I can’t ignore this anymore, Barry Ritholtz at Big Picture has been trading fire with Greg Mankiw over his New York Times article I referenced here. In his latest offensive, Ritholtz has clearly overstated his position with this statement:
The point, which Mankiw so deftly ignored, was that in the real world, people do not respond aggressively to minor incentives (such as marginal changes in income tax).
Really? Where’s the evidence for such a bold assertion.
First, if behavior does not respond to marginal changes, then economics as we know it does not exist. Everything is determined at the margin. Remember the Diamond-Water Paradox that folks struggled with for eons . . . it was solved by the invention of marginal analysis. Surely, Ritholtz doesn’t mean to overthrow all of economics.
So, secondly, maybe by saying “aggressively” he means folks may change some, but not enough to make a difference. Well, I’ve been studying migration patterns for some time now. In two separate states, Connecticut (pdf) and Minnesota (pdf), I have found that out-migration is positively correlated with high state and local tax burdens, especially income taxes (another study in progress finds the same thing)–meaning folks move to where state and local taxes are, on average, lower. I would consider up-and-moving a pretty “aggressive” tax minimization strategy. As the saying in Maine goes, “The tax savings from Maine is paying for my house in Florida.”
Finally, don’t just take my word for it. Harvard economist Martin Feldstein pioneered the empirical estimations of deadweight loss created by “marginal changes in income tax.” In Feldstein’s own words (pdf):
The appropriate size and role of government depend on the deadweight burden caused by incremental transfers of funds from the private sector. The magnitude of that burden depends on the increases in tax rates required to raise incremental revenue and on the deadweight loss that results from higher tax rates … recent econometric work implies that the deadweight burden caused by incremental taxation (the marginal excess burden) may exceed one dollar per one dollar of revenue raised, making the cost of incremental government spending more than two dollars for each dollar of government spending.
I could go on and cite numerous other academic studies that Feldstein and others have done showing significant changes in taxpayer behavior due to changes in the marginal income tax rate. So, I wonder, who is ignoring reality in this debate?
As for the whole Harvard, Yale, Dartmouth angle . . . Barry Ritholtz fails to distinguish between what Mankiw’s after-tax income would be at each different institution. It is possible that Mankiw’s professorial talents are high enough that an employer would gladly pay his taxes for him by offering him a higher level of compensation. If so, then Mankiw would be indifferent to the state that he works in. My point is . . . just because it could be rational for one person to live in a high tax state, does not mean it is rational for everyone living in the state.