--:-- Marianne McKeown: So, Marianne, can you just lay out how it works? Okay, so very simply, the U.S. government says, if you work but you're still poor, we're going to give you a bonus. And if you have kids, it's going to be a big bonus, a big chunk of money. It could be more than a third of what you made all year And it comes in one big lump sum When I was at the tax center in Newark I met this woman named Miriam Ochoa and she says she still remembers the first time that she got it I say, are you serious? This is for me? It was about $3,000, and that's after making only about $9,000 the whole year working part-time at a bank. And living on $9,000, that is really hard. Ochoa had to seriously save every penny of her money. She told me that on her long commute to work, she remembers going past this one McDonald's every day and smelling the french fries, but telling herself, You have to say no, because I have to pay my rent. Living on $9,000 is clearly very difficult. And if you want to design a policy that's going to help poor people, giving them $3,000 more, that seems like a pretty intuitive thing to do. But the EITC, the more you learn about it, the more counterintuitive it seems. So let's just walk through this. So imagine, you know, the way American policymakers have thought throughout history about helping poor people. You imagine the poorer someone is, the more help they need. So the more money you want to give them. So, for example, you get food stamps or you get subsidized housing. You get, you know, free government health insurance if you're poor. And if you start working and make enough money, you get kicked off food stamps or you get kicked out of your housing. You know, or you no longer have government health insurance because you no longer have need. And for most of us, we look at that and say that makes a lot of sense. And there's certainly lots of good arguments for why these programs are useful. But when economists look at that, they see something different. They see that you're actually paying people to stay poor. Right. So when they designed the earned income tax credit, economists were coming from a totally different direction. They did an economist mind flip. They said if the ultimate goal is to help people move up the economic ladder, then you have to pay them to move up the economic ladder. Somebody like Miriam Ochoa, when she made $9,000, she got a $3,000 bonus. When she made $15,000, four years later, she got $4,000 from the EITC. Then that's the sort of economist mind flip, right, is the more you make, the more the EITC pays you. And that's a pretty radical change. You know, it was in the 90s that the EITC was created in a big way, right? And that was when we were reforming welfare as we know it. So welfare up until that point had, for the most part, given people money because they proved that they had need. And then it would take that money away if they started working and made too much money. So the EITC was this new approach to that problem. Yeah, it's this very delicately designed equation. You start out, you make more and more money, you get bigger and bigger bonuses. And then at some point you peak somewhere, say, between $12,000 and $20,000, depending on how many kids you have. and then the bonuses start to get smaller again. But even when the bonuses are getting smaller again, they're not getting smaller so quickly that it makes you want to stay at a smaller salary. Right. And for Ochoa, this was like magic. When she first started getting the EITC, she was working part-time. She was caring for a son who was in special ed. She was on food stamps and she was in debt from her divorce. And since then, with help from the EITC, she has paid her debt. She's gotten off food stamps. She went to school for accounting And when she was unhappy with the Newark high school her son was going to have to enroll in, she managed to even move to a better school district. I found an apartment there, and I changed my son's life. Could you have moved to a nicer neighborhood with nicer schools without the earned income tax credit? No. No, no, no. Because my income is low. It's low income. OK, so we've got this delicately designed equation that actually pays you more the more money you make to help you move up the economic ladder. And then we have the second magic ingredient that makes the earned income tax credit so successful. And the second is that it just pays you cash. Like it follows a very simple idea that economists love, which is that the best way to help poor people is to give them cash and trust them how to spend it best. And this kind of aid to poor families in economics is called a cash transfer. And right now, the majority of the assistance the government offers to poor people is not cash. We're not spending a lot of time handing over cash. The government is giving poor people things like health care or vouchers for housing, food stamps, things called in-kind transfers. There are a lot of economists out there who really prefer the cash transfers to the in-kind transfers. And it's not just economists. If you ask someone like Ray Osorio, recent father of these two twin boys you hear napping loudly in his living room, cash is the only kind of help he wants. I know. I know how to spend it. For everybody else. I can't speak for everyone else. I'm not sure. What he needed was some cash to invest in his business. He wanted to start a luxury car service, get a fancy ride to shuttle around actors and diplomats. And he knew a lot of people like that because of his years working in the hotel industry. So when his twins were born, he actually cashed out his 401k to buy this fancy car. He started his business and is going along, but slowly. And he had just run out of all of his savings when he found out that he qualified for the earned income tax credit this year. And he said he was, quote, delighted. I was like, wow, that's incredible. That's a really nice number. That's more than a third of what you made last year, right? Definitely is. And it was incredible. So you're like, woo, we're going on vacation. Not