In End This Depression Now! (pages 77–78) Paul Krugman offers the strangest arguments I have seen. The story opens with familiar fulminations about the “top 1 percent” (those earning more than $366,623 in 2011). As he put it in a 2011 column, “income inequality in America really is about oligarchs versus everyone else.”

“Incomes of the rich,” his book claims, “are at the heart of what has been happening to America’s economy and society.” Yet it apparently requires great bravery to even dare to mention “the rising incomes” of the top 1 percent or top 0.1 percent:

Merely to raise the issue was to enter a political war zone: income distribution at the top is one of those areas where anyone who raises his head above the parapet will encounter fierce attacks from what amount to hired guns protecting the interests of the wealthy. For example, a few years ago Thomas Piketty and Emmanuel Saez … found themselves under fire from Alan Reynolds of the Cato Institute, who has spent decades arguing that inequality hasn’t really increased; every time one of his arguments is thoroughly debunked, he pops up with another.

To be called a “hired gun” of the wealthy might be insulting if it was not so ridiculous. First of all, no employer has ever tried to influence what I write. Second, I have been a very successful investor and live quite comfortably from realized capital gains plus mandatory distributions from IRA, Keogh and 403(b) accounts that President Obama would regard as much too large. I negotiated a token salary from Cato (smaller than my Social Security check) but return at least 40 percent of it as a charitable donation. I am usually in the top 1 percent, at least when stocks are up, and thus not easily bribed. I would be flabbergasted if Krugman is not also a member of that demonized bunch of oligarchs.

Krugman complains that some of my arguments changed (new ones popped up) over decades, but arguments should change after decades of new data. I must have made a couple of mistakes since 1992, but mistakes (including Krugman’s) are not evidence of deliberate deception or corruption.

An illustration of the way my work has supposedly been “thoroughly debunked,” was provided by Brad DeLong. He found it scientifically definitive to rerun Tim Noah’s complaint that, “Reynolds’s technique is to bury you under a mountain of hard-to-follow, often irrelevant, and sometimes entirely erroneous statistical quibbles to the point where you cry ‘Uncle!’ ” How this journalist who was admittedly unable to follow my simple charts and graphs was nevertheless able to identify all of them as irrelevant or erroneous quibbles remains a puzzle.

Back to Krugman’s book. Two graphs compare a mean average of real incomes of the top 1 percent of tax units with median income for households from 1947 to 2007. Did I ever suggest that inequality of pretax, pre-transfer income has not increased since 1947? Of course not. I wrote that broad measures of the inequality of disposable income, consumption and wealth have not increased since 1988. 

Krugman cites an instantly obsolete 2011 Congressional Budget Office (CBO) report about top 1 percent income shares from 1979 to 2007. Aside from cyclical ups and down, most swings in top 1 percent shares were due to taxpayer response to (1) deep cuts in individual income tax rates in 1983–88 causing a surge in business income reported by pass-through entities, and to (2) increases in realization of capital gains after the capital gains tax rate was cut in 1997 and 2003.

The disgraceful thing about the October 15, 2011 CBO report was stopping the data with the cyclical peak of 2007 even though the CBO knew perfectly well that many “top 1 percent” businesses and investors were devastated by crashing real estate and stocks. CBO estimates that the top 1 percent’s share of after tax income fell to 11.5 percent in 2009 – down from 17.4 percent in 2000 and unchanged from the 11.4 percent average of 1986–89.

Incomes of the top 1 percent did not bounce back after 2009, according to Piketty and Saez, merely rising from 18.1 percent of “market income” in 2009 (which arbitrarily excludes rising transfer payments from total incomes) to 19.8 percent in 2011. Piketty and Saez estimate that average real income of the top 1 percent was $1,322,635 in 2000 (measured in 2011 dollars) but real income dropped 20.7 percent by 2011 to $1,048, 234. Does a 20.7 percent drop over eleven years justify Krugman’s anguish about “rising income” among the top 1 percent?

