Back in March, 2001, I wrote a little fable about taxation for the op-ed piece of the Wall Street Journal. Several readers have asked me to post that fable here on the blog. Your wish is my command. At the bottom of this post, I’ll say a few words relating the fable to another recent blog post.
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Once upon a time, a man went to work and earned a dollar. He used the dollar to buy a share of stock. The stock paid a dividend of 10 cents a year, 10% being the going rate of return in the land.
Thanks to wise corporate management, the dividend eventually doubled to 20 cents a year, causing the stock price to double as well. The man sold his share for $2, which he put in the bank. Eventually, his children inherited the money and reinvested it in the same company. They used their 20-cent annual dividend to purchase goods and services, happily ever after.
That was a fairy tale. Here is the reality:
Once upon a time, a man went to work and earned a dollar. After paying state and federal income taxes, he was left with 50 cents. He used the 50 cents to buy half a share of stock. When the stock price doubled, he sold his half-share for a dollar, paid a 10-cent tax on the capital gain, and put the remaining 90 cents in the bank. Eventually, his children inherited the money, paid 50 cents in inheritance tax, and reinvested the remaining 40 cents in the original company.
The company continued to earn a 10% rate of return, of which half went to pay corporate income and excise taxes. The children therefore received an annual dividend of 5%, which came to two cents a year. After paying personal income tax on the dividend, they were left with a penny a year in income. They used part of that penny to purchase goods and services, and the rest to pay sales taxes.
Okay, that’s a worst-case scenario. There are many things the man could have done to reduce his family’s tax burden. He could have chosen an investment that paid no dividends. He could have held his stock instead of selling it, accepting some extra risk. He could have spent everything he had before he died. For that matter, he could have chosen not to go to work in the first place. But the fact remains that after a series of perfectly reasonable economic choices, this family lost 95% of its income to taxes.
Ninety-five percent! From 20 cents a year down to a penny! How could such a thing happen? Simple: by taxing the same income five times.
Some aspects of multiple taxation are widely recognized, but others aren’t. Everyone knows about the “double taxation” of corporate income: first when it’s earned and then when it’s paid out as dividends. But not everyone realizes that capital gains are always caused by expectations of future income. That means the capital-gains tax amounts to a third tax on income that’s already slated to be taxed twice. Taxing both dividends and capital gains is like fining drivers for speeding and then fining them again for
having a high speedometer reading.
More important, each of these taxes — along with the inheritance tax and, for that matter, any tax at all on capital income — is ultimately a disguised tax on labor. That’s because Marx was right: Capital is the embodiment of past labor. Today’s capital income is a deferred reward for yesterday’s hard work. Tax that reward and you’re taxing the work that made it possible.
A tax on capital — whether it comes in the form of a tax on dividends, corporate income, capital gains or inheritance — is equivalent not just to a tax on labor, but to a highly discriminatory tax on labor. It penalizes the labor of the young (who have many years of saving ahead of them) far more heavily than the labor of the old (who tend to spend their income as it arrives). So not only are people penalized for working, they’re penalized doubly for working early in life.
A tax on labor discourages work. A tax on capital discourages work disproportionately among the young, distorting saving decisions and retarding economic growth. So a tax on capital has all the disadvantages of an extra tax on labor, and more besides.
Moreover, a tax on capital is a deceptive tax. When your income is taxed on five separate occasions, you’re less likely to notice the bite than if it’s taken all at once. Arguably, that allows politicians to get away with higher total tax rates than if they were forced to operate in the open.
All of which suggests that we’d be better off with a single tax on labor income and no taxes at all on corporate income, dividends, capital gains or inheritance. A growing body of research in macroeconomics supports that suggestion. The main contributors to that research include Christophe Chamley of Harvard, Ken Judd of Stanford, Peter Diamond of the Massachusetts Institute of Technology, Patrick Kehoe at Penn, V.V. Chari at Minnesota and Robert E. Lucas at Chicago. Mr. Lucas is a Nobel laureate who has been recognized for 30 years as the world’s most thoughtful and influential macroeconomist. Here’s how he sums up the findings so far:
When I left graduate school in 1963, I believed that the single most desirable change in the U.S. tax structure would be the taxation of capital gains as ordinary income. I now believe that neither capital gains nor any of the income from capital should be taxed at all. My earlier view was based on what I viewed as the best available economic analysis, but of course I think my current view is based on better analysis.
Of course, further analysis will be forthcoming and the conclusions might change. But for now, the best thinking confirms common sense: Five taxes is at least four too many.
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And so ends my Wall Street Journal column. Now a little context:
Last week, I explained that a tax on interest effectively taxes current and future consumption at different rates. In today’s fable, I’ve pointed out that a tax on interest effectively taxes current and future labor at different rates (penalizing labor when you’re young more heavily than labor when you’re old).
There’s a general principle in economics that says everything ought to be taxed at the same rate. (That’s not an assumption; it’s the conclusion of an argument I’ve not provided here, though it’s in all the textbooks.) Last week, we saw that if you apply this principle to current and future consumption, there should be no tax on interest; today we saw that if you apply the same principle to current and future labor, there should still be no tax on interest.
I for one don’t actually own any economics textbooks, so wouldn’t mind at least a pointer to where I can find the argument for the general principle that everything should be taxed at the same rate. (Presumably you can tell from the logic whether we should apply the principle to current and future income/current and future labour/etc.)
John: I will try to find time to illustrate the argument with a graph or two and then post them here.
John Faben: I’m going to try to answer your question without drawing graphs; I hope this is possible to follow. I’m sure it would be easier with graphs, and I might come back with those.
Suppose you live in Upper Slobbovia, where apples are taxed at a higher rate than oranges. You choose to buy, say, 20 apples and 30 oranges, and the government ends up with, say, 15% of your income.
Your identical twin (same income, same preferences, etc.) lives in Lower Slobbovia, where apples and oranges are both taxed at 15%—so that government revenue is the same in both Slobbovias. Your twin therefore has the same after-tax income as you, so he can afford, if he wants, to mimic your behavior and buy exactly 20 apples and 30 oranges. This already shows that he can’t be *worse* off than you. It remains to be shown that he’s actually *better* off.
Here’s the simplest plausibility argument: You and your twin face different menus of choices. You can each afford some baskets the other can’t. But we know that on *your* menu, basket (20,30) is the very best (according to your preferences)—and that very best choice appears on your twin’s menu. That probably means he’s got even better choices.
To replace the “probably” with “surely”, we have to think about why (20,30) was your best choice. I claim that when you buy 20 apples and 30 oranges, the last dollar you spent on apples must have brought you the same satisfaction as the last dollar you spent on oranges—otherwise, you’d have switched that dollar from apples to oranges (or vice versa) and bought some quantities other than (20,30). In other words, if I offered you the chance to move just one dollar’s worth of expenditure from apples to oranges, you’d be just indifferent. But your twin has the opportunity to move a dollar’s worth of expenditure from apples to oranges at a better rate of exchange—so he’ll surely want to do this. Thus there must be a basket with fewer apples and more oranges that is available to your twin, and that your twin prefers.
And to reintroduce reality…
For my income bracket, there is this wonderful invention called a 401(k). The Traditional 401(k) is a capital fund that comes from pre-tax income, and is taxed on exit. Taxed once. Or a Roth 401(k) which comes from post-tax income, and is untaxed on exit. Taxed once. (And if the rate of return is larger than 0%, eventually there will be some part of that gain was was effectively never taxed…which is the whole point.)
Then there’s the estate tax, which shows up only for large amounts — there’s a $3.5 million dollar exemption in 2009 (http://en.wikipedia.org/wiki/Estate_tax_in_the_United_States), though the exemption falls to $1million in 2011. $1million is still a lot of money.
So for your example, there would be no estate tax (the value was too small), so the ~entire amount should go to the inheritors.
Which brings us to my (still pertinent) comments from http://www.thebigquestions.com/2010/01/27/a-quick-economics-lesson/#comment-2139 — in my income bracket, I know of only one person who actually invests *outside* of a 401(k) (and thus could be subject to the multiple taxations you outline). I suspect (though cannot prove) that the majority of people subject to the multiple taxations are still making large sums of money (compared to me), and at the high end are paying a lower percentage in taxes than I am (the aforementioned Warren Buffet example).
So, in a country where GDP has been increasing over the last 30 years, productivity is up 40+%, yet the median wage has been stagnant for the last 30 years compared to inflation (http://www.dailykos.com/story/2007/4/2/162947/5397), and the total share of income going to the ultra-wealthy has been increasing over the same period of time (http://www.dailykos.com/story/2010/1/30/832076/-Surprise!-Income-Inequality-Bad-for-Your-Health.-And-the-Nations)…
*Why* do we need to have a tax policy that, in effect, wages class warfare on the poor and middle class, giving most/all of the gains to the ultra-rich (who *already* have a ton of advantages)? *That* is what a “no capital gains” tax would do — allow the ultra-rich to get richer at a faster rate than they’re already getting richer.
Certainly, the poor and middle class would be able to take advantage of it, but (1) most of the net gains would be to the very rich (as they’d have more money available to invest, unlike the poor who often don’t have anything to invest) and (2) the poor and middle class already have a single-tax investment vehicle at their disposal: 401(k) plans.
Yes, from a theoretical/level-playing-field what you say makes sense. When it hits the reality of a wholly *unlevel* playing field, in which the poor and middle class don’t have as much access as their richer brethren, it’s the recipe for a return to 15th century Europe: an uber-rich oligarchy surrounded by poor peasants. (Which is fine for the oligarchy, they’re not peasants!)
Daniel – you seem to be making alot of contradciroy statements….ie you deride the current system for “keeping the poor down” but removing capital gains tax will “keep the poor down” so let’s stick to the current system? Or are you just talking degrees? In which case are you suggesting we abolish all income tax and shift the whole tax burden to capital gains so only the wealthy pay taxes? What do you think that will do to capital flows in this country? Who do you think will suffer the most?
@Jonathan_Pryor: You do realize that those tax-advantaged investment vehicles require you to lock up the earnings until you’re over 59, or else pay an additional penalty tax, right? That’s a pretty huge cost to someone deciding what to do with investment money.
Also, it requires someone to be able to delicately balance a portfolio between three different structures, one of which (401k) is restricted to your employer’s plan. Most people can’t handle this themselves and have to hire someone else to do it. That negates much of the benefit.
Plus, you subject yourself to future tax-increases (in the case of the 401k) and future decisions by the government to tax the money you thought wouldn’t be.
