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65 September 25, 1978 TAX-BASED INCOME POLICY: LATEST APPROACH TO WAGE AND PRICE CONTROLS INTRODUCTION The program of wage and price'controls enacted by Richard Nixon ended in,early 1974, but inflation has started to rise again in the United States and recen t opinion polls show it to be the public's number one concern. At present, Administration policy is restricted to "jawboning as it is termed (i.e exhorting unions and management to hold down wage rises and working with them behind the scenes. The Administr a tion has an "inflation czar as The Washington Post has termed him, in Robert Strauss who is claiming major successes in particular industries; but still inflation continues rising and the public sees current efforts,as only a public relations exercise. Ge o rge Meany, President of the AFL-CIO, has applied the term "wishboning" to the Administration's policy; and Arthur Okun, former Johnson Administration Council of Economic Advisers Chairman, has said that President Carter is do ing everything possible to ma ximize the possibility of a miracle. The Council on Wage and Price Stability under Barry Bosworth has had major disputes with labor is little surprise to have talks of wage and price controls re surfacing. Within the Congress, the Joint Economic Committee recently advocated "limited" controls and suggested a tax-based income policy (TIP) be given serious consideration The staff of the Senate Committee on Banking, Housing, and Urban Affairs is known to be drafting TIP legislation for introduction by Senato r William Proxmire (D-Wis late in 1978 or early in 1979, and eight members of the House of Representatives (Representatives Lundine and So against this background, it 2 Pattison of'New York, Mikva and Simon of Illinois, Moorhead of Pennsylvania, Fisher of V irginia, Maguire of New Jersey, and Mikulski of Maryland) havejoined in the introduction of H.R. 13865 the "Comprehensive Anti-Inflation Act of 1978," which also embodies a TIP scheme.. This legislation was referred to the House Commit tee on Government O p erations and the House Committee on Education and Labor, before which it is currently pending TIP also has strong supportwithinthe Carter Administration as indicated by reports that staff employees of the U.S. Treasury Department and Internal Revenue Serv ice were instructed to cancel their summer vacations so that they might work to determine what sort of TIP legislation should be promoted by the Administration. Lyle Gramley of the President's Council of Economic Advisers has been quoted as saying that "TI P is becoming more attractive simply because the other alternatives aren't much better or they're not working The FederalReserve Board of New York, formerly a strong advocate of monetary discipline and free enterprise, recently sur prised several observer s in its 1977 annual report, released on February 28, 1978, by suggesting that an income policy might be necessary to beat inflationary expectations and citing Britain as evidence. The AFL-CIO predictably announced its opposition to con trols as rumors spr e ad, and business is almost universally against them. TIP also enjoys the support of such leading figures as Henry Wallich of the Federal Reserve Board and Arthur Okun of the Brookings Institution (Brookings received a $75,000 grant from the Ford Foundatio n early in 1.978 toward conduct of a seminar in Wash ington, D.C., designed to focus on TIP It may also be highly significant that, as reported in the September 20, 1978, edition of The Washinqton Post; "White House anti-inflation czar Robert S Strauss" ha d stated that "President Carter should adopt 'the toughest possible' wage-price program he can, and not listen to those who contend it would hurt him politically This datum as sumes added significance when it is noted that, speaking on Septem ber 20 before the annual convention of the United Steelworkers of America, President Carter announced that he would soon disclose de tails of a "tough" anti-inflation program. It is expected that this program will be centered around a set of "voluntary" wage price guid e lines backed by a system of limited sanctions TAX-BASED INCOME POLICIES The Initial Proposal Wallich and Weintraub Although some economists had thought that there was some merit in taxing either firms or employees in the event that they needed or achieved large wage incomes during the 1960's, the first expo- sition of a comprehensive scheme along those lines to fight infla tion was made in 1971 by Henry Wallich (currently a governor of the 3 Federal Reserve Bank) and Sidney Weintraub (now Professor of Eco- nomics at the University of Pennsylvania 1 The Background The exposition of a tax-based income policy could not be mean ingful without a prior understanding of the economic context in which the proposal was made. Wallich and Weintraub were essentially pes simistic about the efficacy of wage and price controls to have any "real" effect on underlying rates of inflation in the U.S. economy. They acknowl edged that the cause of inflation is expansionably monetary and fiscal policy and that price and wage contr o ls can certainly pre vent inflation if they simply dictate the level of price increases and the government has official clout to enforce this, but as soon as controls are released prices rise faster than before the con trols, resulting in a situation wher e the price level is not appreciably lower2 and may even be higher3 than 'it would have been in the absence of controls 0 They alsoconsidered the serious effects of controls on re source allocation via reductions of production, and the inability of price c h anges to signal changes in consumer preferences. Never theless, they considered that the institutional structure of the U.S. economy4 is such that monetary and fiscal policy could only lower inflation at an economic cost in terms of lost output 1. Henry C . Wallich and S. Weintraub A Tax-Based Income Policy," Journal of Economic Issues, June 1971 2. See, for example, Michael Parkin in Lloyds Bank Review, July 1975, and Edgar L Feigu and Douglas K. Pearce, "The Wage-Price Controls Experiment Did It Work Chal l enge, Vol. 16, No 3 (July/August 1973), for analysis of the U.K. and U.S situations respectively 3. See Timothy W. McGuire, "On Estimating the Effects of Controls" in The Eco nomics of Wages and Price Controls, Vol 2 of Carnegie-Rochester Conference Serie s on Public Policy, edited by K. Brunner and Allan H. Meltzer (Amsterdam: North Holland Publishing Company, 19761, pp. 115-156, and Charles H. Whiteman A New Investigation of the Impact of Wage and Price Controls," Federal Reserve Bank of Minneapolis Quart e rly Review, Spring 1978 4. And Britain as well it would seem. Weintraub madeoneof the original ex planations of the proposal in the Lloyds Bank Review (January 1970) perhaps with the anticipation that any form of wage and price policy was more likely unde r the then) socialist government in Britain than President Nixon in the U.S event, the Labor Party lost power in 1970 and a Conservative Government was elected under Mr. Heath. When the government imposed controls in 1972, they reverted to the classic rigi d controls typical of the 1966 freeze In any 4 and employment. This was because, on the one hand, industry con tinued a large degree of concentration in the marketing and service sector and thus had considerable ability to "administer" prices and, on the o t her, labor had a powerful union structure over a large part of the economy including many remuneration agreements with scope wider than' just individual firms. Hence, restrictive monetary policy would be accompanied not by rapid reductions in the rate of i ncreasing prices and wages, but by a continuing'high level of price and wage hikes based more on historical circumstances and the actions of competitors than on anticipation of future aggre gate demand. This would mean that firms would find themselves fac ed with concurrent falling'demand for their output and rising costs for their labor output. Hence, a recession would develop. In the 1930's wage and price controls fell because of a different institutional structure to the present day, but now the cost in terms of lost output was a major item to be borne in mind when consider ing macroeconomic solutions to inflation. To give the reader an idea of the kind of costs which proponents of TIP envisage, George Perry of the Brookings Institution has estimated tha t one percent increase in unemployment will lower the inflation rate by 0.3 per centage points in.the first year and 0.7 percentage points if main tained for three years. Furthermore, one percent unemployment is equivalent