wants to make the world a better place, and he’d like to do this by presenting cogent arguments that can help convince people that his views are correct. I assume that Mankiw sincerely believes that higher taxes on the rich are a bad thing and will ultimately make everyone less well-off (just as Krugman, say, believes the opposite). But he feels uncomfortable characterizing his actions as idealistic and, as a result, ends up placing his work and child-care decisions into a nearly nonsensical framework of dollars and cents.

P.S. More here.

32 thoughts on “Mankiw’s marginal tax rate (which declined from 93% to 80% in two years) and the difficulty of microeconomic reasoning

  1. I'm not a child, but I'm still my father's kid. Speaking as a kid, if I had a choice between my father earning another $1000 or spending more time with me, I would pick the latter.

    Andrew, nice job throwing some "spin" back at a spinmaster.

  2. It seems to me that thinking this way is an occupational hazard for economists. If your equations all assume humans are rational profit maximization units, then is it any wonder that you start to use that assumption to explain your own actions.

    I'm not sure that I am much better at examining the reasons/rationalizations behind my own actions. After all, I'm the easiest one to fool.

    @kevin I would not call Mankiw a spin master. He is an accomplished economist with deep insights. An easy way to casually dismiss everything someone argues without examining the substance of the argument is to call them names.

  3. Mankiw doesn't have to believe "its all about the benjamins" for his analysis to go through. He's doing marginal analysis and presumably these other non-benjamin factors are fixed if marginal tax rates go up. His argument is that all else equal (including non-pecuniary rewards), paying people less will induce them to work less. Mankiw might not write less newspaper editorials when taxes go up, but he's claiming his overall production will go down. Pretty straight-forward.

    He nowhere in that article says that higher taxes on the rich will make everyone worse off. Where did this come from? Did you find an old link of his where he said this?

    Its possible to believe that increasing taxes on a group of people will induce them to work less AND AT THE SAME TIME believe that this is a good policy for everyone on net. Mankiw is well known to have this set of views about so-called Pigovian taxes. Nothing he wrote in that article suggests he can't have the same set of views about taxes on the rich.

    (PS. this is the first time I've commented on your blog but I've been reading it for many years. Love the blog; not so much this post. :-)

  4. You are probably right that Mankiw won't change his habits much due to tax code changes. But in the large, people do respond to incentives, and with higher tax rates we will likely see fewer life-saving surgeries, fewer technology breakthroughs, and fewer financial innovations that will cripple the banking sector. Ok, that last one may not be bad. But in general giving talented people less reason to work isn't a good thing. Using his own income as an example just gives a numerical example that is fairly dramatic.

    And putting things into dollars is simply a way to convert to a common medium of exchange. He could have presented an entire discussion about that, or he could just reference his micro book.

    Kevin, the question isn't "would I rather my father earn $1000 or play with me for a couple hours?", but rather, "would I rather my father give me $1000 or play with me for a couple hours?". When I was growing up, I would have rather had $1000 (my father played with me a lot, so the marginal value of his playing with me was less than $500/hr)

  5. Pushmedia:

    Regarding the benjamins, I do think that Mankiw's argument completely falls apart if you try to apply it to his newspaper columns, for which I suspect nearly all of his benefit comes in non-monetary form. (In this particular case, Mankiw may have received enough flak from his column to wish he'd never written it. But I think it's fair to say that his prospective expected utility gain from writing a column is positive.)

    As a statistician, I'm not impressed with an argument when it doesn't work on the example it's been applied to. If Mankiw or anyone else wants to try again with this argument, it's fine, but to be convinced I'd need to see a better example than Mankiw's tradeoff between article-writing and playing-with-kids.