@Steve Landsburg Thanks for the explanation. In it you say “I claim that when you buy 20 apples and 30 oranges, the last dollar you spent on apples must have brought you the same satisfaction as the last dollar you spent on oranges” as part of your argument for changing “probably” with “surely”. But what if that’s not true? I like to pack an apple in my lunch for work so 20 covers the month. I also like to eat an orange with breakfast every day, weekends included. Hey, that works out to 30 for the month. So the 20/30 ratio is set by my consumption preferences. But trading some apples for oranges, or vice versa, isn’t what I want so they aren’t the same to me. Unless, of course, you’re comparing apple to oranges and saying they’re the same thing. :-)
Stephen Coy: Your example, if I understand it correctly, violates the standard assumption that you are maximizing a differentiable utility function, subject to the constraints imposed by prices and your income. I don’t object to such examples, though I think that they are relatively rare in practice. If the assumptions are violated, than I’m stuck with “probably” and can’t go to “surely”.
Jonathan Pryor, thanks for bringing us back to reality. Your post is well informed, provides thru links appropriate support for your argument, and is tightly reasoned. I hope it draws a response from Steve.
Jonathan: Questions about how important one’s income relative to the people around one is versus one’s absolute income is an interesting one, and one I’m not insensible to: I live in New York, which gives you some perspective on this, because even if you make quite a lot of money by most people’s standards you will almost certainly be quite poor compared to the really wealthy individuals here. And this can certainly be a bit frustrating, though I think it frustrates some people a lot more than others (and the truly _massive_ distortions in the housing market here don’t help.)
I think though, that a good case can be made that even if a scheme that eliminated taxes on capital gains increased income inequality it would also increase the absolute wealth of the middle class, and even the poor. It seems to me that one of the biggest factors in how much wealth an economy produces is how efficiently it allocates capital, and I tend to think that eliminating these sorts of distortions would greatly improve that.
Beyond that, you’re assuming your conclusion here, to some extent, I think. Is it not possible that one of the reasons you know so few people at your income level who invest outside of 401(k) plans precisely because the incentive to do so is greatly lessened by taxation? And does that not make it harder for you and the people you know to accumulate capital?
One proposal I have seen is to remove taxation on the capital gains made from all future income, but not make that retroactive (there are a number of instruments one could use to do this.) If this were done it would not benefit the people who already have a great deal of capital as much as an elimination of these taxes otherwise would. I’m not saying that I necessarily think that should be done, but would that make you happier with the idea?
I’d also like to point out some things about how much $1 million is in the context of even a small family business being inherited, but this post is already kind of long, so I’ll just toss that out there as something to think about.
Yesterday, I mentioned Howard’s Law: every governmental action achieves the opposite of what was intended. It strikes me that taxes on interest/investment income, capital gains, corporate income, inheritance, etc are an excellent example of Howard’s Law. “What was intended” by such taxes (at least, the most sensible idea that I can think of) is to narrow the gap between “the rich” and the rest of us. That is the idea of Jonathan Pryor in this thread, as well as the idea of Warren Buffet, as quoted by Jonathan. (And the fact that Warren Buffet sponsors this idea should itself raise concerns.)
As this post makes clear, the effect of such taxes is actually to *widen* the gap between “the rich” and the rest of us. The Warren Buffets of this world can find all kinds of tax dodges; and if all else fails, they can move to a tax haven. Meanwhile, the rest of us are prevented from putting aside a nest egg.
A disclaimer: in the previous thread:
http://www.thebigquestions.com/2010/01/27/a-quick-economics-lesson/
my comments might seem to support Jonathan’s idea. However, my main concern was to avoid achieving the opposite of what was intended.
Tagore, I think you’ve missed the larger point Jonathan makes, to which btw I subscribe. For convenience I’ll copy it here:
“So, in a country where GDP has been increasing over the last 30 years, productivity is up 40+%, yet the median wage has been stagnant for the last 30 years compared to inflation (http://www.dailykos.com/story/2007/4/2/162947/5397), and the total share of income going to the ultra-wealthy has been increasing over the same period of time (http://www.dailykos.com/story/2010/1/30/832076/-Surprise!-Income-Inequality-Bad-for-Your-Health.-And-the-Nations)…
“*Why* do we need to have a tax policy that, in effect, wages class warfare on the poor and middle class, giving most/all of the gains to the ultra-rich (who *already* have a ton of advantages)? *That* is what a “no capital gains” tax would do — allow the ultra-rich to get richer at a faster rate than they’re already getting richer.
Certainly, the poor and middle class would be able to take advantage of it, but (1) most of the net gains would be to the very rich (as they’d have more money available to invest, unlike the poor who often don’t have anything to invest) and (2) the poor and middle class already have a single-tax investment vehicle at their disposal: 401(k) plans.
“Yes, from a theoretical/level-playing-field what you say makes sense. When it hits the reality of a wholly *unlevel* playing field, in which the poor and middle class don’t have as much access as their richer brethren, it’s the recipe for a return to 15th century Europe: an uber-rich oligarchy surrounded by poor peasants. (Which is fine for the oligarchy, they’re not peasants!)”
For the sake of simplicity, let’s assume there are two groups in the world: those who receive all their income for wages and those who receive all their income from capital.
It’s clear that by eliminating all taxes on capital, wage earners will suffer economic losses through shifts in the total tax burden to them, until (assuming the new wealth does in fact eventually trickle down to wage earners) wages finally “catch up” and allow wage earners to enjoy a “net benefit” from the economic growth generated by eliminating taxes on capital.
But of course, wage earners have still lost ground during the time they waited for the trickle-down benefits of eliminating taxes on capital. Does economiuc theory explain how wages will rise beyond this point of “net benefit” to eventually compensate wage earners for the losses they incur until the long term arrives. Maybe they will in the “long, long run.” (Keynes on “the long run” comes to mind here.)
Second, how should the different marginal values of a dollar (between a high-income capital owner and a lower income wage earner) be recognized in our economic calculations on this question of eliminating all taxes on capital?
Third, our host has proposed an interesting device for assuring some impartiality in addressing questions like this: the amnesia principle. This principle, applied in this case, calls for us to imagine choosing which “group” we’d rather be borne into in a world of no taxes on capital: the far more numerous and lower wealth wage earners who carry the entire burden of taxes, or the less numerous, high wealth owners of capital who are exempt from taxes?
(I’ve asked Steve if the amnesia principle assumes an advanced degree in economics, but he hasn’t responded yet. Maybe it sounded snippy.)
Anyway, I know which I’d choose. Every time. Even if I took the leap of faith that wealth would eventually spread through the economy and lift all boats.
Our host also proposes that we apply an Economist’s Golden Rule (EGR) to determine whether a course of action is moral (or at least to avoid “jerkhood” status). Again, I’m assuming the EGR is to be applied by those with a modest knowledge of economics.
If so, it seems reasonable that, given the complexity and uncertainty involved in the theory and calculations required to answer the question of whether a world without taxes on capital is a good thing for most people, a naive economist, using the EGR, could reasonably come to a conclusion that a world where there is a more equitable distribution of taxes on capital and wages is a better world.
I don’t doubt that reductions in taxes on capital will increase aggregate wealth. Obviously, capital owners will clearly be enriched. What I’m questioning is whether wage earners ultimately participate in that increase in aggregate wealth, how long is required before they do, and more fundamentally–back in the real world, whether they would benefit more from alternate policies; for example, eliminating all taxes on wages.
If taxes on wages were eliminated, wouldn’t wage earners work harder and benefit more directly and immediately than if taxes on capital were eliminated?
Wouldn’t aggregate wealth increase to the ultimate benefit of all, including capital owners?
When you think about the complexity of the interactions of all these theoretical and empirical questions, how could any reasonable person, even many economists, come to a conclusion that a world without taxes on capital is so clearly superior to some alternative world of taxation.
I have serious doubts one can, without donning the blinders of ideology.
Finally, considering all of the above, I can’t help suspecting that most of those who advocate zero taxation on capital do so in hopes of creating an incentive for wage earners to join them in a political agenda to cut government spending (and all the elements of their anti-government ideology), irrespective of its merits or whether wage earners benefit from that spending, as an alternative to wage earners supporting a more equitable division of the tax burden between capital owners and wage earners.
@Steve Landsburg Let me approach this in two ways. First, if I want to put my example in terms of utility functions it’s quite easy. Assume a function U with two parameters, apples and oranges. Because of my preferences U(a, o) peaks at U(20, 30) and falls off all around that peak since more fruit is just wasted and less fruit doesn’t make me happy. Mathematically we can easily create a smooth, differentiable surface representing this. If we let the cost of an apple or an orange equal $1 to simplify things then what you claimed was that U(19, 31) = U(20, 30) and this is not so.
Another way of looking at it: Again for simplicity let’s set the value of oranges and apples at $1 each. According to your argument I’d be just as happy with a (19, 31) ratio as my (20, 30) original choice. By your argument I could then start with a (19, 31) ratio, change the last dollar’s worth of buying to get an (18, 32) ratio and still be just as happy. Rinse, repeat and all we get is that any ratio that results in the same dollars spent results in the same amount of happiness.
Stephen Coy: The standard assumption is that U is increasing in both apples and oranges. You maximize U(x,y) subject to the constraint P_A x + P_O y = I, where P_A, P_O and I are the prices of apples and oranges and your income. The first order condition for this is U_1(x,y)/U_2(x,y) = P_A/P_O where U_1 and U_2 are the first and second derivatives.
Philip: (I’ve asked Steve if the amnesia principle assumes an advanced degree in economics, but he hasn’t responded yet. Maybe it sounded snippy.) It didn’t sound snippy and I didn’t mean to ignore you. Hoping to have time to get back to this….
To Jonathan Pryor and anyone else who thinks that capital gains taxes are a tax on the wealthy:
I EXIST!
Not having the luxury of wealthy parents, I graduated just 20 months ago with -60K in debt from the University of Rochester. I now have a few thousand dollars (money, not debt). I have made 40K per year from my pay check since graduating. I have a modest phone plan, no cable, a cheap, but new car. I shop around for the best interest rates on my loans. I live in an apartment and have, so far, defered getting married and having children. I have been frugal with month to month things, but I haven’t been cheap and travel and eat out more often then most my age.
I do not think that a progressive tax is fair under any circumstances, but if you are looking for one, you really should make it on income. I have done nothing that isn’t possible for anyone of average intelligence, some discipline, and an internet connection. I have no inside knowledge, no special education, no advantage at all over anyone with a few bucks and internet access.
Making money off of capital gains and interest is the most fair playing field I have ever experienced. Everyone has the same information and the same power. I’ve had jobs that couldn’t employ me before offering it to the lazy union workers. I’ve failed to get jobs until telling them that I know the right person who works there. Stocks are not like that at all. Anyone who does not take full advantage of such an oppertunity is a fool. For a government to do anything to harm such an environment is evil.