In the summer of 2006 I presented a paper at the Western Economic Association International about statistical difficulties with using income reported (rather than unreported) on individual (rather than corporate) tax returns to gauge inequality of living standards. A condensed 24-page version appeared as a Cato Institute paper, and received some academic attention. I also wrote a 248-page book, Income and Wealth, with a chapter devoted to this issue, including a reprise of 1992 disagreements with Krugman. 

Piketty and Saez responded only to the first of two short Wall Street Journal articles on the topic, never to my 2007 or 2012 Cato papers or my book. Among other things, they asserted that “the emerging consensus is that there can be substantial responses [to tax changes] in the short-run due to retiming of income… but that the long-term response is small.” On the contrary, all studies by Saez and others, including studies from other countries, find a very large and sustained response (elasticity) of reported income among the top 1 percent to changes in marginal tax rates on income, dividends and capital gains. 

My100-page 2012 working paper offers detailed factual answers to the Piketty and Saez comments on my 2006 op ed, plus a critical examination of CBO and other measures of distribution. Here are some truncated highlights:

“It has become commonplace to use top 1 percent shares of market income as a shorthand measure of inequality, and as an argument for greater taxes on higher incomes and/​or larger transfer payments to the bottom 90 percent. This paper finds the data inappropriate for such purposes for several reasons:

• Excluding rapidly increased transfer payments and employer-financed benefits from total income results in exaggerating the rise in the top 1 percent’s share between 1979 and 2010 by 23 percent because a growing share of other income is missing.
• Using estimates of the top 1 percent’s share of pretax, pretransfer income (Piketty and Saez 2003) as an argument for higher tax rates on top incomes or larger transfer payments to others is illogical and contradictory because the data exclude taxes and transfers.
• Using highly cyclical top 1 percent shares as a measure of overall inequality leads, paradoxically, to describing most recessions as a welcome reduction in inequality, because poverty and unemployment rates typically rise when the top 1 percent’s share falls, and fall when the top 1 percent’s share rises.
• Top 1 percent incomes are shown to be extremely sensitive (“elastic”) to changes in the highest tax rates on ordinary income, capital gains and dividends. Although estimates of the elasticity of ordinary income for the top 1 percent range from 0.62 (Saez 2004) to 1.99 (Moffitt and Wilhelm), those estimates fail to account for demonstrably dramatic responses to changes in the highest tax rate on capital gains and dividends.
• I estimate that more than half of the increase in the top 1 percent’s share of pretax, pretransfer income since 1983, and all of the increase since 2000, is attributable to behavioral reactions to lower marginal tax rates on salaries unincorporated businesses, dividends and capital gains.”

Krugman and DeLong are not obligated to acknowledge my recent research in any way, but they ought to at least avoid the pretense that anyone has “thoroughly debunked” any of it, much less all of it.

Continuing our ongoing series on the wealth of Washington, we bring you the lead story in Friday’s “Mansion” section of the Wall Street Journal:

The Journal reports:

As other American cities have been buffeted by an uneven economy, Washington’s property market has been buoyed two forces specific to the capital city: a surge of federal contractors and a rising tide of government spending. The result: what real-estate agents and developers are calling an unprecedented real-estate surge.

Yes, a rising tide of government spending may be bad for the American economy, but it’s great for the Washington area.

Washington is wealthy and getting wealthier, despite history’s slowest recovery in most of the country. As we’ve said here before, this of course reflects partly the high level of federal pay, as Chris Edwards and Tad DeHaven have been detailing. And it also reflects the boom in lobbying as government comes to claim and redistribute more of the wealth produced in all those other metropolitan areas. 

Money spent in Washington is taken from the people who produced it all over America. Washington produces little real value on its own. National defense and courts are essential to our freedom and prosperity, but that’s a small part of what the federal government does these days. Most federal activity involves taking money from some people, giving it to others and keeping a big chunk as a transaction fee.