    On the other poing, I wrote that Mankiw "believes that higher taxes on the rich are a bad thing and will ultimately make everyone less well-off." I guess you're right that higher taxes wouldn't make everyone less well-off. What I was writing was shorthand for the general claim that higher taxes make the economy less efficient and discourage economic growth, then in the long-term we'd see a lower rate of growth and people would in general be less well-off than they would've been had taxes been lower. It's my impression that this is Mankiw's general view. In his article, he's arguing against higher taxes on the rich, not on fairness grounds, but on general welfare grounds: that rich people produce services that many people want, so don't kill the golden goose.

  6. Darf: To repeat what I wrote in the above comment:

    As a statistician, I'm not impressed with an argument when it doesn't work on the example it's been applied to. If Mankiw or anyone else wants to try again with this argument, it's fine, but to be convinced I'd need to see a better example than Mankiw's tradeoff between article-writing and playing-with-kids.

  7. Why do you assume he was only arguing about the newspaper column? He explicitly mentions his "talking to a business group, consulting on a legal case, giving a guest lecture, teaching summer school or writing an article". Presumably Mankiw's argument is about his supply of all this stuff.

  8. It seems that you and Mankiw are arguing about logarithms — Mankiw argues that his take home pay goes down by 50% (from 20% to 10%) and you argue that his tax rate only goes up by 10% (from 80% to 90%). This seems more like a framing question of who deserves the nation's income — the individual or the collective.

  9. I can tell you that my productivity is almost completely independent of the amount of money that I am earning. In fact I'm probably more productive as a graduate researcher (getting pittance), than I was earning a fair bit of money as a statistician at a major university.

    My hypothesis is that the type of work we want talented people to do is not the type of work that monetary motivation works on.

    These two videos are pretty informative about what motivates us:

  10. Pushmedia:

    Mankiw writes:

    Is it any wonder that I turn down most of the money-making opportunities I am offered? . . . Now you might not care if I supply less of my services to the marketplace — although, because you are reading this article, you are one of my customers.

    So, yes, I think he's using his newspaper column as an example. As I wrote above, I don't buy it. Mankiw has enough money that he can limit himself to doing what he wants to do, which includes activities such as blogging that pay $0/hour and newspaper writing that pays not much more than $0/hour. Good for him–he's earned it. Now he can relax with his kids. Or, if he'd rather work, he could admit that he's doing it out of some combination of enjoyment and duty (to share his insights with the world, pretty much the same as I feel about my teaching, research, and writing activities) rather than feel the need to "respond to incentives" like some hypothetical actor in an Econ 1 textbook.

    Beyond this, as noted above, he can feel free to spend some of his money on research assistants and other productivity-enhancing tools, in which case his marginal tax rate is nothing close to 93% or 80% or whatever.

    Mankiw has a lot to offer, but I think he underestimates the challenges in thinking seriously about microeconomics.

  11. Anonymous:

    No. When I say that Mankiw is taking home 290% of what he was expecting to take home, I'm comparing his currently-estimated 20% take-home with his 7% take-home that he was anticipating in 2008.

    I'm using the exact same numbers and framing as Mankiw is. I never said his tax rate "only" goes up by 10%. What I did was repeat his claim that his tax rate was going from 80% to 90% and then say this is good news for him, because this remains lower than the 93% that he was anticipated.

  12. Andrew: I can appreciate that you care for the argument as presented, but the article was presented for a general audience, not academics. I found it to be an interesting numerical example of how taxes could affect an individual.

    You seem to be convinced that Mankiw is not sincere about his stated preferences. That seems like a something that a statistician could check. I'm willing to write a joint paper with you in a couple of years, when we know the results of the Obama tax hikes on Mankiws columns. I'll count the number of WSJ articles he writes before and after the tax rate change, and you can do the multilevel bayes analysis.

    By the way, the "kill the goose that layed the golden egg" doesn't only hold for the rich. I think it was Steven Landsburgs Price theory book that showed that any tax, other than a head tax, creates a dead-weight loss. In other words, any taxes cause mis-allocation of resources.

  13. Andrew,

    One of the best posts I've read in a while.