to 60 million of lost output. It is against this model of the economy that TIP has been ac cepted.by its .main proponents, -and it is in an'attempt to anticipate the side effects of monetary restraint that it seems to have fun neled support amongst many people close to the policy proc e ss.5 TIP has been proposed at a propitious time for its proponents, for inflation shows no signs of abating and politicans are reluctant to tighten monetary policy to make it. It is perhaps because of this poverty of alternatives that the Joint Economic C ommittee re cently held two days of hearings on TIP and said We have long been on record as opposed to comprehensive wage-price controls and we do not recommend them now. However, we are deeply concerned that pressures will mount for such policies if we do not get inflation under control. We should therefore implement an in comes policy now so that we will not be driven into more drastic measures.later One idea that deserves serious consideration is a tax-based incomes policy TIP) .6 5. See, for example, U . S. Congress, Congressional Budget Office, Recovery With Inflation, July 1977, p. 40; U.S. Congress, Joint Economic Committee, The 1977 Midyear Review of the Economy, 95th Congress, 1st Session, September 26, 1977 p. 76 6. U.S. Congress, Joint Economic Com m ittee, 1978 Report. 5 SHORT RUN OR LONG RUN However, Wallich and Weintraub did not propose TIP solely as an ameliorative measure during the process of price stabilization ad justments. True, they say It would be an error, however, to regard an incomes pol i cy such as we propose as a substitute for monetary and fiscal policy. Instead, the proposal is conceived as a supplement to the familiar monetary fiscal poli cies so tha.t the economy might operate closer to full employment without the inflationary change s of excess demand and "overheating .I' 7 But the important word here is "operate" for they also state TIP deserves consideration as a long run solution. One of the clearly demonstrated characteristics of other forms of incomes policy is that, given that t hey are attractive initially, they tend to break apart in the course of time. The effectiveness of TIP should im prove over time as administrative techniques are per fected and the market learns to respond to it.8 (Empha sis added. 1 In other words TIP is a long-term policy'to, in the proponents' be lief, run the economy at a higher rate of employment without in flation. Thus, politicians are latching onto TIP for one reason whilst its authors envisioned it for another. It is also not clear what kind of mo n etary policy various TIP proponents consider as appropriate. Weintraub, for example, says Given. a suitable incomes policy to align wages (and salaries) to productivity, monetary policy would be released to make its contribution to full employment Full em p loyment requires ample money supplies for its sustenance. 9 And Robert J. Gordon, at a recent Brookings conference, certainly saw an exposition by Lawrence S. Seidman as implying an "accommo dative" monetary policy. 10 fiscal policy" is, in fact, a euphem i sm for the suspension of marketing restraints and the original authors' acknowledgement of It seems that "appropriate monetary and 7. Wallich and Weintraub, op. cit p. 1 8. Wallich and Weintraub, op. cit p. 18 9. S. Weintraub Incomes Policy: Completing th e Stabilization Triangle," Journal of Economic Issues, December 1972, pp. 105-22 10. See Brookinqs Papers on Economic Activity, Issue 2, 1978, p. 349 Brookings Institution, Washington, D.C. 6 monetary and fiscal policy as the cause of inflation as well! H owever, Arthur Okun of the Brookings Institution has explained the policy more'in terms of an ameliorative measure for the price of returning to price s.tability. 11 A.D.ETAILED EXPLANATION OF WALLICH AND W.EINTRAUB'S ORIGINAL PROPOSAL In essence, Wallich and Weintraub advocated that the govern ment should announce a "guidepost" for wage increases; for exam?le 5 percent. Any firm settling for a wage increase greater than the guidepost would be penalized by% higher rate of tax on its profits For example, if profits tax were 40 percent and the firm settled a wage increase of 6 percent.(i.e., one percent above the guidepost) then the excess tax may be 2 percent and the firn would pay 42 percent profits tax rather than 40 percent. They also envisage that the pr o fitstax would be progressive so that the higher the wage settlement above the guidepost, the greater would be the excess tax on the firm's profits. Wallich and Weintraub also foresee the government changing the rate of excess profits tax as time passes un til, they say, a point was reached where the policy was truly effective. Most interestingly,perhaps, the proposal does not tax waqes directly, but the profits of the firms,because the intention bone Implicit in this is the notion that wage bargaining is at least in the manufacturing sector of the U.S. economy, simi lar to pollution. In normal circumstances the union and the em ployer bargain and diverge and, even though the process may in volve some industrial disruption, in the final analysis a wage barga i n is arrived at which the employer can pass on to the con sumer. Thus, unions and employers may "externalize" the costs of wage increases (ensure they are borne by sources other than the participants to the bargaining process As evidence of this Wallich a n d Weintraub cite the historical relationship exhibiting approximate constancy in labor's and capital's share of the na tional product. The cost of wage increases has also been in excess of the long-run increase in productivity but has not resulted in unem p loyment and a squeeze on profits because the government has pursued expansionablyfiscal and monetary policies that have main tained employment at high and approximately stable levels. in the minds. of the authors, is to "strengthen the employer's back 11. Arthur M Okun, Vhe Great Stagflation Swamp I Challenge, November December 1977. 7 The second interesting feature of the poligy is that it is aimed at correcting the asymmetry in the bargaining process between the relative strengths of capital and labor. T o the extent that the burden of restraining union power is passed from politicians to em ployers, TIP will find great favor with Congress and the White House. Experience in America has been that "jawboning" by the President's aides and even, at times, by t he President himself has simply made the President look powerless, but TIP passes this buck to business and could thereby be termed "a 'hired-gun' incomes policy. The economic logic for TIP is that set out above, and Wallich and Weintraub point out that t he idea of firms simply fixing prices as a markup over costs is shared in many econometric models of the U.S. economy. The inflation restraints function works,. say the authors, because the firm would settle lower increases, and thus the markup would resu l t. in proportionably lower price rises, causing in flation to steadily decline restraints on prices because of the "historical relation" of the constant ratio of prices above cost that this could not rise. Furthermore, implicit within the foregoing statem e nt is the assumption that firms could not pass on in price increases any of the excess tax on profits were they to be forced to settle above the guidepost. Wallich and Weintraub do not, how ever, hinge everything on the "historical relation" and suggest t h at if labor objects to profiteering, then an excess profits tax could be introduced to supplement TIP There would be no need to place any Competitive pressure would probably ensure WHY TAX PROFITS TO RESTRAIN WAGES It may have struck the reader that Walli c h's and Weintraub's proposal is very "indirect In order to lower wage increases, they propose the taxation of profits, so why not go straight to wages and tax increases above the guidepost by making them not deductible for income tax purposes or by levyin g a dollar-for-dollar payroll tax? Wallich and Weintraub point out that such a tax would be shiftable. Labor would simply add an amount onto its wage claim to compensate for the tax, and management would pass it onto the consumer. Such a system of direct tax would also be more complex to administer. It should be stressed that it is not the intention of TIP to raise revenue for the government, so any revenue gained would be offset by tax reductions elsewhere--perhaps on the profits tax of firms who do sett l e within the guidepost; they could receive credits propor tional to the difference between the guidepost and their settlement SETTING THE GUIDEPOSTS As for the ckiteria for setting the guideposts, there are some economic features to bear in