The Wedge Model Explains California Shortages and Clogged Ports

Commentary Back on Oct. 15 in The Epoch Times, I was one of the first to blame California’s high taxes and regulations for the shortages and clogged ports we’re all suffering, leading to higher prices. On Oct. 21 on CalMatters, Emily Hoeven wrote, “In a Tuesday letter to Newsom, the business groups asked him to declare a state of emergency at the ports. They also demanded he suspend numerous controversial state laws, including one that requires developers to mitigate their projects’ environmental impact and another that forced many companies to reclassify independent workers as employees.” She quoted the 19 business groups, who wrote: “The supply chain crisis at the ports is the inevitable culmination of … a series of state, regional and local mandates forced upon every aspect of the goods movement economy.” There’s actually a theory for this, called the Wedge Model. It was developed by economist Arthur Laffer, who helped design tax cuts for Presidents Ronald Reagan and Donald Trump, California’s Proposition 13 tax cut from 1978, and many other tax cuts. Another economist, the late Jude Wanniski, described it clearly back in 2002, so adjust for inflated prices and costs today. I’ll provide some contemporary comments. Wanniski: “The ‘Wedge’ in the Wedge model should be pictured as a government Wedge that is used to come between two potential transactors. As Laffer developed it, he discussed the Wedge between an employer and an employee, between management and labor. “The worker gets paid $12.50 per hour or $500 per week, but because the federal, state and local governments take a variety of income and payroll taxes out of the wage, the worker sees a net of only $380, or $9.50 an hour. The $120 per week difference is the Wedge. The worker is doing $500 worth of work, but getting only $380 for his labors, and has a tendency to offer less labor as the Wedge increases.” That explains why so many workers are not going back to their old jobs nowadays, even though unemployment insurance has run out. Before the COVID-19 lockdowns laid off millions beginning in March 2020, people got used to paying the high Wedge price in taxes and regulations. But after they were out of work for so long, more than a year in many cases, they looked at the Wedge and saw there was no point in going back to work. Maybe a spouse made enough money now so the family could survive on one income. Or other income, such as a pension, was enough to cover expenses. If the Wedge were reduced—through tax cuts or a large pay increase—the person still might go back to work. But not until then. “With a progressive income tax, the worker may be offered time-and-a-half for an extra hour’s work, but because the extra hour is taxed at a higher progressive rate, the worker will get something less than time-and-a-half. The Wedge became particularly onerous in the rapid inflationary years of the 1970s, as inflation drove workers into higher tax brackets with no increase in purchasing power.” We now have inflation again, with prices going up rapidly. A raise only pushes workers into a higher bracket. In California in 2021, the 9.3 percent state income tax bracket digs in at about $60,000 of income. Contrast that with the new 2.5 percent flat tax of Arizona. Or the 0.0 percent state income tax rates of Texas, Florida, Nevada, and Washington. Yet it still takes at least $165,000 a year just to afford a simple home mortgage in California, because median housing prices now are $900,000. The high housing prices, too, are a Wedge, and the biggest one. For many couples, a second income now just will push the family gross income into much higher tax brackets, making the work less desirable. Wanniski calculated that an average worker, such as a carpenter, in 1965 paid just 5.2 percent of income in federal taxes (not including state taxes). But by 2002, because inflation pushed the worker into a higher tax bracket, that had risen to 25 percent of income for the same work at an inflated but equivalent wage. That 25 percent Wedge tax is about the same today. Income has been indexed to inflation since 1985, but was never backdated to take account of the vast 1970s inflation. Wanniski concluded in 2002 something that is just as true today: “The observable fact is that it is much harder for a breadwinner to support a family of four today than it was [in 1965]. Laffer’s Wedge partly explains why.” Port Problems On the ports, an Oct. 26 Yahoo Finance article quoted truckers, port executives, and union officials blaming one another for the backlog. Whoever is to blame, the article reported, “Essential workers are still scarce but U.S. consumers are still in a buying mood, meaning the congestion is not expected to wind down until the second half of 2022.” Wanniski expanded on the Wedge Model in his 1978 book, “The Way the World Works,” which advanced the supply-side economics theories that underpinned Reaganomics, which ought to be revived today. The Wedge, he

The Wedge Model Explains California Shortages and Clogged Ports

Commentary

Back on Oct. 15 in The Epoch Times, I was one of the first to blame California’s high taxes and regulations for the shortages and clogged ports we’re all suffering, leading to higher prices.

On Oct. 21 on CalMatters, Emily Hoeven wrote, “In a Tuesday letter to Newsom, the business groups asked him to declare a state of emergency at the ports. They also demanded he suspend numerous controversial state laws, including one that requires developers to mitigate their projects’ environmental impact and another that forced many companies to reclassify independent workers as employees.”

She quoted the 19 business groups, who wrote: “The supply chain crisis at the ports is the inevitable culmination of … a series of state, regional and local mandates forced upon every aspect of the goods movement economy.”

There’s actually a theory for this, called the Wedge Model. It was developed by economist Arthur Laffer, who helped design tax cuts for Presidents Ronald Reagan and Donald Trump, California’s Proposition 13 tax cut from 1978, and many other tax cuts.

Another economist, the late Jude Wanniski, described it clearly back in 2002, so adjust for inflated prices and costs today. I’ll provide some contemporary comments.

