Which inequalities matter and which taxes are appropriate?

by Kenneth Arrow on December 17, 2015

Professor Piketty and his colleagues at the Top Income Distribution Study have put us all in great debt for the great increase in our knowledge of historical development of inequalities in income and in wealth in a number of leading countries.

Notice I have already mentioned two inequalities, income and wealth. There is one more leading inequality which does not receive much attention in Piketty’s work: consumption. Papers and books have already appeared which try to measure this inequality. Many more inequalities, e.g. health, educational achievement, race, and gender differences have been the subject of study, but these are more specialized and less central to economic analysis.

There is a strong argument for emphasizing consumption. Why, after all, do we consider inequality in wealth, income, or consumption to be undesirable? If we consider only economic arguments, it is because the poor are being deprived of goods that are valuable to their lives, exactly because they are more basic than the desires of the rich.

This has important implications for how we evaluate Piketty’s arguments about inequality. It suggests an alternative metric of inequality, one under which some of the problems that Piketty identifies are not, in fact, problematic.

Consider a world, like that envisioned by Piketty, in which the rich consume relatively little (compared with their property income). They accumulate wealth by investing in industry, thereby increasing output in the future. If they do not consume more in the future, but instead, simply continue to accumulate, then the additional future output is available for the consumption of the poor.

If, instead of being available to the poor, the additional output were somehow reinvested in the productive sector, we would find a world in which the ratio of investment to consumption is steadily rising. This is not the world we live in, and would produce visible results contrary to even casual observation.

In the neoclassical picture, consumption is the ultimate end of the economy. The rich accumulate for ultimate consumption, perhaps of generations in the far future, or, in some significant part, for philanthropy. Piketty seems instead to have a picture of the economy as a process of automatic accumulation, without regard to planned consumption. Estates grow at the market rate of return (100% saving out of property income). This is not a realistic account of how rich people – or indeed anybody – treats their income. It also leads us to ignore the politics of how this wealth is actually consumed.

Taking consumption seriously has important implications for measurement. If we are truly concerned with inequality, we should be most concerned with the distribution of consumption. The measurements we should look to are measurements of inequality in consumption, since it is differences in consumption that we really ought to care about.

This also has implications for policy: for example, if what we care about is differences in consumption, we might consider a progressive tax on total consumption of an individual. This would have to be done on an annual basis, like the current income tax, not at point of sale. Such a tax was long ago proposed by John Stuart Mill and later by Irving Fisher and Nicholas Kaldor. Piketty refers to Kaldor’s work but does little to refute it, saying only that no such tax exists. This is true, but of course the progressive wealth tax favored by Piketty is equally untried in practice.

We might be especially moved to consider a consumption tax if we consider that Piketty’s proposed wealth tax seems in any case to be much higher than it sounds. If we are to assume, say a 5% return on property, then a 2% per annum tax on wealth would amount to about 40% of property income. If investment is financed by property income, this implies a very considerable reduction in investment. Is this desirable? One might doubt it, especially since the effects on investment would be substantial, even apart from incentive effects, which might also be quite considerable.

{ 104 comments }

1

Omega Centauri 12.17.15 at 9:20 pm

Should we attempt to influence how much of their income/wealth the rich spend versus invest?
A consumption tax would presumably result is less consumption and more savings/investment. This might or might not be desirable. If the economy was underperforming because of too little investment, we might want to encourage investment/discourage consumption. But if plenty of funds are flowing into investments, then we might wish to encourage consumption, as this would reduce the runaway growth of inequality which Piketty attributes to(r>g).

2

Rakesh Bhandari 12.17.15 at 9:24 pm

“We might be especially moved to consider a consumption tax if we consider that Piketty’s proposed wealth tax seems in any case to be much higher than it sounds. If we are to assume, say a 5% return on property, then a 2% per annum tax on wealth would amount to about 40% of property income. If investment is financed by property income, this implies a very considerable reduction in investment. Is this desirable?”

I don’t see why a capital income tax of 40% on those who have big fortunes would be undesirable.

Note that Piketty is not proposing an across-the-board 2% per annum tax on wealth–this would only apply to European fortunes over 5 million euros (about 2.5% of the population), so his proposal would not tax away 40% of property income. please see p. 528

This tax revenue equivalent to about 2% of Europe’s GDP would in fact be used, to a large extent, for investment–social investments, perhaps of the kind in health that Professor Arrow champions.

Finally as Piketty has already noted, a consumption tax would be too narrow–it would not allow the Koch brothers to taxed for their purchase of their political goods, like the Republican candidates.

3

MPAVictoria 12.17.15 at 9:25 pm

“If investment is financed by property income, this implies a very considerable reduction in investment.”

Why? The money doesn’t vanish. Rather see it spent on new schools than $100 million super yachts.

4

James Wimberley 12.17.15 at 9:28 pm

Honoured to have you with us, Professor Arrow.

Should we be happy with the Scrooge & Marley world in which the rich live modestly and accumulate wealth indefinitely, the growth in consumption going by default to the Cratchits? There are very rich men and families like the Mulliez in France who live rather like that, but not I think typically. We need more novelists to tell us how they live; the celebrity sheets are biased towards the high-consuming entertainers and playpersons.

1. Wealth is power. We are seeing its abuse in American elections today. The use is not limited to protecting the income and wealth of the rich from taxation, though that is clearly part of it.
2. Wealth is freedom, as potential consumption. The rich can fire the boss any time, go to live somewhere warm, take up art collecting or ballooning, and so on. Also, like Trump, trade in spouses.

Great inequality in power and freedom is, I suggest, undesirable by itself and a threat to democracy.

We can also doubt the psychological sustainability of the Scrooge & Marley model, certainly over several generations. Even if the tycoon gets bored with pure accumulation, his children are unlikely all to want to outdo him. Part of the secret of the Mulliez seems to be the old Catholic norm of large families, increasing the odds that at least some of the next generation will want to manage the retail empire, while others ski. Anyway, a shift towards higher and more conspicuous consumption over time seems likely.

Allow me to tout the very partial solution of encouraging capital destruction through innovation and weakening of intellectual property rights (for example by compulsory licensing). We are about to see a great downgrading in the wealth of the oil barons; the Kochs are behaving rationally in attacking renewable energy and climate realism any way they can. There are ways to reward innovation that do not promote the accumulation of great wealth. A Nobel Prize like Professor Arrow’s eminently deserved one only carries a modest purse, but is a great motivator.

5

cassander 12.17.15 at 9:29 pm

Consumption clearly matters more than wealth. A penniless, starving Somali technically has more wealth than an american who graduated med school yesterday with $100,000 in debt, but he his not better off. Or, if you want a less extreme comparison, take two people who both had the same lifetime income. One of them leaves leaves their kid 10,000 in assets the other goes 10,000 dollar vacation with the kid right before his death. Is there any moral reason to tax one more than the other?

6

James Wimberley 12.17.15 at 9:30 pm

Corrigendum: .. the tycoon does not get bored with pure accumulation …

7

Rakesh Bhandari 12.17.15 at 9:36 pm

“If, instead of being available to the poor, the additional output were somehow reinvested in the productive sector, we would find a world in which the ratio of investment to consumption is steadily rising. This is not the world we live in, and would produce visible results contrary to even casual observation.”

I heard Arrow once respond to Sen, and I was surprised to hear him cite Sombart. Perhaps he would be interested that Tugan-Baronwsky tried to show just this–that, yes, the economy could be driven forward by producing machines to produce machines to produce machines. Rosa Luxemburg found this as absurd as Arrow does here. Hayek explored the same idea. To use Hayek’s metaphor the continuous flow of the river of investment can vary independently of the level of the tide (sales of final goods) at the mouth. The upper reaches of the volume of water is affected by the immediate flow of the tributaries to the maintstream (variations in new and replacement technology). In any given period there is no obvious correspondence between changes in the upper reaches and the sale of final goods; nor between the sale of final goods and employment.

“In the neoclassical picture, consumption is the ultimate end of the economy. The rich accumulate for ultimate consumption, perhaps of generations in the far future, or, in some significant part, for philanthropy. Piketty seems instead to have a picture of the economy as a process of automatic accumulation, without regard to planned consumption. This is not a realistic account of how rich people – or indeed anybody – treats their income. It also leads us to ignore the politics of how this wealth is actually consumed.”

First point to get here would be why Piketty rejects an understanding of consumption in terms of the life-cycle hypothesis.

Second, it is quite possible for rentiers to actually increase annually their flow of consumption income even if they invest a rising percentage of their returns (see Otto Bauer’s updating of Marx’s reproduction schema in 1913). That is, there is no necessary contradiction–within broad limits– between rentiers enjoying rising annual consumption and investing a rising percentage of their income.

Thirdly, I agree with the gist of this comment. I fault both Weber (Protestant Work Ethic) and Marx (Accumulate, accumulate. That is the Moses and the Prophets) for depicting capitalists as ascetic social servants of the accumulation process.

8

Bruce Wilder 12.18.15 at 2:00 am

They accumulate wealth by investing in industry, thereby increasing output in the future. If they do not consume more in the future, but instead, simply continue to accumulate, then the additional future output is available for the consumption of the poor.

It seems presumptuous to simply assume that the wealthy and their investments are so virtuous and accumulation beneficent.

The wealthy could be investing in payday loans and insurance scams and additional accumulation simply adds to the immiseration of the poor.

9

Bill Murray 12.18.15 at 2:07 am

If we consider only economic arguments,

why would we want to do that? If I only consider Tuesdays, it’s been snowing quite a bit lately, but that leaves out the vast majority of the actual information

10

Peter Green 12.18.15 at 3:16 am

Terry Pratchett wrote some ground-breaking work on the subject of consumption inequality: http://www.goodreads.com/quotes/72745-the-reason-that-the-rich-were-so-rich-vimes-reasoned

11

Rakesh Bhandari 12.18.15 at 3:40 am

@8 is a good point, but let me play devil’s advocate against Piketty. Most of my comments have been in defense of him, but let me try the other side.