mind,although t he choice is ul'timately a political one. The economic fact that the government must take 8 into account is that there is a long-run productivity growth rate in the economy which, in the case of the U.S is approximately 3 percent. Thus, if the inflation r a te is 10 percent at the time of implementation, the government could choose any figure between and including 3 percent to 13 percent for the guideposts,depending on how far and how fast it wished to slow inflation. The figure is clearly related to the ave r age growth of productivity and does not allow for higher wage rises for higher productivity gains in par ticular firms or industries except at the cost of a fine in the form of the excess tax. It is because, at the firm level, wages can be raised for this reason or simply to accede to a powerful union that Wallich and Weintraub call TIP something of a "free market" solution to inflation and attempt to get support from market economists for it As will be argued below, the fact that relative prices can still adjust, albeit at a cost, is.a rather selective use of the notion of a free market ADMINISTRATIVE QUESTIONS Several points of administrative interest still need to be clarified TIP would have to apply to total remuneration, not just wages and salaries (e. g., fringe benefits, bonuses, etc and it would have to be adjusted on a per employee basis if it were to actually succeed in restraining total money expenditure. It would also have to rely on data that arealready available if it were not to induce the grow th of a new bureaucracy. Furthermore TIP would induce a change in the "skill mix" if employers could release higher skilled workers and employ lower skilled ones,as lower skilled workers typically would have lower wages and hence could be given larger rai ses before the firm's wage bill rose to the level where it was when the higher skilled workers were employed. There would also need to be the now-understood regulation associated with any policy of controls to prevent "regradings" and shop dls missals foll owed by reappointments at higher wages. For these rea sons Wallich and Weintraub propose that the classification should be Total wage and related payments in each job classification and grade, divided by the number of man-hours worked in the respective ca t egories, and combined into a weighted index of wage incomes. This would give a fairly water tight specification of. a wage increase. The data should be available on the records 12 12. Hehry C. Wallich and S. Weintraub, op. cit p. 14 9 Nevertheless, they d o see a shift toward less-skilled labor as necessity, a negative by-product of TIP as it would tend to lead towards greater income equity SCOPE AND COVERAGE OF TIP For administrative and economic reasons, Wallich and Weintraub would exclude small firms fro m coverage. To have its desired ef fect, they say, only firms with profits in excess of 1 million would need to be covered. Similarly new firms could be excluded as their size is likely to be insignificant. More difficult they feel, is the question of long -term con tracts. Difficult legal and political questions would be raised if pre-existing contracts g.ave wage increases significantly higher than under TIP. Even if the problem were solved by excluding from excess profits tax those firms that had entered theathere would still be the problem that TIP would take three years to be fully effective. For public utilities, where there is an established practice of regulating authorities,allowing them a "normal" and steady rate of return, there are clearly possibilities for profits tax shift ing ment and exclude utilities from TIP than upsxt it. Wallich and Weintraub would rather continue with this arrange AN-EVALUATION OF TIP The success or otherwise of TIP crucially depends on firms not being able to shift forward to consumers the excess tax on profits that the government levies. Nevertheless, their d i scussion of the subject is very unsatisfactory that all they have done is express a vague hope that the tax will not be passed on.13 in concentrated industries relative to competitive industries is evidence of little tax shifting. They suggest that the ef f ect of a profits tax hitting different firms unequally may be the reason for the fact that it is not passed on, unlike a payroll tax which does hit all firms equally. But absence of supernormal profits in a concentrated industry can be explained by other t han profit It seems to leave the impression They say that the lack of greater profitability 13. Henry C. Wallich and S. Weintraub, op. cit p. 5. 10 maximizing behavior on the part of firms and is. not any kind of evidence of the inability to shift the cor porate income tax Other studies14 conclude that the burden can be shifted, depending on the firm's behavior; and Musgrave and Musgrave15 in a detailed analysis conclude that the empirical evidence (the "litmus test of any theory) is inconclusive. Isard's study and Miller's study are especially interesting. Isard compares two cases: in the first, the firm is a profit maximizer and in the second, it follows amarkuprule. It sets prices. at a certain percentage above what costs happen. to be. The firm.is assu med to face the same constant elasticity demand curve. in both cases,bu.t in Case 1 knows the curve and in Case 2 does not. His analysis concludes that in the first case (prof it maximization) the firm.wil1 first of all make the output de cision and then p ay tax on the profits; thus, the tax .will. not be passed on. However, in the second case the whole of any in crease in labor costs is shifted forwarband also a fraction or multiple of the increase in tax assessments. Although Isard sees Case 1 pricing be havior as more likely to reflect real-life business behavior, his Case 2 pricing behavior is a closer approx imation to the real-life pricing behavior assumedby Wallich and Weintraub. Miller, in his analysis, assumes that the revenue raised by TIP is redis tributed to firms that increase unit labor costs by less than the TIP guidepost and Weintraub, that'the firm has some "price administering power i.e., it faces a downward sloping demand curve. In this situation he notes that TIP becomes a-tax on labor. If an employer wishes to hire one more worker,then he has to pay the market wage rate. Assuming a rising supply curve, this means that the hiring of an extra employee under TIP, with the tax included, is unprofitable whereas it would have been profitable wit h no TIP. However, it is now very profitable to sack employees, for the employer is entitled to a subsidy for reducing unit labor costs by producing less with fewer employees; But becauseless is being produced the price of each unit.of output is higher,so TIP has raised the price level and reduced wages. It has also increased the profits of the firm. As the evidence is considered, it is difficult to say anything very definite about the ability of firms to pass on corporate taxes,and this constitutes a seri ous'charge against TIP proponents It also assumes in line with Wallich 14. Economic Journal, September 1971; Preston Miller, "TIP: The Wrong Way to Fight P. Isard, "The Effectivenessof Using the Tax System to Cut Inflationary Col lective Bargaining: An Ana lysis of the Wallich-Weintraub Plan Journal of Political Economy, May-June 1973, pp. 729-740 15. Richard A. Musgrave and Ryan B. Musgrave, Public Finance in Theory and Practice (New York: McGraw-Hill Book Company, 19731,Chapter 18, pp. 415-419 See John Ho t son, "Advance Effects of Tax'and Interest Hikes," Canadian Inflation," Federal Reserve Bank. of Minneapolis Quarterly Review, Spring 1978 11 THE EFFECT OF TIP ON WAGE SETTLEMENTS Nevertheless, assuming that not all the tax can be passed on, the effect of T IP on wage settlements is the next major question. Wallich and Weintraub assume a model of collective bargaining in which manage ment gradually increases its wage offer during the negotiating time which may include industrial disruption such as strikes) a nd labor gradually reduces its claim. This arises due to increasing costs to both parties due to strikes, disruptions, etc. The effect of TIP say Wallich and Weintraub, is to increase management's "backbone" and make it hold out longer. For example, consid er the following. The government announces a TIP guidepost. The effect is to move the management wage offer curve down and, if the union's wage demand curve remains. at its ori ginal position, then the wage settlement is reduced A lower settle ment has be e n reached (as TIP proponents claim) but at a,cost of more industrial disruption. Now consider what will happen if the unions grow disgruntled with TIP after some months and start