http://www.jstor.org/stable/724835 (requires registration to access full article)
Almost a decade ago Aaron Director proposed a law of public expenditures: Public expenditures are made for the primary benefit of the middle classes, and financed with taxes which are borne in considerable part by the poor and rich. ...
The philosophy of Director's law is as follows. Government has coercive power, which allows it to engage in acts (above all, the taking of resources) which could not be performed by voluntary agreement of the members of a society. Any portion of the society which can secure control of the state's machinery will employ the machinery to improve its own position. Under a set of conditions to be discussed below, this dominant group will be the middle income classes.
Here is a video of Milton Friedman explaining 'Director's Law', which he stated this way —
Director's law is that almost invariably government programs benefit the middle income class at the expense of the very poor and the very rich.
Without mentioning or attempting to defend 'Director's Law', here is Robert Samuelson pointing out the government expenditures that demonstrate the law —
http://www.washingtonpost.com/opinions/robert-samuelson-repairing-the-middle-class-in-2015.html
https://archive.is/QmLGy
Reparing the middle class in 2015
By Robert J. Samuelson | December 28, 2014
What is curious about the present understandable preoccupation with the middle class is the assumption — both explicit and implicit — that the system is “rigged” (to use Sen. Elizabeth Warren’s favorite term) against this vast constituency of Americans. In reality, just the opposite is true. The system is rigged in favor of the middle class. That’s a natural result for a democracy in which politicians compete more for votes than for dollars.
If you look at how the federal government spends and raises its money, the bias for the middle class and poor becomes plain. In fiscal 2014, about two-thirds of the $3.5 trillion federal budget went for “payments to individuals.” This covers 59 million Social Security recipients, more than 54 million Medicare beneficiaries (overlapping with Social Security), 68 million Medicaid recipients, 46 million food-stamp recipients — and many more.
Meanwhile, government raises most of its taxes from the upper middle class and the wealthy. In 2011, the richest 1 percent of Americans paid 24 percent of all federal taxes (income, payroll and excise) and the richest 20 percent, including the top 1 percent, paid 69 percent of taxes, says the Congressional Budget Office.
It is possible to argue that, reflecting the growing inequality of market incomes, taxes on the rich and affluent should be higher or that middle-class subsidies should be more generous. It’s also possible to complain that some programs aimed at helping the poor and middle class have gone awry: College student loans, now worth about $1.1 trillion and facing 11 percent delinquency, are a current popular example. These are legitimate views, as are (of course) the opposing positions. They’re the stuff of responsible debate.
But if you accept these numbers — which I have cited many times — it is not possible to pretend that the whole superstructure of government has somehow been turned against the middle class. This is not just a distortion of reality; it is the converse of reality.
Likewise, the financial crisis and Great Recession are typically blamed on the miscalculations and greed of financial institutions and their overlords. There is much evidence for this, but it ignores the deeper cause: an intellectual, political and social climate that legitimized lax lending policies in the name of promoting middle-class well-being. This was reinforced by a parallel conceit (which now seems foolish) that our enhanced economic understanding enabled us to enjoy prolonged expansions and brief recessions.
What the middle class faces today is a crisis of faith. Being middle class is more than attaining some threshold income. It also involves embracing a set of beliefs that, unfortunately, have been severely shaken.
Middle-class Americans believe in opportunity, stability, reward for effort, a brighter future and the ability to control their lives, as sociologist Herbert Gans showed in his 1988 book “Middle American Individualism.” Big government and big companies are distrusted, because they might impose their own imperatives on individuals’ personal preferences. But government is also expected to provide economic security — a contradiction that’s widely accepted.
...
We overestimated our ability to control the economic environment. What we have learned is that outside events — here, the financial crisis and Great Recession — can overwhelm collective protections and discredit conventional beliefs. The economy is more random, unstable and insecure than we imagined. It is less susceptible to policy engineering. The fact that the upper classes can better shield themselves against its upsets naturally breeds resentment.
...
As one would expect, Samuelson's column received a large number of derogatory comments from those who wish to ascribe a victim status to the middle class — but what is fascinating about such responses is that they demonstrate the root cause of 'Director's Law'. That is, while being unable to refute the easily demonstrable point of Samuelson's column — that the bulk of the U.S. government's budget is consumed by transfer payments to the middle class, and that the wealthy pay the bulk of all taxes, including payroll taxes — the typical responder still claims members of the middle class are victims, and should receive more.