Given the multidimensionality of inequality it could be that top centile controls more income and wealth and that the capital share of income increases while inequalities in morbidity, longevity, well-being and educational attainment narrow or at least do not worsen. It could be that for the least well-off life is getting absolutely better off by such measures as well. All this could be the beneficent result of continued capital accumulation and growth in total output. These gains may compensate to some extent to the shame that Anne Cudd astutely said wealth poverty may bring.

Of course this is not what is happening.

But it could be that the emergence of rentier society is not easily connected with sharpened social suffering and indignation about income and wealth inequality. It could also be that norms shift such that rentiers as a whole tend to become philanthropists, which would also dampen popular indignation at rentier domination. So what the rentiers are not accumulating, they are gifting to society.

That the rentier structure of society contradicts the meritocratic ideology in terms of which the results of market tests and outcomes are justified may turn out to be a minor nuisance, but surely not a cause of indignation.

12

ZM 12.18.15 at 8:07 am

From the OP : ” If investment is financed by property income, this implies a very considerable reduction in investment. Is this desirable? One might doubt it, especially since the effects on investment would be substantial, even apart from incentive effects, which might also be quite considerable.”

I thought of this problem in another thread of this book event , I thought as a solution all the wealth tax could be used by government for a green national investment fund. This would also have the benefit of meaning national assets increased, thus improving the national assets to national debt ratio that is not so good now compared to the immediate post-war era.

I like the idea of a consumption tax that takes into consideration the amount of individual consumption, I hadn’t thought of an end of financial year consumption tax.

I think it would still be best to charge this at the point of sale though, then have a consumption tax form to fill out annually that adjusts it, and people might owe extra tax or get a tax return. If you left it all to the end of financial year it would be too big a sum to pay all together for many people.

13

reason 12.18.15 at 8:39 am

mmm…
I’m very disappointing in this rather simplistic criticism. Wealth is as much about power as it is about (postponed) consumption. Power matters.
And this
“If we are to assume, say a 5% return on property, then a 2% per annum tax on wealth would amount to about 40% of property income. If investment is financed by property income, this implies a very considerable reduction in investment. “
includes a massive ceteris paribus fallacy. The macro-economy firstly doesn’t just invest out of property income, investment is mainly driven by (expected) growth in consumption in the first place and can be debt financed. An interest rates can adjust to maintain the desired supply of finance. Not to mention that the government can (and arguably should) invest part of the revenue from such taxes. This may be different investment, but in the right places may be more important than private investment (it seems almost a consensus these days that governments at the current time invest too little).

14

reason 12.18.15 at 8:56 am

There is another fallacy in the wealth tax argument – money illusion. I’ve seen this with arguments about death duties, but in a reduced sense the same applies. Imagine somebody has wealth than consists entirely of real assets (land and machinery) and has to pay the tax. Then in order to pay this tax he has to sell some of the assets (ok in this case he can’t buy new assets he would otherwise buy). This would push down the price of these assets – democratising the ownership of the assets. It wouldn’t actually reduce the supply of assets.

Somehow something doesn’t quite work with this whole argument – the reason someone invests is not because he has savings lying around he doesn’t otherwise know what to do with, but because he can make a profit on the investment. That he can make a profit on the investment is not a function of how much is saved, but of future expected consumption. That in spite of that fact (and the fact that there are taxes in general) the rate of return on investment (and Picketty’s investment and investment in real productive assets may be different things) remains so high is in a sense a piece of magic that is not exactly explained by Picketty – nor in Arrow’s criticism.

15

reason 12.18.15 at 9:04 am

Another way to think about this is that (and these arguments for simplicity have been assuming a closed economy – open economies may work differently) you cannot consume unless something has been produced. And in order to produce, you need to invest first. So the investment precedes the consumption and is part of the cost of the consumption. There is no real sense in which you can either invest or you can consume. (And see other economic arguments relating to the circular flow of money, that in fact investment generates savings – not the other way around – simply because if you don’t invest then income falls to match savings and investment ex post. So the whole argument – reducing savings => reducing investment is a fallacy.)

16

Chris 12.18.15 at 9:34 am

It’s interesting to see consumption being looked at in this way. The way our economy is structured, whilst transferring jobs to low wage countries and increasing automation reduces cost of production, we only need to produce that which is consumed. If lack of local wages and jobs reduces consumption, production needs to reduce too.

A certain level of consumption, enough to live on, for all citizens is useful to ensure the economy prospers (the alternative being to starve them, reducing consumption and fostering disease and crime).

The current status quo, where we laud those who produce more than they consume, and pillory those who consume more than they produce, fails to consider that the two should always remain in balance, so that overall production and consumption balance.

17

reason 12.18.15 at 9:55 am

Chris,
thanks, I just want to add one more thing if I may, then I will be silent. I am distressed by an increasing tendency to not clearly distinguish between ordinary Keynesian effects and incentive effects. It seems even top economists in their public pronouncements keep mixing the two things up all the time, rather than making sure they identify them both distinctly. Here we have Arrow saying that if money is taken from the pot that is used for investment then investment will fall. But that money doesn’t just disappear – it depends what happens to that money. You should NEVER use ceteris paribus arguments in macro-economics. Macro-economics is what happens when you drop the ceteris paribus.

18

MisterMr 12.18.15 at 11:10 am

I think that the situation we are in, with record high profit share that leads to an increase of wealth but to total income growth, is a situation where there is too much investiment, not too few, so I’m really surprised from the argument “wealth taxes are bad for investiment”.
For example, suppose that investment is a function of profits, so that total additional investment (net of capital replacement) is 20% of net profits.
If the profit share of income is 30%, net additional investment is 6% of NDP, if the profit share is 50% net additional investment is 10% of NDP.
However, at a given technological level, if the economy is close to potential, the only useful additional investment is that due to technological change, and it isn’t unlimited.
So what happens if “capitalists” are investing 10% of NDP, but the economy can only absorb productively, say, 4% of NDP as new capital investment?
There are various possibilities IMHO:
1) There is an extreme competition among producers, who are forced to cut margins; this automatically leads to an increase of the wage share. This is exactly what is NOT happening, and the real question is why this is not happening.
2) The investment could go towards assets whose supply is limited, thus pumping up the value of these assets (but not increasing income). This is IMHO what happened with land prices in the 19th century, and with the stock price of some companies today.
3) Investment money could go through the financial system and become consumption, for example if this money buys treasuries and then becomes government worker’s wage.

2) and 3) can happen together, and I think that this is what is happening.

@Cassander 5
“A penniless, starving Somali technically has more wealth than an american who graduated med school yesterday with $100,000 in debt, but he his not better off”
This is income inequality (indeed a more serious concern than wealth inequality IMHO), not consumption inequality.
An example of consumption inequality would be this: Somaly guy gets 100$ a month, and spends everything in consuption. American guy gets 10,000$ a month, thus an income inequality of 100 to 1. But the american guy only consumes 5,000$ a month because he doesn’t really need anymore stuff. Hence consumption inequality is only 50 to 1. It seems to me that this only makes things worse honestly. “Is there any moral reason to tax one more than the other?” In my example clearly yes.

@reason 14
” the reason someone invests is not because he has savings lying around he doesn’t otherwise know what to do with, but because he can make a profit on the investment.”
But, how can one NOT invest? If I have 100$, I can spend it in icecreams (consumption), I can buy an icecream machine to sell icecreams to others (investment), or I can just leave the money in the bank.
But then the bank owes me 100$! Thus the bank has to lend it to someone, thus I’m always investing all the money that I don’t consume, either in real capital goods or in financial investment.

19

weareastrangemonkey 12.18.15 at 11:41 am

Some people seem to have missed the point on this:

” If we are to assume, say a 5% return on property, then a 2% per annum tax on wealth would amount to about 40% of property income. “

He is not saying it is a problem to have a 40% tax because it is mean to rich people. Read one line further:

“If investment is financed by property income, this implies a very considerable reduction in investment. “

What this implies is that the rich will consume their wealth rather than invest it. This will cause a fall in the complement to labour, capital, and lower real wages. A progressive consumption tax however incentivises the rich to invest more and drive up real wages. Both taxes can be calibrated to generate similar revenues so they allow for the same amount of redistribution or government investment.

Final point, on the political side of things lobbying will be measured for tax purposes as individual consumption or charitable donations (or business expenditure). Pushing rich people to accumulate wealth less will push them to consume more, which in this case will lead to more expenditure on lobbying.

20

Paul 12.18.15 at 1:04 pm

Firstly, I’d echo reason @13: “Wealth is as much about power as it is about (postponed) consumption. Power matters.”

There’s another interesting facet to this. There is one quantity, X, the value of the output of a unit of productive capital; and another, Y, the value of the output of a unit of productive capital captured by the capital owner. In some ways, our challenge is to maximise n.X (where n is the number of units of capital) while minimising Y (either by assuming that the distribution of capital ownership is essentially independent of merit; or by assuming that capital owners generally have high total income and limiting their capital income maximises welfare on the basis of diminishing returns).
Piketty charts and increase in n.Y, but there are clearly phenomena relating to n (regrowth of the physical capital stock after war) and phenomena related to Y (political capture by elites, institutional factors, etc.).

21

HoosierPoli 12.18.15 at 1:05 pm

“They accumulate wealth by investing in industry, thereby increasing output in the future.”

I know that’s what the models say is supposed to happen, but frankly it seems just as likely that wealth is accumulated by blowing up massive asset bubbles that then crash the global economy when they burst.