I am not wealthy yet. Please don’t pretend that capital gains taxes only hurt those at the very top – they hurt me too.
Respectfully,
Pete
Thank you, Pete, for reminding us that there’s no such thing as “the rich” and “the poor”. The vast majority of people start their adult lives in the first category and end them in the second, with nearly everyone at least moving in that direction. I like to paraphrase Thomas Sowell on this topic: “People talk about ‘the rich’ and ‘the poor’ as if some people have a ‘P’ or an ‘R’ on their forehead. Most people are both at different points in their lives.”
Five years ago, I was a “poor” college student, then later a “poor” graduate student with a low income, and recently took a job that pays 5/2 my grad school stipend. It would have been grotesque to classify me as “the poor” when I was a student, although I technically fit into a low income bracket. People move up income brackets throughout their lives, and they also accumulate wealth throughout their lives. There are class divisions, and people get born into privilege, sure. But the narrative of the downtrodden worker slaving away for minimum wage his whole life is a myth, at least in the US.
I understand that many want to tax things like inheritance and capital gains so that we don’t get a class of people who can live entirely tax-free off of such things.
There is already a tax scheme that perfectly addresses these concerns as well being equally discouraging all things. Furthermore, it was conviently written about by Professor Landsburg not too long ago:
http://www.slate.com/id/2181833/
I don’t think there is a chance in hell Congress will ever pass the Fair Tax or that this president will sign it. The idea of expanding IRA contributions, and perhaps later expanding the time or reasons they can be withdrawn, however, is a real possibility.
Philip: Well, it is certainly possible that I missedJonathan’s point, but it is not the case that I did so because I was unaware of the points you bring up: I was aware of them. I had hoped that my answers to them were implicit in what I had written. Had I made them explicit the comment would have been very long.
I do however think you might have misunderstood or glossed over a couple points. First, the Amnesia Principle is, if I’m not mistaken, very similar to John Rawls’s proposed “veil of ignorance.” If that’s the case, assuming that both the capital haves and the capital have-nots continue to exist, which you would prefer to be is not the important question. The important question is, given that you have no way of knowing which class you are in, what policies would you prefer. That you would prefer to have a lot of capital says nothing, unless you are arguing that all that accumulated capital should be confiscated and redistributed- it is hard to imagine a system in which any reasonable meaning of “having a lot of capital” was preserved in which you would not prefer to have a lot of the stuff.
I’ll also say that I have pretty grave reservations about the Amnesia Principle, past a certain point. The reasons for this are a bit too long for this comment though. That said, I do think it’s a valuable tool for building intuition about certain things, so I don’t object to its use as long as that use stays within certain bounds and isn’t used to hide assumptions, or as a hand-waving aid.
You and Jonathan bring up a few questions that I think have to be treated separately. First, we have to ask “In a world in which capital gains are not taxed” (or perhaps, “In a world in which only consumption is taxed”) would the median person be better off in absolute terms? Would the poorest be better off, in absolute terms?
I believe that they would, and I don’t think it would take all that long for them to “catch up.” In particular, I think that there would be ways to level the playing field to some extent (such as the idea I mentioned above of allowing only the capital gains from principal derived from future earnings to be untaxed.) There are some fiddly but very important details here about whether the capital haves can take income derived from old capital and treat it as new capital, or not. I’m not saying that I would endorse those measures, but they are worth considering if your position is a very egalitarian one.
You’re right that the world is very complicated, and that I cannot definitively prove that this would be the case. But the same can be said for your position: that they would not be, at least not within any reasonable time-frame. I will refrain from speculating as to the motives that lead you to take the position that you take ;). At any rate, this is a question of fact, even if it is not possible to determine the truth value of a given answer to it with absolute certainty.
There is another question here though, and it is one that Jonathan’s post also seems to imply, at least based on the links he provides. To wit, we can also ask “Even if the capital have-nots are more wealthy in absolute terms under the proposed regime, would they be worse off because they are less wealthy relative to the wealthiest x%?”
There are certainly radical egalitarians out there who would prefer a world in which everyone is quite poor to one in which no one was poor, but some were much richer than others. At the other end of the spectrum there are some people who care only about aggregate output and don’t give a fig about its distribution. Between those positions there is a continuum of considerable extent.
Anyway, if I seem not to have answered your points in great detail it is because I am not actually sure where you fall on that continuum, and I am not sure where Jonathan falls on that continuum. Whether or not the have-nots having a smaller piece of a bigger pie would lead to them having a larger piece of pie is one question. Whether or not it would be a good or a bad thing if they did, given certain values for large and small, is another. Neither is a simple question, though the former has the virtue of being less normative than the latter.
I apologize for posting twice in a row. Pete’s comment, and the responses to it, were posted after I had begun my previous comment. At any rate, I’ll make this comment more concise (if brevity is the soul of wit then I am afraid I am a singularly humorless fellow.)
I’m well aware that you exist, Pete. In some respects I have been in a similar position to yours in the past. I am frugal by nature (with a few conspicuous exceptions), maybe because I grew up in what I think could be fairly described as abject poverty. At one point in my early teens I lived a house that lacked even an outhouse, and in which it was not uncommon for temperatures to fall well below zero Fahrenheit in my bedroom.
I am quite a bit older than you, but I still live a lifestyle reminiscent of a recent graduate, despite sometimes making a reasonable amount of money. A few years ago I noted with some satisfaction that my total expenses for housing, food, utilities, transportation, and clothing amounted to less than 15% of my pre-tax income (note that I was not in New York at the time ;) ). I then proceeded to not work for a few years while living on my savings, so I’m afraid that the only capital I netted by doing that is rather intangible (though real, I expect.)
I would like to point out though that there really is a huge difference between what you’re talking about and the kind of capital that some people are born with. Despite the biography I offered above (which is quite true) I have known a lot of very rich people since I was a child, people who had inherited, or were going to inherit, 7 or 8 figures.
I applaud your thriftiness and foresight (I have the first, but I’m afraid I might not have much of the second.) And part of the reason I agree with Steve about this is because I think you should not be penalized for failing to eat your seed corn. But it is important to recognize that the kind of Capital you are talking about and the kind of capital that some other commenters in this thread are talking about are not quite the same (though they work equally well per unit as investment capital when put in the capital markets.)
We are primates. As such certain things offend our sense of fairness. This is not necessarily rational in the technical sense of the term, but it is indisputably true. I don’t think that your story is likely to offend most sensibilities. On the other hand the Rockefellers and the Mellons accumulation of capital does. So that is where the argument naturally goes.
@Steve Landsburg With the assumption that U is always increasing the math makes sense. But as I noted, my desire for apples and oranges is limited so for me, U is not monotinic so the standard assumption, and hence the rest of the argument doesn’t apply. I guess what I’m having trouble wrapping my head around is when does this assumption apply? You say that it’s rare for it not to apply. Can you give me any examples of goods that you buy that where this standard assumption does apply?
Stephen Coy: I have no evidence for this at my fingertips, but all I’m asking you to believe is that most people, having just been to the grocery store and stocked up on apples and oranges, would gladly accept another apple or another orange if it were free. That strikes me as pretty easy to believe.
Stephen: I think that limiting the discussion to apples and oranges muddies the waters a bit in this case, or at least makes it easier to muddy them. We should really be discussing a basket of economic goods that encompasses all your wants, and in that case it is much less likely that you will encounter pathological cases like “well, I have enough apples _and_ oranges, so I don’t really want more fruit.”
When you consider most people’s economic behavior it is usually the case that more spending on X means less spending on Y. It is also usually the case that people measure the utility of spending as a function of both the cost for and the value of what they are spending on.
So here’s the thing- I think you are being misled here because both apples and oranges are so cheap that you can afford as many of them as you want. Substitute expensive goods (Insert paragraph about hookers, cocaine, machine guns, and trips to Bali that I decided to delete) and I think you might be able to follow the logic more easily.
As a general rule I think it is safe to say that if we make it more expensive to acquire some good that good will make up a smaller part of the basket of goods you choose to buy. There will probably be exceptions, but I’d like to see someone refute that general rule.
Pete and GregS,
I can’t speak for anyone else who “agrees with Jonathan” but I’m not arguing the merits of any specific tax on capital. I’m arguing our host’s earlier advocacy for the elimination of ALL taxes om capital.
And if the top 1% of wealth holders are not “rich” and the bottom 1% are not “poor”, then what are they?
Steve: thanks,that explains things quite clearly. It’s essentially how I thought the argument must go, but I hadn’t quite managed to formulate it in my head.
So Apples Today must be taxed at the same rate as Apples Tomorrow because I get to choose the ratio between Apples Today and Apples Tomorrow, and whatever ratio I choose is (to all intents and purposes) the “real” interest rate?
(so if I happen to choose a different ratio to everyone else, I happen to make a profit by virtue of having different preferences)
John Faben: I do not understand any part of the following:
So Apples Today must be taxed at the same rate as Apples Tomorrow because I get to choose the ratio between Apples Today and Apples Tomorrow, and whatever ratio I choose is (to all intents and purposes) the “real” interest rate?
I’m not sure how much of this is because we’re speaking different languages and how much is because I’ve confused you. Again, I expect a graph will help, and I’ll try to get around to posting one.
Tagore, I appreciate your thoughtful response, your careful avoidance of making assumptions about where we stand on questions we haven’t explicitly addressed, and the absense of vitriol and mischaraterizations of what we have said. Thsese seem to be a rare quality in these discussions.
A first reaction:
I think you’re correct (and very diplomatic). I’ve misapplied the amnesia principle. Let me try a different track:
Assume a world in which there are two groups: those who earn all their income from wages and those who earn all their income from capital, and I know I will be born a wage earner. Do I prefer to be born into a world with no taxes on capital or one with some mix of taxes on wages and capital.
On the face of it, I’m pretty sure I’ll prefer the mixed system. But let’s say I’m briefed before I make my choice by an advocate for the tax exemption of all capital. She makes a good case for how this policy will create more wealth in the economy and thereby benefit everyone including wage earners.
But she believes in full disclosure, so she explains that…
* capital owners benefit first and more than wage earners. That’s OK, because I’ll still be better off.
* I’ll bear a greater portion of the tax burden, either by a rise in taxes on wages or through deficit spending that promises higher taxes on wages in the future (or abandoning the exemption of taxes on capital), but still I’ll be better of down the road.
* moreover, it will take some time for the tax benefits won by capital owners to have their effect on economic growth and trickle down to wage earners. But in the long run my income will rise to offset your losses. Hmmm…
* and then, to recover your accummulated losses as you waited for the wealth to trickle down, your income will contine to rise (in the long, long run) and offset those accummulated losses.
