The Noise-to-signal Ratio as a Metaphor for the Deadweight Loss of Taxes

That is the name of an article of mine that was posted at the "Library of Economics and Liberty" site. Click here to read it. It is an elaboration and expansion on a letter to the editor of the WSJ I had published in 2007. Deadweight loss is a way for economists to show inefficiency of things like taxes and negative externalities. Deadweight loss increases at an increasing rate with taxes, similar to what I said in my letter.

Click here to go to my letter. Or you can read it here.

"Stephen Moore did a great job explaining how complicated our tax code is and how high taxes have gotten relative to what was originally promised in 1913. One other way to see the insidiousness of taxes is to realize that they are just as much the "noise" in the economy as prices are the "signals." The income you get paid is the price for your services and therefore signals the value of those services. But taxes reduce the clarity of that signal (hence, they are noise) by reducing how much of your pay you actually get to keep. As taxes increase, the noise-to-signal ratio in the economy increases even more, meaning distortions, and the misallocation of resources they cause increases disproportionately. For example, if the income tax rate is 10%, you keep 90% of your income. The noise-to-signal ratio is .111 (or .1/.9). But if the tax rate goes up by .10, or to 20%, the noise-to-signal ratio goes up even more, by .15 to .25 since you keep 80% of your income. The .25 comes from .20/.80 equaling .25. Another .10 increase in the tax rate increases the noise-to-signal ratio by .179 from .25 to .429. Then going from a 30% tax rate to a 40% tax rate makes it go up by .238, from .429 to .667. Every tax increase causes increasing damage to the economy's ability to efficiently allocate resources."

Testing the “superstar hypothesis”

The historic rollout of television in the United States provides a natural experiment in scale-related technological change.

By Tyler Smith of the AEA. It is not very long. But it is worth reading the whole thing. Excerpts:

"Technological advancement has brought enormous wealth and prosperity to humanity. But some technologies widen the gap between the haves and the have-nots, according to a paper in the American Economic Review: Insights. 

Author Felix Koenig found that so-called “scale-related technical change” in US television markets in the middle of the 20th century significantly boosted entertainer wages at the top of the distribution at the expense of those at the bottom.

The findings are some of the first empirical confirmation of economists' standard tool for modeling “superstar” dynamics."

"Koenig analyzed what happened to the wages of entertainers in the United States when local television stations became popular in the 40s and 50s.

Before television, an entertainer's audience was limited by the number of people that could fit in an auditorium or stadium. But local TV made it possible to reach significantly more people, creating local superstars.

However, television didn’t spread to everyone immediately like today’s new platforms."

"the launch of a TV station shifted more income to the entertainers who were already earning the most, with smaller increases at slightly lower income levels. And the further down in the income scale, the faster the gains disappeared. The impact could even be seen in the overall US wage distribution: the share of entertainers in the top 1 percent doubled."

Related posts:

How changing technology has affected inequality since 1980 (2019). Excerpt:

"Inspired by economist Sherwin Rosen’s landmark 1981 article, “The Economics of Superstars,” the three economists suggest that STS workers (Skilled tradable services) have become earnings superstars because, as Rosen showed, individuals with great talent can gain access to larger markets and incomes as communication costs drop. Competitors in that same market whose talent is just slightly less (or less popular) will lose market share to the star. Lower-skilled rivals make much less money than superstars like Serena Williams and Beyoncé, whose talents are shared instantly across world stages."

How Technology Has Changed The Distribution Of Income Among Musicians (2019). Excerpt:

"Sixty percent of all concert-ticket revenue world-wide went to the top 1% of performers ranked by revenue in 2017, according to an analysis by Alan Krueger, a Princeton University economist. That’s more than double the 26% that the top acts took home in 1982."

"Performers’ royalties—for acts big and small—are generally much smaller on streaming than on records, CDs or download sales, so artists have to turn to concert revenue for more of their income. And it’s only the superstars who have the ability to charge significantly more for tickets than their predecessors did a generation ago. That leaves non-superstar performers competing for a shrinking share of the concert pie." [Interesting point here is not that the technology is putting more money in the pockets of superstars but it means that only the superstars can make money the "old fashioned" way, from live performances]

Labor Market Headfake? Key Report Could Be Overestimating Job Growth (the Bureau of Labor Statistics' “birth-death model”)

Some data signal more weakness than high-profile payroll survey implies

By Gwynn Guilford of The WSJ. Excerpts:

"The payroll survey showed a gain of 339,000 jobs, while the household survey showed employment falling 310,000 and the number of unemployed leaping 440,000 to its highest level since February 2022. 

