Tuesday, 2 September 2014

Implausible counterfactuals

Imagine that Winston Peters had a more clever web team and came up with a nifty infographic. The infographic asked you to input your race. Then it showed how many more jobs each race got in New Zealand in the period 1980 to present. If you'd selected "Asian" at the start, the infographic would tell you that your group got tens of thousands more jobs over the period than your group would have gotten if job growth had been distributed "evenly" instead. If you'd selected "White" or "Maori", you'd see how many fewer jobs your group had gotten, with calls of They Took His Job to follow. A parallel one would show Kiwis how many more houses they'd have if growth in the number of houses owned, by race, had been evened out.

It would be pretty obvious that the infographic was nonsense. Immigration from Asia over the period meant that we had more growth in the number of employed Asians. If those migrants hadn't come, it's not like we'd have had more jobs left for everybody else: that's the lump of labour fallacy. The counterfactual is implausible. 

Well, the NZ Herald's nifty new infographic asks you to input your household income and some basics on your household composition. It then tells you which decile you're in. That's all fine. But when you then hit "Next", you get this. I'd inputted $5000 per week as an arbitrarily large income to get a top-decile household. 
Over the last 30 years, all incomes have grown, but not at the same rate. A household like yours is now 29% – or $23621 a year –better off than it would be if all incomes had grown evenly.
If you choose a lower-income household, it tells you how much worse off you are than you would have been if growth had been equal across deciles. So the counterfactual is a New Zealand that had the same overall growth over the period, but where all deciles experienced even growth. The problem here is that there is no way of evening out those growth rates without affecting growth rates. Higher income taxes for more redistribution can even things out, but they also reduce total growth. People can take whatever values-based position they want on how much the state should redistribute. But we ought to at least start by recognizing that it's not a free policy. 

The recommended approach is to consider whether or not to include deadweight losses on a case-by-case basis. As a general rule, deadweight losses should be included if they are of sufficient size relative to the overall costs and benefits of the proposal that they are capable of altering the decision as to whether or not to proceed with the proposal.  
Having said this, deadweight losses are notoriously difficult to quantify. Estimates vary from 14%31 up to 50%32 of the revenue collected. Treasury suggests a rate of 20% as a default deadweight loss value in the absence of an alternative evidence based value. Thus public expenditures should be multiplied by a factor of 1.2 prior to discounting to incorporate the effects of deadweight loss. 
If you want to get one dollar from a high decile person to a lower decile person, you should reckon on its costing $1.20. If you want to even out growth entirely, well, those costs are going to be much higher. I'd believe the 1.2 for top income tax ranges from 30% to 40%. It would be an interesting exercise to work out just how much higher the top marginal tax rate would have needed to be to even out growth entirely over the last three decades. I expect that the rate would be really rather high, and that the associated deadweight losses would be rather large as well.

The Herald infographic invites the reader to assume that those deadweight costs don't exist. Dey Turk Er Income, except for that most of that income wouldn't have existed for anybody in the counterfactual.

There are a few policies around that can improve outcomes in lower income cohorts at relatively low cost. Improving education and training is one. But there are no policies that would equalise income growth across deciles without simultaneously substantially affecting total growth.


  1. The info-graphic is attributed to http://closertogether.org.nz/about-us/ who have been posting a lot of really poor-quality graphs on twitter: https://twitter.com/CloserTogether broken y axis, weird choices of variables (disposable income & housing costs) etc. Their website has some pretty creepy policy proposals (time banks). Disappointing to see The Herald republishing.

  2. The ACT party recently published some information suggesting that the rich have not, in fact, been getting richer in NZ. Is their assertion that the top deciles have done better than lower deciles even true?