Wednesday, July 11, 2012

An Economics Lesson From Michael Jordan...And The Reality Of Small Businesses

I'm a big fan of explaining complex concepts using simple real-world examples.  This is a great one from Matthew Schoenfeld at the Wall Street Journal (emphasis mine):

What does Michael Jordan tell us about income inequality in the United States? The U.S. has greater income inequality than nearly all other developed nations, and the former basketball star earned far more in most years than the typical American earns in a lifetime. So is our system unfair and stacked against the middle class? First, some historical perspective.

"From the time of Pericles until the end of the 18th century in London—2,300 years," notes Harvard Prof. Lawrence Summers, "standards of living on Earth increased perhaps 100%." In the U.S. since 1790, by contrast, real per capita gross domestic product has increased nearly 4,000%. Quality of life, in other words, increased 40 times more in 220 years of American history than it had globally over two millennia. In 2012, a typical American in the bottom fifth of the income distribution has a far higher quality of life—and life expectancy—than the average member of the top 1% in 1790.

Critics today often point to the 1950s as the last years before American society became so divided between haves and have-nots. At the end of that decade, America's "Gini coefficient"—the most common measure of income inequality, running from 0 (least unequal) to 1 (most unequal)—was 0.37. Today it is 0.45.

But in 1959, more than 20% of families fell below the poverty line. In 2010 that figure was just over 13%. Real per capita GDP today is 270% higher than it was in 1959. A family in the bottom fifth of the income distribution today makes the same amount in real terms as a family earning the median income in 1950. So inequality might have increased, but so too—dramatically—has quality of life.

Even over the last two decades, while real income has essentially stagnated for the bottom fifth of earners, basic conveniences have become far more affordable. In 1992, only 20% of American families below the poverty line had a dishwasher—50% had air conditioning and 60% owned a microwave. When the Census Bureau last surveyed these figures in 2005, those figures were 37%, 79% and 91%, respectively. Critics who minimize the importance of these conveniences likely have never had to do without them.

And that brings us to Michael Jordan, who starred for the Chicago Bulls from 1984 to 1998. In 1986, the Bulls' median player salary was $300,000. The team's lowest-paid player made $135,000, and its highest-paid player made $806,000. The team's Gini coefficient was 0.36. But Jordan's superstardom increased the team's popularity and revenues, and by 1998 salaries looked different. The median income was $2.3 million, the lowest was $500,000, and the highest (Jordan's) was $33 million. The Gini coefficient had nearly doubled, to 0.67.

Jordan's salary of $33 million consumed over half the payroll, but everyone was better off. The median player in 1998 made more than seven times what the median player made in 1986, while the income of the lowest-paid player in 1998 quadrupled that of his 1986 peer.

Detractors would suggest that this situation is anomalous to sports, that many of today's wealthy inherited their money or acquired it without adding commensurate value to society. But consider another basketball player, Rashard Lewis of the Washington Wizards.

Lewis was the second-highest paid player in the National Basketball Association in 2012, making $22.1 million—even though he appeared in fewer than half of his team's games and performed poorly when he did. Is it fair that Lewis was compensated so handsomely? More pertinently, if his team could repossess a portion of his salary and redistribute it more "fairly" to deserving players following the season, would it benefit the franchise?

Perhaps it would in the short term, as the team could reward players and temporarily strengthen morale. But top players would be disincentivized to play for the team in the future, knowing that such repossession could also happen to them. And without an objective measure of overall player performance, the team could one day decide that even a high-performing player was overcompensated and therefore should see some of his proceeds redistributed to his teammates. The team would quickly become uncompetitive.

Certainly there are reasons for concern if lower-income Americans aren't able to save or acquire sufficient capital to pursue innovative ideas, or to see their children attend decent schools. They will suffer, and the country will lose out on significant intellectual capital and growth opportunities. But this should not be confused with inequality.

Equality is not a good in itself and shouldn't be analyzed in a vacuum. If we remember that, perhaps a century from now low-income Americans will pity the living standards of today's 1%.