to make higher wage claims but do not lower industrial disruption at a faste r rate. This could be termed an "increase in militancy In other words over a period of time union response has rendered TIP both ineffec tive at restraining wage increases and more costly in terms of strikes. Supposing that the government responds by incr easing the excess tax on profits, thus moving management's wage offer curve further down, then by this time strikes will have become so ubiquitous as to render all the virtues of TIP meaningless. Management and labor would be in a state of "industrial civ i l war" and screaming at the government to repeal the policy. The long-term implications of such an increase in industrial militancy are even more worrying, for'if it increases during a TIP period, will it dissipate just as quickly? British experience sugg ests that the demonstration effect proves otherwise. Once labor grows big muscles, it starts to flex them. Little is to be found in the writings of TIP proponents about the possibility of this; and that fact alone is surprising because what is essentially taking place, in the latter scenario, is a change in the institutional structure,and all the major writers on TIP are people who give the greatest attention to institutions in their analyses attention to an institutional change which is, of itself, a suf ficient condition to render the credibility of TIP meaningless It is odd that they should have given so little A possibility which would appear to enhance the chance of the phenomenon described above is that due to the tendency for prices to adjust to wag e s with a substantial lag, there would be an initial windfall increase in the product share of profits upon the implementation of TIP. This was certainly one concern ex pressed at a recent conference at the Brookings Institution.16 16. Brookings Papers on Economic Activity, Issue 2, 1978, pp. 351-353, 257. Brookings Institution, Washington, D.C. 12 WOULD BUSINESS LIKE TIP Not only would labor oppose TIP, but so would business. It would be placed right in the firing line of the anti-inflation battle responsible for causing a disease which government had crea t ed. Traditionally a supporter of strong monetary and fis cal policy to curb inflation, business morale would plummet and investments slump as firms sOUght-.tO keep assets liquid in case they should have to face a large wage demand and because the outlook u nder a long-term TIP would be very depressed WOULD TIP LET THE MARKET FUNCTION The great claim for TIP over strict controls on wages and prices is that it would let the market function tioned earlier this relies on a very selective idea of what a function i ng market is. Certainly prices would be free to rise and fall, but the ability of firms to react to changes in prices as signals of unexploited profit opp~rtunitiesl~ would be severely hampered by the tax they would have to pay if they wished to hire labo r or raise wages for existing employees. As a.result profit opportunities (i.e.,consumer wants) would either go un satisfied or be provided for by imports. More broadly, TIP takes no account of millions of changes in productivity that occur every year in a sophisticated economy like the U.S but simply limits wage increases to the national long-run average. This is a fatal flaw, because the long-run national average growth of productivity is barely a'real figure'. Certainly, someone in America probably achie v ed it over the last few years, but it is essentially a sta tistical construct. It is the statistician's way of trying to make sense of a world where there have been thousands of new terms created and old ones destroyed, millions of new products introduced and changes in the whole structure of the economy and its technology; and, as such, to apply it to the determination of all wage settlements is to take macroeconomics beyond the extremes of its usefulness. John Dunlop of Harvard, an expert on labor econom i cs, puts it more straightforwardly However; as men Single, uniform standards for wages, as for prices, are simply not effective.18 17. For one of the best discussions of the role of entrepreneurship, see Israel M. Kingner, Competition and Entrepreneurship , New York, 1971 18. Quoted in Business Week, October 3, 1977. And when would TIP be implemented? When is the market in equilibrium so that imposing a "single uniform standard" will not create perceived inequities How is the problem of multiyear contracts to be resolved? Wallich and Weintraub do not have a satisfactory answer THE ADMINISTRATIVE PROBLEMS OF TIP Furthermore, the administrative problems with TIP could be enormous. There are problems of scope and coverage,and proponents say that only companies with profits of $1 million or the Fortune top 1,000 would need to be covered; but inevitably distortions will arise that Yill get worse with time In some industries there are longstanding union agreements that apply ta large and small firms alike where go v ernment. mandated severance would be found to create friction. Reeslg raises many questions of this kind, such as, what would happen.ifa union struck an industry-wide or pattern-setting agreement in excess of the guidepost with an unprofitable chain that w ould suffer under TIP? The implications would certainly rebound elsewhere,and thecostsof wage settlements would still be externalized--one of the problems that Wallich and Weintraub assert they would solve. How would non-profit-making institutions be trea ted? Some of these are quite large and the government, as one of them, could find itself a prime target. Anotherclaim by its proponents is that TIP would not require any new bureaucracy, but this is a claim that has been made for all controls since World W ar I1 and has never proved to be the case. Gardner Ackley has commented From my experience in designing and administering price controls during World War 11, and again, in a policy role, during the Korean War, I retain keen, and some times bitter,memories of great ideas of about ways to restrain wage and price increases for which the fine print could never be written-or if it could be written filled endless volumes of the Federal Register with constant revisions, exceptions, and adjustments neces sary to c over special situations that could never have been dreamed of in advance by the most imaginative economists accountants and lawyers. 20 19. A. Rees, "New Policies to Fight Inflation: Sources of Skepticism," Brookings Papers on Economic Activity, Issue 2, 1 978, pp. 453-477 20. Gardner Ackley, "Okun's New Tax-Based Income Policy Proposal," Economic Outlook, USA, Winter 1978, p. 8 14 It is difficult to see how the proposals could even be ad ministered accurately at the firm level, even with the firm acting on good faith,because the definition of employee compensation put krwardby Wallich and Weintraub (see above) asks for statistics which initially no large firms currently compute and certainly no small ones do CONCLUSION The view that controls or incomes poli c y can contribute to a permanent reduction in the rate of inflation associated with any given level of unemployment (i-e a reduction in the "natural rate of unemployment) is fundamentally misguided. As an indica tion of the adjustment process to a stable p rice level, TIP is likely to make things worse, in terms of wage settlements and strike costs, rather than better. Above all, the distortions that such policies induce in the market reduce the economic wel fare of everyone. More insidious but no less impor tant is the tendency of con trols, even a novel one like the above, to detract from the real cause of inflation. The real cause is laxity in monetary and fiscal policy over a long period of years that has built-up in flationary expectations to such a leve l that it will not be pos sible to eradicate them in a matter of months. Nevertheless the adjustment, if it started now, could reduce inflation to tolerable levels by the end of 1980, but progress in this demands our attention to the task that is not engen dered whilst short-cuts are mistakenly believed to exist. The economists who believe that the economy can be interfered with to any degree by government have, essentially, an engineer's view of economics. An engineer is told a particular end to achieve he has all the necessary information on the state of technology and he has only a few variables to deal with The economist, by contrast, does not know the value hierarchies of consumers, nor does he know all the available means to achieve those unknown ends, and he is dealing with an infinite number of variables in those unknown means to achieve those unknown ends. Sometimes, economists forget this 1 Andrew Chalk Walker Fellow In Economics
