Tuesday, March 27, 2007

Katz vs Lazear

In yesterday's Wall Street Journal, Larry Katz takes on Eddie Lazear:

"The term 'income inequality' is a bit misleading because it suggests in a somewhat pejorative way that the rich are getting richer at the expense of the poor," Edward Lazear, a Stanford University labor economist who is now chairman of Mr. Bush's Council of Economic Advisers, said last May. While it's a concern that some people are being left behind, he said, "There is some good news...most of the inequality reflects an increase in returns to 'investing in skills.'"...

Some economists question Mr. Lazear's assertion that, for instance, raising taxes on higher-wage earners will reduce individuals' incentive to acquire new skills. Lawrence Katz, a Harvard University labor economist who served in the Clinton Labor Department, says there's "not a shred of evidence" lower taxes boost educational attainment. "That's first-order goofball."

Like Larry, I also don't know of any evidence for the impact of taxes on educational attainment. On the other hand, producing evidence would not be easy, as current taxes are less relevant for educational choice than expected future taxes. That is, in deciding how much to invest in skill acquisition, a young person would have to consider expected tax rates that would apply over the next several decades of working. Eddie's view that taxes matter for human capital accumulation seems like a plausible hypothesis. Reasonable people can disagree about the likely magnitude of the effect.

This situation exemplifies a common conundrum for policy advisers like Eddie. In the absence of hard evidence, should he act as if there is no effect, as Larry seems to be suggesting here? Or should Eddie rely on the general principle that people respond to incentives and make an educated guess about the magnitude?

In this case, as in many others, being an economist involved in the policy process is harder than being an economist in academia. Academics can easily say "I don't know" and move on to another question. Policy advisers are often required to take a position on the key issues of the day, sometimes in the absence of reliable evidence.

Update: Larry Katz emails me:

Dear Greg,

I noticed that you have a posting on the quotes from me in yesterday's WSJ piece on inequality. In fact, the quotes are taken out of context and not quite accurate based on my memory of my conversation with Greg Ip from a couple weeks ago. I know this does not affect the themes of your posting, but I do want to clarify what I believe I actually said and meant.

Most of my interview with Greg Ip of the WSJ focused on how I substantially agreed with Eddie Lazear's view that a major part of the growth of U.S. earnings inequality is driven by rising returns to skills and the interaction of sharp secular increases in skill demand combined with slower growth in the supply of skills (education) in the U.S in recent decades relative to the past.

(I actually have almost completed book on these themes with Claudia Goldin and a couple new papers making these points: here and here.)

A tiny part of my discussion with the Ip involved my reaction to the notion that cutting tax rates for top end (top 1%) earners would reduce inequality by stimulating college enrollments. The "goofball" quote is actually not about the notion that the supply of skills might be somewhat responsive to tax rates but about the notion that the main strategy for addressing the U.S. inequality problem is the lowering of marginal tax rates on the top 1% of earners. I did suggest that small increases in top marginal rates to fund a more generous or broader EITC (to expand the EITC to cover poor singles without kids) or to help with college access could have the potential to play a small role in reducing inequality without large efficiency costs (and possibly even with efficiency gains by improving work incentives versus crime incentives through a broader EITC or by helping overcome capital market/information constraints for college investments).

I also noted (and believe) that we have pretty good evidence that college entry decisions respond to the college wage premium but scant evidence on the effects of top end tax rates on college enrollment decisions. I never said anything about general educational investments and tax rates, I specifically talked about college enrollments and marginal tax rates at the very top end of the distribution.

Furthermore, I was (and am) skeptical that given the huge increases in private sector returns to skills in the past 25 years (a doubling of the college premium for young workers and even larger increases for post-college training) that modest changes in tax rates at the top end would be salient to students on the margin considering whether or not to make college investments. I suspect than college financial aid is much more salient than future top end tax rates to high school seniors on the margin of whether to invest in college. Top end tax rates are relevant for many things but those who are likely to be affected by them are not likely to be "marginal" with respect to going to and completing college.

But it is interesting how much attention one can get if one uses the phrase "goofball." I'll need to remember to use this phrase again if I actually want to get attention.


Thanks, Larry, for allowing me to share your insights.