I think most of us wage earners abandon the tax-exampt-capital ship at this point, and for good reason. It smells like a pig in a poke.
That’s even before we consider alternate tax policies, like one making wages tax exempt instead.
Thanks for you patience.
My apologies, but one final observation. Economic power and political power are fungible. Therefore, the increase in economic inequality makes me, as a wage earner, a loser on another dimension, even if I eventually experience a net rise in my wealth. A policy of exempting capital from taxes gives capital holders more resources than wage earners receive to use in the political realm (e.g., through lobbying and campaign contributitions) to further their interests at the expense of wage earners.
John: Consumption today must be balanced against future consumption. In the end all economic activity exists in order to allow consumption: if we were spirits of the air, able to subsist on nothing, we would not need an economy. We would just consume air.
We are, unfortunately, not spirits living in a world that provides the essentials of life in all cases. I would argue that compensation should be linked to one’s ability to keep the wolf from the door. Does your philosophy account for this? There are more things under heaven and earth than yda yada yada ;).
Steve, I guess that was not very intelligible, probably partly because it was late, and partly because I don’t think I fully understood what I was saying. Essentially, I was trying to figure out in my head why the argument given applies equally to Apples Today and Apples Tomorrow as to Apples Today and Oranges Today.
I guess I skipped several steps in what I thought was my reasoning, but essentially the reason would be that Apples Today and Apples Tomorrow are two different things, which have their own different prices (Apples Tomorrow being cheaper, due to interest), and taxing them differently will distort the ratio in which I choose to buy them?
John Faben: Your most recent comment is exactly correct.
On Phillp’s observation that “economic power and political power are fungible.”
I agree with you, but that is only true in a system where the government owns so much of the wealth and wields so much power. Rich people and corporations lobby for subsidies because the government has made a habit of handing out subsidies. Wealthy, well-connected private contractors get sweetheart contracts because city governments insist on doing “public works projects” with their citizens’ money. By allowing the government to confiscate more wealth, we makes this problem worse, not better. If the government has more favors to sell, people will spend more money and effort attempting to curry them, and the relatively wealthy will benefit more than the relatively poor from these favors. (On a topic unrelated to taxation, “the rich”, or at least the well connected rich, generally control regulatory bodies and strong-arm the relatively smaller, less-connected businesses out of the market. Or use Eminent Domain to outright confiscate the land they want; see the Bruce Ratner case.) In a laissez-faire economy, rich people can’t bribe the government to steal things for them. If they want something that comes “at the expense of the wage earners,” they must purchase it from the wage earners directly.
At any rate, capital accumulation helps the poor, not just the rich. The reason factory workers in America earn more than sweatshop laborers in the third world is because their labor is more productive. The reason their labor is more productive is because of capital accumulation…more advanced and efficient factories, better machines, etc. There is no way to tax “capital gains that benefits the rich” without also taxing “capital gains that benefit the poor”.
In response to GregS: I think your comments apply to any government though less to democratic ones than other forms. Even before American independence was won, men of modest means became wealthy from govt. spending suppling war materiale to General Washington’s army. This is not unique to the post-New Deal or even the post-Civil War enpowered federal govt.
The authority of our current federal govt comes directly from the Constitution’s Commerce Clause, the Neccesary and Proper Clause, the war-making authority, the taxing authority, and the 13th, 14th and the 16th Amendments among others. These powers were ceded to the govt. by “the people” through legally-sanctioned democratic processes. Therefore, I think your use of the word “confiscation” is inappropriate as the word connotes the illegal seazure of private assets.
Rather than questioning the legal authority of the govt to enact the policies you object to, the more appropiate approach is to question their effects and therefore their wisdom.
I agree with your observations about the power of the wealthy to bend govt policy to their won ends. But your prescription of laissez fair policies will not resolve that problem.
While the govt is often an instrument of the wealthy, on occasion it is also a powerful instrument of the not-wealthy. Jefferson broke the back of the economic elites in the Federalist party, Jackson broke the backs of economic elites by abolishing the Second National Bank, Lincoln and Congress resorted to arms to break the backs of the slave-holding economic elites of the South (by freeing the slaves and “confiscating” the vast majority of their assets without compensation), TR used the Commerce Clause to restrain powerful elites who owned the monopolies, the Progressives expanded the franchise to women, Truman integrated the armed forces, Kennedy and Johnson broke the back of Southern elites to expand the franchise to blacks. I could cite others.
Yes, these are exceptions to the “rule” of the wealthy’s influence on policy that we both object to. But they are hugely important exceptions. You may not agree with the policies in this list, but they are clearly constituional and clearly benefited the not-wealthy. And I don’t see how any of them would have been possible under a much weaker, laissez fair govt.
I don’t doubt that capital accumulation benefits labor and capital-owners. What I’m questioning is whether this particular policy, eliminating ALL taxes on capital, ultimately benefits labor and whether there are other tax policies that would benefit labor directly while indirectly benefitting capital owners and lead to the accumulation of capital.
First, @GregS: I basically agree with you about a lot of things. That said, I don’t think that a laissez faire system would accomplish everything you think it would. I’ve been thinking about these things for almost as long as I’ve been alive, and the conclusion I’ve come to is that primate societies are naturally hierarchical. I don’t believe that it is possible to create a society in which some people don’t have disproportionate power. Nature abhors a vacuum, etc. So my takeaway is that things should be structured in such a way that the powerful must serve the interests of the powerless as part and parcel of serving their own interests. Arranging things so that is the case is not easy, since it is necessarily against the interests of the powerful.
@Philip: it seems clear to me that in our _current_ system wage earners do benefit from increases in aggregate output. In fact it seems so clear to me that I am at a bit of a loss when it comes to defending that proposition: I feel like I’m being asked to defend the statement that the sky is blue.
I don’t believe that wages have been truly stagnant over the close to 40 years I have spent on this planet. I’m typing this comment on a cheap laptop that is connected to the internet. When I compare that to my access to computers in the 70s it is hard to not consider it an increase in absolute wealth.
I do think that we might have come to the end of that sort of increasing wealth, but I believe that that is the case because we have been eating our capital for a long time. And that is _exactly_ what you would expect under a system that penalizes saving.
I don’t think it’s an accident that we have 1) a system that makes present consumption more attractive than future consumption and 2) a system that is falling apart because people prefer present consumption, under the prevailing regime.
I am afraid that the near future will amply demonstrate that it is better to be middle-class, or even poor, in a society that is rich than it is to be so in a society that is not. And I do believe that this will be demonstrated because we have failed to allocate capital in a sensible way. The distortions introduced by the tax code are just one factor in this, but it’s an important factor, IMHO.
Some context:
“After paying state and federal income taxes, he was left with 50 cents”- Means that this poor man was in the top 1% of earners. This model-dollar = a half million US dollars. His tax bracket owns about 50% of the capital wealth of his country which coincides nicely with his bracket tax rate
“Eventually, his children inherited the money, paid 50 cents in inheritance tax, and reinvested the remaining 40 cents in the original company.”- Meaning that he was actually one of the one half of one percent of Americans whose heirs will pay any tax at all on his post mortem gift.
In this case the “50 cents” his children received equals more than $174Million dollars. Only an estate of over $315Million, after deducting the $3.5M exemption and then taxing the remainder at the estate tax rate yields a net tax of anything close to the 45% used in this model. It actually only gets us to a net tax of 44.5% which I can round up.
To make your model more accurate by another decimal (to 44.95) would require an initial estate of $3Billion.
Yes, I get it, a model is just a tool to make a point. But by illustrating a model that only represents maybe a dozen or two individuals in a way intended to appeal to the average reader is duplicitous.
@Benkyou: The context you provide is immaterial. I could give you a set of numbers both in line with the current codes and similar in discouraging the accumulation of capital.
Even without that your comment shows a lack of understanding of a basic principle (well more than one, really): future consumption is predicated on current savings. That is true no matter how much money the rich have. If it is your aim to reduce future consumption then your points are well taken. If not, you need to go back to the drawing board.
Benkyou: I think you’ve missed the key point, which is that any tax on capital is a disguised tax on labor, with labor in one period being (implicitly) taxed at a different rate than labor in another period. Change the percentage tax rates to anything you like and the point will still hold.
Philip
I’m surprised by your examples. They are almost entirely examples of government institutions being corrected by government, not of private institutions being corrected by government. Slavery and disenfranchisement of women are emphatically state institutions. In the case of slavery, wealthy parties agitated and lobbied the government in pursuit of their interests. And they got what they wanted because they were powerful and connected. Slavery is not a market institution; it requires force and a government or quasi-government entity to enforce it.
You state that your examples are exceptions to the rule; that’s somewhat an admission that the expected outcome is the one I described: of moneyed interests gaining control of state power, with a small chance of actual justice being done. The expected outcome is far more important than the intended outcome.
I didn’t mean to comment on the legality of any form of taxation, but the word “confiscate” usually means “taken by force.” Anyway, something can be legal and still be immoral or terribly unwise. Taxing capital is terribly unwise. Had we been taxing capital gains this heavily since the beginning of the industrial revolution, we’d have had far fewer gains, and our laborers wouldn’t command the relatively high wages they do today (high compared to what they used to be and what they are in the developing world.)
Oops, I should say, “and they got what they wanted for a while.” I’m refering to the plantation owners, not the abolitionists, when I refer to wealthy parties lobbying for their own interests.
@Steve Landsburg Where did the fre stuf come from? You stated that I’d be just as happy spending my last dollar on apples as oranges. You only get one or the other, where does the fre come from?
@Tagore Smith What I’m arguing is that Steve’s assumption that the utility funciton is monotonic and returns a value direclty correlated to the number of dollars spent is a false assumption. Hence the arguments he builds on that assumption, while they may get to a valid conclusion, are not valid arguments.
You mention applying this to higher priced items. Let’s say I need a new washer and dryer. I’ve got a budget of $1000. At the local applicance store I find a model I like where each piece costs $500. According to Steve’s definition of “standard assumption” utility function I will gain just as much utility from buying 2 washers and no drier or 2 driers and no washer as I would buying 1 of each. This is clearly ridiculous.
In summary, I assert that in the real world utility functions are rarely, if ever, monotonic. I also assert that the value/utility of an item may have little to do with its cost implying that moving my spending dollars from one item to another doesn’t result in the same utility result even though the dollars spent may be the same. Both these assertions directly contradict Steve’s definition of the “standard assumption” utility function upon which he based his argument.
Stephen Coy: To show that the utility function is monotonic, I have to show that your utility would increase in the (hypothetical) event that someone gave you some free stuff. The free stuff comes from that hypothesis.