65 September 25, 1978 TAX-BASED INCOME POLICY: LATEST APPROACH TO WAGE AND PRICE CONTROLS INTRODUCTION The program of wage and price'controls enacted by Richard Nixon ended in,early 1974, but inflation has started to rise again in the United States and recen t opinion polls show it to be the public's number one concern. At present, Administration policy is restricted to "jawboning as it is termed (i.e exhorting unions and management to hold down wage rises and working with them behind the scenes. The Administr a tion has an "inflation czar as The Washington Post has termed him, in Robert Strauss who is claiming major successes in particular industries; but still inflation continues rising and the public sees current efforts,as only a public relations exercise. Ge o rge Meany, President of the AFL-CIO, has applied the term "wishboning" to the Administration's policy; and Arthur Okun, former Johnson Administration Council of Economic Advisers Chairman, has said that President Carter is do ing everything possible to ma ximize the possibility of a miracle. The Council on Wage and Price Stability under Barry Bosworth has had major disputes with labor is little surprise to have talks of wage and price controls re surfacing. Within the Congress, the Joint Economic Committee recently advocated "limited" controls and suggested a tax-based income policy (TIP) be given serious consideration The staff of the Senate Committee on Banking, Housing, and Urban Affairs is known to be drafting TIP legislation for introduction by Senato r William Proxmire (D-Wis late in 1978 or early in 1979, and eight members of the House of Representatives (Representatives Lundine and So against this background, it 2 Pattison of'New York, Mikva and Simon of Illinois, Moorhead of Pennsylvania, Fisher of V irginia, Maguire of New Jersey, and Mikulski of Maryland) havejoined in the introduction of H.R. 13865 the "Comprehensive Anti-Inflation Act of 1978," which also embodies a TIP scheme.. This legislation was referred to the House Commit tee on Government O p erations and the House Committee on Education and Labor, before which it is currently pending TIP also has strong supportwithinthe Carter Administration as indicated by reports that staff employees of the U.S. Treasury Department and Internal Revenue Serv ice were instructed to cancel their summer vacations so that they might work to determine what sort of TIP legislation should be promoted by the Administration. Lyle Gramley of the President's Council of Economic Advisers has been quoted as saying that "TI P is becoming more attractive simply because the other alternatives aren't much better or they're not working The FederalReserve Board of New York, formerly a strong advocate of monetary discipline and free enterprise, recently sur prised several observer s in its 1977 annual report, released on February 28, 1978, by suggesting that an income policy might be necessary to beat inflationary expectations and citing Britain as evidence. The AFL-CIO predictably announced its opposition to con trols as rumors spr e ad, and business is almost universally against them. TIP also enjoys the support of such leading figures as Henry Wallich of the Federal Reserve Board and Arthur Okun of the Brookings Institution (Brookings received a $75,000 grant from the Ford Foundatio n early in 1.978 toward conduct of a seminar in Wash ington, D.C., designed to focus on TIP It may also be highly significant that, as reported in the September 20, 1978, edition of The Washinqton Post; "White House anti-inflation czar Robert S Strauss" ha d stated that "President Carter should adopt 'the toughest possible' wage-price program he can, and not listen to those who contend it would hurt him politically This datum as sumes added significance when it is noted that, speaking on Septem ber 20 before the annual convention of the United Steelworkers of America, President Carter announced that he would soon disclose de tails of a "tough" anti-inflation program. It is expected that this program will be centered around a set of "voluntary" wage price guid e lines backed by a system of limited sanctions TAX-BASED INCOME POLICIES The Initial Proposal Wallich and Weintraub Although some economists had thought that there was some merit in taxing either firms or employees in the event that they needed or achieved large wage incomes during the 1960's, the first expo- sition of a comprehensive scheme along those lines to fight infla tion was made in 1971 by Henry Wallich (currently a governor of the 3 Federal Reserve Bank) and Sidney Weintraub (now Professor of Eco- nomics at the University of Pennsylvania 1 The Background The exposition of a tax-based income policy could not be mean ingful without a prior understanding of the economic context in which the proposal was made. Wallich and Weintraub were essentially pes simistic about the efficacy of wage and price controls to have any "real" effect on underlying rates of inflation in the U.S. economy. They acknowl edged that the cause of inflation is expansionably monetary and fiscal policy and that price and wage contr o ls can certainly pre vent inflation if they simply dictate the level of price increases and the government has official clout to enforce this, but as soon as controls are released prices rise faster than before the con trols, resulting in a situation wher e the price level is not appreciably lower2 and may even be higher3 than 'it would have been in the absence of controls 0 They alsoconsidered the serious effects of controls on re source allocation via reductions of production, and the inability of price c h anges to signal changes in consumer preferences. Never theless, they considered that the institutional structure of the U.S. economy4 is such that monetary and fiscal policy could only lower inflation at an economic cost in terms of lost output 1. Henry C . Wallich and S. Weintraub A Tax-Based Income Policy," Journal of Economic Issues, June 1971 2. See, for example, Michael Parkin in Lloyds Bank Review, July 1975, and Edgar L Feigu and Douglas K. Pearce, "The Wage-Price Controls Experiment Did It Work Chal l enge, Vol. 16, No 3 (July/August 1973), for analysis of the U.K. and U.S situations respectively 3. See Timothy W. McGuire, "On Estimating the Effects of Controls" in The Eco nomics of Wages and Price Controls, Vol 2 of Carnegie-Rochester Conference Serie s on Public Policy, edited by K. Brunner and Allan H. Meltzer (Amsterdam: North Holland Publishing Company, 19761, pp. 115-156, and Charles H. Whiteman A New Investigation of the Impact of Wage and Price Controls," Federal Reserve Bank of Minneapolis Quart e rly Review, Spring 1978 4. And Britain as well it would seem. Weintraub madeoneof the original ex planations of the proposal in the Lloyds Bank Review (January 1970) perhaps with the anticipation that any form of wage and price policy was more likely unde r the then) socialist government in Britain than President Nixon in the U.S event, the Labor Party lost power in 1970 and a Conservative Government was elected under Mr. Heath. When the government imposed controls in 1972, they reverted to the classic rigi d controls typical of the 1966 freeze In any 4 and employment. This was because, on the one hand, industry con tinued a large degree of concentration in the marketing and service sector and thus had considerable ability to "administer" prices and, on the o t her, labor had a powerful union structure over a large part of the economy including many remuneration agreements with scope wider than' just individual firms. Hence, restrictive monetary policy would be accompanied not by rapid reductions in the rate of i ncreasing prices and wages, but by a continuing'high level of price and wage hikes based more on historical circumstances and the actions of competitors than on anticipation of future aggre gate demand. This would mean that firms would find themselves fac ed with concurrent falling'demand for their output and rising costs for their labor output. Hence, a recession would develop. In the 1930's wage and price controls fell because of a different institutional structure to the present day, but now the cost in terms of lost output was a major item to be borne in mind when consider ing macroeconomic solutions to inflation. To give the reader an idea of the kind of costs which proponents of TIP envisage, George Perry of the Brookings Institution has estimated tha t one percent increase in unemployment will lower the inflation rate by 0.3 per centage points in.the first year and 0.7 percentage points if main tained for three years. Furthermore, one percent unemployment is equivalent to 60 million of lost output. It is against this model of the economy that TIP has been ac cepted.by its .main proponents, -and it is in an'attempt to anticipate the side effects of monetary restraint that it seems to have fun neled support amongst many people close to the policy proc e ss.5 TIP has been proposed at a propitious time for its proponents, for inflation shows no signs of abating and politicans are reluctant to tighten monetary policy to make it. It is perhaps because of this poverty of alternatives that the Joint Economic C ommittee re cently held two days of hearings on TIP and said We have long been on record as opposed to comprehensive wage-price controls and we do not recommend them now. However, we are deeply concerned that pressures will mount for such policies if we do not get inflation under control. We should therefore implement an in comes policy now so that we will not be driven into more drastic measures.later One idea that deserves serious consideration is a tax-based incomes policy TIP) .6 5. See, for example, U . S. Congress, Congressional Budget Office, Recovery With Inflation, July 1977, p. 40; U.S. Congress, Joint Economic Committee, The 1977 Midyear Review of the Economy, 95th Congress, 1st Session, September 26, 1977 p. 76 6. U.S. Congress, Joint Economic Com m ittee, 1978 Report. 