The letter quoted below is a good representation of the typical response to Samuelson's column. Notice that this letter does not contradict the points Samuelson made in his column, but only adds that the rich make a large share of the national income (of course), and that wages have not kept up with productivity increases — the reader's comments on the greed of financial institutions in the last paragraph elaborate on a point Samuelson acknowledged in his column above (though Samuelson claimed it was not the root cause of the Great Recession) —
http://www.washingtonpost.com/opinions/no-the-us-economic-system-is-not-rigged-in-favor-of-the-middle-class...html
https://archive.is/lRgyM
Robert J. Samuelson, in his Dec. 29 op-ed column, “Repairing the middle class,” wrote that the economic-political system is rigged in favor of the middle class and to believe otherwise is “a distortion of reality.” But he relied on a slim slice of reality to support his thesis that most taxes come from the wealthy and go to the middle class and lower-income earners. Reality is much more nuanced.
Mr. Samuelson counted Social Security and Medicare as subsidies of the middle class. Federal revenue generated from payroll taxes and returned to the taxpayer in retirement is a much-needed national annuity structure managed by federal agencies.
Any discussion of who pays the bulk of federal taxes also must include an assessment of who earns the bulk of taxable income and who benefits most from the tax code in terms of earned income and asset-generated income. Mr. Samuelson neglected this. Based on data analyzed by the Tax Policy Center, the top 1 percent of income earners pay 26 percent of all federal taxes and earn 24 percent of all national income. In 2013, the top 1 percent earned, on average, $1.12 million after federal taxes; the bottom 20 percent earned $13,300.
According to a 2012 Economic Policy Institute study, since 1948, productivity increased 254 percent while real wages increased 113 percent. If wages had kept up with increases in worker output, there would be (in theory, at least) little or no poverty, all those pesky subsidies of lower-income earners would be eliminated and tax revenue would explode.
Finally, was the underlying cause of the “Great Recession” really “lax lending policies in the name of promoting middle-class well-being”? Was the fact that the homeownership rate in the United States went up a few points the cause of a worldwide recession? Or was the cause more along the lines of lenders making loans they did not service, collecting up-front fees while shifting risk downstream, creating risky derivatives and purchasing desired ratings from the rating agencies, concocting exotic hedging structures based on a foundation of arrogance and greed, and sending traders around the world pushing investments in portfolios the details of which they knew almost nothing about?
The importance of this discussion, acknowledged by Mr. Samuelson, begs for balanced analysis sans blinders.
Gregory Diercks, Alexandria
The second paragraph in the letter quoted above, describing Social Security and Medicare as 'a much-needed national annuity structure', provides support to Samuelson's premise that the system is rigged in favor of the middle class. That is, stating that federal agencies are providing programs that are a forced annuity to support the middle class — especially when those programs transfer debt to future generations — obviously supports the premise that government has been captured by the middle class, and not the reverse.
The third paragraph quoted above regrading who earns the bulk of taxable income is obvious, and, again, does nothing to undercut the premise of Samuelson's column and the idea that the middle class has captured government. Of course, the rich earn a large share of total taxable income — if this were not the case, how would the top 1% be able to pay 26% of all federal taxes? And it's fascinating that this reader considers the small 1% minority, who pays 26% of all federal taxes, as 'benefiting most from the tax code'. That is a pretty bizarre twist on the concept of a 'benefit'.
The fourth paragraph quoted above regarding productivity and wage increases is an old fallacy that gets repeated over and over again, despite being absurd. There is no reason that wages should increase in direct proportion to productivity increases over time, since productivity increases often come from capital improvements that make businesses less reliant on labor. For example, if a farmer spends many thousands of dollars to purchase a combine, and that combine, say, doubles the productivity of his farming operation, should all of the farmer's employees have their pay doubled? Of course, the fallacy is obvious — worker output is not simply a function of the skill and labor of the worker.