Every business and interest group in society has an office in Washington devoted to getting some of the $3.6 trillion federal budget for itself: senior citizens, farmers, veterans, teachers, social workers, oil companies, labor unions — you name it. The massive spending increases of the Bush-Obama years have created a lot of well-off people in Washington. New regulatory burdens, notably from Obamacare, are also generating jobs in the lobbying and regulatory compliance business.

Walk down K Street, the heart of Washington’s lobbying industry, and look at the directory in any office building. They’re full of lobbyists and associations that are in Washington, for one reason: because, as Willie Sutton said about why he robbed banks, “That’s where the money is.”

The wonder is why the taxpayers put up with it.

Responding to a student question after a recent Kansas State debate with Brad DeLong I posed a conceptual puzzle. I asked students to ponder why textbooks treat Treasury sales of government bonds as a “stimulus” to demand (nominal GDP) in the same sense as Federal Reserve purchases of such bonds. “Those are very different polices,” I noted; “Why should they have the same effect?” 

The remark was intended to encourage students to probe more deeply into what such metaphors as “stimulating” or “jump starting” really mean, not to accept as dogma that fiscal and monetary policy are equally effective or that economists are certain just how they work.

DeLong’s misinterpretation of my question led him to lecture me that, “if you really do think that monetary expansion undoes fiscal expansion because monetary expansion buys bonds and fiscal expansion sells bonds, you need to educate yourself.” Citing that wholly imaginary rewriting of my question, Paul Krugman wrote, “My heart goes out to Brad DeLong, who debated Alan Reynolds and discovered that his opponent really doesn’t understand at all how either fiscal or monetary policy work.”

Did I really say that “monetary expansion undoes fiscal expansion”? Of course not. If that had been my question, I would have answered myself by saying that piling more debt on the backs of taxpayers is unlikely to stimulate private spending (much less encourage more or better labor and capital) unless the added debt is “monetized” by the Fed and regulators allow banks to lend more to private borrowers. DeLong made much the same point by saying, “Expansionary monetary policy makes it a sure thing that expansionary fiscal policy is effective by removing the channels for interest-rate and tax crowding out.” 

The Fed’s current bond-buying spree is bound to have some effect, if only to facilitate cheap corporate buybacks of shares and speculative day trading of such stocks on margin. But selling more government bonds per se (if the Fed won’t buy more) would be just as much an added burden for taxpayers as it would be a benefit to whoever receives the resulting government transfers, contracts or subsidies. 

This make-believe squabble about monetary expansion undoing fiscal expansion exists only in DeLong’s imagination, like my non-prediction of mammoth inflation or Krugman’s non-facts about Ireland’s fiscal frugality.

I do have a few minor issues, however, with DeLong’s remark that, “It’s not possible to get confused if you have the IS-LM diagram in front of you.” To lean too heavily on John Hicks’ 1937 ad hoc diagram, which reduced the whole economy to two curves manipulated separately, is not an answer but rather part of my question. As theory goes, I much prefer Hicks’ 1975 book, The Crisis in Keynesian Economics (57) including his assessment (57) that “one of the worst things about Keynes’s doctrine … is the impression he gives that Liquidity Preference is wholly, and always, bad.…The trouble lies deep in his version of short-run macroeconomics, in which one form of investment appears as good as another.”

The question I posed to the Kansas students was more clearly explained in my 2009 Cato Journal essay, “The Misuse of Economic History.” I wrote that “it is a non sequitur to claim a ‘liquidity trap’ demonstrates that aggressive fiscal policy will ‘raise aggregate spending.’ Fiscal stimulus means selling more government securities; monetary stimulus mainly means central banks buying such securities with new money. Those are distinctly different policies, and their effectiveness raises distinctly different questions. Do big budget deficits stimulate demand? In postwar U.S. data there is no discernible connection, over short periods or long, between cyclically adjusted budget deficits and the growth of final sales to domestic purchasers. It is easier to find connections between aggregate spending and exogenous monetary policy changes.”