5 SHORT RUN OR LONG RUN However, Wallich and Weintraub did not propose TIP solely as an ameliorative measure during the process of price stabilization ad justments. True, they say It would be an error, however, to regard an incomes pol i cy such as we propose as a substitute for monetary and fiscal policy. Instead, the proposal is conceived as a supplement to the familiar monetary fiscal poli cies so tha.t the economy might operate closer to full employment without the inflationary change s of excess demand and "overheating .I' 7 But the important word here is "operate" for they also state TIP deserves consideration as a long run solution. One of the clearly demonstrated characteristics of other forms of incomes policy is that, given that t hey are attractive initially, they tend to break apart in the course of time. The effectiveness of TIP should im prove over time as administrative techniques are per fected and the market learns to respond to it.8 (Empha sis added. 1 In other words TIP is a long-term policy'to, in the proponents' be lief, run the economy at a higher rate of employment without in flation. Thus, politicians are latching onto TIP for one reason whilst its authors envisioned it for another. It is also not clear what kind of mo n etary policy various TIP proponents consider as appropriate. Weintraub, for example, says Given. a suitable incomes policy to align wages (and salaries) to productivity, monetary policy would be released to make its contribution to full employment Full em p loyment requires ample money supplies for its sustenance. 9 And Robert J. Gordon, at a recent Brookings conference, certainly saw an exposition by Lawrence S. Seidman as implying an "accommo dative" monetary policy. 10 fiscal policy" is, in fact, a euphem i sm for the suspension of marketing restraints and the original authors' acknowledgement of It seems that "appropriate monetary and 7. Wallich and Weintraub, op. cit p. 1 8. Wallich and Weintraub, op. cit p. 18 9. S. Weintraub Incomes Policy: Completing th e Stabilization Triangle," Journal of Economic Issues, December 1972, pp. 105-22 10. See Brookinqs Papers on Economic Activity, Issue 2, 1978, p. 349 Brookings Institution, Washington, D.C. 6 monetary and fiscal policy as the cause of inflation as well! H owever, Arthur Okun of the Brookings Institution has explained the policy more'in terms of an ameliorative measure for the price of returning to price s.tability. 11 A.D.ETAILED EXPLANATION OF WALLICH AND W.EINTRAUB'S ORIGINAL PROPOSAL In essence, Wallich and Weintraub advocated that the govern ment should announce a "guidepost" for wage increases; for exam?le 5 percent. Any firm settling for a wage increase greater than the guidepost would be penalized by% higher rate of tax on its profits For example, if profits tax were 40 percent and the firm settled a wage increase of 6 percent.(i.e., one percent above the guidepost) then the excess tax may be 2 percent and the firn would pay 42 percent profits tax rather than 40 percent. They also envisage that the pr o fitstax would be progressive so that the higher the wage settlement above the guidepost, the greater would be the excess tax on the firm's profits. Wallich and Weintraub also foresee the government changing the rate of excess profits tax as time passes un til, they say, a point was reached where the policy was truly effective. Most interestingly,perhaps, the proposal does not tax waqes directly, but the profits of the firms,because the intention bone Implicit in this is the notion that wage bargaining is at least in the manufacturing sector of the U.S. economy, simi lar to pollution. In normal circumstances the union and the em ployer bargain and diverge and, even though the process may in volve some industrial disruption, in the final analysis a wage barga i n is arrived at which the employer can pass on to the con sumer. Thus, unions and employers may "externalize" the costs of wage increases (ensure they are borne by sources other than the participants to the bargaining process As evidence of this Wallich a n d Weintraub cite the historical relationship exhibiting approximate constancy in labor's and capital's share of the na tional product. The cost of wage increases has also been in excess of the long-run increase in productivity but has not resulted in unem p loyment and a squeeze on profits because the government has pursued expansionablyfiscal and monetary policies that have main tained employment at high and approximately stable levels. in the minds. of the authors, is to "strengthen the employer's back 11. Arthur M Okun, Vhe Great Stagflation Swamp I Challenge, November December 1977. 7 The second interesting feature of the poligy is that it is aimed at correcting the asymmetry in the bargaining process between the relative strengths of capital and labor. T o the extent that the burden of restraining union power is passed from politicians to em ployers, TIP will find great favor with Congress and the White House. Experience in America has been that "jawboning" by the President's aides and even, at times, by t he President himself has simply made the President look powerless, but TIP passes this buck to business and could thereby be termed "a 'hired-gun' incomes policy. The economic logic for TIP is that set out above, and Wallich and Weintraub point out that t he idea of firms simply fixing prices as a markup over costs is shared in many econometric models of the U.S. economy. The inflation restraints function works,. say the authors, because the firm would settle lower increases, and thus the markup would resu l t. in proportionably lower price rises, causing in flation to steadily decline restraints on prices because of the "historical relation" of the constant ratio of prices above cost that this could not rise. Furthermore, implicit within the foregoing statem e nt is the assumption that firms could not pass on in price increases any of the excess tax on profits were they to be forced to settle above the guidepost. Wallich and Weintraub do not, how ever, hinge everything on the "historical relation" and suggest t h at if labor objects to profiteering, then an excess profits tax could be introduced to supplement TIP There would be no need to place any Competitive pressure would probably ensure WHY TAX PROFITS TO RESTRAIN WAGES It may have struck the reader that Walli c h's and Weintraub's proposal is very "indirect In order to lower wage increases, they propose the taxation of profits, so why not go straight to wages and tax increases above the guidepost by making them not deductible for income tax purposes or by levyin g a dollar-for-dollar payroll tax? Wallich and Weintraub point out that such a tax would be shiftable. Labor would simply add an amount onto its wage claim to compensate for the tax, and management would pass it onto the consumer. Such a system of direct tax would also be more complex to administer. It should be stressed that it is not the intention of TIP to raise revenue for the government, so any revenue gained would be offset by tax reductions elsewhere--perhaps on the profits tax of firms who do sett l e within the guidepost; they could receive credits propor tional to the difference between the guidepost and their settlement SETTING THE GUIDEPOSTS As for the ckiteria for setting the guideposts, there are some economic features to bear in mind,although t he choice is