    According to a famous paper by Campbell and Mankiw (1989), a proportion of workers are Keynesians (they consume out of the after tax income), while another proportion are more foresighted Ricardian consumers (they consume out their permanent income, and treat tax cuts as simply implying higher taxes later on, for which they save).

    I would think that Mankiw would consider himself a Ricardian. In such a case, he has already saved to pay these higher taxes, and so his consumption/leisure decision has already been made. He should quit his whinging.

  14. Darf:

    1. As a numerical example, it has problems, given that, by Mankiw's own calculations, he's currently keeping 290% of what he was expecting to keep. I find it hard to believe that he's making decisions based on a number that might be off by a factor of 2.9.

    2. I don't think Mankiw is being insincere–and I don't think I suggested anything of the sort. My guess is that he's being sincere but is working within an impoverished model that does not fully account for non-monetary rationales for his work. He can accept that he plays with his kids for non-monetary reasons; why is it so difficult to accept that he writes newspaper columns for nonmonetary reasons also? I'm not saying he should not write more columns; I just think it's a bit silly to analyze that decision based on his dollar compensation for them, given that this has got to be the most minor reason for writing them.

  15. I wouldn't know the literature (I don't know any Econ literature), but one has to imagine there would be (a large body of?) literature looking for optimal tax rates in the context of various assumptions about utility functions for money (marginal utility diminishing, diminishing to zero, or whatever).

    I think this kind of thing would amount to formalization of your point.

    Relatedly, I do know you aren't a big fan of utility functions, and I'm familiar with the examples that show their difficulties. I'm just not sure I know how significant the problems are in their impact on theory. (Are utility functions somehow close enough to be useful anyway?) Is anyone working on alternatives?

    Glad I discovered this blog. Thanks for writing it!

  16. Andrew,

    You should be a little more careful with statements like this: "According to Mankiw's calculations, he is currently keeping almost three times the proportion of his income that he was expecting to keep under the Obama administration…"

    You're basing that statement on the marginal tax rate, but the statement refers to "his income," which would imply that you should use his average tax rate. His average rate is far, far lower than 80%. This means that he's not keeping three times the proportion of his income that he expected to keep, he's keeping some multiple n, where 1

  17. Matthew:

    Yes, in all cases here, Mankiw and I are both talking about his marginal tax rate. But I think this is appropriate, given that we're discussing any jobs he might take on, in addition to his free-flowing sources of income (from salary and books) that already put him in the top bracket).

  18. It's too much effort to go through Mankiw's
    "reasoning", but if he is facing a 93% marginal
    tax rate under a top marginal tax rate of
    41%, then under a top marginal tax rate of
    48% he would be facing a 100% marginal tax
    rate, and if the top marginal tax rate was raised to 53%, he would have to pay the government
    five cents on every dollar he earned (I'm
    getting the 41% from the link in the post
    above under "calculated").

    This is ridiculous. What I find amazing is that in Gelman's original post and the comments
    is that this inconsistency is not noted. One
    thing that Mankiw and others of his ilk do is
    avoid any historicity–the obvious point is
    that marginal tax rates were in the 90 percent
    range from WWII to 1962 and then were at 70%
    from 1962 to 1978 (when Carter sign a reduction in capital gains from 70% to 50%). Reagan than
    passed through a reduction to 50%, which dropped to 28% in 1986. Note that from 1931 (when Hoover put the top rate to the 60% range) to 1986, individuals in the top tax bracket were, by Mankiw's logical, paying the government for working more. Give me a break.

  19. Mankiw is not a behavioral economist, so he often gets his microeconomics wrong, just as Andrew has pointed out. As Joseph Heath and Dan Ariely, among others, have asserted (and Andrew echoes) real situations are complex. It's doubtful that higher taxes will deter Warren Buffett from making more money for his clients. Nor is it likely that high-income earners actually consider tax rates when pondering what to do on any given day. Mankiw oversimplifies in the time-honored way of economists, but doesn't overtly say so, giving the reader the impression that Mankiw is speaking from the mount, when in fact he's oversimplified to the point of absurdity. For example, if Mankiw seriously maintains that he turns down work due to the tax rate reducing his kids' trust fund, there are certainly economists without children who will take that work, and life goes on. He neglects to remind us that he is merely one small part of his market. Mankiw exhibits several fallacies in his article, none of which does he apologize for, but none is more egregious than tacitly generalizing from his own peculiar viewpoint.

