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Thursday, May 24, 2007

A point of view from the smart people

Gary Becker (Nobel Laureate in economics) and his student Kevin Becker have an interesting article over at American.com concerning the growing income gap between those with a college education and those without.

Two of the best paragraphs are saved for last:
For many, the solution to an increase in inequality is to make the tax structure more progressive—raise taxes on high-income households and reduce taxes on low-income households. While this may sound sensible, it is not. Would these same indi­viduals advocate a tax on going to college and a subsidy for dropping out of high school in response to the increased importance of education? We think not. Yet shifting the tax structure has exactly this effect.

A more sensible policy is to try to take greater advantage of the opportunities afforded by the higher returns to human capital and encourage more human capital investment. Attempts to raise taxes and impose other penalties on the higher earnings that come from greater skills could greatly reduce the productivity of the world’s leading economy by discouraging investments in its most productive and precious form of capital—human capital.
It is very frustrating to economists that proposed policy is often exactly the opposite of what is not only logical but empirically well-established.

It is sensible that taxing an activity tends to reduce the amount of it undertaken whereas subsidizing an activity tends to increase the amount of it undertaken. However, politics often intercedes and makes it difficult to implement policies that are logical and most likely to have the desired (at least from the view of the population) effect.

Perhaps it is because I like Becker's approach to most things that I find his writing much easier to read than Dr. Krugman's.

Let's be fair. Progressive taxation is not the same as a subsidy for dropping out of high school or a tax for going to college. Progressive taxation shifts real income from the upper class to the lower class. So, while the upper class will be less inclined to purchase education due to a decrease real income and a decrease in the marginal benefit of a college degree, the lower class will be more inclined to purchase education due to an increase in income.

Becker’s analogy hinges on the assumption that the poor can afford education, but choose not to obtain it. It is entirely possible (likely?) that many poor people would like to obtain higher education but cannot afford it.

It's not as if progressive taxation would create a scenario in which higher education would not be associated with an overall larger income.
Progressive taxation doesn't shift real income from the wealthy to the poor. Rather, progressive taxation shifts real income from the wealthy to the government. Government transfers, in turn, shift real income from the government to the poor. Progressive taxation is neither necessary nor sufficient for income to be shifted from the wealthy to the poor.

I read Becker/Murphy's last paragraph as suggesting that education should be subsidized (in some fashion) through their statement "...encourage more human capital investment."

Despite the extreme example of in which the two choices are dropping out of high school or getting a college degree, neo-classical economists (which I think Becker and Murphy would be considered) would argue that taxing higher incomes that are generated by higher marginal productivity would dissuade individuals from investing in higher education on the margin.

Perhaps B&M could have been more clear on this point. In my mind a better example would have been: an individual obtains an Associate's degree rather than a bachelor's degree or an individual earns a bachelor's degree rather than pursuing a Ph.D.

It is tempting to conclude that because the marginal tax rate is not 100% an individual should always work an extra hour or invest in human capital on the margin. Yet, working or investing in human capital carry both explicit and opportunity costs which, on the margin, are weighed against the benefits of working or investing in human capital.

If the marginal costs exceed the marginal benefits, then a rational decision is to not engage in the additional activity. If marginal benefits exceed marginal costs, then a rational decision is to engage in the additional activity. Public policy (taxes and subsidies) alter perceived and actual marginal benefits and marginal costs and therefore would be expected to alter behavior.
Demand consists of two parts, preference and ability. For example, a poor person may want to purchase a car for $10,000 but may lack the resources necessary to do so. However, if her taxes are lowered, she will be more likely to purchase a car not because she has any greater preference for the car but because she now has the ability to complete the transaction.

If the poor are taxed less and the rich are taxed more, preferences will shift away from education because the benefits of higher education will decrease. However, the poor would also have a greater ability to obtain education and would therefore be more likely to purchase higher education. So, there are two opposing forces.

There are essentially two groups of poor uneducated people, those who would choose to purchase higher education if they could afford it and those who wouldn’t. If the proportion of the former is greater than the latter, then decreasing taxes for the poor would be expected to result in more poor people who choose to purchase higher education. Alternatively, if the proportion of the former is greater than the latter, then fewer poor people would be expected to purchase higher education. It would be interesting to compare historical evidence of progressive taxation and enrollment in higher education to see what relationships exist.
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