[Edward C.] Prescott [a 2004 Noble prize winner] visited with us on The Investing Revolution in 2007 to discuss the topic. Here’s a startling fact: Based on labor market statistics from the Organisation for Economic Co-operation and Development (OECD), American workers aged 15 to 64 work 50% more than French workers. Comparisons between Americans and Germans or Italians are similar. What’s going on here? What can possibly account for these large differences in the hours people work? It turns out that the answer is not related to cultural differences or institutional factors like unemployment benefits. Rather, “marginal tax rates explain virtually all of this difference,” says Prescott. He goes on to say, “I’ve made this point about tax rates before, but it bears repeating because it reflects a fundamental economic insight that gets to the heart of policymaking: People respond to incentives. You don’t make economic policy for nations; you make it for people. And it’s the responses of those people, when aggregated, that give us those data that we all love to analyze.
In fact, the current marginal income tax rate in the United States shown in Figure 1-1 rewards dual-income households more than it did in the 1970s when the average tax rate doubled when a spouse joined the workforce. Now that more people are working, there is a greater need for labor to do some of the things people often don’t have time to do for themselves—like provide child care, prepare meals, clean the house, and run errands. Prescott goes on to say, “The bottom line is that a thorough analysis of historical data in the United States and Europe indicates that, given similar incentives, people make similar choices about labor and leisure. Free European workers from their tax bondage and you will see an increase in gross domestic product. The same holds true for Americans and Europeans who live and work in America.”
When I first came to this country in the late 1970s, a sort of ethos had been set by John F. Kennedy, who had said earlier that if you’re young, if you’re idealistic, and if you care, join the Peace Corps. Become a public servant. So the idea was that if you work for yourself or if you’re an entrepreneur or an investor, well, you’re kind of a greedy, selfish guy, but if you go work for the Department of Education, you’re a noble person putting the public good ahead of your own.
“Reagan challenged all that, and he said, it’s not the public servant—who would be called, by the way, the bureaucrat—but rather the entrepreneur who is the embodiment of the American dream. And so Reagan was pushing for a cultural shift. And I think we’ve seen that. We’ve seen a cultural shift in America today, so more parents today would probably like their kids to be like Bill Gates rather than, say, Bill Clinton. And that’s going beyond politics. So when I look back at Reaganism, most people would focus on the Cold War and so on, but I think Reagan also produced
an economic and a sort of cultural shift in the United States.”
And politics takes advantage of that, the prejudice against the rich guy, the successful guy, the entrepreneur. The basic idea is that they must be succeeding at the expense of everybody or they must be succeeding by finagling their way to success, and I think ultimately entrepreneurs are in some ways always on the defensive against this kind of thing.”
I keep hearing people say, ‘The rich are getting richer and the poor are getting poorer.’ But when I actually looked at American living standards over the past generation—let’s say from World War II, or even from 1980—what you see is that the rich get richer, and the poor also get richer, although not at the same pace. So, yes, inequality does rise, but it’s rising because more people from the middle class are moving up.