Business investment will only happen if businesses are facing greater demand than they can provide – taxing consumption will tamp down further on the consumption side of the economy, making investment less profitable and directing more savings into speculation rather than investment.

Inequality of wealth promotes instability precisely because rich people don’t actually consume all that much relative to what they invest, which throws the savings/consumption balance in the economy seriously off-kilter, with negative consequences for all.

Confiscating some of that excess savings and turning it over to people who will actually use it to consume goods and services that people need is a much better idea than a tax that will only encourage more savings in a saving-rich, growth-poor ecosystem.

22

Paul 12.18.15 at 1:10 pm

Another thought, remembering Keynes’ work measuring the rate of interest of wheat in wheat. Consider a furnace that is itself made of steel. Let’s suppose all the other things needed to make steel are abundant and essentially free. Each year the furnace produces 50% of its own mass in steel. Then, after technological improvement, this number rises to 60%. Measured in steel, the furnace has become more productive. But if there is no demand for any more steel, measured in money, the rate of return might not have increased.
The point is that the productive capacity of the economy and the value of its output are two different things. If I own a share, as a consumer, and it rises in value, I don’t really care why. But society needs to know why before it can decide whether my capital gain is worthwhile investment or simple appropriation.

23

ZM 12.18.15 at 1:11 pm

Also there is too much material consumption globally – so it is not just a matter of making consumption less unequal, but about decreasing overall consumption as well as attending to issues of equity.

24

Paul 12.18.15 at 1:28 pm

Rakesh @11 – you’re in danger of saying that the good society is one where our beneficent overlords look kindlily over us. There’s a huge difference between entitlement and charity even if the material transfer is the same.

25

reason 12.18.15 at 2:34 pm

wearestrangemonkeys @18
No I didn’t miss his point, it is just that it doesn’t make sense, and you missed my point. The point is he makes a ceteris paribus extrapolation that can’t possibly happen that way (if only the tax was raised and nothing else changed the economy would not stagnate, it would collapse). This is also a problem with Picketty by the way. Somewhere along the line somebody would have to increase consumption or the investments would all make a loss. And that breaks the driving assumptions about a constant rate of return and 100% savings from investment income. One solution would be to have the taxes used for investments by public bodies (for instance perhaps on the Norwegian model), another would be for interest rates to change so that savings behaviour from wages or investment income changes. Another of course is that any extra production is exported, but that just pushes the problem of “where will the final demand come from” somewhere else.

26

reason 12.18.15 at 2:45 pm

ZM
Yes that IS another issue, but I am sure Arrow explicitly said he was confining himself to the neoclassical model, which I admit is a bit of a cop out (it also lets him ignore the power issue).

27

Joshua Preiss 12.18.15 at 2:52 pm

Arrow writes, “Why, after all, do we consider inequality in wealth, income, or consumption to be undesirable? If we consider only economic arguments, it is because the poor are being deprived of goods that are valuable to their lives, exactly because they are more basic than the desires of the rich… If we are truly concerned with inequality, we should be most concerned with the distribution of consumption.”

Steve Horowitz made precisely the same argument as Arrow in our recent discussion of inequality, and it is well taken. The problem is thinking that, as Horwiz stated and Arrow comes dangerously close to implying, that consumption is “what we really care about.” Here are some other things people care about, which inequalities of income and wealth impact:

1. Freedom
2. Power and domination
3. Democracy
4. Opportunity
5. Responsibility
6. Job Security
7. Time with friends and family
8. Quality of work life
9. Respect

I could go on and on. Are we wrong to care about these things? Is the discipline of economics really so limited? Long story short, inequality of wealth and income matter, even if consumption inequalities are not growing as fast as income and wealth inequalities.

28

Rakesh Bhandari 12.18.15 at 3:57 pm

@18. Please remember that the 2% per annum wealth tax applies only to the top centile or two in wealth holdings. Say they have 35% of the total wealth of society and enjoy returns of 8% on their wealth. So by my rough calculation only about 34% of property income is taxed, not 40%; but more importantly the wealthy who would be taxed would not be taxed at 40% of their capital income but only probably 25%? Why? They enjoy higher returns of around 8%, so a 2% wealth tax would leave them with 75% of their property income, not 60% as the OP claimed.
Looked at this way, the wealth tax is unlikely to come at the expense of investment, especially given the reasons that the wealthy save.
But also looked at this way it would still leave r-g quite high (6%-1.5%); so against Piketty I must say that it is difficult how this wealth tax could do much work in reducing inequality.
It would have to be much higher.

29

weareastrangemonkey 12.18.15 at 3:57 pm

reason @25

Several people made similar points to yours earlier so I didn’t target it at your point in particular. My apologies but it is not at all clear to me what you are saying.

It sounds like you are claiming that Arrow is ignoring the issue of the knock on effects of tax. This would be surprising given his Nobel Prize was for developing the main economic framework for looking at the interaction between multiple markets, i.e., allowing all things to not be equal. Its possible but I don’t see any evidence of that. I expect that what is really happening is not that Arrow is ignoring GE effects but that you have an unorthodox or heterodox model or pseudo-model in mind that would create different knock on effects to those that result from applying the standard framework. As it is not at all clear to me what you are saying I can’t agree or disagree with you.

30

Rakesh Bhandari 12.18.15 at 3:58 pm

wearestrangemoney,
my 28 is a response to your earlier comment.

31

Rakesh Bhandari 12.18.15 at 4:10 pm

Well of course I made a mistake. If the tax applies to only the top centile but they have 35% of the wealth and make a higher return than other wealth holders (say 8% instead of 5%), then they have much more than 35% of the capital income–say a bit over 50%. But I think my other point is still correct.
Out of that capital income they will be paying a 2% tax on their wealth. This will still leave them much more of their capital income than the 60% indicated in the OP. It should leave them 75% of their capital income. They get an 8% return on their capital but only pay a 2% annual tax on their wealth.

32

Bruce Wilder 12.18.15 at 4:23 pm

Wealth isn’t just about funding an accumulating stock of productive gadgets. You could also think about it as a providing a fund for insuring risk-taking investment in potentially productive gadgets.

In an uncertain world with wealth distributed according to a power law and with large pools of wealth being more effective pools of insurance, earning higher returns as insurance, the poor are disadvantaged in undertaking those risky investments that their local knowledge may place before them and must cooperate with the rich to undertake them, giving up in an effective tax (the insurance premium) part of the return. The poor, in their risk-taking, must become stolid peasants, excessively averse to risk or bandits and wastrels, in love with risk, while the rich must be tempted to become usurers, lending to those who can be made to (re)pay without regard to whether the loan has contributed anything to future production.

33

Rakesh Bhandari 12.18.15 at 4:24 pm

I stand back and look at the numbers I just posted. Unbelievable. Could the top 1% in wealth really be receiving at least half of the total capital income? I think Piketty said that the top 10% have 70% of the wealth, and the top 1% half of that. I think he estimates that the top 1% may have returns in the range of 8% if the average is 5%. So that gives the top 1% more than half of the total capital income, no? Could this be right? Wow!
I must go back to the book and look at the numbers again. But if this is true, does a 2% tax on the top centile’s wealth holdings seem onerous?

34

reason 12.18.15 at 4:28 pm

weareastrangemonkey @29
“This would be surprising given his Nobel Prize was for developing the main economic framework for looking at the interaction between multiple markets, i.e., allowing all things to not be equal.”
Yes I did find it very strange, but I suspect he actually was trying to say something completely different and expressed it very badly. It looks to me like a fully incomplete thought.

35

weareastrangemonkey 12.18.15 at 5:22 pm

reason @34

But I don’t see why you think he ignored knock on effects or policy decisions – most mainstream models are going to give the results that he claims. There is one minor thing he ignores, that I will note below, but it is really minor and irrelevant to the overall argument. As I said, I think you have a different model in mind – its not that Arrow has ignored knock on effects. If I am correct then you need to argue that he is using the wrong economic model for the circumstances.

Looking at your particular comment and considering this in the medium run (to disentangle this from cyclical fiscal and monetary policy effects)

“ The macro-economy firstly doesn’t just invest out of property income,”

Note when he uses property income he is talking about all capital holdings. So holding stocks you knock 2% off the return. If you hold bonds you knock 2% off the return there too. If you hold cash then presumably you knock 2% off the returns there. This is a general disincentive to accumulate wealth full stop and will push the rich towards consuming more. He does ignore the GE (or even PE) effects here to some extent, the price of bonds would have to go up to reflect the lower demand for investment. But given he is using ball park figures here there would be little point in getting into this feature. They would not, keeping it ceteris paribus for a moment, unravel the main result of reducing the incentive to hold wealth i.e. to invest in capital assets.

“investment is mainly driven by (expected) growth in consumption in the first place”

I don’t think this is true. Switch mainly for partially and we might be closer to the truth. I would probably say “jointly determined by beliefs about future consumption and supply capacity”. But we would be pulling ourselves up by the bootstraps if we wanted to say that higher consumption caused by lower proportional investment would increase investment in expectation of the higher consumption. I suspect you are not saying that – but it does sound a little like that.

“and can be debt financed.”

Someone has to hold the other side of the debt. That is they have to hold the bonds which are getting taxed by the wealth tax. This will induce a reduction in lending, an increase in interest rates and a reduction in investment. A further reduction in investment will occur as a result of the expected wealth tax in the event of the venture becoming successful and making the borrower rich. This second effect may be small, it may not, the evidence on the effect of expected future taxes is mixed.

“An interest rates can adjust to maintain the desired supply of finance.”