The last paragraph quoted above, regarding lending practices leading up to the financial crisis, is a common and fascinating evasion. The letter writer states that 'lenders making loans they did not service' was part of the cause of the financial crisis, but fails to mention the responsibility of borrowers for taking out, and then defaulting on, loans they could not afford. That is, why is it important for lenders to service the loans they originate, if borrowers are not attempting to borrow more than they can afford, with the same 'arrogance and greed' the letter writer ascribes to financial institutions? And the letter writer dismissed 'lax lending policies' as being a principle cause of the Great Recession, but how is making lenders service the loans they originate not an attempt to prevent 'lax lending policies'? In the same way, the mention of 'risky derivatives' and 'purchasing desired ratings from the rating agencies' avoids stating that unworthy borrowers created the risk that justified low credit ratings. It is such an odd extreme denial — Wall St. is the whipping boy for creating risky investments derived from mortgage loans to borrowers who were the source of the risk, and yet the borrower's roll in the financial crisis is almost never mentioned.
This is a fascinating evasion that gets repeated over and over again, ad nauseam, because it is so satisfying to middle America to pretend that financial institutions were solely responsible for the financial crisis that led to the Great Recession. It is an obvious contradiction, given that the 'risky derivatives' and the 'purchased ratings from agencies' would have been completely irrelevant had the majority of borrowers taken loans they could afford and so had no reason to default. And it is a comical non sequitur to decry 'risky derivatives' as this letter writer does, in an attempt to pretend that the derivatives (like credit default swaps) were not derived from mortgage backed securities, and that any risk they entailed was not completely determined by borrowers.
It is worth stressing that the borrower has the most control in determining a loan's risk — not the financial institution originating the loan. The borrower makes all of the choices that affect the risk in the loan — the borrower chooses the property for purchase, the borrower selects the loan terms, and, of course, the borrower is the only person that has intimate knowledge of their sources of income and the stability of those sources. Of course, the lender has to scrutinize the borrower, but this is not done to eliminate the risk (which is not possible) — it is done to assess the risk to determine if the loan is even worth originating, and, if so, what charges are appropriate (such as the interest rate). Financial institutions that make loans obviously have to reject loan applications for which the risk is too high, but the information provided by the borrower about themselves is what determines the risk.
In the most common comments on the financial crisis, it is as if people operate with both the unstated and unacknowledged assumption that borrowers are corrupt by default, and so it is up to financial institutions to ensure that loan applicants are trustworthy, reliable, and have not falsified any information in their loan application — this is the only reasonable interpretation of the often heard claim that 'lenders making loans they did not service' was part of the cause of the financial crisis — if borrower's are not corrupt by default, then it is not important to create a special incentive for lenders to give borrowers extra scrutiny, by requiring lenders to service the loans they originate. But however borrowers behave, only Wall St. will be charged with 'arrogance and greed'.
And here is a comment to Samuelson's column that is a fascinating display of dishonesty — this reader attempts to redefine what constitutes a progressive tax by making the claim that the U.S. tax system is not progressive because those with incomes among the highest 1% supposedly do not pay more in taxes than that group's share of the national income —
http://www.washingtonpost.com/opinions/robert-samuelson-repairing-the-middle-class-in-2015.html (in comment section)
ianmac37
1/4/2015 10:41 AM PST [Edited]
When I was a young man working as an economist, I taught a course in basic statistics to a group of secretaries who were studying to upgrade their job skills. I volunteered for that task, of course. I used a text titled “How to Lie With Statistics,” not because I wanted to teach people how to misrepresent facts, but how to recognize such false representation. Robert Samuelson should study that small text because his column on the woes of the middle class is a good example of how to misrepresent data and still sound authoritative.
Samuelson states that the top 1 percent of American income earners paid 24 percent of all federal taxes, according to the Congressional Budget Office. True, but misleading. He is comparing a percentage of the population, a proportion of people, with a proportion of money. Those are not equal things, even though it sounds like a few people paying far, far more than their share of taxes, he left our the proper comparison: percentage of money income to percentage of taxes paid.
It turns out that the top 1 percent of American income earners also take in 24 percent of national income, so the fact that they pay 24 percent of all federal taxes seems proper and not even a little progressive, which our tax system is supposed to be. In addition, according to Nobel laureate Joseph Stiglitz, those same 1 percenters own 40 percent of all national financial wealth (that’s net worth less the value of homes). So, those who own 40 percent of everything only pay 24 percent of federal taxes.
