European reaction to Robert Lucas

Via Mark Thoma, here is a European response to the Wall Street Journal‘s weekend interview of Nobel Laureate Robert Lucas.

When he [Lucas] is asked about Europe, he talks about the cost of high taxes. From the interview:

For the best explanation of what happened in Europe and Japan, he points to research by fellow Nobelist Ed Prescott. In Europe, governments typically commandeer 50% of GDP. The burden to pay for all this largess falls on workers in the form of high marginal tax rates, and in particular on married women who might otherwise think of going to work as second earners in their households. “The welfare state is so expensive, it just breaks the link between work effort and what you get out of it, your living standard,” says Mr. Lucas. “And it’s really hurting them.”

No doubt that (theoretically) high taxes could discourage effort but is this statement empirically relevant? Below is a chart of marginal tax rates … and the female employment to population ratio for the age range (25-54) for 2010 … (the chart looks similar if we look at a different age range or male participation rates).

Do we see more or less effort in countries with high tax rates? Not obvious. In fact, in the sample I have selected there seems to be a positive correlation, not a negative one. …. The US appears as a country with low taxes but also low levels of effort.

Antonio Fatás, “Macroeconomics: Evidence or Ideology“, Antonio Fatas and Ilian Mihov on the Global Economy, 26 September 2011.

Mr Fatás teaches economics at INSEAD, an international business school. He has an undergraduate degree (1987) from the Universidad de Valencia and a PhD (1993) from Harvard University.

This is yet another example of what I call “faith-based economics”: High taxes must discourage work, no matter what the evidence shows!

Tags:

2 Responses to “European reaction to Robert Lucas”

  1. Eric Olson writes:

    Hi Larry,

    Thank you for the terrific daily dose of intellectual stimulation via Thought du Jour.

    In this particular reference, Lucas may have been mistaken about this specific point related to married women — difficult to know what he was thinking of without a reference to a paper (past or forthcoming) by Ed Prescott that he had in mind — but was generally correct in his overall characterization of Prescott’s assertions about marginal tax rates.

    On this general issue, however, Prescott uses a measure of labor supply based on average hours worked per person to measure work effort. The employment to population ratios shown in the post by Fatas give part of the picture, but if average hours worked per person are significantly different across countries (which Prescott claims they are, using mainly OECD data), then the ratios don’t give a complete picture of work effort.

    Below is a link to an article on this issue by Prescott, published in 2004. The article seeks to explain the differences in average hours worked across countries but does not address the issue of labour supply of married women. A quick Internet search did not find anything by Prescott on this issue, but it did turn up an article entitled “To work or Not to Work: Did Tax Reforms Affect Labor Force Participation of Married Couples?” (http://www.bepress.com/bejm/vol9/iss1/art28/ ) where the authors thank Prescott for the idea that initiated the paper.

    Prescott is a controversial figure who foments disagreement and provokes strong reactions. He also often looks at issues, data and terms in ways that are unconventional. But from what I have seen on this general issue, his research starts with the cross-country differences in the data and then attempts to explain them.

    Here’s the link to the paper:

    http://www.minneapolisfed.org/research/QR/QR2811.pdf

    “Why do Americans work so much more than Europeans?”

    Abstract

    “Americans now work 50 percent more than do the Germans, French, and Italians. This was not the case in the early 1970s, when the Western Europeans worked more than Americans. This article examines the role of taxes in accounting for the differences in labor supply across time and across countries; in particular, the effective marginal tax rate on labor income. The population of countries considered is the G-7 countries, which are major advanced industrial countries. The surprising finding is that this marginal tax rate accounts for the predominance of differences at points in time and the large change in relative labor supply over time.”

    From page 3:

    “I emphasize that my labor supply measure is hours worked per person aged 15-64 in the taxed market sector. The two principal margins of work effort are hours actually worked by employees and the fraction of the working-age population that works. Paid vacations, sick leave, and holidays are hours of nonworking time. Time spent working in the underground economy or in the home sector is not counted. Other things equal, a country with more weeks of vacation and more holidays will have a lower labor supply in the sense that I am using the term. I focus only on that part of working time for which the resulting labor income is taxed.”

  2. Eric,

    Thank you for this contribution to TdJ.

    In economics, nothing is ever as simple as it might at first seem. That is what makes the subject so interesting.