That is not at all clear. If all wealth is being taxed then you might be able to shift people away from government bonds towards other forms of wealth holdings but they are still going to want to consume more of their wealth than they did previously. Note further that even in cyclical situations the central banks have had limited success at inducing investment through lowering interest rates. Trying to induce a long run increase investment through perpetually low interest rates is going to be much much less effective.

“Not to mention that the government can (and arguably should) invest part of the revenue from such taxes. This may be different investment, but in the right places may be more important than private investment (it seems almost a consensus these days that governments at the current time invest too little).”

The government can raise revenues for the purpose of investment in many ways – for example with the progressive consumption tax suggested by Arrow. Unlike the wealth tax a consumption tax increases private investment and can similarly be used to fund public investment.

I think that your better argument is that we should perhaps not be focusing only on the economic dimension but on the political dimension. I think the economist can be excused to some extent for focusing on the area where he has expertise. There will be plenty of others making the political point.

36

Max Sawicky 12.18.15 at 5:23 pm

A few notes.

Consumption taxation is not all that improbable. The U.S. income tax is already part-consumption tax via preferences for saving and capital income. If you exempt returns to capital via 401ks or lower rates for capital gains etc you have consumption taxation.

Assuming you had something approaching complete consumption taxation, it is very difficult to match the extent of progressivity of the income tax, however flawed the latter. You would need extremely, improbably high rates at the top.

As someone upthread noted, the great Richard Musgrave in his advocacy of income taxation, rather than consumption taxation, noted that wealth confers power, hence a stream of annual benefit not accounted for by consumption. You could liken it to insurance.

A leading advocate of consumption taxation, the late David Bradford, thought it would have little impact on savings/investment. It would simplify the tax code and for him, conform to a particular notion of fairness.

37

Rakesh Bhandari 12.18.15 at 5:34 pm

“This is a general disincentive to accumulate wealth full stop and will push the rich towards consuming more.”
There is no more than the top 1 or at least .01% can consume. This is what the example of Liliane Bettencourt is getting at. She can’t possibly consume more than 5% of her capital income. You know, Fitzgerald and all that.

38

Rakesh Bhandari 12.18.15 at 5:40 pm

Also, if you assume that the wealthy are more interested in improving their relative standing than their consumption–and this follows from the critique of the life cycle hypothesis– then the top centile can’t increase their consumption to the point that their wealth grows more slowly than income. If anything, we should expect luxury consumption to fall as a percentage of capital income from a wealth tax. Social investments could be made from the tax revenue.

39

eric titus 12.18.15 at 6:33 pm

To add to the other critiques here, inequality of consumption is much more difficult to measure than other forms of inequality. It is no doubt important, but income is a fairly good proxy.

In order to measure consumption directly, you would need a complete set of consumption activities by individuals. It’s more practical perhaps to use change in total assets (minus income) as a measure of consumption, but that data will be subject to all sorts of errors.
Then you have the problem of things like cars and houses. A car renter might appear to consume (pay) more than someone who owns their car. The idea of creating a progressive consumption tax seems equally infeasible because of the difficulty of measuring consumption.

40

F. Foundling 12.18.15 at 7:16 pm

james wimberley@4
reason@13
paul@21
Joshua Preiss@28

Yes. FGS.

41

Bruce Wilder 12.18.15 at 7:32 pm

I do not know that measuring consumption is any more ambiguous than first-order indications of welfare. The real difficulties come when you acknowledge the connection to production. The distribution of consumption claims in an economy organised instrumentally to produce goods for consumption motivates production. Could a different distribution of consumption produce more, enabling more consumption? Economists are infamous for trapping such thoughts in such cul de sacs of the mind as Pareto optimally, but inequality raises anew the question of whether wealth liberates or oppresses. The neoclassical model posits a self-limiting diminishing return on investment in an accumulating stock. Piketty suggests saving may blow past that limit even as concentration of wealth at the top sharpens the pointy end of the stick. Wealth at the margin becomes pathological. He raises this prospect in detached, abstract fashion, but he raises it.

42

Peter Dorman 12.18.15 at 8:35 pm

Ken Arrow is, of course, renowned for his work in general equilibrium theory, so it is surprising that he would make an argument that depends entirely on a (flawed) partial equilibrium analysis. I will pass by his suggestion that we refocus our attention on consumption (consumption inequality is crucial in some contexts, but not in most higher income countries), and dwell a bit on his statement:

“If we are to assume, say a 5% return on property, then a 2% per annum tax on wealth would amount to about 40% of property income. If investment is financed by property income, this implies a very considerable reduction in investment. Is this desirable? One might doubt it, especially since the effects on investment would be substantial, even apart from incentive effects, which might also be quite considerable.”

What is the model of investment that underlies this? I get the impression it’s that wealth owners receive an exogenously determined pretax flow of investment income, some of that income is withdrawn by a Piketty-inspired tax, and then a portion of what remains is dedicated to productive investment using a hurdle rate of return sensitive to the property income tax rate. Thus such a tax reduces the volume of investment through both income and substitution effects.

Each piece of this model is disputable. (1) The pretax flow of property income depends on a number of factors that are endogenous to fiscal policy. This flow obviously depends on the overall size of national income: there’s a macroeconomic dimension in which the fiscal system will obviously play a large role. It also depends on the share of revenues capital is able to capture, as Josh Mason ably showed, and this too could be altered by tax policy. It depends on the productivity of existing investments, which in turn depend in part on how fully and well the state has provided the necessary collective goods, such as education and infrastructure. (2) The volume of new investment does not depend on a prior flow of savings. Rather, there is a joint determination of net income, investment, and interest rates. In the steady state—if such a notion were meaningful, which I doubt—a high investment economy would have to be a high savings economy, but that doesn’t mean that amassing savings causes greater investment; indeed it can be the other way around. Of course, it is also true that publicly financed investment can be as or more productive than privately financed, e.g. in pharmaceutical development. (3) The investment share in national income is a large empirical mystery; at the very least we can say that it does not depend in any systematic way on rates of capital income taxation either over time or across countries.

Perhaps I’m misinterpreting, but I think this is a case of economic authority espousing doctrines that well-established economic research does not support. It’s as if there were two disciplines, one for the knowledgeable practitioner, the other for the public whose populist tendencies have to be held in check.

43

Rakesh Bhandari 12.18.15 at 9:33 pm

Peter Dorman writes:
“What is the model of investment that underlies this? I get the impression it’s that wealth owners receive an exogenously determined pretax flow of investment income, some of that income is withdrawn by a Piketty-inspired tax, and then a portion of what remains is dedicated to productive investment using a hurdle rate of return sensitive to the property income tax rate. Thus such a tax reduces the volume of investment through both income and substitution effects.”

But this reproduces Arrow’s error–you don’t leave any room for the luxury consumption of the rentier. This is likely what takes a hit from a wealth tax because the rentier is motivated keep the rate of growth of his capital as high above the growth rate of income, as possible. This is how he raises his social status relative to society, and that is what is motivating the rentier over and above conspicuous consumption that has already reached its limits.

The best way to hit the consumption of the rentier is the wealth tax, given the difficulties and imprecision of a consumption tax; Arrow has it backwards here.

The wealth tax will relieve the rentiers of the strain they are under to find more and more difficult ways to consume their income in ways that may actually have negative marginal utility.

44

Rakesh Bhandari 12.18.15 at 9:48 pm

Also of course if rentiers remain interested in what they bequeath to to their heirs–in addition to the social status their wealth growing bigger relative to income gives them–then again they will reduce their luxury consumption by the amount of the wealth tax. They will not reduce their savings; perhaps they will reduce their philanthropic gifts by the sum that is lost via the wealth tax. but then that raises the question of whether Bill Gates or the state should be making social investments. Bill Gates’ argument is that as a cosmopolitan he is more likely to make investments to maximize welfare, given that he will choose projects from a global menu rather than a national one.

45

weareastrangemonkey 12.19.15 at 12:07 am

peter dorman @43

“I will pass by his suggestion that we refocus our attention on consumption”

I don’t think you should as he is comparing the two:

“We might be especially moved to consider a consumption tax if we consider that Piketty’s proposed wealth tax seems in any case to be much higher than it sounds.”

My interpretation, and the stronger interpretation, is that this is an exercise in comparing a consumption tax that raises the same revenue as the wealth tax. I expect, given Arrow is no slouch, this is the one he meant. As the revenue is the same in both cases I think we can ignore the parts of point (1) and (2) that refer to the efficacy of fiscal policy and public investment.

“What is the model of investment that underlies this? I get the impression it’s that wealth owners receive an exogenously determined pretax flow of investment income”

I doubt it. Arrow is using rough numbers and doesn’t put a quantity on the reduction in the supply of investment funds. Given this, it doesn’t make a lot of sense going into the GE or PE effects of a reduction in the supply of investment. Unless you have a story where the GE effects are going to totally undo the reduction in supply.

Regarding the part of point (1) not about fiscal policy, this only works if capital is able to capture more as a result of the tax than it was previously. If this is the case then that would have to be at the expense of labour. However, this seems unlikely – the taxes reduce supply of capital and increase the bargaining power but cannot completely offset it otherwise the supply will not have gone down. Unless there is some strange mechanism by which there is an increase in the bargaining power of capital not related to a change in supply this argument doesn’t seem to hold.

Regarding the part of point (2) that is not about the value of public spending,

“that doesn’t mean that amassing savings causes greater investment”

I don’t think this holds either. The amassed “savings” is going to largely be ownership of, and claims on the returns of, investment. There are many savings vehicles, the most common one for the rich is not cash but bonds and equity. These bonds and equity represent prior investment. The amassing of savings is the accumulation of claims on investment – so reducing saving rates is going to reduce the level of total savings by reducing the total amount of investment and hence capital.