at all. Not at all. I'm just looking down. I'm just trying to focus on the future. Hopefully my business will bring me plenty of vacations later on down the line. So we've got two EITC poster children here, Ochoa and Osorio. And there are millions more whose lives have really and truly been changed by this policy. But before we get too happy, Hannah, I do need to say that the EITC doesn't solve every problem. First of all, it only helps people who are working. If you don't or can't work, there's nothing in it for you. Some people that should get it don't, and some people game the system. They get it when they shouldn't. And there are a lot of economists who argue that if you didn't have in-kind transfers like food stamps or government health care, the EITC wouldn't be so successful. It has to exist alongside those other programs. Because a lot of people who are on EITC are also getting food stamps or getting those kinds of supports as well at the same time. Yes, it's different in every state, but certainly people benefit from both at the same time. OK, so maybe those things help the EITC be super successful. But still, the things that economists love about it, those things really do work. Marianne McKeown and Hannah Jaffe-Walt from 2013. In the United States and all around the world, the rich get taxed at a higher rate than the poor. But it took a while in the United States to come around to this sort of system that we have now. The founders of the United States did not include the idea of an income tax in the Constitution. And it wasn't until the Constitution was amended in 1913 that we got what we know as a permanent progressive tax system. Professor Derek Hamilton, what does that mean? It's progressive. And, you know, this doesn't mean politically progressive. It means it's economically progressive. Essentially, it means the more you have, the higher the tax rate you have to pay. And in the old days, there was this really wide range. If someone was poor, they would maybe not pay anything in taxes. But for the very richest of Americans at a certain point during the last century, I think their marginal tax rate was up to 70 percent on that very last dollar that they earned. This is a classic example of a progressive tax code, but some American taxes are regressive. What's a regressive tax and what's an example of that? A flat tax is a regressive tax. Everybody pays 12 percent? Everybody pays 12 percent of their income. That's regressive because some people just have lower incomes. When we think about consumption taxes, those are regressive taxes. Consumption taxes meaning like sales tax. A sales tax. Everybody who buys a bagel in New York City pays, I think it's like almost 9% of the price tag, something in there. Getting up there. 9% of a bagel doesn't mean very much to me, perhaps, but it might mean a lot to somebody who's making a very low wage. Yeah. If a bagel costs $10, that dollar that goes towards taxes for somebody who earns $1,000 a week is much less than somebody who earns $100 a week. So we have this progressive income tax code in the United States, and maybe you can say we do it because it's the right thing to do. But there's an economic way to think about progressive taxation, and that's through this concept called marginal utility. Marginal utility is the use that you get out of every extra dollar, let's just say. You hand me a dollar, put it in my pocket, maybe send it through the wash, maybe put it in the bank account. I won't necessarily spend it because I have extra money. Or you hoard it. Or if you give a single dollar to someone who is making below average wages, they're more likely to spend it or, as we heard in the story, invest in their business or even go to Disneyland. How does this marginal utility play into thinking about taxes? Is it literally that, like, a dollar means less to me than it does to them? You know, the concept of marginal utility is often thought about in an individual perspective. And indeed, there is this other concept in economics called diminishing returns. Explain that. It simply means the more you have of something having an additional unit of it at some point begins to tail off in terms of increasing value to you So we can give a simple example So If you have and you get an additional dollar well going from to might be less valuable to you than going from say $1 and getting an additional dollar. Double the money. And we can think of it in a literal sense in terms of being able to simply buy things. When you want to buy food, for example, if you have a whole lot of money, getting an additional dollar is not going to make that much of a difference in your consumption habit for food. But if you're lower income, getting additional dollars or an additional dollar will indeed lead to a bigger effect in terms of what you can actually consume. So if you're building a tax code and you know this economic principle, do you literally think, well, not that I'm taking from the rich and giving to the poor, but you're thinking like a dollar means less to a rich person than it does to a poor person? Well, if you ask them, they might tell you, no, it means the same to me. But also in economics, we know that revealed preference often happens through some behavioral thing. Don't tell me what you value. Show me what you value. But we can go a little deeper, Robert. We actually get to define value. We actually get to use our tax code. We get to, as a society, make choices of what we value. So we may not like the fact that poor people simply don't have enough money to eat. So as a society, we can ensure that people have enough money to eat. And furthermore, not only will they have enough money to eat, they can use that additional money in ways to invest in their own productivity that becomes more valuable than that single $1 would have been to somebody who's already wealthy. And as we heard from the earned income tax credit story, people across the political spectrum, they're okay with that. Coming up on our taxing episode of Planet Money Summer School, if the tax code can send money to the poor and even help them invest in their own futures, what other magical things can it do? Can it save the planet? After the break. Support for this podcast and the following message come from Indeed. You just realized your business needed to hire someone yesterday. yesterday. Indeed's sponsored jobs helps you stand out. According to Indeed data, sponsored jobs posted directly on Indeed have 45% more applications than non-sponsored jobs. 