Monday, February 17, 2014

He says "Robert Downey Jr.", I say "Paris Hilton".

I had hoped to put my series of posts about inequality behind me (see Inequality, does it matter? and Inequality and the genetic lottery: Two views), but Greg Mankiw wrote a New York Times commentary in defense of the top 1% and I felt compelled to respond and my reply parallels Larry Summers' comments about America turning into a Downton Abbey economy. In the article, Mankiw's made two points. First, the wealthy are deserving of what they earn:
In 2012, the actor Robert Downey Jr., played the role of Tony Stark, a.k.a. Iron Man, in “The Avengers.” For his work in that single film, Mr. Downey was paid an astounding $50 million.

Does that fact make you mad? Does his compensation strike you as a great injustice? Does it make you want to take to the streets in protest? These questions go to the heart of the debate over economic inequality, to which President Obama has recently been drawing attention.
Second, the rich pay their fair share of taxes:
A reliable tax system is also important to ensure that the wealthy pay their fair share to support the public weal. That is generally the case. Our tax system is far from perfect and is arguably in dire need of reform, but examples of the tax-dodging wealthy are not at all the norm.

The Tax Policy Center estimates that in 2013, the top one-tenth of 1 percent of the income distribution, those earning more than $2.7 million, paid 33.8 percent of their income in federal taxes. By contrast, the middle class, defined as the middle fifth of the income distribution, paid just 12.4 percent.

Equality of opportunity
I have two responses to Mankiw's points. In my previous post (Inequality, does it matter?), I wrote that in order for the American Dream to flourish, it is the equality of opportunity that matters the most. Mankiw is partially right, most people would not begrudge an entertainer, sports figure, or company founder from his or her wealth.

The flip side of that coin is that people must also be allowed to fail, otherwise the free market becomes impaired by policies that support a segment of the population that did not earn their rewards. Otherwise, the "destruction" part of "creative destruction" doesn't happen.

I present, as Exhibit 1, Paris Hilton. How is someone like Paris Hilton, who is famous for being famous because of her surname, deserving of her wealth and career? Should a poor black girl in the slums who is similar self-absorbed be deserving of such fame and public notoriety?

As supporting evidence, I present the Rich Kids of Instagram, a generation of ultra-rich young men and women who did nothing to earn their wealth. While we might be inclined to congratulate and celebrate the accomplishment of the parents who were able to generate such riches, we are far less inclined to celebrate the behavior of a generation of out of control rich kids. These kids haven’t learned the value of a dollar. They certainly know how to spend it, but it is less clear they know how to make it.

Allowing downside of creative destruction to work is the same principle that I espoused when I advocated bringing back the partnership investment bank (see A proposal for reforming Wall Street). If you don't let the TBTF institutions to make mistakes, you end up with a case of mis-aligned incentives and, at best, a society dominated by crony capitalism.

Tax policy an instance of where the rubber meets the road in the application of the principle of creative destruction. Mankiw contends that the rich pay their fair share of taxes, but does current tax policy encourage the entrenchment of an Upstairs/Downstairs class system, or does it allow free market forces to do their work so that destructive part of creative destruction to occur?

Consider, as one of many examples, the Bush II dividend tax cut. What economic effect did it have? Ask yourself these questions:
  1. Did it encourage more investment in the economy because it lowered the cost of equity? Or was the main effect a shift in preference between debt and equity financing?
  2. Did it shift taxable individual investor preferences towards equity and away from municipal bonds, which raised the cost of capital for state and local authorities? If so, was that an intended or unintended side effect?
I would contend that current American tax policy, particularly under Bush II, has served to entrench established interests, encourage crony capitalism and ultimately impair market efficiency. An upstairs/downstairs society only impairs American competitiveness.

Surely, Greg Mankiw is not against allowing free market forces to work, is he?

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.


Anonymous said...

Nice article! Thanks for sharing.

Rik said...

Paris Hilton is a brilliant marketing strategist and sales person in the niche she is in.

She basically started the niche herself as she saw the potential, and explored it effectively.

And is able to generate a lot of media attention with things you and I (I definitely) think is garbage and added earning potential to that (in that way she is far superior than Facebook another modern phenomenon).

The ultimate crapseller. Well we see it as crap of the worst sort, but a substantial part of humanity think it is interesting (we think it is interesting as well of course but from another perspective).

Her name set her up may be, but she herself was clearly to develop that into a global brand.
And as said she has seen as one of the first that 'puking on the street after drinking a bottle of vodka', is a product and one for which people want to pay if marketed properly and very well on top of that.

One of the most interesting people in modern marketing imho.
A lot of people can play Whateverman, but there is only one Paris Hilton, one of marketing's all time greats.
It all says a lot about the average consumer as well btw.

CeeB said...

Though I agree in large part with your argument here, I'd challenge you to think about "mis-aligned incentives" and "a society dominated by crony capitalism" from another perspective.

If we believe wealth inequality is serious enough of an issue to demand government intervention, whether it be through more progressive tax policy or simply more borrow-and-spend transfers from government to citizens, don't we seriously risk mis-aligning people's incentive to work? At what point do we draw the line?

Likewise, don't we risk creating (or enlarging) a system of crony government agencies intent on protecting their funding and influence?

One need only glance at the government track record in managing large scale entitlement programs to see evidence that it lacks accountability and often, effectiveness in terms of delivering value for dollars spent.

Personally, I would like to see more of the free market forces of creative destruction turned on government, particularly as it is literally spending the "common wealth" of this nation, belonging to every citizen. That to me seems a prerequisite before we even begin to discuss enlarging government's role in leveling the inequality playing field.

Rik said...

At the end of the day the most interesting question is: are people uncomfortable with Paris Hilton because of the 'money for nothing aspect', or because it says a lot about Western 'civilisation'?

Take care, great blog.

Anonymous said...

Taxing dividends is double taxation.

Why in the name of everything holy should i even need to say anything further to defend div tax cuts?