GregS:
How can you claim that slavery and the disenfranchisement of women were the result of government institutions? Neither was the result of government intervention in the economy. Both reflected the actions/preferences of private individuals acting in a free market, in the case of slavery (and child labor I might add), who comprised the majority who owned most of the economic resources in the country and the majority of those who were enfranchished. Neither resulted from govt intervention.
Yes, in the case of slavery, but not the disenfranchisement of women, slave owners used the power of government to secure their property. But most emphatically it was the government, and the people through the instrument of govt, that ended slavery by “confiscating” the slaves and freeing them without compensation to their owners.
Slavery was not a market institution? Slaves were acquired in the African slave markets at market prices, a source of wealth to their owners(in fact, by far the largest source of wealth in the South), bought and sold in the US at market prices, protected by law like any other property (until the Civil War ended) from conscription by the government, and were, under the law, subject to return to their owners if “stolen” by abolitionists.
What is missing to support a claim that slavery was not a “market institution”?
And yes, slavery was maintained by force, the force of the whip and the chain, wielded by private individuals. This ended only through the invention of government by force of arms and law.
As for the rest of your response, please note that I said…
* I agreed with your notion that these examples are exceptions, but said they are hugely important exceptions that never would have occured under a weak, laissez fair govt. (I take it you’re not black or female.)
* I said that your agruments are emphatically at odds with our constitution but that it’s entirely appropriate for you to oppose them as unwise, which your latest post appears to reflect, though you don’t acknowledge the persuasiveness of this point.
* Of course, anything can be immoral and yet legal. Slavery, for example, pre-1865.
@Steve Landsburg Contrary to your hypothesis, I’ve already got 1 barely working washer, if you give me another the utility is decreased because of the cost of storing or disposing of the item. the same with apples. If I’ve already bought the 20 I’m going to eat thas month having you give me 2300 more just gives me lots of rotten apples I have to get rid of. Basically what you’re saying is that more of anything is better. I think there’s plenty of cases where that’s not true.
You also completely ignored my other assertion. Any particular reason?
@Stephen: I think you are not reading what Steve wrote carefully enough. I also think you might be using a non-standard definition of monotonic. The key phrase from Steve is “the last dollar you spent on apples must have brought you the same satisfaction as the last dollar you spent on oranges—otherwise, you’d have switched that dollar from apples to oranges.”
This seems obviously true to me- if the value of spending that last dollar on apples were less than the value of spending it on oranges you would not have spent that dollar on apples.
A monotonic function is simply a function the result of which never decreases (or, alternatively, one for which the value always increases at least a bit.) For a function to be monotonic it is not necessary that the output increase at the same rate over all intervals.
Steve is not claiming that the last apple is as valuable as the first. He is only claiming that it has _some_ value to you. But he is also pointing out that _precisely because_ the utility of buying that apple is predicated on both the value of _that_ apple (to you) and the price of apples in general a change in the price of apples might well result in you buying less apples than you would have preferred to buy if the price were different.
Response to Tagore,
As I think you know, I am not arguing that the current tax system doesn’t benefit wage earners through increases in aggregate wealth.
I’m arguing that there are signficant reasons for doubting the proposed policy of eliminating all taxes on capital will ultimately benefit wage earners. Indeed, the fact that wage earners have significantly benefitted from the current, more equitable distribution of the tax burden leads me to question the merits of abandoning the current system for the claimed benefits of the proposed system.
This doubt is reinforced by my observations that…
– the theories and calculations for how wage earners will ultimately benefit, after immediately losing ground by the shift in tax burden implied, are so complex and even difficult to explain to non-economists by advocates of the policy,
– the benefits go directly and immediately to capital owners and indirectly and at some time in the future to labor,
– for someone with some experience in the real world, this theory looks like the cloaking of self-interest with economic theory,
– other economists strongly contest the claim that eliminating all taxes on capital will ultimately benefit labor or that alternate tax policies would not provide greater, more immediate, more certain, direct benefits to labor while also increasing capital accumulation, though indirectly.
– my direct career experience with tax policy making in DC, over more decades than I like to admit, convinces me that an increase in economic inequality increases the advantage that capital has over labor in the political arena and that capital holders will use this advantage to further increase their wealth, because most of them don’t really believe in economic theory as much as they do the pursuit of their economic self-interest. And with this enhance political advantage, by ignoring their stated preference for policies that increase aggregate wealth, they’ll pursue their self-interest at the direct expense of labor.
As Dr. House says, “Everybody lies.”
Why is this skepticism misguided?
Philip: I don’t think your skepticism (that’s the wrong word in my opinion- I would say cynicism, and I consider myself a cynic) is misguided. I just think you’re applying it selectively.
Let’s put it this way: you assume that the powerful will be able to bend things in such a way that they wind up the main beneficiaries. You’re probably right about that. I wonder if it has occurred to you that this has probably already happened ;)? If that’s the case then we should assume that any theoretical proposal that makes any sense at all would benefit them less than the current reality. Unfortunately we would also have to conclude that the actual implementation of that theory would probably wind up benefiting them more than the theory by itself implied ;).
I would call that a wash. The current system has been gamed by the powerful. Any proposed system will also wind up gamed by the powerful. I suppose it’s possible to argue that the powerful have become more sophisticated since the current sytem was put in place, and that we should thus make _no_ changes for fear that they would game any new system to a greater degree than they have gamed the existing one- indeed this seems to be what you are arguing.
That argument is not entirely without merit. I wonder if you know that you have become a thoroughgoing conservative by making it though ;). I am reminded of the title of an essay penned by the protagonist of Joseph Heller’s novel “Good As Gold” (in my opinion the greatest unknown novel of the 20th century, and a much better book than the same author’s “Catch-22”): “Every Change is for the Worse.”
@Tagore Ah, the light is slowly beginning to come on. Yes, I understand what monotonic is, I just believe that there are case where more of an item is of negative value, ie there is such a thing as “too much of a good thing”.
The real clarity is in your statement “if the value of spending that last dollar on apples were less than the value of spending it on oranges you would not have spent that dollar on apples.” I totally agree with this. You are comparing the value of the last dollar I spent on apples with the value I might have gotten if I had spent it on oranges instead.
Steve’s statement says that the value from the last dollar spent on apples is the same as the value from the last dollar spent on oranges. It says nothing about the value of the _next_ dollar spent on oranges. I realize that’s a bit pedantic but that seems to be the rule for this blog.
Thanks for the clarification.
Philip
It’s quite rude of you to guess at my race and sex (I’m sure it occurred to you that my handle is some combination of letters in my last and first names). I don’t see how either item is relevant. All you know about me is a few of my opinions.
I won’t quibble about the definition of “market institution;” yours apparently encompasses slavery and mine doesn’t. This is what I meant by my comment: Slavery would not have existed for long without the help of government. Slavery requires more than just force, it requires heavily subsidized force, the subsidies coming from people who don’t pay willingly. Of course it’s impossible to prove this, but I recommend “Applied Economics” by Thomas Sowell. The relevant reasoning is in his chapter on “The Economics of Discrimination.” The same reasoning is in “Capitalism and Freedom”, and also in Professor Landsburg’s Pricing Theory textbook (as I recall it is). Postwar discrimination was also prolonged by the government, through Jim Crow laws. That kind of discrimination was propped up by the state, just as slavery was (again, see Sowell’s book for the full argument; I’m sure it wouldn’t fit here.)
You’ll pardon me if I don’t think it’s a great triumph of government when the state stops doing evil things. This is more appropriately seen as a removal of government, or the government fixing it’s own errors.
From your last comment: “– the benefits go directly and immediately to capital owners and indirectly and at some time in the future to labor,”
I for one am quite happy to be the indirect beneficiary of capital accumulation, which has happened over hundreds of years, and which would be significantly smaller with the kinds of taxes you’re advocating. Shouldn’t we be doing things that benefit labor “indirectly and at some point in the future?” Do you realize that you state two good things about cutting capital taxes in that bullet point? The capital owners you refer to include everyone; working class people saving for retirement (as in Landsburg’s example) are hurt by the tax on capital. Even a “tax-free” 401-k grows more slowly because of the capital gains tax.
Dr. Landsburg
An added benefit of removing the multiple forms of taxation is that fewer tax accountants would be needed, fewer corporate lobbyists would attempt to re-write tax laws (which are gamed because they are currently complicated), and fewer bureaucratic “policy experts” would be needed in Washington. Pardon me, but those are make-work jobs that create a dead-weight loss to the economy. (Unless you follow the “broken window” fallacy and believe we’re enriched when extra work is created.) Considering this, I wonder if a tax on labor alone is still the best policy. What taxation regime would minimize transaction costs? I suspect a flat tax on sales alone would require the fewest tax accountants (one per store instead of one per worker). Then again, a tax on labor could be made extremely simple so it requires zero accountants. Considering transaction costs, is a single tax on labor still the best policy? I’d like to know Dr. Landsburg’s answer.
I realize that make-work jobs are usually filled by people who lobby hard to hold onto their jobs; there is political resistance to a more efficient taxation regime that has nothing to do with the “fairness” to the working class. The tax accounting industry and the IRS would have less to do in such a regime, and I don’t suppose they’ll take kindly to their jobs becoming obsolete.
Response to Tagore:
“Philip: I don’t think your skepticism (that’s the wrong word in my opinion- I would say cynicism, and I consider myself a cynic) is misguided.”
Nope, I subscribe to skepticism, but I find contemporary western cynicism highly objectionable. Classical Greek Cynics, that’s another matter.
“you assume that the powerful will be able to bend things in such a way that they wind up the main beneficiaries. You’re probably right about that. I wonder if it has occurred to you that this has probably already happened ;)?”
As you’ve surmised, I do.
“If that’s the case then we should assume that any theoretical proposal that makes any sense at all would benefit them less than the current reality.”
No we don’t. That is, unless you assume that the powerful have been able to completely dominate policy making, maximize their benefits and have no further opportunities, which I do not assume and would contest, and forthermore, you assume that current conditions are static and changes do not present new opportunities to exploit, in reaction to or anticpating those changes, which I do not assume and would guess you wouldn’t either.
“Unfortunately we would also have to conclude that the actual implementation of that theory would probably wind up benefiting them more than the theory by itself implied ;).”
Indeed.
“I would call that a wash.”
Not if you accept my rebuttal above.
“The current system has been gamed by the powerful. Any proposed system will also wind up gamed by the powerful. I suppose it’s possible to argue that the powerful have become more sophisticated since the current sytem was put new system to a greater degree than they have gamed the existing one- indeed this seems to be what you are arguing.”