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Learn more at Insperity.com slash Tiger. Okay, class. It's about to get dirty in the summer school. We're going to talk about a dead economist, an impossible-to-understand equation, and somewhere in there a way that the government can nudge businesses to do what's right for society. It's a case study from Sarah Gonzalez and Jacob Goldstein, and it's the story of Arthur Pigou and the thing that he invented called Pigouvian taxes. Pigou was born in England in 1877. Okay, sounds like the beginning of a story. And for 35 years, Pagu was the only professor of economics at Cambridge University. And he started when he was really young, 30. Everything we know about Pagu is kind of patchwork-y because Pagu didn't want us to know about him. Nahid Aslanbegi is a Pagu expert, has been studying Pagu since the 80s, wrote a book on Arthur Cecil Pagu. I think he thought his life would be subject to a lot of scrutiny after his death. So he destroyed his private correspondence. He was a very private man. Pigou loved the outdoors. He was a serious mountain climber, would show up to fancy economics lunches in his climbing clothes with an ice axe and all of the... That's compelling. That's tough. But Pigou cared about the world and he cared about people. He cared about people living in poverty, kids working in factories, maternity leave. He wanted mothers to get maternity leave. A hundred years ago. Yes. How progressive of Pigou. Yes, he was a progressive, like a lot of the late Victorians. So Pigou loved the outdoors, and he was living near London at this time, the early 1900s, when air pollution had become a huge problem. They're burning coal, right? And it's like you see those old pictures where it's like dark in the middle of the day. It's like worse pollution than you can imagine now. Yeah, and the smog was called at the time London fog. Some people called it pea soup. It looked like pea soup. If you make split pea soup with yellow split peas, it was thick. It covered everything. It was an oily substance that covered furniture. Enter your rooms, you would breathe it. It killed people. It killed animals. And Pagu thought about this not just as an outdoorsman, but as an economist. As an economist, he also saw the cost of London fog. He thought it would increase health care costs. It would affect vegetation, livestock. It would wreck your furniture. Everyone would have to buy new furniture. Everyone had to wash their clothes more often. Those are all costs. And the people burning the coal weren't going to be paying for this. Innocent bystanders would. This is a problem economists have since come to call a negative externality, right? Negative because it's bad. It's external because it is some innocent third party being affected. It's not the company burning the coal to make the product. And it's not the person buying the product. It's just all the random people who have to breathe the polluted air. All the people who are external to the buying and selling of the product. And Pigou was the person who gave us this whole framework for thinking about negative externalities. And to be clear, Pigou didn't discover that sometimes private companies do things that hurt society. But what Pigou did was come up with a solution to the problem. And he laid out this solution in this key graph in a book he published called Wealth and Welfare. And then, like, once that came out, everybody was like, great, Pigou, thanks. We got it. Instant fame. Now, economists of 1912, they weren't quite ready for Pigou's graph. Well, they were baffled by it. Some people criticized it. and in the future editions of his book, I think he eliminated that graph. He didn't use it anymore. He took it out? He took it out because there were complaints. What were they complaining about? It was too complicated. His vocabulary, you have to really work through it very hard to understand what he's saying. Like anyone who writes anything in the early 1900s? Some are worse than others. I think his text is worse. Oh, okay. Interesting. Yes. Okay. So here, Jacob, is his terrible, not easy to understand graph. Okay. Apart from this condition, ON may be either greater or less than OM, according to the relations that subsist between the curves where ON is blah, blah, blah. And then there is a graph that is just brutal, just totally unintelligible. Yeah. And Nahid was basically like, you will never understand this graph. Okay. Fair enough. I'll give up now. Don't even try. Okay. So luckily for us, like later on, economists simplified Pagou's famous graph. So here is the more easy to understand Pagou graph. I'm waving my hands. Okay. We're doing graphs on the radio. Yes, it's hard, but we're planet money. We're going to do it. Okay. So there's an x-axis and a y-axis. The classic econ graph. Vertical axis is price. The horizontal axis is quantity. Okay. So far, so good. There's these two lines going up and to the right, basic, you know, positive slope lines on the graph. And one of them says PMC. Which is private marginal cost. OK, so private marginal cost. This is like the classic idea of cost, right? Like, let's go back to the Pigou, London fog, early 1900s world. Sarah, say you have a factory in London. You are burning coal to make your products, whatever you're making. Socks. I'm making socks. So this line, the private marginal cost line, is the cost for you to make socks in your coal-burning, polluting factory. That's the private marginal cost. OK. And then this other line says SMC. SMC, that's the social marginal cost. And that would be the cost on society for me to make my socks. So that one is not only