ul'timately a political one. The economic fact that the government must take 8 into account is that there is a long-run productivity growth rate in the economy which, in the case of the U.S is approximately 3 percent. Thus, if the inflation r a te is 10 percent at the time of implementation, the government could choose any figure between and including 3 percent to 13 percent for the guideposts,depending on how far and how fast it wished to slow inflation. The figure is clearly related to the ave r age growth of productivity and does not allow for higher wage rises for higher productivity gains in par ticular firms or industries except at the cost of a fine in the form of the excess tax. It is because, at the firm level, wages can be raised for this reason or simply to accede to a powerful union that Wallich and Weintraub call TIP something of a "free market" solution to inflation and attempt to get support from market economists for it As will be argued below, the fact that relative prices can still adjust, albeit at a cost, is.a rather selective use of the notion of a free market ADMINISTRATIVE QUESTIONS Several points of administrative interest still need to be clarified TIP would have to apply to total remuneration, not just wages and salaries (e. g., fringe benefits, bonuses, etc and it would have to be adjusted on a per employee basis if it were to actually succeed in restraining total money expenditure. It would also have to rely on data that arealready available if it were not to induce the grow th of a new bureaucracy. Furthermore TIP would induce a change in the "skill mix" if employers could release higher skilled workers and employ lower skilled ones,as lower skilled workers typically would have lower wages and hence could be given larger rai ses before the firm's wage bill rose to the level where it was when the higher skilled workers were employed. There would also need to be the now-understood regulation associated with any policy of controls to prevent "regradings" and shop dls missals foll owed by reappointments at higher wages. For these rea sons Wallich and Weintraub propose that the classification should be Total wage and related payments in each job classification and grade, divided by the number of man-hours worked in the respective ca t egories, and combined into a weighted index of wage incomes. This would give a fairly water tight specification of. a wage increase. The data should be available on the records 12 12. Hehry C. Wallich and S. Weintraub, op. cit p. 14 9 Nevertheless, they d o see a shift toward less-skilled labor as necessity, a negative by-product of TIP as it would tend to lead towards greater income equity SCOPE AND COVERAGE OF TIP For administrative and economic reasons, Wallich and Weintraub would exclude small firms fro m coverage. To have its desired ef fect, they say, only firms with profits in excess of 1 million would need to be covered. Similarly new firms could be excluded as their size is likely to be insignificant. More difficult they feel, is the question of long -term con tracts. Difficult legal and political questions would be raised if pre-existing contracts g.ave wage increases significantly higher than under TIP. Even if the problem were solved by excluding from excess profits tax those firms that had entered theathere would still be the problem that TIP would take three years to be fully effective. For public utilities, where there is an established practice of regulating authorities,allowing them a "normal" and steady rate of return, there are clearly possibilities for profits tax shift ing ment and exclude utilities from TIP than upsxt it. Wallich and Weintraub would rather continue with this arrange AN-EVALUATION OF TIP The success or otherwise of TIP crucially depends on firms not being able to shift forward to consumers the excess tax on profits that the government levies. Nevertheless, their d i scussion of the subject is very unsatisfactory that all they have done is express a vague hope that the tax will not be passed on.13 in concentrated industries relative to competitive industries is evidence of little tax shifting. They suggest that the ef f ect of a profits tax hitting different firms unequally may be the reason for the fact that it is not passed on, unlike a payroll tax which does hit all firms equally. But absence of supernormal profits in a concentrated industry can be explained by other t han profit It seems to leave the impression They say that the lack of greater profitability 13. Henry C. Wallich and S. Weintraub, op. cit p. 5. 10 maximizing behavior on the part of firms and is. not any kind of evidence of the inability to shift the cor porate income tax Other studies14 conclude that the burden can be shifted, depending on the firm's behavior; and Musgrave and Musgrave15 in a detailed analysis conclude that the empirical evidence (the "litmus test of any theory) is inconclusive. Isard's study and Miller's study are especially interesting. Isard compares two cases: in the first, the firm is a profit maximizer and in the second, it follows amarkuprule. It sets prices. at a certain percentage above what costs happen. to be. The firm.is assu med to face the same constant elasticity demand curve. in both cases,bu.t in Case 1 knows the curve and in Case 2 does not. His analysis concludes that in the first case (prof it maximization) the firm.wil1 first of all make the output de cision and then p ay tax on the profits; thus, the tax .will. not be passed on. However, in the second case the whole of any in crease in labor costs is shifted forwarband also a fraction or multiple of the increase in tax assessments. Although Isard sees Case 1 pricing be havior as more likely to reflect real-life business behavior, his Case 2 pricing behavior is a closer approx imation to the real-life pricing behavior assumedby Wallich and Weintraub. Miller, in his analysis, assumes that the revenue raised by TIP is redis tributed to firms that increase unit labor costs by less than the TIP guidepost and Weintraub, that'the firm has some "price administering power i.e., it faces a downward sloping demand curve. In this situation he notes that TIP becomes a-tax on labor. If an employer wishes to hire one more worker,then he has to pay the market wage rate. Assuming a rising supply curve, this means that the hiring of an extra employee under TIP, with the tax included, is unprofitable whereas it would have been profitable wit h no TIP. However, it is now very profitable to sack employees, for the employer is entitled to a subsidy for reducing unit labor costs by producing less with fewer employees; But becauseless is being produced the price of each unit.of output is higher,so TIP has raised the price level and reduced wages. It has also increased the profits of the firm. As the evidence is considered, it is difficult to say anything very definite about the ability of firms to pass on corporate taxes,and this constitutes a seri ous'charge against TIP proponents It also assumes in line with Wallich 14. Economic Journal, September 1971; Preston Miller, "TIP: The Wrong Way to Fight P. Isard, "The Effectivenessof Using the Tax System to Cut Inflationary Col lective Bargaining: An Ana lysis of the Wallich-Weintraub Plan Journal of Political Economy, May-June 1973, pp. 729-740 15. Richard A. Musgrave and Ryan B. Musgrave, Public Finance in Theory and Practice (New York: McGraw-Hill Book Company, 19731,Chapter 18, pp. 415-419 See John Ho t son, "Advance Effects of Tax'and Interest Hikes," Canadian Inflation," Federal Reserve Bank. of Minneapolis Quarterly Review, Spring 1978 11 THE EFFECT OF TIP ON WAGE SETTLEMENTS Nevertheless, assuming that not all the tax can be passed on, the effect of T IP on wage settlements is the next major question. Wallich and Weintraub assume a model of collective bargaining in which manage ment gradually increases its wage offer during the negotiating time which may include industrial disruption such as strikes) a nd labor gradually reduces its claim. This arises due to increasing costs to both parties due to strikes, disruptions, etc. The effect of TIP say Wallich and Weintraub, is to increase management's "backbone" and make it hold out longer. For example, consid er the following. The government announces a TIP guidepost. The effect is to move the management wage offer curve down and, if the union's wage demand curve remains. at its ori ginal position, then the wage settlement is reduced A lower settle ment has be e n reached (as TIP proponents claim) but at a,cost of more industrial disruption. Now consider what will happen if the unions grow disgruntled with TIP after some months and start to make higher wage claims