While PolitiFact might rate Samuelson’s comment mostly true, because the facts as stated were correct, I rate it as an Attempt to Mislead, because any economist should be aware of this kind of false equivalence and be wary of expressing incompatible data in this fashion.
The determination with which people construct rationalizations to justify forcing others to pay for the cost of some service they are using is absolutely fascinating.
Notice that the U.S. tax system is not only progressive, it has become more progressive in recent decades. In a previous blog post I wrote about the IRS data that show that since roughly 2004 the top 1% have paid more in income taxes each year than the bottom 90%.
And notice this quote from the 'Congressional Budget Office' report, 'The Distribution of Household Income and Federal Taxes, 2011', that Samuelson referred to in his column, and that directly contradicts the statements made by both the author of the letter and the author of the comment above regarding the share of taxes paid by the top 1% in comparison to their share of the national income. The top quintile is the only group that pays a larger share of Federal taxes than their share of before-tax income, exactly as 'Director's Law' predicts —
https://www.cbo.gov/publication/49440
https://www.cbo.gov/sites/default/files/113th-congress-2013-2014/reports/49440-Distribution-of-Income-and-Taxes-2.pdf
https://www.cbo.gov/publication/51361
https://www.cbo.gov/sites/default/files/114th-congress-2015-2016/reports/51361-householdincomefedtaxes.pdf
https://www.cbo.gov/topics/income-distribution
As a result of the progressive federal tax structure, households in the highest quintile of before-tax income paid a greater share of federal taxes in 2011 than they received in before-tax income, while households in each of the other quintiles paid a smaller share of federal taxes than they received in before-tax income (see Figure 1). Households in the highest income quintile received a little more than half of total before-tax income and paid more than two-thirds of all federal taxes in 2011. In contrast, households in the lowest income quintile received approximately 5 percent of total before-tax income in 2011 and paid less than 1 percent of all federal taxes, CBO estimates.
And considering Social Security taxes — they seem regressive, because there is an annual maximum wage that is subject to the Social Security tax ($118,500 as of 2015) — but the wage cap on Social Security taxes is only fair, given that Social Security benefits are also capped, since wages above the annual cap are ignored when computing Social Security benefit amounts. For example, the largest possible Social Security benefit check you could receive in 2015 is $3,501, provided you had the maximum-taxable earnings every year for the prior 35 years, and you retired at age 70 in 2015 —
http://www.ssa.gov/oact/cola/examplemax.html
http://www.ssa.gov/pubs/EN-05-10070.pdf
http://www.ssa.gov/oact/cola/Benefits.html
And Medicare payroll taxes have no such limit.
But more importantly, notice this bizarre definition of fairness that people use when discussing taxes — that people who earn more are somehow automatically responsible for paying the costs incurred by others who earn less. No one attempts to use this definition of fairness in their normal dealings, since few people would let them get away with it — certainly, no one wants to be treated this way, because they would see it as blatantly unfair to be forced to pay more for something than someone else who earned less. It is only by pretending that one is in a group that has victim status that makes this pretense seem plausible.
For example, if you had a group of friends that you regularly went out to dinner with, and you normally divided a single check for the dinner based on each person's meal cost, how would you react if one member of the group suggested that as a rule the check be divided based on each person's income?
Most people I know would find this offensive — and most importantly, those with the lowest incomes would find it offensive, because they would not want to be treated as a dependent. That is, they take pride in being self-sufficient, even if they do not earn as much as some others.
In short, it is absurd to claim, as that comment author did, that you have to know a person's share of the national income to know their fair share of the cost of running government — just as it is absurd to claim that you have to know the income of a dinner party member to know their fair share of the check.
Why is it that so many people not only celebrate, but demand being a dependent of the more wealthy when it comes to financing government?
Notice that the authors of both the letter to the editor and the comment quoted above made disparaging remarks about Samuelson ('sans blinders' and 'a good example of how to misrepresent data'), even though they did nothing but reveal their own biases in their failed, fallacy-laden criticisms.
We do need an analysis 'sans blinders', but we will not get it any time soon when the caliber of the typical reader's response is so low.
'Director's Law' almost seems on a par with the Law of Gravity, but if it is, it means the vast majority of people are dishonest as a rule.
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