The two surveys often diverge because of statistical noise or because they define employment differently. For example, the self-employed are counted by the household survey but not the payroll survey, and their numbers fell sharply in May.  

Historically, economists consider the payroll survey a more reliable indicator of labor market health, except at turning points in the economy.

For example, from 2007 to 2010, a period dominated by recession and a weak recovery, the payroll survey overstated jobs by a cumulative 1.7 million, as shown by subsequent, more comprehensive tax data. 

A major cause of such overestimates is related to jobs created by startups and lost by business closures. The survey has no way of capturing businesses it doesn’t yet know exist, or whether a company that doesn’t respond to the survey is ghosting it, or has closed, until many quarters later, when tax data become available. 

Until then, the Bureau of Labor Statistics uses a “birth-death model” to extrapolate from recent trends how many jobs are created by new companies and lost to business closures. Its contributions are significant, said Omair Sharif, founder of Inflation Insights. “In some years, business net births make up around 40% of the payroll increase.” 

But when a weakening economy is closing companies and snuffing out new business, the model might erroneously count jobs that haven’t actually been added."

"It is also possible that the birth-death model is overestimating net new business creations, as it has at previous economic turning points."

"Jonathan Pingle, chief U.S. economist at UBS, said that the level of nonfarm payroll employment at the end of 2022 was likely too high by several hundred thousand, and that the overstatement might have carried into 2023."

"The employment decline it [the household survey] showed in May could be noise given gains in the prior two months, and the series is prone to swings." 

"three months of declines “would signal . . . that the labor market is at an inflection point and we are now truly shedding jobs”"

See also Comparing employment from the BLS household and payroll surveys from the BLS.

Related posts:

The economy added 339,000 jobs in May according to the establishment survey but the household survey showed a loss of 310,000 and a rise in the unemployment rate (2023)

The establishment survey and the household survey currently tell conflicting stories about unemployment (2022)

Why U.S. Job Gains Are So Hard to Count During Covid-19 (2021)

How is Iran in the 2020s like the USA in the 1920s?

The picture below is of a few paragraphs from the book The Economics of Public Issues, which I often used as a supplemental textbook when I was teaching.

Now for modern day Iran. See See Alcohol Poisonings Rise in Iran, Where Bootleggers Defy a Ban by Farnaz Fassihi and Leily Nikounazar of The NY Times. Excerpts:

"Iran’s prohibition of the drinking and selling of alcohol has led to a flourishing underground market. But even officials have acknowledged a wave of hospitalizations and deaths in recent months."

"Iranians . . . have found ways around the Islamic Republic’s longstanding ban on the sale and consumption of alcohol, which is punishable by a penalty of up to 80 lashes and fines."

"Rather than stopping drinking, the ban over time has led to a flourishing and dangerous bootleg market. In the past three months, a wave of alcohol poisonings has spread across Iranian towns big and small, with an average of about 10 cases per day of hospitalizations and deaths, according to official tallies in local news reports.

The culprit is methanol, found in homemade distilled alcohol and counterfeit brand bottles, apparently circulating widely"

"The clerical rulers who took power after the 1979 revolution, instituting a theocracy, banned the consumption and selling of alcohol in accordance with Islamic rules prohibiting intoxication. Religious minorities are exempt. Over the decades, reports of methanol contaminations occasionally surfaced, but not in the scope and frequency seen in recent months.

Even officials are now publicly acknowledging that the problem has escalated. Mehdi Forouzesh, Tehran’s chief coroner, said in a news conference in June that the number of hospitalizations and deaths from methanol poisoning had sharply risen. In only Tehran, he said, it had climbed by 36.8 percent since the beginning of March.

From the beginning of May until July 3, at least 309 people had been hospitalized and 31 had died from methanol poisoning, according to Iranian news reports. But the real number is likely much higher because many cases go unreported out of fear of retribution for breaking the law."

"644 people had died in 2022 from alcohol poisoning, a 30 percent rise from the previous year. Many victims permanently lost their eyesight."

"The police have discovered underground distilleries in a veterinary clinic, a roadside shack, a deodorant factory and abandoned warehouses. The business of bottled liquor can involve underground operations that pay scavengers to collect vodka and whiskey bottles from the trash to be filled with bootleg alcohol and sold as imported brand labels, according to interviews and media reports.

Experts say it is nearly impossible for an average consumer to detect deadly methanol, which does not smell or taste different from ethanol, in a drink. Home distillation increases the risk of methanol poisoning, they say, if the process is not carefully and properly executed."