These are questions of fact, not theory. I was using historical data to show that monetary policy appeared relatively potent at times when Krugman claims it was not, while fiscal policy in the demand-side sense (budget deficits rather than tax rates) had no clear links to nominal or real GDP even during the Great Depression or post-1991 Japan. 

Although Keynesian theory postulates a solid link between cyclically-adjusted budget deficits and changes in aggregate demand (nominal GDP), I find no such correlation in any data at home or abroad. Counterfactual simulations from Keynesian black box models are not evidence.

The burden of proof is entirely on those who assert that some measure of fiscal stimulus is linked with some measure of aggregate demand. Where did that happen and when? I am almost begging for some shred of evidence. In End This Depression Now! (234) Krugman could only uncover a study of military spending which suggests, he says, that “every year in which there was big [military] spending increase was also a year of strong growth.” Even if that causality was not ambiguous (i.e., we could afford a fatter defense budget when the economy and revenues were strong) any effect of military contracts on (defense industry) output says nothing about deficits per se, nor about the bulk of federal spending which is on payrolls, subsidies and transfers.

DeLong believes “anything that boosts the government’s deficit over the next two years passes the benefit-cost test–anything at all.” Just as there is no obvious reason to expect identical economic effects from marketing or monetizing federal debt, however, there is likewise no reason to expect all types of government spending (purchases, payrolls, interest expense and transfers) to have the same effect. The evidence that different sorts of taxing and spending have quite different effects (to get back to my initial microeconomic question) is entirely on the side of Casey Mulligan, who found increased transfer payments positively harmful to employment and output. 

Unless government debt was literally a free lunch, how could it possibly be true that “anything that boosts the government’s deficit over the next two years passes the benefit-cost test”? Suppose interest rates doubled or tripled, as consequence of faster growth of nominal GDP, that would greatly increases the government’s deficit through larger interest payments. Would the “benefit” of that larger deficit really exceed the added interest cost to taxpayers? Would it qualify as a stimulus?

In the Brookings Papers on Economic Activity Brad DeLong and Larry Summers remind us of the changing fashions defining the mainstream economic consensus: “The late 1960s and 1970s,” they write, “provided powerful demonstrations that monetary policy had major effects on economic performance. The 1970s provided convincing evidence … that in the medium and long runs demand-management policy [whether fiscal or monetary] could affect levels of nominal but not real income. The late 1970s and the 1980s brought increased emphasis on the supply-side aspects of tax and expenditure policies. These three factors had led most economists by the 1990s to reject discretionary fiscal policy directed at aggregate demand as a tool of stabilization policy. Indeed, a central element of the economic strategy of the Clinton administration was the idea that deficit-reduction policy was likely to accelerate economic growth.” 

For the DeLong and Summers to switch from advocating deficit-reduction in the Clinton-Bush years to advocating deficit-expansion in 2012 demonstrates impressive intellectual agility. Yet actual results of larger spending and debt have been far less impressive than the results of U.S. and Canadian spending reduction from 1992 to 2000.

For me to continue to “reject discretionary fiscal policy as a tool of stabilization policy,” just as “most economists” (including DeLong and Summers) did a decade ago, is now being redefined as ignorant heresy by DeLong and Krugman, who both wrote of being terrified by modest budget deficits in 2003–2004. The new reality, as opposed to old theory, is that national, historical and international evidence that increased government spending, borrowing and taxing is commonly unproductive or counterproductive has only grown stronger in recent years. Compare, for example, Ireland and Iceland.

You can’t make this up: Obamacare exempts certain American Indians from the “choice” Americans will face as of January of buying health insurance or paying Chief Justice Roberts’s special tax. But apparently this is a far narrower category of people than those recognized as “Indian” under various state laws:

The problem is so new that the federal government is still seeking to establish how many people might be affected, although Indian health advocacy groups estimate it could be up to 480,000.

In California alone, about 21,000 people who currently receive free health care through Indian clinics are not recognized as Native American by the federal government and would have to pay the penalty, according to the nonprofit California Rural Indian Health Board.