I cannot speak to point (3). Some references would be good. I would have thought that there is a large literature showing that investment responds to corporate and capital taxes as theory would suggest. Of course none of this can speak to a world where the tax is implemented globally and capital has nowhere to “run”. In the absence of empirical evidence we can only rely on what theory suggests – that wealth tax will harm investment whereas progressive consumption taxes will spur it.

46

Roger Gathman 12.19.15 at 12:20 am

Who are the poor? This, to my mind, is not a very “well formed” category. I much prefer capital and labor. But if we are going to use poverty, than I would suggest that it means those households that possess x amount less than the top 1 percent of households. Myself, I’d put that x as, say, one thousand – households that possess a thousandth or less than the share of the top one percent. I think that would give us, in the American case, about 80 percent of the population.
The point being that the middle class is lifted out of this comparison as if, of course, we aren’t concerned that the middle class household has one thousandth of the wealth of the wealthier household. I beg to differ. The middle class is vitally concerned with egalitarianism, more than the poor.; Their vitality and chance of upward social mobility seems to me to be linked to the ability of the society they live in to curb the wealth of the wealthiest.
The middle class, in the neo-classical schema, have made it. They can take care of themselves. There’s no evidence for this at all. On the contrary, the post-war pact, with the state becoming the largest employer, was the base on which middle class households stood.

47

Rakesh Bhandari 12.19.15 at 2:20 am

Better to tax the wealth directly; almost all of the “centile” rentiers’ income is saved and would thus not be taxable. Seems to be a huge threat of revenue loss if only consumption is taxed. What would appear to be charitable donations such as contributions to politicians’ foundations and the buying of economics departments may not be taxable as consumption. Arrow does not clarify whether his consumption taxes would preserve exemptions for charitable donations. wearestrangemonkey also does not clarify.
I also think the risks of the wealth tax reducing investment are being exaggerated, but this creates a problem for Piketty if the main goal of the wealth tax is to reduce the difference between the rate at which wealth is growing and the rate at which income is growing.

48

magari 12.19.15 at 4:23 am

@27 well said.

49

weareastrangemonkey 12.19.15 at 12:01 pm

Rakesh Bhandari @48

A wealth tax necessarily exempts charitable donations, such as lobbying, because charitable donations reduce wealth one for one. Whereas exempting charitable donations from a consumption tax is a choice. Perhaps we want to make no exemptions, perhaps we want to try and select what charities are exempted.

50

weareastrangemonkey 12.19.15 at 12:42 pm

For this audience, I feel like Arrow didn’t do a great job of pointing out the virtues of progressive consumption taxes. This is one of the things that the left should be focusing on right now as it is achievable and it does not involve an equity “efficiency” trade-off. It looks like the best candidate for something that is both more “efficient” and more equitable than the current system.

For those who are interested Robert Frank has some good stuff on the virtues of a progressive consumption tax. He is on the left but is trying hard to also sell this to some people on the right as well (I suspect that will be difficult for the knee jerk tribalism issues that dominate the right) so please take that into account. There is a long youtube video called “The Libertarian Welfare State” https://www.youtube.com/watch?v=dZkbsLCsqGA and a short video where he is trying to sell the progressive consumption tax to a room of millionaires https://www.youtube.com/watch?v=1ZYVCgHsjec

A progressive consumption tax may actually be politically feasible because it can garner support from across the spectrum, would reduce inequality and increase human welfare overall. This is really something that progressives and the somewhat reformist left should be pursuing whole heartedly. The wealth tax is popular mainly because it is a good way of demonstrating tribal affiliation. But it doesn’t seem to make that much sense when there are so many better ways to rest wealth and power from the rich.

51

Layman 12.19.15 at 2:28 pm

“Whereas exempting charitable donations from a consumption tax is a choice. Perhaps we want to make no exemptions, perhaps we want to try and select what charities are exempted.”

I was trying to imagine the politics that lead to the adoption of a highly progressive consumption tax. Add in that charitable donations would not be exempted, and it’s frankly impossible for me to imagine. Adding more income tax brackets with much more steeply progressive marginal rates seems a walk in the park by comparison.

That could just be my failure of imagination, of course, but I doubt it.

52

weareastrangemonkey 12.19.15 at 3:37 pm

layman @52

I, like Arrow, am comparing progressive consumption tax to a wealth tax. No one was discussing income tax.

53

Bruce Wilder 12.19.15 at 4:17 pm

weareastrangemonkey

Could you give a precis of the virtues of a progressive consumption tax? because I am not seeing it on my own. First, since the super wealthy consume less as a percent of income, doesn’t that fact alone blunt the potential progressivity?

One reason to tax wealth is to force an audit that identifies and enumerates wealth. Corporate and personal income taxes serve a similar purpose as do VATs to an extent. What does a consumption tax do?

What are the behavioral effects supposed to be? You mentioned lobbying as charity above and I was confused.

54

Layman 12.19.15 at 5:57 pm

weareastrangemonkey @ 53

Yes, you’re right. I think a wealth tax is marginally more imaginable than a progressive consumption tax, but not by much. And I don’t see the value in proposing an impossibility as an alternative to a near impossibility. What is the electoral constituency for abandoning progressive income taxes in favor of consumption taxes, which are usually more regressive? If you tried to make them progressive, how would you deal with the problem that voters would be swamped with false information about the negative effects of such a tax on themselves? Keep in mind that the wealthy have done a great job of convincing a lot of voters that every conservative tax cut in the last 30 years has primarily benefited the working class, not the wealthy, while increasing revenues by spurring growth (!) despite the rather obvious math to the contrary.

55

engels 12.19.15 at 6:58 pm

This post seems to ignore the rest of the seminar. There have been many excellent gains given why inequality is not all that matters at a normative level – power, status and health, for starters – and it doesn’t appear to give any reason for thinking otherwise.

56

engels 12.19.15 at 6:58 pm

“many excellent reasons given”

57

Rakesh Bhandari 12.19.15 at 7:05 pm

@54, Bruce, so maybe the real reason Piketty wants a wealth tax rather than more progressive and estate taxes is the light that would be thrown on society by the information that would have to be collected? It’s not as if he is hiding this motivation. OK will have to re-read the chapter on the wealth tax.

58

Rakesh Bhandari 12.19.15 at 7:05 pm

so maybe the real reason Piketty wants a wealth tax rather than more progressive INCOME and estate taxes is the light that would be thrown on society by the information that would have to be collected?

59

weareastrangemonkey 12.19.15 at 10:33 pm

Bruce wilder @54

Virtues of consumption tax,

See links @51
See http://morgana.unimore.it/bilancini_ennio/frank-progressivetaxation.pdf
See http://web.stanford.edu/group/scspi/_media/pdf/pathways/summer_2010/Frank.pdf

Basically, a lot of consumption is about relative position. A consumption tax ends up being a tax on this ‘rat race’. It distorts labour and investment decisions less than an income or wealth tax would. People also seem to tend towards shortsightedness when saving and a consumption tax also cuts against this. The lower propensity to consume of the rich, that you mention, in no way inhibits the potential for progressivity because when you are taxing consumption you can tax at rates exceeding 100% if you want. Suppose someone earning 10 million consumes only 20% of their income, if you want you can tax them at 300% and claim a total of 80% of their income (falsely assuming they don’t reduce consumption, but you get the point).

Auditing, whatever we do we can always run such an audit as you describe. None the less a consumption tax would require auditing people’s savings/investment/wealth to establish what proportion of their income they are consuming.

Behavioural effects, see links mentioned and other discussion of the effects of taxes on decisions.

The charity point, merely that a wealth tax would shift people away from investing (accumulating wealth) and towards consumption. From the perspective of a wealth tax any money I spend on lobbying will not be hit by the wealth tax i.e. it will effectively be consumption.

Lobbying and charity point, was in response to other people, I think. But anyway, plenty of lobbying is classified as charity and this makes it exempt from many kinds of taxes such as income taxes. It is incidental.

60

weareastrangemonkey 12.19.15 at 10:56 pm

layman @55

We can have meaningful discussion over what the best economic policy is before discussing the political feasibility of policies. Further more establishing consensus about which policies will make people better off is a key part to defining what kinds of policies are feasible.

Progressive consumption tax has appeal across the political spectrum:

http://www.economist.com/blogs/democracyinamerica/2010/11/inequality_and_executive_pay
http://mic.com/articles/3352/a-better-tax-system-the-progressive-consumption-tax
http://www.taxresearch.org.uk/Blog/2015/10/02/time-to-get-rid-of-national-insurance-and-replace-it-with-a-progressive-consumption-tax/

(Note Richard Murphy is economic adviser to the now much more left wing British Labour party.)

The electoral constituency can be pretty much everyone. They can be designed to make nearly everyone better off if we believe that there is any element of a rat race in human consumption.

Regarding the bombardment of information, there are also laws that could and should be passed to help keep money out of politics. The fact is tax is still progressive and we still have lots of public spending on the poor. So it doesn’t look like the rich get it all their own way. However, this is going to be a problem for any kind of tax system including one with a wealth tax.

Anyway, I hope you do read up on the merits of a progressive consumption tax. There is more support for it than you think and it could be very beneficial.

61

Rakesh Bhandari 12.19.15 at 11:34 pm

It is possible that Piketty really wants the wealth tax for the beneficial results that the information gathered would have for democratic decision-making. Here it would be great to have a history of how changes in the way the state gathers and presents information has affected democratic deliberation both in and outside formal political channels. There was a great comment elsewhere on how Piketty’s interest in knowledge can be traced back to the Enlightenment tradition of Condorcet. Piketty may be content with the tax being nominal while the penalties for non-reporting and false reporting be steep and unforgiving!