We just talked about the Gini coefficient in my economics class, and while it's an interesting metric I find it (based on my admittedly limited understanding of it) and the whole premise of 'income inequality' to be a little bit superfluous and misleading.  Schoenfeld's article describes a real-world example of the theory of 'a rising tide raises all boats.'  Rather than focusing on the standard of living of all Americans, metrics like the Gini coefficient instead seek only to portray relative unfairness.  In the 2012 Economic Report of the President, we see the following chart that portrays the current picture of income inequality:

Let's assume that the nation's median income (around $51k/yr) lands squarely in the middle of the middle quintile.  That would mean the difference in income growth between the top 1 percent and the middle of the pack is roughly 243%.  Now, you could look at that as being hideously unfair and unequal, but what happens if we doubled everyone's income?  The gap between the top 1 percent and the middle of the pack would also double, bringing it to 486%.  Using the same logic, that would be an even more unequal distribution of wealth, wouldn't it?

Except...the middle of the pack would now be earning six figures.

So, which makes more sense as a genuine measure of wealth: income inequality, or the dollars people are actually earning?  And the next logical question is: which is more desirable, to narrow the income inequality gap, or to raise all incomes across the board?

I prefer the second answer to both questions.  The Michael Jordan example shows us clearly what happens when there is a rising tide - all boats go up.  Sure, the income gap between Jordan and the lowest-paid player on the team was HUGE...but I'm sure the lowest-paid player could easily console himself with his shiny new quadrupled $500k/yr salary.  And don't forget the danger that lurks in the Rashard Lewis redistribution example, either.  If performance is rewarded with redistribution of the performer's gains, then there is no incentive to perform well at all.  If we want mediocrity in all things, redistribution of the spoils of success is the way to do it.

So how do we create a rising tide that would lift up everyone?  Not by doing what Obama's doing, as described by Ed Carson at Investor's Business Daily:

"I've cut taxes for small business owners 18 times since I've been in office," President Obama said Monday as he proposed tax hikes on the well-off. He stressed, "This isn't about taxing job creators, this is about helping job creators."

Well, that's what he says, but everyone with skin in the game knows better.

The Small Business Optimism Index fell 3 points in June to 91.4, the National Federation of Independent Business reported Tuesday. That's the lowest level since last October and the biggest one-month drop in two years. Net employment at small firms declined for the first time this year. Business owners also soured on the prospects for their profits and sales as well as the overall economy. The report adds to a slew of recent data pointing to deteriorating economic activity at home and abroad.

And that doesn't include the recent ruling that Obamacare will stand.  That one piece of legislation alone packs a whopper of a punch to small businesses:

"With over 20 new taxes contained in the law -- a price-tag of $800 billion -- and most of the regulations yet to be written by HHS, the implications for employee costs remain unclear," said NFIB Chief Economist William Dunkelberg in a statement. "Uncertainty reigns supreme for much of Main Street." 

And that never sparks job creation.  Of course, Obama's playing the political game and saying one thing...

Obama on Monday proposed extending tax cuts, for one year, on families making less than $250,000, while arguing that people making more than that should see higher taxes. 

...while doing another...

Republicans and business groups said that would hit many small business owners. Obama claimed that 97% would be exempt, which is why he said he's not targeting "job creators".


Once again, liberals are ignoring the fact that a huge number of the so-called 'rich' are actually small businesses.  And, since small businesses provide something like 70-80% of all jobs in this country, that's an equally huge problem that actually does mean Obama is targeting job creators.

Obama's small business tax cuts ... often are less impressive in reality than on paper.

ObamaCare includes tax credits to help small firms offer health insurance for employees. The administration's Council of Economic Advisers thought 4 million would use them. But just 170,000 small businesses took advantage in 2010, IRS figures show, according to a recent study by the nonpartisan Government Accountability Office. The reason: The credit was too small and too complex for small business owners.

It's far better to rely on simple tax rates and understandable regulations than intricate policies full of twists and turns and exceptions.  Large companies like McDonald's can afford to hire teams of attorneys and CPAs to pore over every word of the 60,000+ page tax code and ply it to their best advantage...but small businesses can't.  On top of that, large companies like McDonald's have the political pull to manipulate things to their benefit even outside of the tax code.  For example, McDonald's was given an exemption from Obamacare by the Obama administration, so they don't face the penalties for non-participation that small businesses would.  The bottom line:

It's true that about 80% of small firms are one-man or -woman operations with no employees. But firms that start tiny tend to stay that way. Startups that develop into big "job creators" tend to have several employees from day one. But those are firms are more likely to have income above $250,000. Higher taxes on such businesses would exacerbate a key but little-known weakness of the anemic recovery: The number and size of startups plunged during the recession and haven't recovered. 

Ultimately, when Obama claims to be taxing the rich and helping small business, he's doing just the opposite, and they know it.  Now you know it, too.

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