No, that’s not what I’m arguing, but I’d might accept it as a proposition, esp. in a political environment in which the power of lobbying and campaign contributions has increased dramatically over the past 20 years. And the trend is likely to accelerate with the Supreme Court’s decision in United Citizens.
“I wonder if you know that you have become a thoroughgoing conservative by making it though ;).”
Sure, I’m conservative on a number of dimensions. To cite two, I’m a pro-defense Democrat in the mold of Scoop Jackson, Lloyd Bentsen, and Sam Nunn, and I tend toward strict constructionism in interpreting the US Constitution. (And I have high regard for Edmund Burke.)
But I have profound differences with the “strict construtionists” on this court who, for example, have written in “corporations” where the constitution reads “the people” despite the word never appearing in the document and the founders having great fear of the power of corporations and sought to curb their influence through the instrument of the constitution. (Several of the Federalist Papers support this claim, but at the moment only #10 comes to mind.)
Finally, I do not believe “every change is for the worse” or that anything I’ve said leads to that conclusion. What I AM arguing, however, is that this paticular change, to eliminate all taxes on capital, is indeed for the worse.
Tagore- I think it is presumptuous to suggest that disagreement requires a lack of understanding. But besides that, you make a valid point. But there is one point … Do you really think that the super-super-wealthy illustrated by this model make decisions on what to buy based on how much their income is taxed? For one, the more of their income they invest, the less tax they pay on it.
Steve L- I got it. But I think there is a distinction that needs to be made. Since you agree with Marx about the relationship of capital value and labor, you should identify that a tax on capital is not a tax on labor. It is a tax on the value of the labor that is not paid to the laborers. Marx had some interesting views on economics, but mathematically he was a nightmare. I wouldn’t base a tax code on his principles.
Could you rewrite your “reality” to reflect the situation 95% of us experience? Something like:
Once upon a time, a man went to work and earned a dollar. After paying state and federal income taxes and receiving his earned income credit and the Child Tax Credit, he was left with $1.10. He used $1.00 to buy a share of stock and 10 cents to buy The Big Questions by S. Landsburg. When the stock price doubled, he sold his share for 2 dollars, paid nothing on the capital gain, and put the $2 in the bank. Eventually, his children inherited the money, paid nothing in inheritance tax, and reinvested it in the original company.
And then explain how this largest portion of rational self interested voters should vote on whether to raise or lower capital gains tax.
GregS, I apologize if I offended you by my reference to race and gender.
I suppose I assumed wrongly that most blacks, whose forebears won their freedom, and women, whose predecessors won the franchise, through the actions of a strong central government, acting under constitutional procedures and subject to the requirements of overwhelming popular support demonstrated by the amendment ratification process (in other words, a government accountable to the people through multiple means), would likely prefer such a government over one, conforming with laissez faire ecomonics, that is virtually powerless to accomplish these ends.
“I won’t quibble about the definition of “market institution;” yours apparently encompasses slavery and mine doesn’t.”
OK, but you neither refute my “definition” nor offer one of your own.
“This is what I meant by my comment: Slavery would not have existed for long without the help of government.”
This is simply historically inaccurate. Slavery did not initially require goverment support or endorsement in order to thrive for more than 100 years before it was accommodated by compromise in the US Constitution.
The reason is that slavery was so embedded in the culture and economy of the South that there was little need for government intervention to sustain it. It was only when opposition began to emerge outside the South that slave-holders became nervous and turned to govt. intervention to protect and preserve slavery. They succeeded until Lincoln was elected and the South seceded.
It is an irony that the govt. institutions that were used by slave owners (100+ years after slavery came to America through private enterprise) later came to be used to end slavery.
This “irony” is at the heart of American political history, and what I’m saying is that dynamic capability would be sacrificed under a weak, laissez faire govt. I personally think that’s a hell of a lot to give up, too much, but my current objection is that libertarian proponents of a weak central govt. fail to recognize, ignore or deny this crucial role of a sufficiently strong central govt.
“Slavery requires more than just force, it requires heavily subsidized force, the subsidies coming from people who don’t pay willingly. Of course it’s impossible to prove this…”
Well, this is not self-evident. What subsidies are you refering to?
In fact, the vast majority of southerners supported slavery, esp. after 1800, and in the north where slavery continued to be practiced, though limited, into the 1840s, most people didn’t care much about the issue. That began to change after 1840 through a series of private and state actions.
“That kind of discrimination [Jim Crow] was propped up by the state…”
Sure it was. But it had its roots in slavery which originated out of private action without intervention by a strong (or weak) govt. And it was a strong central govt. that ended Jim Crow in the 1960s, as it did slavery 100 years earlier.
“You’ll pardon me if I don’t think it’s a great triumph of government when the state stops doing evil things. This is more appropriately seen as a removal of government, or the government fixing it’s own errors.”
You’re pardoned. Slavery is a classic example of how private action, unaided by govt intervention, creates abuses, either in the market or the surrounding society, which lead to reform efforts expressed through a strong central government. Those reform efforts are blocked when those private interests capture the legislative and regulatory arms of the govt and protect and extend their interests. Reform efforts are redoubled and eventually the reformers fail, and the efforts fade away until a later generation takes them up again. Or, through great effort, and typically some damn good luck, they succeed
in pushing through the reforms.
This is, in a nutshell, the cycle that every major reform movement since the republic was founded has gone through. These reforms typically represent great expansions in liberty, which today are largely taken for granted.
“From your last comment: “– the benefits go directly and immediately to capital owners and indirectly and at some time in the future to labor,”. I for one am quite happy to be the indirect beneficiary of capital accumulation, which has happened over hundreds of years…”
I’m happy about that, too. But that’s not the point. I’m arguing against this particular policy prescription, eliminating all taxes on capital, and asking a question that no one has acknowledged much less addressed:
Why is capital accumulation not increased by eliminating all taxes on labor? Will not labor have more income to save, increasing capital, or spend. Also, with a stronger work incentive from lower taxes, won’t they work harder and further increase their savings and/or spending. And won’t increased spending by labor increase sales, and eventually prices, and thereby profits, benefiting capital owners and leading to increases in investment to meet higher demand?
“The capital owners you refer to include everyone; working class people saving for retirement (as in Landsburg’s example) are hurt by the tax on capital.”
Well, you’ve forgotten that, for simplicity’s sake, I initially stated an assumption that there were two groups: those who earn all their income from wages and those who earn all their income from capital.
But let’s set the assumption aside.
No, everyone in America is not a capital owner. But let’s agree that most Americans are. That’s irrelevant to my argument. Most people earn most of their income from wages. Fewer people earn most of their income from capital. There will be differential effects of eliminating taxes on capital on different mixes of capital and wage income. Nevertheless, my argument still holds.
Philip – If I ever find myself in trouble, I’d like to have you arguing in my defense…
All,
When I read the topic thread I remembered a blog post of Paul Krugman’s from a couple years back. We essentialy did have an experiment where capital gains and dividends taxes were cut back. The conclusion that Krugman drew from the data was: “The fact is that the economy did a lot better in an era when we had a 39.6% tax rate on dividends and a 28% rate on capital gains than it has in an era with both rates down to 15%.”
Here is the article (it’s short with 3 charts):
http://krugman.blogs.nytimes.com/2008/01/06/charts-for-17-column/
So the questions are:
Is Krugman’s analysis wrong, if so, why?
Is Krugman’s analysis right, if so, why did what actually happened differ from theory (or does it?)?
Lzzydog- Up until maybe 2003 I would hold Krugman up as a gold standard of economic analysis. This particular case though suffers from over simplification and (I think) cherry-picking.
The tax rates were higher and the economy was better, true. Now show me a causal relationship. It can be done but it gets into much fuzzier math than the initial offering makes it seem.
I mean, in 1944 taxes amounted to 120% of GDP and every doughboy had a job waiting for him when he got home. That must mean that raising the corporate tax rate to 120% will fix unemployment.
Keep in mind, I do favor a stronger tax on interest and I’m not opposed to returning marginal income tax to 1994 levels (historically, still some of the lowest tax rates in a century).
But I think that the expansion of free-trade under Clinton, the period of relative peace and global stability, and his reluctance to spread our military action abroad contributed to the increased national prosperity more than moving tax rates a few percent one way or another.
Tagore- You challenged Mr. Coy’s concern that the powerfull will game the system with, “The current system has been gamed by the powerful. Any proposed system will also wind up gamed by the powerful.” with is true.
It’s an affirmative defense, as they say. I wonder if another such defense is appropriate. That “The Rich” are not the only “Powerfull” in this country. Think of the power yielded by groups such as ACORN or the senior community.
Izzydog,
Thank you.
As a purchaser of The Big Questions who has studied it at some length and an avid participant in this site, I had hoped that Steve would respond directly to my argument.
Maybe that is too much to expect. I know he has many other demands on his time. But I wonder if it also has something to do with the fact that I have questioned his policy prescription in a way that also questions some very basic assumptions and arguments that are central to the economic theory and philosophy he advocates. And that I am clearly not an economist.
Phillip- He gets back to my posts about 2-3 times out of ten. Best results are when you keep it brief.
Read his other books too, they are great and make the foundation for a lot of really good economic-philosophic arguments. Like the community stream concept driven home in “More sex is safer sex” tells us that taxes and subsidies should only be applied to the degree that the actual cost of an action matches the actual gain. So polluters shouldn’t necessarily be on the hook for all of their cleanup costs since society as a whole benefits at least a little from the product made by the polluter.
Then see how this philosophy allows a challenge to cap and trade legislation that assigns makes polluters pay the cost for carbon emissions that normally are paid entirely by the society at large. (if CO2 emmissions are too trendy, use the C&T program for sulfur emmissions)
Philip: My non-response is attributable only to the fact that your comments tend to be very long. I do read them, but then I feel like I shouldn’t respond without re-reading them to make sure I’ve understood you, and that tends to get put on the back burner.
This is *not* a complaint. I am very glad that you’re taking the trouble to write these long posts and I do value them. And I hope eventually to find time to re-read and respond.
Benkyou,
Frist, the Krugman article was meant for a popular audience, in a very limited space. Presentation of a more complex explication of the theory and evidence supporting his argument could not be, and would not be appropriate for, this venue. I suggest you look elsewhere. But perhaps you have and are still unsatisfied.
Second, it does not logically follow that raising the corporate tax rate to 120% would lead to the same result as it did in 1944. Economic conditions and relevant economic ((and other) variables have changed vastly in the intervening 66 years. Besides, no one is arguing for that.
BTW, I’d like to get educated on this subject. Can you cite me your source(s) for the corporate tax rate and GDP, unemployment rates that you have presented? I don’t doubt their accuracy, I’d just like to review them.