But of course there is more to it, and it is there on pp. 524 f for anyone who cares to read that far in the book.
Personal income or consumption taxes result in the wealthy perhaps paying taxes on only 1 or perhaps at most 10 percent of their actual income. There is thus no way to make them progressive enough that the wealthy would be contributing out of their income at the same rate most people are. Without the wealth tax, the tax system cannot but be regressive, perhaps even steeply regressive; and it will not put burdens on the wealthy alone to contribute what their ability to pay allows.

Note that Arrow and Bill Gates who has already made the same argument for consumption taxes don’t really engage Piketty’s reasoning here.

Lastly I do not think the arguments for negative effects on investment are strong at all–we could have stronger social investment for which there are higher marginal gains than private investment; we could have the same volume of investment financed by workers’ savings given the tax relief that they enjoy due to the wealth tax; the wealthy probably would reduce their own consumption more than their investment.

62

Collin Street 12.20.15 at 12:36 am

> It distorts labour and investment decisions less than an income or wealth tax would.

FFS.

We want to “distort” labour and investment decisions: specifically, we want to encourage the rich to invest less and consume more. We’re trying to change things here, no?: that means we have to take actions that will, you know, change things.

[how would the world look to you if your guiding principles were in error? how would this be different from how the world looks to you now?]

63

Collin Street 12.20.15 at 12:39 am

Which is to say: an “undistorting” tax framework will lead to no negative changes, but also no positive changes.

[there’s also some major conceptual issues, since the very existence of “property” is a government-mandated distortion. There’s no a-priori proper “undistorted” state, no absolute frame of reference: you can’t just dismiss something as “distorting”, because everything distorts in incomparable ways. You have to pick not the least distorting but the one that generates the distortions you want, which means you have to look at what the distortions actually are.]

64

Roger Gathman 12.20.15 at 12:43 am

The form of “investment” at the moment is, I’d say, the leading contributor to inequality. At the peak of the progressive era in the US, when it was still an issue, progressives hammered out a way of dealing with what they called ‘watered stock” – and a form for speculation in general. It would have tied the price of stock – the base of the financial markets – to the assets and income of the company issuing the stock. At the end of the year, the commerce department would use the figures given by the company to dictate the price of the stock, and if the price of stocks for the company was over that price, the price would have to fall. It would, in other words, have ended the premium on stocks which we have now accepted as an inevitable part of capitalism. It isn’t. If facebook, for instance, were to fall under Commerce department dictate like this, it would not have a market value larger than General Electric. It would be a midrange stock. Zuckerberg would not be a billionaire.
There are other dimension to the advantage of the progressive suggestion. CEOs would no longer be vastly awarded for managing to dramatically increase the market value of their companies. They would be rewarded for yearly profits, but not in the grotesque measure they are now.
In general, the devaluation of the speculative sphere would have a very robust affect on the assets of the wealthiest. This, without affecting real investment at all.

65

Rakesh Bhandari 12.20.15 at 1:10 am

@63 Collin Street: “specifically, we want to encourage the rich to invest less and consume more.”

I think this is Marshall Steinbaum’s reason for criticizing the consumption tax (it seems that Steinbaum, DeLong and Boushey have a forthcoming book from Harvard on Piketty).

But of course this argument assumes that

1. that a wealth tax would work as the neoclassical economists are telling us–it would raise rentier consumption since any addition to wealth would be taxed more progressively. I see no reason to believe this.

2. It’s based on underconsumptionist theory–that the prospects of final consumption have to be brightened first one way or another for capital investment and therewith employment to rise. Here the deal with the devil is to spur capital on to an orgiastic feast of consumption as a way to power the economy to full recovery. This is not the place to get into this theory, so all I shall say is that there are some grounds for skepticism.

.

66

weareastrangemonkey 12.20.15 at 1:17 am

collin street @63

FFS don’t be a … sigh.

The links I have given should be sufficient to explain the logic behind a consumption tax vs a wealth or income tax.

Enjoy.

67

Sebastian H 12.20.15 at 6:05 am

“Wealth is as much about power as it is about (postponed) consumption. Power matters.”

I may just be insufficiently imaginative, but aren’t enough of the power aspects of wealth found in the spending of it to make that a distinction without a difference? I suppose every now in then power is found in the withholding of spending, but you can’t do that for very long and maintain the power.

68

bad Jim 12.20.15 at 6:54 am

Two very simple points: it’s easier to measure flows, like income and expenditures, than states, like wealth. It’s hard to say how much my home is worth, for example.

Many commenters are concerned about the way the wealthiest wield their power in the political realm, but surely political contributions could be considered consumption and, above a certain threshold, progressively taxed. Perhaps this could be a more workable response to the Citizens United decision than a constitutional amendment.

69

Layman 12.20.15 at 5:38 pm

“Many commenters are concerned about the way the wealthiest wield their power in the political realm, but surely political contributions could be considered consumption and, above a certain threshold, progressively taxed. Perhaps this could be a more workable response to the Citizens United decision than a constitutional amendment.”

This seems unlikely in the extreme. Political contributions are considered protected speech. If they were treated as consumption in a consumption tax regime, you’d be taxing free speech, thus constraining it. Good luck selling that sort of thing to a Roberts court.

70

Sebastian H 12.20.15 at 8:08 pm

Even in the US you can tax things that are fundamental rights.

71

JRLRC 12.20.15 at 8:40 pm

Disappointing.

72

Layman 12.20.15 at 10:40 pm

“Even in the US you can tax things that are fundamental rights.”

Perhaps, but I frankly can’t think of an example of taxing explicit constitutional rights. Not speech, religion, assembly, due process. Others? Taxing a right allows the government to take it out of reach of those who can’t pay the tax. This is why there is no poll tax.

And, a progressive tax would tax some ‘speech’ more than others. I can’t imagine a Roberts court signing on, can you?

73

Tabasco 12.21.15 at 1:04 am

Warren Buffett apparently lives quite modestly. Are we meant to believe that he is no better off than someone with much less wealth but who consumes the same amount as him?

74

hix 12.21.15 at 1:41 am

What a pointless distraction. Am i seriously supposed to be concerned about some super rich starting to spend the money on more yachts to avoid estate taxes…….

Or is it that those non super rich that have more money if the super richstart to pay genuine progressive taxes cant be trusted to save. Both models only deserve to be laughed at, not debated.

75

bad Jim 12.21.15 at 3:21 am

The tax system already privileges some expenditures over others. Charitable contributions are deductible while political contributions are not (at least in theory). Were consumption to be taxed more broadly, it’s not at all obvious that political expenditures should be treated differently than professional services like landscaping, housecleaning, remodeling, cosmetic surgery, accounting and legal work.

76

Rakesh Bhandari 12.21.15 at 6:18 am

@76
OK, let’s say we want to tax consumption and we agree that consumption should be defined liberally to include the expenditures that perhaps only the wealthy make.

First, there seem to be all kinds of political expenditures that the top centile could make out of their capital income that would be tax-exempt. Perhaps this would not include direct contributions to candidates but there are other ways to buy influence. A consumption tax may not touch this.

Second, Piketty gives the example of Bill Gates’ flying his private plane for a business-related meeting. Does this count as consumption or investment? Probably the latter. So Gates’ luxury consumption will not be taxed with a consumption tax!

Piketty’s argument is that consumption in unusual forms that the truly wealthy often do it would not be taxed. Now he may be wrong, Auerbach, Arrow, Mankiw and others may be right. But I am not seeing the refutation of the point that he is making here.

Unlike Collin Street, I am not opposed on the basis of underconsumption theory of taxing the consumption of the wealthy on the grounds that then they will consume less and over-invest, leading to even more excess productive capacity.

So what I have been suggesting is that if we really want to tax the consumption of the highest centile–and Bill Gates is on board here–the wealth tax may do a better job than consumption taxes which won’t really reach a lot of the top rentiers’ consumption.

I also say this because Piketty’s critique of the life-cycle hypothesis shows me that the wealthy are driven to add to their wealth at a higher rate than income is growing; they are not saving for later consumption. They are saving for social power and dynastic prestige. If their income is reduced, they will not sacrifice their investments.

This suggests they may well cut their consumption at least as much from a wealth tax as a consumption tax and possibly more. Not that they will have to cut their consumption that much!

Now even if they cut their investment from a wealth tax, the state still could use the revenue and make social investments with higher social returns than the private investments would have yielded. Or the state could cut taxes on workers and the workers may use the extra income as savings to fill any investment gap. So I think fears of an investment decline from a wealth tax are overblown.

And so the wealth tax may

1. motivate capitalists to reduce their consumption, not their investment–just as consumption taxes are meant to do but can’t do well

2. with the added revenue the state may carry out public investments with high rates of social return that more than compensate for any loss of private investment.

3. the wealth tax would aid democratic deliberation by adding knowledge about wealth distribution (again I think the left will be most disappointed to find out that there is simply not enough wealth to tax to solve growing social problems)

4. the wealth tax will lead to more justice in that most of the income the wealthiest make will not show up as income or consumption and so no progressivity on income or consumption taxes will have the wealthy pay taxes at any near the rates of their income as most people do.

Piketty’s arguments for the wealth tax are 3 and 4.

Again I am not in principle opposed to consumption taxes; and one could grant all the problems with them and still stay they are relatively better than wealth taxes for two reasons: 1. it will be even more difficult to estimate wealth than consumption and 2. wealth taxes are not politically feasible while consumption taxes are.

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Rakesh Bhandari 12.21.15 at 7:56 am

OK I am just trying to understand this proposal to replace proposals for progressive wealth taxes and income taxes with a highly progressive consumption tax.

I must be missing something because it seems to me that a consumption tax regime would create tax revolt sentiments not seen here since the American Revolution.

OK say the rentier has $1Billion in holdings and a 8% return.