So people who’ve considered themselves American Indian all their lives and have been treated as such by their states–including for health care purposes–suddenly won’t be considered Indian as far as Obamacare is concerned. 

Wow–Indian law is complicated and constitutionally problematic enough without having further regulatory overlays bollix up the works even more. But that’s what happens when government encoraches more and more into civil society. As I wrote in January in an article on, of all things, the contraceptive mandate:

But there’s an even bigger issue here. This is just the latest example of the difficulties in turning health care—or increasing parts of our economy more broadly—over to the government. As my colleague Roger Pilon has written, when health care (or anything) is socialized or treated as a public utility, we’re forced to fight for every “carve-out” of liberty…

The more government controls—whether health care, education, or even marriage—the greater the battles over conflicting values. With certain things, such as national defense, basic infrastructure, clean air and water and other “public goods,” we largely agree, at least inside reasonable margins. But we have vast disagreements about social programs, economic regulation and so much else that government now dominates at the expense of individual liberty.

Obamacare delenda est.

Pakistan always has been a good example of being careful for what one wishes when it comes to democracy in Third World nations. The Pakistani people theoretically rule the unstable nuclear state. Whether that actually is positive is not so clear.

In the latest election, Nawaz Sharif’s Pakistan Muslim League-Nawaz won a strong plurality, making him the almost certain prime minister. However, that position may be a poisoned chalice. When he was last premier, for the second time, in 1999, he found himself ousted in a coup, imprisoned for months, and eventually bundled into exile.

Despite the relatively free (though violence-laden) vote, Pakistan’s political, economic, and security problems are enormous. And the dangers of a failed state reach well beyond Pakistan’s borders. As I wrote in my latest Forbes online column:

for those who worry about an Islamic Bomb in Tehran, one already exists in Islamabad. Pakistan has between 90 and 120 warheads, and is producing more plutonium than any other nation on earth. The result likely will be an expanded arsenal. Observed Tom Hundley of the Pulitzer Center on Crisis Reporting: “Pakistan could end up in third place, behind Russia and the United States, within a decade.” Yet the contest with India has left Islamabad officials “hobbled by fear, paranoia, and a deep sense of inferiority,” in Hundley’s words. At the same time, Pakistan has increasingly dispersed its warheads to frustrate any U.S. attempt to seize the weapons. The practice increases the possibility of radicals grabbing a warhead or fissile material.

Oh joy.

Although only the Pakistani people can fix their own country, Washington could help. It should wind down the war in Afghanistan, which is a destabilizing force in Pakistan. The U.S. should reduce its use of drones, which have made America hated by Pakistanis. Washington should resist the temptation to dump ever more foreign “aid” into the corrupt and incompetent institution known as the Pakistani government. Finally, Americans should hope—and pray!—that Nawaz Sharif has learned something during his 14 years in the political wilderness.

One of the most important lessons one learns from traveling abroad is to be culturally sensitive. A self-professed sophisticate like myself would never want to be considered to be the prototypical “Ugly American.”

Yet as I’m visiting the Persian Gulf kingdom of Qatar I’ve been thinking about who gets to decide on culture.

Most of us believe that certain practices are beyond the bounds of tolerance. Consider the Indian practice of suttee—the burning of widows—which Britain banned. Set aside whether the British government should have shown up with soldiers, guns, and warships and claimed the Indian subcontinent as its own; once there, surely it was right to forbid murder.

In a story that may be apocryphal but should be true even if not, an Indian complained to a British colonial official that it was tradition to burn widows on their deceased husbands’ funeral pyres. The official replied, according to the story, that it was British tradition to execute those who burned widows on their deceased husbands’ funeral pyres.

Of course, nothing like suttee is going on in Qatar. Indeed, as Muslim societies go, it is a pretty liberal place. Observance of conservative Islamic tenets is routine but often not deeply held. Some younger Qatar citizens (and TV cameramen!) look a lot like their Western counterparts. I wasn’t the only person on my flight to arrive wearing shorts. Hotels that cater to Westerners serve alcohol and provide Western television stations. Men and women use the gym together.