Wanniski: “The ‘Wedge’ in the Wedge model should be pictured as a government Wedge that is used to come between two potential transactors. As Laffer developed it, he discussed the Wedge between an employer and an employee, between management and labor.

“The worker gets paid $12.50 per hour or $500 per week, but because the federal, state and local governments take a variety of income and payroll taxes out of the wage, the worker sees a net of only $380, or $9.50 an hour. The $120 per week difference is the Wedge. The worker is doing $500 worth of work, but getting only $380 for his labors, and has a tendency to offer less labor as the Wedge increases.”

That explains why so many workers are not going back to their old jobs nowadays, even though unemployment insurance has run out. Before the COVID-19 lockdowns laid off millions beginning in March 2020, people got used to paying the high Wedge price in taxes and regulations. But after they were out of work for so long, more than a year in many cases, they looked at the Wedge and saw there was no point in going back to work. Maybe a spouse made enough money now so the family could survive on one income. Or other income, such as a pension, was enough to cover expenses. If the Wedge were reduced—through tax cuts or a large pay increase—the person still might go back to work. But not until then.

“With a progressive income tax, the worker may be offered time-and-a-half for an extra hour’s work, but because the extra hour is taxed at a higher progressive rate, the worker will get something less than time-and-a-half. The Wedge became particularly onerous in the rapid inflationary years of the 1970s, as inflation drove workers into higher tax brackets with no increase in purchasing power.”

We now have inflation again, with prices going up rapidly. A raise only pushes workers into a higher bracket. In California in 2021, the 9.3 percent state income tax bracket digs in at about $60,000 of income. Contrast that with the new 2.5 percent flat tax of Arizona. Or the 0.0 percent state income tax rates of Texas, Florida, Nevada, and Washington. Yet it still takes at least $165,000 a year just to afford a simple home mortgage in California, because median housing prices now are $900,000. The high housing prices, too, are a Wedge, and the biggest one.

For many couples, a second income now just will push the family gross income into much higher tax brackets, making the work less desirable.

Wanniski calculated that an average worker, such as a carpenter, in 1965 paid just 5.2 percent of income in federal taxes (not including state taxes). But by 2002, because inflation pushed the worker into a higher tax bracket, that had risen to 25 percent of income for the same work at an inflated but equivalent wage. That 25 percent Wedge tax is about the same today. Income has been indexed to inflation since 1985, but was never backdated to take account of the vast 1970s inflation.

Wanniski concluded in 2002 something that is just as true today: “The observable fact is that it is much harder for a breadwinner to support a family of four today than it was [in 1965]. Laffer’s Wedge partly explains why.”

Port Problems

On the ports, an Oct. 26 Yahoo Finance article quoted truckers, port executives, and union officials blaming one another for the backlog. Whoever is to blame, the article reported, “Essential workers are still scarce but U.S. consumers are still in a buying mood, meaning the congestion is not expected to wind down until the second half of 2022.”

Wanniski expanded on the Wedge Model in his 1978 book, “The Way the World Works,” which advanced the supply-side economics theories that underpinned Reaganomics, which ought to be revived today.

The Wedge, he wrote, is not just taxes, “but also all the other government burdens on the transaction that require labor. Because the government does not realize revenues from a regulatory order—red tape and paperwork—it does not think of such orders as ‘taxes.’” But to a worker or company, “there is no difference between financial taxes and regulatory burdens; each requires precise amounts of labor.”

A company filling out numerous new forms from a recently passed law has a “precise” cost for that labor and lost time. Wanniski’s solution: “Taxes of all sorts must be reduced”—taxes meaning not just what one pays to government, but taxes such as filling out forms and otherwise complying with regulations.

Here’s a good example: I have known several doctors over the years who, when Medicare, Medi-Cal, and other regulations increased, either quit practicing medicine or just stopped handling patients with government-supplied insurance.

We’re seeing a similar Wedge at work as vaccine requirements are driving some police and medical workers to leave their jobs. As a response, last Sunday Gov. Ron DeSantis of Florida offered $5,000 bonuses to such police officers to come to patrol in Florida if they leave New York City, Minneapolis, Chicago, Seattle, and other police departments due to vaccination mandates.

Another example: After two In-N-Out Burger joints were closed in the Bay Area for refusing to comply with COVID vaccine mandates for indoor customers, Florida invited them to leave the Golden State for the Sunshine State. Florida CFO Jimmy Patronis urged, “I know this it would never happen in the state of Florida, but mark my words, just like Tesla left the state of California because of overregulation, you’ll see In-N-Out Burger move out of the state.”

Finally, a big part of the Wedge is long-term effects. Everybody knows California is regulation-giddy. I wrote a four-part series in The Epoch Times on just some of the hundreds of new bills Gov. Gavin Newsom signed into law this year. Even if California institutes temporary measures to ease port problems, in the future the same problems will persist. That gives truckers, crane operators and others who might otherwise come here for a short-term job a reason to avoid the state and seek employment elsewhere.

Until California wises up and reduces its Wedge by cutting taxes and regulations, future crises will just repeat the current logjams and shortages.

Views expressed in this article are the opinions of the author and do not necessarily reflect the views of The Epoch Times.


John Seiler

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John Seiler is a veteran California opinion writer. He has written editorials for The Orange County Register for almost 30 years. He is a U.S. Army veteran and former press secretary to California State Sen. John Moorlach. He blogs at [email protected]