That gives us $80 million in capital income

Say $50 million goes to real investment (I do this to give 3 as the difference between r and g, which we can estimate at best as 2%; Piketty gets his explosive wealth concentration from r-g moving from 2 to 3)

Another $10 million goes to tax-deductible philanthropy

and $10 million of actual luxury and political consumption is disguised as investment

so with a progressive consumption tax of 80% of every dollar spent on consumption this gives us for consumption (C)

1.8C =10 million which is what is left after the $70 million is taken from the $80 million in capital income
so
$5.5 million for C or annual consumption
$4.5 million is paid in consumption tax

So in this case the wealthy would be taxed $4.5 million out of $80 million in capital income–a tax rate on the wealthiest of only 6% which would be a wildly regressive tax system.

Perhaps the consumption tax would lead the rentier to give a few more million to philanthropy or invest a bit more, but that advantage cannot compensate for how wildly regressive such a system would be.

And the consumption tax would as much encourage the wealthy to disguise their consumption as cut it. And if they better disguise it, they won’t be accumulating more or paying taxes on consumption. The consumption tax would fail on its own terms. And again it would be highly regressive and would probably give birth to a great tax revolt.

At least a straight wealth tax of 2% yields $20 million straight off. And then in addition with the right income taxes the wealthy would be paying taxes at a higher rate than those without assets.

If we see investment decline due to a wealth tax, I am saying that the critique of the life-cycle hypothesis gives us reason to believe that it won’t be real investment that is cut first but luxury consumption that had been disguised as investment. That gives us $10 million of the wealth tax right there without touching at all investment.

Now of course Gates’ warning is that the wealth + income tax will force the rentiers to cut their investments and philanthropy. This is probably right but not so dire a situation.

So if they cut their philanthropy they are not cutting their investment as the OP warns. But then we have Gates’ argument that his philanthropic expenditures (or Paul Allen’s in Ebola research) have higher social returns than the US state can get. But this is not the argument that the academic critics of the wealth tax are making. And it has not been considered here yet.

Investment may indeed be cut but not necessarily by much, and there is no reason that the state could not carry out high-return social investments with the revenue from the wealth tax.

Plus, whatever cut there is investment may be the necessary price to pay for the tax system to have at least the semblance of fairness.

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TM 12.21.15 at 11:23 am

Arrow: “Consider a world, like that envisioned by Piketty, in which the rich consume relatively little (compared with their property income). They accumulate wealth by investing in industry, thereby increasing output in the future. (…) This is not the world we live in, and would produce visible results contrary to even casual observation.”

The rest of the article is pretty weak.

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Robespierre 12.21.15 at 11:58 am

@73:
Gun ownership, while a political taboo, is a “fundamental right” I’d be happy to tax the shit out of.

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Layman 12.21.15 at 3:05 pm

@ Robespierre: Me, too, but as things stand, it would not survive a court challenge.

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Layman 12.21.15 at 3:08 pm

“Were consumption to be taxed more broadly, it’s not at all obvious that political expenditures should be treated differently than professional services like landscaping, housecleaning, remodeling, cosmetic surgery, accounting and legal work.”

This strikes me as a statement of the form “were a fish to become a man, it’s not obvious at all that he couldn’t ride a bicycle.”

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reason 12.21.15 at 6:07 pm

weareastrangemonkey
@Various posts
“Someone has to hold the other side of the debt.”
Yes but it can be a bank using newly created money.
Look this is not a complicated argument. If I want to consume more then someone needs to produce more. In order to produce more they have to invest more. If I want to consume less, then they will stop investing and run down their capacity. Someone looking to invest, will have to accept look overseas.

Of course equilibrium theorists will see two possible adjustment paths:
1. returns to alternative invests will fall to discourage savings and encourage (speculative) investment.
2. exchange rates will change net exports sufficiently to balance total demand.

The real problem with the global equilibrium model, is that there isn’t (global equilibrium). The US has been running big trade deficits for a long time (so local production has expanded less than local consumption and the net assets of the middle class are being eroded). But the real exchange just seems to continually go in the wrong direction from the point of view of encouraging local investment.

As regards a progressive consumption tax, at the moment with a liquidity trap (i.e. excess savings) the last thing we need is to encourage more savings. Besides which, I have always been suspicious of something than gives an increasing incentive to the very rich to increase their relative wealth. Without being combined with substantial gift and inheritance taxes, it risks making the problem of increased concentration of power worse. Trickle down doesn’t work, but a progressive consumption is designed to make sure it doesn’t happen. We really need some sort of active redistribution to spread wealth around, and I don’t see progressive consumption taxes doing that.

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Rakesh Bhandari 12.21.15 at 6:21 pm

reason @83, please clarify: Are you trying to encourage investment by increasing the marginal propensity to consume through rejection of consumption taxes; or are you trying to discourage investment by not penalizing consumption?

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Rakesh Bhandari 12.21.15 at 6:27 pm

@83. Please also note that Piketty is not rejecting consumption taxes due to any positive or negative effect on investment or savings. Arrow insists that we should have consumption taxes because they will encourage investment. Piketty rejects consumption taxes because they will make the tax system highly regressive and get the wealthy off the hook of contributing what they can afford.

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Max Sawicky 12.21.15 at 6:47 pm

Some misconceptions here about consumption taxes.

By one definition, cash income minus net savings (net purchases of assets), consumption is pretty easy to measure. Of course, when intangibles are involved it becomes difficult, but the main point I think is that taxing cash income minus net savings is relatively easy to administer. It’s a cash-flow measure. Measuring ‘economic’ income including some things like imputed rent for owner-occupied housing is another matter.

It’s not obvious a system based on consumption would have less revenue. It might have more since it could include a VAT component, and it could be founded on an agreement from elites to accept a bigger revenue system in return for a less progressive one.

In the direct component of a consumption tax, one can include or exclude any expenditure you like, including political donations or charity. It’s simple as long as it’s cash. If it’s not cash, such as a donated work of art, then the valuation problems are back.

It’s hard to imagine a progressive consumption tax improving inequality, in and of itself. The numbers just can’t work, as others have pointed out. A bigger revenue system with progressive spending could advance equality.

Wealth taxation is inherently more difficult because it would entail annual valuation of assets that were not traded. Some assets could be subject to simple rules, e.g., common stock valued at its Dec 31 value, or whatever. Real estate, closely-held businesses, options, etc would be a different story.

Taxing transfers of wealth — estates and gifts — is a bit easier since it only entails valuation once, when transferred. Keeping this in the tax base of a consumption tax is easy and would clearly improve progressivity.

To me the only plausible version of a wealth tax is one with a very low (<1%) rate that supplements other revenue sources. It would cost a lot to administer and be useful more for the information it provided than for the revenue net of administrative costs.

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weareastrangemonkey 12.21.15 at 10:12 pm

reason @83

You speak as if your opinions are in line with consensus views of economists, which confuses me. The only thing within mainstream economics close to your description of expected consumption being necessary to generate investment is short-run macro analysis. But this wouldn’t be appropriate for thinking about the long-run (10 or more years) effects of structural adjustments like wealth or consumption taxes. Even then it seems a bit off.

I can say with some degree of certainty (not my field but I am an academic economist who has to teach this stuff) that from a neoclassical growth perspective what I (and Arrow) are saying is correct. It might be the case that the neoclassical approach is inappropriate for analysing this problem but that would be a separate claim and a different argument and not the one I have been making. Further, while the evidence on tax elasticities is far from perfect it does generally point in the direction that theory suggests – income taxes reduce total wage earnings, consumption taxes reduce consumption, and capital taxes reduce investment.

As to the thing about banks printing the money, banks can’t just print money in an unconstrained fashion. This is a misconception that has come about from a series of misrepresentations or misinterpretations of banks’ abilities to create deposit accounts. At the end of the day, literally, banks have to be able to pay the people from whom their debtors have bought goods and services. On this issue I suggest watching Perry Mehrling’s excellent online course on money and banking.

I have spent too much time discussing this now – I suggest reading the links that I have put elsewhere in the comments and reading (or re-reading) an undergraduate textbook on Macro or even something like Harford’s Undercover Macro book for a less technical version.

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weareastrangemonkey 12.21.15 at 10:20 pm

weareastrangemonkey @87

Sorry I said something that will almost certainly be misconstrued:

“The only thing within mainstream economics close to your description of expected consumption being necessary to generate investment is short-run macro analysis. “

I am not saying people do not think about what people will want in the future when making their investment decisions. I am saying that in standard models that the increased supply resulting from higher investment will create its own demand in the medium to long term.

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Alex 12.22.15 at 1:08 am

I am saying that in standard models that the increased supply resulting from higher investment will create its own demand in the medium to long term

In the long run, Say’s law is dead.

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Alex 12.22.15 at 1:12 am

Also, weareastrangemonkey, I think you’ve been a bit rude to essentially tell reason to go away and read an economics book. You might be an economist but that doesn’t give you a right to look down your nose at him/her, especially as their viewpoint seems fairly defensible.

90

Norwegian Guy 12.22.15 at 1:20 am

“Piketty refers to Kaldor’s work but does little to refute it, saying only that no such tax exists. This is true, but of course the progressive wealth tax favored by Piketty is equally untried in practice.”

Some counties, including Piketty’s native France, have progressive wealth taxes. I assume it must be more common than having a progressive consumption tax. And many jurisdictions have different forms of property taxes.

A global wealth tax will be more difficult, but so would a global consumption tax. Of course, you can tax both income, wealth and consumption, if you like. There’s no need to limit yourself to one form of taxation.

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Ellie Kesselman 12.22.15 at 2:03 am

@65 is correct about asset valuations not being representative of reality, e.g. that Facebook has a market capitalization greater than General Electric at the moment. I would attribute that to current investor attitudes (e.g. expectation of high returns through deux ex machina/techno-utopianism) as well as regulator capture (widespread acceptance, even by the SEC, of non-GAAP in earnings reports).