but do not lower industrial disruption at a faste r rate. This could be termed an "increase in militancy In other words over a period of time union response has rendered TIP both ineffec tive at restraining wage increases and more costly in terms of strikes. Supposing that the government responds by incr easing the excess tax on profits, thus moving management's wage offer curve further down, then by this time strikes will have become so ubiquitous as to render all the virtues of TIP meaningless. Management and labor would be in a state of "industrial civ i l war" and screaming at the government to repeal the policy. The long-term implications of such an increase in industrial militancy are even more worrying, for'if it increases during a TIP period, will it dissipate just as quickly? British experience sugg ests that the demonstration effect proves otherwise. Once labor grows big muscles, it starts to flex them. Little is to be found in the writings of TIP proponents about the possibility of this; and that fact alone is surprising because what is essentially taking place, in the latter scenario, is a change in the institutional structure,and all the major writers on TIP are people who give the greatest attention to institutions in their analyses attention to an institutional change which is, of itself, a suf ficient condition to render the credibility of TIP meaningless It is odd that they should have given so little A possibility which would appear to enhance the chance of the phenomenon described above is that due to the tendency for prices to adjust to wag e s with a substantial lag, there would be an initial windfall increase in the product share of profits upon the implementation of TIP. This was certainly one concern ex pressed at a recent conference at the Brookings Institution.16 16. Brookings Papers on Economic Activity, Issue 2, 1978, pp. 351-353, 257. Brookings Institution, Washington, D.C. 12 WOULD BUSINESS LIKE TIP Not only would labor oppose TIP, but so would business. It would be placed right in the firing line of the anti-inflation battle responsible for causing a disease which government had crea t ed. Traditionally a supporter of strong monetary and fis cal policy to curb inflation, business morale would plummet and investments slump as firms sOUght-.tO keep assets liquid in case they should have to face a large wage demand and because the outlook u nder a long-term TIP would be very depressed WOULD TIP LET THE MARKET FUNCTION The great claim for TIP over strict controls on wages and prices is that it would let the market function tioned earlier this relies on a very selective idea of what a function i ng market is. Certainly prices would be free to rise and fall, but the ability of firms to react to changes in prices as signals of unexploited profit opp~rtunitiesl~ would be severely hampered by the tax they would have to pay if they wished to hire labo r or raise wages for existing employees. As a.result profit opportunities (i.e.,consumer wants) would either go un satisfied or be provided for by imports. More broadly, TIP takes no account of millions of changes in productivity that occur every year in a sophisticated economy like the U.S but simply limits wage increases to the national long-run average. This is a fatal flaw, because the long-run national average growth of productivity is barely a'real figure'. Certainly, someone in America probably achie v ed it over the last few years, but it is essentially a sta tistical construct. It is the statistician's way of trying to make sense of a world where there have been thousands of new terms created and old ones destroyed, millions of new products introduced and changes in the whole structure of the economy and its technology; and, as such, to apply it to the determination of all wage settlements is to take macroeconomics beyond the extremes of its usefulness. John Dunlop of Harvard, an expert on labor econom i cs, puts it more straightforwardly However; as men Single, uniform standards for wages, as for prices, are simply not effective.18 17. For one of the best discussions of the role of entrepreneurship, see Israel M. Kingner, Competition and Entrepreneurship , New York, 1971 18. Quoted in Business Week, October 3, 1977. And when would TIP be implemented? When is the market in equilibrium so that imposing a "single uniform standard" will not create perceived inequities How is the problem of multiyear contracts to be resolved? Wallich and Weintraub do not have a satisfactory answer THE ADMINISTRATIVE PROBLEMS OF TIP Furthermore, the administrative problems with TIP could be enormous. There are problems of scope and coverage,and proponents say that only companies with profits of $1 million or the Fortune top 1,000 would need to be covered; but inevitably distortions will arise that Yill get worse with time In some industries there are longstanding union agreements that apply ta large and small firms alike where go v ernment. mandated severance would be found to create friction. Reeslg raises many questions of this kind, such as, what would happen.ifa union struck an industry-wide or pattern-setting agreement in excess of the guidepost with an unprofitable chain that w ould suffer under TIP? The implications would certainly rebound elsewhere,and thecostsof wage settlements would still be externalized--one of the problems that Wallich and Weintraub assert they would solve. How would non-profit-making institutions be trea ted? Some of these are quite large and the government, as one of them, could find itself a prime target. Anotherclaim by its proponents is that TIP would not require any new bureaucracy, but this is a claim that has been made for all controls since World W ar I1 and has never proved to be the case. Gardner Ackley has commented From my experience in designing and administering price controls during World War 11, and again, in a policy role, during the Korean War, I retain keen, and some times bitter,memories of great ideas of about ways to restrain wage and price increases for which the fine print could never be written-or if it could be written filled endless volumes of the Federal Register with constant revisions, exceptions, and adjustments neces sary to c over special situations that could never have been dreamed of in advance by the most imaginative economists accountants and lawyers. 20 19. A. Rees, "New Policies to Fight Inflation: Sources of Skepticism," Brookings Papers on Economic Activity, Issue 2, 1 978, pp. 453-477 20. Gardner Ackley, "Okun's New Tax-Based Income Policy Proposal," Economic Outlook, USA, Winter 1978, p. 8 14 It is difficult to see how the proposals could even be ad ministered accurately at the firm level, even with the firm acting on good faith,because the definition of employee compensation put krwardby Wallich and Weintraub (see above) asks for statistics which initially no large firms currently compute and certainly no small ones do CONCLUSION The view that controls or incomes poli c y can contribute to a permanent reduction in the rate of inflation associated with any given level of unemployment (i-e a reduction in the "natural rate of unemployment) is fundamentally misguided. As an indica tion of the adjustment process to a stable p rice level, TIP is likely to make things worse, in terms of wage settlements and strike costs, rather than better. Above all, the distortions that such policies induce in the market reduce the economic wel fare of everyone. More insidious but no less impor tant is the tendency of con trols, even a novel one like the above, to detract from the real cause of inflation. The real cause is laxity in monetary and fiscal policy over a long period of years that has built-up in flationary expectations to such a leve l that it will not be pos sible to eradicate them in a matter of months. Nevertheless the adjustment, if it started now, could reduce inflation to tolerable levels by the end of 1980, but progress in this demands our attention to the task that is not engen dered whilst short-cuts are mistakenly believed to exist. The economists who believe that the economy can be interfered with to any degree by government have, essentially, an engineer's view of economics. An engineer is told a particular end to achieve he has all the necessary information on the state of technology and he has only a few variables to deal with The economist, by contrast, does not know the value hierarchies of consumers, nor does he know all the available means to achieve those unknown ends, and he is dealing with an infinite number of variables in those unknown means to achieve those unknown ends. Sometimes, economists forget this 1 Andrew Chalk Walker Fellow In Economics
