Welcome to the 34th issue of Allison’s Ode to the Second Moment, a newsletter about the state we live in and the states people are leaving.
Non-linearity confuses people
A ‘controversial’ paper came out that studied the impact of increasing the minimum wage to $13.00 per hour in Seattle. Overnight, every journalist and commentator became an expert on spatial heterogeneity and synthetic control groups.
Many people were skeptical of the bipartisan team of researchers at the University of Washington, who wrote the paper, and more open to criticism from partisan sources.
I can see why. A popular narrative emerged in the past few years that increasing the minimum wage does not have any impact on employment. In fact, the literature is divided. But even if you put more weight on the no-effect papers, it is still worth noting that the earlier wages increases studied were fairly small. A larger increase is a much riskier policy.
Wojtek Kopczuk points out anyone who argues there’s not much impact on jobs after a wage increase also believes that there’s a nonlinear relationship between wage increases and demand for low-skill employment. Maybe a $0.50 increase doesn’t change much, but few will argue a $1,000.00 minimum wage won’t impact demand for low-skill labor.
The University of Washington paper didn’t see much impact from the increase to $11.00, but started to notice changes in demand at $13.00. This suggests the non-linearity is real and being open to the University of Washington paper is not completely at odds with earlier literature.
States in trouble
How much do taxes matter at the state level? That is the question of our time.
On the one hand, you have Kansas, who cut taxes and only saw middling growth and big economic deficits. I find most of the Kansas coverage unfair. Just like the minimum wage, the relationship between taxes and growth is not always linear and depends on your starting point. If you cut marginal tax rates from 100% to 70%, you might see more of an impact than if you cut them from 40% to 30%. Given that taxes weren’t that high in Kansas to begin with, tax cuts probably weren’t going to do much for growth and would only add to the deficits. But the state has hardly become the hellscape some make it out to be. Unfortunately, Kansas became the poster child for what many people see as the great intellectual folly of supply-side economics. Justin Fox offers a rare fair assessment. He runs through the numbers and proclaims the experiment was more of a political than economic disaster.
Meanwhile, Connecticut increased taxes and growth slowed there. Derek Thompson agrees higher taxes were a factor. But a bigger problem is that people like living in cities these days. Urban renewal has been bad for bedroom communities in places like Connecticut. People who once would’ve lived in Greenwich to raise their families now live in Tribeca. He concludes that Connecticut needs better cities.
Maybe, but no matter how much money you throw at the problem, Bridgeport is never going to compete with New York City. Connecticut’s strength has always been its suburbs.
Anyone who has been paying attention knows that areas of Connecticut that traditionally relied on manufacturing have been struggling for decades. Thompson says it offers liberals a cautionary tale on the perils of inequality. But in reality, Connecticut offers a cautionary tale that you can’t paper over structural problems with redistribution from a richer part of a state to a poorer one.
It all comes back to pensions
It all goes to show how fast economic conditions can turn. Tax rates, whether in Kansas or Connecticut, are only part of deeper economic shifts that impact many remote parts of the country. Structural economic changes aren’t on the radar when states make large pension commitments and then underfund them. When politicians make big promises, they normally assume the best possible economic scenario will transpire—or at least that’s what their discount rates suggest.
Both Connecticut and Kansas have large pension obligations they'll struggle to pay for. They’re faced with hard choices about what services to cut, and that only further encourages people to move away and erodes the tax base.
The Wall Street Journal has an interesting story about how hard it is to cut pensions. These cuts are not only often illegal and they impact the job choices of policemen. For years police and firemen took lower pay for the promise of putting in 20 years and getting a guaranteed income for life. Now that promise looks shaky.
Editorial pages give a lot of space to obsessing about fairly small tax changes and whether they induce people to move, start businesses, and if they mean services, like schools and policemen, are cut. But there is far less time spent on the risk of states committing to long-term obligations that they cannot modify and then underfund.
States have a lot more space to experiment with the right tax rate when they don’t have ginormous unfunded pension obligations.
But you never know. Things could turn around, interest rates might increase, and states might experience a big productivity boom that encourages people to move to Kansas and Connecticut again. The future is uncertain, so it’s best to finance for the worst and hope for the best.
Different ways to finance old age
The Republican health-care proposal created many passionate defenders of Medicaid. It probably a good thing that people are now more aware that Medicaid funds many middle-class American’s long-term care needs. I am not sure if Medicaid is the right way to fund the high expenses involved with advanced aging. Rather than a blanket defense of Medicaid and increasing old age obligations, we should start thinking about what is the right way to finance long-term care. Medicaid is fairly stable now, but as more people age, its long-term costs become a bigger risk.
On a darker note, did you hear about the man in Florida who kept his wife in a freezer for 8 years in order to collect her Social Security?
Until next time, Pension Geeks!