    Another example of oversimplifying is his characterization of taxes as "deadweight loss", a commonly used economics phrase that is true, but extremely limited. Here he gives us a cost/benefit analysis without the "benefit" part, again giving the reader a highly distorted view.

  20. Mankiw's point is about the deadweight loss of taxation. He says that he wouldn't do the job for such little take-home pay. That's his choice which he made based on the economic incentives in the tax code.

    In that case the job doesn't get done, no value is created, and no one gets the money. So, from a social perspective, the fact that Mankiw choses not to work under this tax regime is a loss.

    Makes perfect sense – he makes decisions at the margin of working or not working. Of course we don't have to worry about his total paycheck or his kids. But that wasn't his point.

    And sure, it looks like he's got the numbers wrong.

  21. But again, Mankiw is using legerdemain on us. First, taxes are "deadweight" only by a narrow definition. Taxes are also payments for providing services that are inefficiently provided by a market. He doesn't present both sides of the issue. Those taxes give us roads for goods to be cheaply exchanged in trade, harbors for international shipping to take place, insurance for the banking systems that finance trade, and much more. Mankiw's book couldn't ship, his column couldn't be delivered, and his students couldn't drive to class without those taxes. Without them, he'd be a far poorer guy. As is common with such folks, he presents us only with the dismal side of things, and completely ignores the benefits. He has actually done extremely well out of the deal.

    Even from his own perspective, if he blanches at the thought of working more hours at a higher tax rate, good for him. It's a choice. Other economists will make different choices and pick up that work. The market will operate. He may imagine himself as the single most important economist in the world, and perhaps he is, but he's not the ONLY economist who can do what he does. Younger, hungrier economists will fill the breach, as will greedier ones, or ones that have fallen on harder times.

  22. I'm more curious where he gets anywhere close to those numbers from.
    When I look up marginal tax rates, the IRS tells me that the top bracket is 35%. Yes, that's not including SocSec or Medicare, but in the upper brackets, SocSec drops off.

  23. I think he is assuming a 55% estate tax (death tax) added on to come up with his purported 90% marginal rate. I am confused about why Mankiw is so opposed to the death tax, as according to his framework a death tax will incentivise him to live longer, and eliminating that tax will make dying more financially attractive.

  24. Andrew,
    You want to talk about non-monetary rationales for work? Fine, consider all the motivations, not just the ones that support your position. Who wants to work an extra hour so that Congress can fritter away the fruits of that labor?

    And what becomes the biggest goal in life when margin rates reach absurd levels? Tax avoidance. Talk about deadweight loss.

  25. A few points about Mankiw's article immediately jumped out at me:

    1. Making an arguement about the impact of taxes on an economy by citing the work of a writer (or artists) seems to miss the point. That kind of work simply doesn't drive the economy. Now an auto maker may produce less if taxes go up, but they're not all going to stop making cars and go play with their kids instead. Of course that type of analysis is way too complicated for this kind of article, but that doesn't mean we should just accept an acedote as a substitute.

    2. The article also completely ignores price changes, most importantly the fact that taxes are usually passed on to the end consumer in some part. If Mankiw isn't willing to write articles anymore if taxes go up 3% (at current prices) that doesn't mean that we're going to miss out on his columns after the tax change, the cost of the paper could just go up 3% so they could pay their contributors more (or more likely some lesser percentage, they'd get a little less, and we'd pay a little less).