I don’t blame the Protestant work ethic, as someone else mentioned earlier. Part of that ethic was mediating ostentatious and selfish behavior, and fostering willingness to help one’s community, e.g. by buying locally, hiring locally, investing in property, plants & equipment rather than stock buybacks. Arrow’s wealth tax proposal is well-intended; it attempts to use public policy/government, to mitigate disproportionate concentration of wealth among a tiny elite. It reminds me of the ineffectiveness of the past 8 years of unorthodox monetary policy, e.g. recent zero or negative interest rate policies. Unintended consequence are rife. Also, I suspect that a wealth tax on individuals would be evaded by those who would be impacted the most by it. I don’t have a better idea than Arrow’s.

Wealth inequality IS bad. It results in concentrations of power that undermine pluralist democracy. This effect played out during the 2008 financial crisis (investment bank and AIG bailouts by taxpayers), and is doing so again, right now, in the US territory of Puerto Rico. Some of the wealthiest individuals in the country, whose wealth is derived from financial markets not industry (hedge funds) have enough power to demand that Puerto Rico reduce educational and healthcare spending, see yesterday’s New York Times Power of plutocracy: Biggest hedge funds want Puerto Rico to cut basic services in order to reap 20% returns:

A handful of wealthy investors are trying to rewrite the social contract of an entire United States territory. Puerto Rican officials say they have already cut public services and slashed central government spending by a fifth to keep ahead of payments to the hedge funds and financiers. David Shaw, John Paulson and David Tepper are wealthy investors with a stake in Puerto Rico’s fortunes… These hedge funds are among the largest in the world, with a combined tens of billions of dollars under management. Some of their founders and principals are also donating large sums in the presidential campaign. David E. Shaw of D.E. Shaw has given more than $800,000 to Mrs. Clinton…

They have no self-restraint, but I don’t know who or what is capable of reining in such excess and greed. These people will not be deterred by public policy initiatives such as a wealth tax.

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Ellie Kesselman 12.22.15 at 2:26 am

Oops, I didn’t read Arrow’s post carefully enough, and spent too much time reading comments! Piketty is the one who likes a wealth tax, not Arrow. I’m not sure what Arrow is suggesting exactly. He seems to consider a consumption tax but then rejects it, which makes sense, as a consumption tax will tend to reduce demand and economic growth, just as the academic economist emphasized in @87.

I am embarrassed for all my pontificating above, given that I didn’t fully understand Arrow’s post until my third reading of it!

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R Richard Schweitzer 12.22.15 at 5:54 am

Whatever became of the concept that the purpose of taxation is to provide revenues for the functions of governments?

Is concern with forms of equalities in a society a proper function of its government?

If so, what is not?

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reason 12.22.15 at 8:47 am

Rhakesh Bandari @84 & @85
“reason @83, please clarify: Are you trying to encourage investment by increasing the marginal propensity to consume through rejection of consumption taxes; or are you trying to discourage investment by not penalizing consumption?”

Neither. I think we need more active redistribution for the economy to continue to function, either through direct transfers (I am in favour of basic income) or through government investment (in infrastructure and education), or most likely, through both. I’m inclined to think we need more efficient lifetime education.

I don’t think the model underlying your query is at all realistic – I don’t think these things drive much at all, at least not in a modern economy. I think as Krugman recently wrote “demand creates it own supply”, not the other way around. I think savings are pulled from the economy by high interest rates when returns on investment are high, and they are high when demand is growing. I don’t think savings drive investment. I think recent empirical history has been very unkind to the standard neo-classical model. The standard neo-classical growth model is a model of a economy growing proportionally, so that it is reasonable to expect median wages to grow (and hence invest in growing capacity). Modern Western economies don’t look like that at all (even if we ignore demography which is an additional effect). In modern western economies, debt increases, wages stagnate and interest rates fall.

P.S. I am a trained economist and worked for several years in the economics department of the Reserve Bank of Australia. wearestrangemonkeys attempt to pull rank doesn’t impress me in the least. Perhaps he just hasn’t noticed the liquidity trap, or doesn’t realise the necessity of interest rate and exchange rate adjustments for his neo-classical model to work.

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reason 12.22.15 at 8:53 am

weareastrangemonkey @87
You write as though you believe the neo-classical model to be the truth. A model is a model, with it’s strengths and weaknesses. I think the economy is performing outside the range of usefulness of the neo-classical model. A model is not the same thing as the real world.

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reason 12.22.15 at 9:07 am

R. Richard Schweizer @94
“Is concern with forms of equalities in a society a proper function of its government?”

Well isn’t that the fundamental disagreement? (Are you asking me or a (g)libertarian)?

I’m inclined to see Lincoln’s view (of the people, for the people by the people – where people is defined in the broadest possible sense) as the ideal. That there is a social contract, that only those inequalities will be supported that the general population see as beneficial. We are all born naked animals, and shouldn’t blind ourselves to pretend we have more “rights” than those that are given to us, or that we take by violence. Collectively, the violent option is a bad deal.

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reason 12.22.15 at 9:11 am

Max Sawicky @86
Yes, I pretty much agree with everything you are saying there.

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weareastrangemonkey 12.22.15 at 2:57 pm

reason @97

So to quote myself @87:

“It might be the case that the neoclassical approach is inappropriate for analysing this problem but that would be a separate claim and a different argument and not the one I have been making.”

and @36

“As I said, I think you have a different model in mind – its not that Arrow has ignored knock on effects. If I am correct then you need to argue that he is using the wrong economic model for the circumstances.”

and @30

“I expect that what is really happening is not that Arrow is ignoring GE effects but that you have an unorthodox or heterodox model or pseudo-model in mind that would create different knock on effects to those that result from applying the standard framework.”

So thanks for wasting my time.

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Ellie Kesselman 12.22.15 at 3:52 pm

R. Richard Schweizer @94
>Whatever became of the concept that the purpose of taxation is to provide revenues for the functions of governments?

The concept remains valid. While I like the idea of government acting to redistribute wealth, I don’t believe that it works. People must be willing to act altruistically and compassionately toward the less fortunate of their own free will, or at a minimum, be willing to obey tax authorities out of a overall ideological support for the common good. Forcing the issue leads to totalitarianism.

These consumption and wealth tax proposals seem like nudge theory behavioral economics directed at very high net worth individuals, a form of libertarian paternalism. Economic measures to address extreme points in difficult-to-model settings, e.g. due to regulator capture, is futile. It is too little, too late.

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reason 12.23.15 at 1:10 pm

MisterMr @18
Sorry that argument is just too silly for words. Firstly, the bank may not lend the money you have as a deposit (it holds a reserve). Secondly, it might lend the money for consumption. Or thirdly, you might use the money to pay off a debt – which actually destroys money.

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MisterMr 12.23.15 at 2:26 pm

@reason 101

– If the bank lends the money for consumption, I’m making an indirect financial investment: the bank created a title and reaps interest on it, of wich part (a very small part) comes to me.
– Certainly I could use the money to pay off debts but I have not an indefinite quantity of debt (luckyly). When it happens in the aggregate, an economic crisis ensues, as the increase of debt that used to fuel consumption ceases.
– If the banks holds an amount of reserves (that are liabilities to the bank) that is not related to the quantity of debt it issues, it has a problem.

I made a difference between “real investiment” (basically building new factories) and “financial investment” (like buying bonds or land or similar assets, plus lending). Aggregate demand certainly spurs “real investment”, but “financial investment” doesn’t need aggregate demand, in fact I think part of financial investment is recycled into demand (like the bank that makes a consumption loan in your example).

My opinion is that total investment (real+financial) is a function of the profit share, but the amount of useful real investment is limited, so excess profits go into financial investment instead than in real ones, and likely are recycled into demand, creating the debt-addicted economy we all know and love.
Hence, I think that we are in a situation of excess profits.
What limits real investment? I’ve no idea, but maybe we are already close to full productive capacity. If this is the case, then the corret policy is to shorten the workweek and rise somehow the wage share.

There is also the question: can real and financial investment have totally unrelated profit rates?

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reason 12.23.15 at 6:09 pm

MisterMr
OK the word “investment” (like the word “capital” and the word “saving”) is very ambiguous and this can lead to much misunderstanding. I sometimes wish economists would use special words and avoid words with everyday connotations because very often they not only confuse other people, they confuse themselves. But economists talking about gdp accounting rules generally use “investment” just to mean “real investment in productive capital”.

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reason 12.23.15 at 6:16 pm

weareastrangemonkey @99
Well in a sense I feel I’ve wasted my time with you as well. My whole point is the basic neo-classical growth model (and here we should be specific that we mean the growth), is basically incompatible with the assumptions of the features of Piketty world. If rich people save and invest their capital income and maintain constant returns on investment, that capital will grow at an increasing rate and capital income will become an increasing part of all income, implying consumption will be a falling part all income. So how will these increasing returns be generated? Surely, the standard model would predict rising wages (labour now being the relatively scarce factor) and falling returns to capital.

Secondly, show me where Kenneth Arrow actually addresses the knock-on effects. He postulates an increase in taxes, but makes no assumptions about what happens to the proceeds. Where does he consider changes in wages, interest rates and exchange rates?

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reason 12.23.15 at 6:21 pm

It seems to me that I left out one main criticism of Arrow’s discussion. He notes that consumption doesn’t seem to be as unequal as income and wealth, but doesn’t note that this maintenance of consumption has come at the expense of decreasing net wealth accumulation (worse debt accumulation) and may mean a return to old age poverty. It has also come at the expense of much increased family work commitment (i.e. at the expense of leisure). Is middle class wealth and leisure worthless?

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