Third, if I’m not mistaken the reference you attributed to Mr. Coy was actually my statement, and I entirely agree with the quote you cite from Tagore, just as you do. But I responded to him in a subsequent post that this observation did not undermine or directly address my argument.
Finally, no one is saying the “Rich” are the only “powerful” in the country. However, I AM arguing that the “Rich” and corporate economic interest usually dominate the political realm until the abuses of their power lead to reform movements that sometimes succeed in enacting very important, even transformational, changes in our economy, our liberties, our opportunities, the distribution of the bounty of capitalism, and our rights. I’ve given a list of many (probably too many) important examples. And there are others that are as important or nearly so.
Thank you, Steve.
I also understand that I am refining and clarifing (and I hope strengthening) the argument in response to the questions and challenges offered by other participants here. So the earlier version is somewhat, but not fundamentally, I think, different from the later version. This puts an additional burden, I’m sure, on crafting a response.
Philip: Here is a brief and partial response to some of what you’re saying: You keep talking about taxes on capital as if they were distinct from taxes on wages. But they’re not. A tax on capital *is* a tax on the labor that produced that capital. The difference is that when you tax wages directly, they’re taxed equally in all periods, whereas when you tax them indirectly (through a capital tax) they are taxed more heavily in earlier periods than in later ones.
By the same token, a tax on labor is a tax on capital. You talk about people who “receive all their income from capital”. But that capital was earned, at some point in the past, by those people or their ancestors, or their benefactors, as a reward for labor. A tax on labor would have reduced the quantity of that capital and hence reduced (forever) the stream of income from that capital. So even with a zero tax on capital, those “people who receive all their income from capital” do share in the burden of the tax.
I’m probably wearing out my welcome with so many posts, but most of them are direct responses to others’. And they tend to be long because I’m mounting a fairly complicated argument that reflects an assessment that is, if I’m not mistaken, decidedly in the minority on this site. Therefore, I try to be as clear as possible in my logic and the evidence I site for it.
Re: your argument that polluters “shouldn’t be on the hook” for the full costs of their pollution. I can readily agree with that without reading an economic analysis that supports it.
But in the real world, I think polluters are rarely faced with bearing the full cost of their externalities. They have far too much political influence for this outcome. Initial proposals get watered down through compromises in the congressional process, and even if laws are enacted, they are typically watered down again in the regulatory rulemaking process and enforcement policies adopted. Especially during Republican control of the Congress and/or White House.
Thanks for the references to Steve’s other work. I’ll take a look.
Philip: Be assured that you are not wearing out your welcome, and your participation is appreciated.
Steve,
A few points in response:
* I don’t have the education in economics that enables me to understand why taxes on labor (through taxes on capital) are always higher in earlier periods. But in the real world today, how does that square with the traditional IRAs, especially targeted to wage earners? They shift taxes on labor from earlier years to later years. And if wage earners prefer paying taxes earlier rather than later, they can choose a Roth IRA. But either way, their income from accumulated capital is taxed later.
If the IRA is not sufficient protection for capital-holding wage earners, why wouldn’t they prefer enactment of new tax incentives (or expansion of IRAs to higher, but still middle class income levels) applying directly to them instead of eliminating all taxes on capital providing most of the benefits to large capital holders?
* OK, a tax on capital is a tax on the labor of earlier generations. Why should I care about that? They’ve earned that wealth, died, and passed it on. They can’t be incentivized by taxes imposed or eliminated today.
Of course, the current generation of capital holders are incentivized by the level of taxes on capital, one of which is the ability to pass their wealth along, and that has an impact on the wealth of their offspring. Unless they squander their fortune through high living or poor investments. :)
But as a wage earner, even if I receive or expect to receive income from capital, why would I want to enrich those who receive most or all of their income from capital, and their progeny, by eliminating *all* taxes on capital? Especially since…
* the current tax burden must be shifted to labor or funded through deficit spending which just delays the day of reckoning for labor, and
* I have the option of shifting much of my capital tax burden to later years through an IRA, and
* eliminating taxes on capital increases economic inequality which translates into increases in political clout which increases the likelihood that capital owners (and corporations) bigger than me will be in a better position to pass legislation and weaken regulations in a way that further enriches them, but not me or even at my expense. Unless they are remarkably virtuous and don’t exploit this political advantage. Good luck.
So, I expect you’ll say that increases in cumulative wealth raise all boats. Now we’re back to the heart of my earlier argument that is as yet unaddressed.
Finally, I don’t understan the last two sentences in your last paragraph. It’s probaly straightforward and I’m just dense.
Philip
I’ll bite once more on this digression about slavery. It’s very hard to hold onto your property when the government is not actively enforcing your property rights. This is especially true when your so-called “property” has legs and a mind of its own, and wants to be free of you. If the government had stopped tracking down escaped slaves and returning them to their masters, this would have had several effects: the owners would have been willing to spend less to acquire a slave, knowing it wouldn’t likely be around long (the “demand” for slaves would have decreased). Slaves would have tried to escape more often, knowing they’d be more likely to escape cleanly (the “marginal productivity of labor” of escaping would increase). And abolitionists would have been more likely to help slaves escape, knowing they’d more likely succeed (the “marginal productivity of labor” of slave-freeing would increase.) The demand curve would drop, the supply curve would shift right (presumably it’s more costly to “supply” people with slaves if they aren’t recognized as the property of the supplier, either), and the “quantity” slaves would drop dramatically. I can’t assert that quantity would be zero (though in my opinion it would), but I’m certain it would drop significantly.
You might reject this synopsis, but southern slave-owners didn’t. They repeatedly asked for fugitive slave legislation, and they got it. The latest act was the “Fugitive Slave Law of 1850,” which the government went to great effort to enforce. It even had to circumvent repeated “nullification verdicts” from northern juries (it’s really a fascinating history). When the government uses its general resources to do a favor for a specific group, I call that a subsidy. Call it what you will (again, a quibble about definitions would accomplish nothing of value), but southerners would have definitely had a harder time holding on to their slaves without help from the government, and they knew it.
I still think it’s a little grotesque to praise the government when it stops doing something evil; I wouldn’t “praise” them for ending the internment of Japanese Americans, for example. I’d admonish them for their earlier behavior and say they’re still in the red. Praise is given when you do something helpful, not when you stop doing something harmful. I guess I don’t see eye to eye with you on this, and won’t unless I’m struck with a bout of absolute state-worship. And when one democratic government corrects the abuses of another democratic government, that’s no opportunity to praise “strong government” in general.
I know the narrative of the south you describe, prior to the Civil Rights Movement. The source I listed (Sowell’s) argues plausibly that government institutions get away with discrimination for a long time, and free markets don’t. Government action prolonged discrimination in the south.
I’ll second Steven’s comment, this has been interesting.
Phillip- I was miss-attributing. But I do respect Krugman and a lot of the very best econ. I have read has come from him. He’s the arch-typical Keynesian, the school of econ. with the most applied successes.
But, and this is subjective perception, Krugman’s hatred of our previous president (which by a tiny tiny fraction, I share) has led him to do and say things that do not support even his own economic reasonings.
Keynes gets a bad rap because it’s portrayed as big government. But ideally, government intervention in markets is minimal and only to address market failures and externalities. Balanced by paying back the spending when times are good (counter-cyclical spending). It seems like Krugman has been moving away from that.
Fact-checking my post, I was making a corelation=causation reference and said tax revenue was 120% of GDP in 1944. This is wrong, it was 20.9% of GDP, the highest it’s ever been. DEBT was 120% of GDP. so if you substitute DEBT for TAXES in my point it’s just as ridiculous but more historically relevant. Info can be found at http://www.usgovernmentspending.com/federal_debt_chart.html
My point is that when Krugman says Times were better when we had higher taxes and worse when we had lower taxes there is a slight of hand that implies causation. Just like the enormous debt was not the cause of the economic growth in 1944.
Steve L- You wrote “You talk about people who “receive all their income from capital”. But that capital was earned, at some point in the past, by those people or their ancestors, or their benefactors, as a reward for labor”
With this in mind, do you equate tax on capital to property tax? My labor which was taxed so long ago bought my vacation home in Orlando. That Property pays me a dividend in the form of a free place to stay whenever we want to go to see the Mouse. I pay a property tax every year on this property that will eventually surpass the value of the condo itself.
Note: this is separate from the issue of being taxed on the appreciation of value (or lack of these days) of the property.
Oops. In my example, I should have said “the supply curve shifts to the left.” I should take the advice of the author and draw a diagram instead of doing something that feels like thinking.
GregS,
A few responses:
* I don’t find persuasive the argument that because a govt protects property rights, “big government” should be avoided (I assume, as one example, you’re referencing the post-New Deal govt). OK, I’ll agree that this is a subsidy, but I think it is relatively trivial compared to the kinds of intervention you really object to and we’re discussing here. (Besides, if I’m not mistaken, those property rights protections originate in common law, and as such, required no govt intervention to be used to preserve slavery.)
All democratic govts, and some others, provide protection, within some limits of due process, for property rights. Examples that don’t are Communist govts, other totalitarian regimes and most authoritarian regimes. I don’t think that’s where your headed.
But even if I concede that it’s not a trvial example, it’s irrelevant to my point. That point is that slavery was the product of private action without govt intervention; indeed, in the first steps of the enslavement process in Africa, it was literally action in a “state of nature”. And as I said above, slavery was maintained without govt intervention for 100 years before the revolution.
* I’m not aware of any instances of “the govt tracking down escaped slaves”, though perhaps there are some isolated examples (especially after 1820 or so; more on that below). The tracking was typically conducted by the slave owner or someone in his employ.
* I don’t understand why the price of slaves would decline if they had been freer to flee. This would decrease the supply of slaves, increase the demand to fill their chains, thus leading to an increase in price. Slave owners would then be faced with not only the loss of value of the escaped slave but also the increased price of replacing her. This was especially true as…
– public condemnation (and the related social pressure) mounted against the importing of slaves,
– domestic traffickers of slaves sought restrictions on imports to boost their margins, and
– reformers succeeded in placing govt restrictions on the import of slaves (the last one a direct counter-factual to your basic argument).
* The post you’re responding to specially recognizes that govt came to protect slave-owners in ways far beyond those of preserving basic rights of property, after 1840 or so. The Fugitive Slave Act is exactly what I had in mind. The Dred Scott decision is another. There are many. And I have no quibble with calling this a subsidy.
But these examples don’t bear on the question of the private action origans of slavery, without govt intervention, or its survival for 100+ years thereafter.