    3. Besides these two relatively straight forward macro issues, there are a whole host of issues that are completely ignored when Mankiw does a microeconomic analysis on a macro economic issue. The most important is that when money get's taxed it doesn't disapear! The government spends it, or gives it to someone else, and they spend it. Again, figuring out the impact on the economy of that redistribution is not as simple as telling a story about your own finances and interests, but that still doesn't turn an ancedote in to data.

    4. Assuming that you can change the tax rate in your model without changing the expected rate of return is a pretty big shortcut, and really undercuts any calculations that come after it since the compounding rate of return has more of an impact on the final amount than anything else. If your tax rate goes up 2%, but the government uses that money in a way that stimulates the economy enough to increase the returns on your investments by 1%, over 10 years that a big improvement for your net worth.

    5. It's fairly easy to see that Mankiw's article takes a complicated issue and grossly oversimplifies it by simply noting that he only says that raising taxes from the current level is bad. He doesn't say that the current level is good, or even suggest another tax rate that would be better. If we follow his simple arguement (higher taxes make peopel work less, and the goal is to get people to work more) to it's only logical conclusion, a 0% tax rate would be best.

  26. Jonathan:

    I'm not offering a "position." As I wrote above:

    I'm not trying to suggest that the tax rate be X% or Y% or Z%. I don't know anything about macroeconomics and have nothing to offer you, the readers, on this topic.

    To point out non-monetary rationales for work (as both Mankiw and I have done) is not equivalent to a suggestion that tax rates be raised.

    My point in the above blog is that I don't think Mankiw has fully thought through his decision process.

    I will say this, though, in response to your comment: I doubt that Mankiw's "biggest goal in life" is tax avoidance. My impression is that he's a public-spirited individual who's well paid and is comfortable with his life but is moved to a certain level of political activism because he has ideas about how the world could be a better place.

  27. If he's counting the estate tax in, he's not arranging his estate plans well. There are tons of ways to avoid and/or postpone the estate tax. For example, if someone's kids are making money on their own, he could give enough of it to his kids to fund their own Roth IRA's up to the annual limit. The kids get to pay only their (probably) much lower tax rate since the Roth IRA is funded with posttax money; the money will grow compounded at whatever rate the investment vehicle chosen yields, and it will never be taxed during the child's lifetime.

    He needs to consult a financial advisor.

  28. @ Tim: it's called "deadweight" because no one gets it. If high tax rates make Mankiw not work, then tare are not tax revenues to go around. This is not about redistribution, it's about incentives to work.

  29. This is why, in my opinion, we should not have any income taxes and only have asset taxes.

    It shouldn't matter how much you "make" — it's what you own.

    A person who makes $100,000 and spends $100,000 should pay no tax on income.

    But a person who uses his income to buy a stock or house should pay tax on his property. Or, if he has intellectual property, and so on, pay a tax on that.

  30. Mankiw's argument is especially idiotic because he seems to be particularly against the estate tax (it makes up the bulk of his tendentious "93%"), and yet the more money he leaves to his children, the less motivation, according to his childish reasoning, they themselves will have, when they are grown, to work. Altogether his piece is one big distraction–how could such a ridiculous piece of BS get so many people (all of us here) wasting our own time commenting on it? If my own kids weren't in bed, I'd be playing with them now.

  31. Eric: Don't worry–the 20 or so people commenting here are a tiny tiny tiny fraction of the readership of the New York Times!

  32. At this point in time even life insurance salesmen don't have the temerity to suggest an 8% return on stock investments. If that's the length that Mankiw needs to go to make his argument, he doesn't have one. If you're trying to tell me that this is some kind of fairytale being told to illustrate a point, I'd agree with a capital F. Otherwise, in the real world, Greg and the Bush team effectively borrowed from his AND MY children to fund a couple of wars and Medicare part D, all the while lowering the taxes (that might have helped pay for these fiascos) for him and his ilk, and now he's worried about paying back his kids. MY KIDS say: get back to work, Greg, and try to pay back what your policies have taken from us, and worry about hanging out with your kids later.

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