Still, visitors are warned to be sensitive, especially of dress. People should be modest in all circumstances. Shorts are tolerated, but should hit the knee. Shoulders should be covered.

In response, I left my short red running shorts at home. They are unexceptional in America, but I figured my longer gray gym shorts would be more appropriate for my daily walk. (My marathon-running days ended with a knee implant more than seven years ago.) I wore a muscle shirt in the gym and was going to change to a t‑shirt for my walk, but it was hot and sunny even at 6:30 am. So I figured, what the heck? My hotel is in an isolated area in the midst of multiple construction projects, so I doubted there were many fundamentalists around who would be upset to see my shoulders. I repeated the experiment on the second morning without incident.

But should I even care? If I was visiting Pakistan (as I did a couple months ago) or one of many other “real” nations with a Muslim majority, I would answer “Of course.” But citizens of Qatar, like most of the other Gulf sheikdoms, have effectively subcontracted their society to others. Oil wealth means the government, which essentially is a wholly-owned subsidiary of the al-Thani royal family, hires foreigners to fill most jobs except security.

Hotel staff, drivers, construction workers, sound and video personnel, airport workers, and most everyone else, skilled and unskilled alike, are foreigners. Qatar’s population is roughly 1.9 million. Barely 250,000 of them are citizens, less than 15 percent. In a contract sense, the 250,000 have a perfect right to hire whoever they want with whatever conditions they want. That could include respecting the local culture.

However, people do not come as empty vessels. They have beliefs and habits. Together they have communal practices that reappear when they congregate together. In Qatar one quarter of the population is from India. Another 25 percent comes from elsewhere in the Indian subcontinent—Nepal, Pakistan, and Sri Lanka. One out of 10 comes from the Philippines. Some of these foreign residents are Muslim, but most are not. Add the many tourists and businessmen who visit and Qatar looks even less traditional. In sum, Qatar today is a different Qatar from yesterday. It is unreasonable to expect Qatar’s culture to be unaffected by the change.

It’s really a matter of choice. If you submerge your society in foreigners who believe and act differently than yourself, can you really expect them not to act as they believe in your nation? Or should you accept the fact that you are inviting in their culture along with them? So don’t complain if they wear skimpy clothes, drink different liquids, follow other religions, and so on.

I still have the feeling that I’m a guest here and don’t want to act like the Ugly American. But I’m feeling a bit less sympathetic about local cultural sensitivities. Almost everyone I’ve met here in Qatar is from somewhere else. Who should get to decide what culture in Qatar should be?

The unanimous decision of the Iowa legislature to expand the state’s scholarship tax credit (STC) program yesterday once again demonstrates that school choice programs grow even more popular once implemented. Iowa’s STC expansion bill raises the credit cap from $8.75 million to $12 million and expands the types of corporations eligible to receive tax credits for donations to scholarship organizations. The bill adds no new regulations. Six of the seven states with STC programs enacted before 2010 have subsequently voted to expand those programs. The chart below shows the legislative support and opposition in four of those states. (The expansions in Indiana and Pennsylvania were part of legislation covering other issues so they were excluded from this analysis. The chart includes information for Arizona’s corporate-donor STC program but not its individual-donor STC program, for a similar reason.)

The most dramatic shift was in Georgia’s State House, which moved in just a few years from a fairly even divide to overwhelming support. Support in Iowa went from overwhelming to unanimous. While Florida’s Senate barely moved, support has grown considerably in the House. Arizona has also had modest increases in support for school choice in both chambers. A survey by Harvard University’s Program on Education Policy and Governance found that 72 percent of the American public already supports scholarship tax credit programs. The survey found even higher support among parents, African-Americans, Hispanics, and registered Independents and Democrats. There have not yet been any studies measuring whether support in a given state increases after enacting an STC program, but if legislative support is a reliable proxy then the answer appears to be in the affirmative.