These examples, however, DO bear directly on the argument in my previous post regarding the struggle of reformers to wrest from slave owners the instrument of govt the slave owners had siezed to preserve slavery. And in turn, to use those powerful instruments to free the slaves, even without the recognizition of property rights through compensation. The weak central govt you advocate could never have accomplished these ends.
This gets to the very foundation of the southerners’ (and now their economic and philosophical progenys’) arguments re: state rights. They sought to counter the strong central govt created by the Constitution for the purpose of preserving slavery. These states rights claims were explicitly addressed by Madison in crafting a strong central govt, within limits preserving certain, crucial rights of the states and “the people”, under the proposed Constitution. This is made clear in his authorship of Federalist #10 (and others among the Federalist Papers) in which he urged ratification of the proposed Constitution to replace a very weak central govt under the Articles.
You’re incorrect in your judgment that you and I don’t see eye to eye on the question of Japanese internment. And I agree 100% that it is grotesque to praise the govt when it stops doing something evil. But I didn’t use the example of Japanese internment.
But your point about praising govt is not relevant to the question of slavery (or my other examples of reform) because the origins of slavery long predate the intervention to preserve it.
Finally (whew!), I will not take offense at the potential insult that might be implied that I am an “absolute state worshipper”. :)
Benkyou,
Good post. I agree correlation does not imply causation, and I’m not sure if Krugman was implying causation. My point in referencing the Krugman article was the claim made in Steve’s original post:
“A tax on labor discourages work. A tax on capital discourages work disproportionately among the young, distorting saving decisions and retarding economic growth. So a tax on capital has all the disadvantages of an extra tax on labor, and more besides.”
I was just pointing to a period in our recent and current history where the claim does not appear to be the case. Causation hasn’t been shown in the original claim either (it might be that humans are not rational in the sense that is implied by the logic of the argument, or if they are, it might be the effect is so small as to be inconseqential).
At the very least, if we accept Krugman’s data, we know there are much bigger fish to fry than tax on capital when it comes to the generation of economic growth, otherwise we would have seen stagnation in the 1990’s and growth in the 2000’s, but it was the other way around. What are those fish?
Well, we had a great expansion of free trade in the 1990s. And a great withdrawel from international institutions in the 000s. Also there were two wars.
Izzydog and Benkyou-
A few thoughts in response to your exchange:
Re: Steve’s quote: “A tax on capital…”
I think I understand this at the top level of economic theory. Maybe you (or Tagore) can educate me on how this is an argument in support of eliminating all taxes on capital considering…
* most of the benefits go to capital owners not labor
* tax burdens necessarily and permanently shift from capital to labor through increases in direct taxes on labor or inflation, offsetting much if not all of labor’s eventual indirect gains through increases in capital accumulation (unless we assume that expenditures are cut in the same amount, which hasn’t been specified here, and raises the prospect that labor will be a net loser in expenditure cuts)
* there are tax policy alternatives that provide labor with greater, more immediate benefits (both in absolute terms and comparatively) and still lead to increases in accumulated capital
* increasing economic inequality also increases differentials in political power, making labor more vulnerable to capital in future policy changes (tax and expenditures), changes that may not benefit labor or even be at labor’s expense.
Re: the irrationality of individuals’ economic decisions: I saw a report this morning about how a big percentage (80% I think) of homeowners who are way under water (up to 50%) on their mortgages, nevertheless don’t walk away from their homes despite the fact they could turn around and buy an identical house at the lower market price.
They don’t do the economically rational act despite the fact that laws prevent mortgage holders from seizing any other assets (other than the home) or income. (I don’t think it’s reasonable to assume this behavior is attributable to homeowners lacking information about their alternatives.)
Why no they behave this way? Because they’re ashamed to walk away from their mortgage debt. (I have personal experience watching this dynamic. Most of us probably do.)
Now if emotions drive such significant economic decisions of individuals, shouldn’t that give us considerable pause about following economic theory and logic to strongly advocate policies in the real world, especially policies based on the theorized responses of individuals? (I’ll stipulate that businesses and corporations are more likely to make rational decisions, though imperfectly.)
I’m not arguing that economists should have no role in policy decisions. I’m saying that their policy advocacy should be weighted (by economists and by policy makers) with a lot more circumspection than is typically the case, especially with economic ideologues on the right and left.
If this is a reasonable chain of logic, I think it applies in the case of the tax proposal we’re discussing.
The responses of capital, acting largely (though not exclusively) in the realm of economic decision making, are much more likely to conform to economic theory than are the actions of individuals who are more likely to respond through a powerful and persistent filter of “irrational” (i.e., non-economic) values.
In the case we’re discussing, the actions of capital, and therefore the benefits they reap, are far more predictable than the actions of individuals, whose benefits can only be maximized if their behavior conforms to economic theory. Any response based on “irrational” factors would seem to sub-optimize the benefits theory claims they would receive.
Steve, I’ve studied more closely your response and have some questions:
* Seems to me that we “must” agree taxes on capital and taxes on labor are distinct because, if they are not distinct, what is the point of advocating eliminating all taxes on capital vs eliminating all taxes on labor?
It must be because they are *distinct enough* to have differential impacts (between capital and labor) on something we seek or seek to avoid, such as accumulated wealth, capital spending, income from returns to labor or capital, changes in economic inequality, etc.
In choosing one tax policy alternative over another, why are we not just making choices, based on values we seek, from a set of possible values (some endorsed by economic theory, some outside the reach of economic theory and therefore “irrational”), where some values are in conflict and some overlap? And what is the basis for making one choice over another?
Presumably the answer is that one option optimizes a set of values most or all of us can agree upon. But I wonder how we make this calculation if we admit to the set of values to be optimized, values that lie outside economic theory and are “irrational”. Is it because economic theory encompasses *all* possible values not just those we commonly think of as economic?
* When you say “A tax on labor would have reduced the quantity of that capital and hence reduced (forever) the stream of income for that capital”, why doesn’t this apply as readily to direct taxes on labor as it does to indirect taxes on the “historical” labor of capital owners via taxes on capital?
What I’m getting at is: just as a tax on capital reduces capital accumulation, why doesn’t a tax on labor reduce capital accumulation? A tax on labor means labor has less income and is less able to sock away savings. They also have less to spend which reduces income to business which reduces returns to capital and capital accumulation.
On the other hand, if we eliminate all taxes on labor, why would we not increase capital accumulation? Labor has more income, saves more or spends more, the spending increasing returns to capital, etc.
If, and I have no idea what economic theory says on this point, eliminating taxes on labor leads to *less* capital accumulation than eliminating taxes on capital, it seems to me that this differential must be plugged back into the calculations of the benefits to labor of eliminating taxes on capital, further reducing the attractiveness to labor of eliminating all taxes on capital vs eliminating them on labor.
Why doesn’t this all boil down to an argument that *all* taxes should be reduced equally? Or, climbing out on a limb here, why shouldn’t they be reduced to a level at which the marginal value of an additional dollar to labor lost through taxes is equal to the marginal value of an additional dollar lost through taxes to capital?
Philip:
* Seems to me that we “must” agree taxes on capital and taxes on labor are distinct because, if they are not distinct, what is the point of advocating eliminating all taxes on capital vs eliminating all taxes on labor?
The distinction is that under a labor tax, labor in all periods is taxed equally, whereas under a capital tax, labor in different periods is taxed at different rates.
You are right that a tax on labor reduces capital accumulation, just as a tax on capital reduces labor. Those are distortions. But the capital tax introduces the *additional* distortion of taxing early labor more heavily than late labor.
Benkyou,
You wrote: “Well, we had a great expansion of free trade in the 1990s. And a great withdrawel from international institutions in the 000s. Also there were two wars.”
I’m not doubting you, but I’m not sure that I know exactly what you mean by great expansion of free trade in the 90’s and a withdrawl from international institutions in the 000’s. Can you elaborate a little, because I’m not sure I think of the 000’s as having less free trade than the 90’s, but I would think of the 000’s as less regulated than the 90’s. Again, not doubting, just trying to better understand what you are saying.
I’ve been thinking about your wars comment from earlier. While I’m not a fan, I do believe war contributes to employment (i.e. the military now fills the recruiting quota they couldn’t fill just a couple years ago, not because people are “choosing” to join the military but rather because they have no other alternative ways to pay the bills. Bomb makers get paid to build replacements etc.), so 2 wars would skew the stats more toward the correlation Krugman was pointing out rather than detract — I think.
Lzzy- NAFTA blossomed in the 90s. Despite Perot’s prediction, the giant “sucking” sound was that of our goods and services flowing to mexico, not our jobs. Manufacturing employment and overall manufacturing productivity showed massive gains under NAFTA, freetrade.org, a cato institute site, has a a number of impeccably researched pieces explaining the effects of NAFTA on American employment.
Under Bush we had a lot of FTAs but almost all were with small oil producing dictatorships, allowing those groups to move their product in to our market easier http://en.wikipedia.org/wiki/United_States_free_trade_agreements#Past_free_trade_agreements
Now I didn’t name off free-trade specifically under Bush, but international institutions. Like the WTO and international legal regimes like the Rome Statute. The kinds of things that make foreign business more comfortable working in and with American Business.
Regarding war’s affect on employment- This isn’t 1945 anymore. We have about 200k soldiers in Iraq and another 70k in Afghanistan. We had 16 Million in WW2. We lost a half a million men in WW2. The affect this war has is much different.
The old wars were fought with guns, men, tanks, and planes, and lots of them. Today’s wars just don’t have much of any of them. missiles replace planes, and a lot of men, and most of the tanks too. Our enemy is usually without an airforce so a few good choppers replaces a million fighter planes.
The way war machines are built has changed too. Manufacturing is not the employment engine it used to be. Maybe for airplanes, but we use few of those. Guns, missiles, hum v’s etc, roll off automated assembly and employ reletively few.
The finance of today’s war has served to channel a great deal of tax payer money into the hands of very few but large private corporations. They former VP was on the board of Haliburton up until he took office. But he’s clean because his own personal shares of the company were frozen during his term in office (where’s that sarcasm mark?).
Steve-
“You are right that a tax on labor reduces capital accumulation, just as a tax on capital reduces labor. Those are distortions. But the capital tax introduces the *additional* distortion of taxing early labor more heavily than late labor.”
For most wage earners, can’t the early/late labor distortion be largely neutralized with a rifle shot like the IRA rather than introducing the “distortions” against labor inherent in eliminating all taxes on capital. The distortions I have in mind are…
* the implied shift in tax burden to labor,
* the greater benefits labor would receive under other tax policies that would still increase capital accumulation and
* the impact of greater wealth inequities on differentials in political power?
If my analysis is correct, shouldn’t labor be opposed to your proposal? Or at a minimum, isn’t there a strong logical foundation for labor’s opposition?