the cost to you of whatever, the wool and the labor and the machines, but also the cost of all of the pollution that your factory is emitting. Exactly. That's the cost of everyone who gets sick from my pollution and everyone who has to wash their clothes and buy new furniture. That's the social cost. And in this graph, the social cost, the cost on society is higher than the private cost. So another way to say this then is when there is a negative externality, right, when you're running your polluting factory to make your socks, the price you're selling those socks at is too low, right? Because if I'm buying your product, I'm paying just the private cost for those socks. But the real cost when you take into account externalities should be higher. The socks that you're selling should be more expensive to take into account the cost of the pollution to society. That's his famous graph. And what this graph said for the first time to the whole entire world was that you had to put a price on these problems or they would never be solved You could calculate that cost and force the guilty parties to pay for it Like figure out how much London fog is costing people and then force the companies burning the coal, creating the London fog, to pay for it. Not the innocent bystander. That's what makes it a Pigouvian tax. There are plenty of other taxes on things that seem bad, like cigarettes and alcohol, but those taxes are meant to prevent you, the drinker or smoker, from drinking or smoking too much. It's not intended to do anything for innocent bystanders. If you want to put a Pigouvian-style tax on alcohol, a government would have to say, OK, what problems does alcohol cause third parties? Crime. When people drink more, they're more likely to commit crimes. Would a government have to say, OK, how much is crime costing us as a result of alcohol? Yes. So how do you know how much crime has been caused by alcohol? Well, that's a million dollar question, isn't it? It's really hard to measure how much crime brought on by alcohol specifically is costing taxpayers or how much smokers who get lung cancer and don't have health insurance cost taxpayers or how much pollution costs society. Sarah Gonzalez and Jacob Goldstein from a show we did in 2019. This idea, the Paguvian tax, was later used to develop carbon taxes in countries like Canada, New Zealand, and Scandinavia. They figured out what burning fossil fuels cost society in terms of climate change, and added that as a tax to companies that sell and produce those fuels. But there are other Paguvian taxes. If you'd like to see one in action, you can come drive in New York City and Manhattan. There is a new congestion tax on cars who drive at a certain part of Manhattan, which is meant to reduce the negative externality of crowded roads, externalities like lost time, pollution, noisy streets. And guess what? After they put the tax in, travel times on the streets of Manhattan have improved. The extra tax money is being spent on public transit. We'll talk about how these taxes work and the unintended consequences with our professor after the break. Support for this podcast and the following message come from Fidelity Wealth Management. Vice President Financial Consultant Jermaine Edwards shares why he helps clients align their investments with their goals. My mission is helping as many people as possible, whether that's helping them watch their grandkids play softball, retiring and traveling the world. I'm very passionate about helping people achieve their ultimate goals. Learn more at fidelity.com slash wealth. Investing involves risk, including risk of loss. Investment minimums apply. Fidelity Brokerage Services, LLC. Member NYSE SIPC. So we're back with our professor, Derek Hamilton from the New School. Hey, Derek. Hey, Derek. You're so excited by taxes. Oh, yeah, I get excited. Let's go to the very basic economic principle of using taxes to change behaviors, whether it's corporate or individual. Why does putting a tax on something create less of it? It makes something more or less expensive. It's pretty simple, right? It's like supply and demand, and the government steps in and makes some things more expensive and some things less expensive. Yes. And we are more likely to do the thing that is less expensive. That's right. How does the government decide what it should put these taxes on in order to influence people? You know, you can make the negative externality argument by making the case that if somebody gets more sickly from the types of food they consume, like sugary drinks, that that becomes a burden on our health care system. But like all taxes, it's often done due to political process. These taxes often work, but there's ways in which they don't work. So one way is that people find a way to avoid the taxes. Maybe they don't have a sugary drink, but they spend it on something else that's bad for them, right? So you always have to think with these taxes, you're not just discouraging one thing. You may be encouraging people to shift to another thing. We use the word unintended consequences. It might divert activity in one area, but sometimes that activity will reappear in other areas in ways that we may have intended and also unintended. People are so, so clever. I'm curious, Professor, as you look around society, is there something that you think has a negative externality? It's creating problems for society that is not priced in that we should put a Pigouvian tax on. Well, frankly, I got a pet peeve with all the junk mail I get, both electronic and paper. We just had an election here. Yes. So from a personal perspective, I would love that there was not a zero cost of sending emails that I certainly don't want to read. And frankly, I wish we taxed some of the mass bulk mailing that I get on a daily basis and have to dispose of. And surely it's not good for the environment. This is genius. And we learned from this episode that you have to kind of work it out. Like, what is the cost to society? How much time are you spending, right, going through junk mail? So we'd have to figure that
