Make the well-off pay?

by John Quiggin on June 20, 2010

I’m still thinking about policy responses to the latest phase of the crisis, though I suspect events are moving faster than I can think about them. Anyway, I thought I would try a little arithmetic on the question of whether, and how, the fiscal hole opened up by the crisis could be filled[1]. The first question is Who Should Pay? The finance sector, taken collectively, was both the biggest beneficiary of the neoliberal era and also bears most responsibility for the crisis. But at most it will be possible to recoup some of the money that has already been spent on bailouts for the banks, not to mention what will have to be spent in Europe in coming months [2].

The big class of beneficiaries of the neoliberal era have been those in the top quintile of the income distribution, a class that includes me and a fair chunk of CT’s contributors and readers. Since no-one much thinks of themselves as “rich”, I’ll use the term “well-off”. Particularly in English-speaking countries, this group has benefited both from an increase in the inequality of market income and from less progressive taxation.

So, can the well-off be made to pay for the crisis, and should they?

At this stage, I’ve got some illustrative arithmetic, and a few thoughts. I’ll estimate the task as improving the fiscal balance by 5 per cent of national income[3]. And I’ll assume that the top quintile gets half of national income, so the job is to increase their effective tax rates, net of publicly funded benefits, by 10 percentage points. In most countries, top marginal tax rates have been cut by more than that, so it ought to be possible to reverse that change without great economic damage. But of course, that only applies to income in the top bracket, so it would not raise enough.

My rough calculation is that an increase of 20 per cent in the tax rate on income in excess of 150 per cent of the average would be sufficient to fit the bill. That would raise taxes for some people a little below the top quintile in most countries, but not by much. And, in most places, it would still leave the top rate well below the levels at the beginning of the neoliberal era.

Would it be feasible? One line of resistance, tax evasion through tax havens and similar, is being closed off by pressure from the OECD, though it is still much more accessible than before financial globalisation. The feasibility of other forms of avoidance and evasion is largely dependent on the political climate. So, if the political situation permitted the increase in tax rates, it would probably also permit an increase in enforcement that would at least offset any induced response in terms of avoidance and evasion.

The big problem then, is the politics. The political power of the well-off and rich has increased massively over the past three decades, and (with the arguable exception of the finance sector) has not really been diminished by the crisis.

That’s where I’m up to for now, so I’d appreciate comments.

fn1. I’m not arguing that it should be filled immediately, except in the case of governments that have run out of capacity to borrow. But, the longer deficits run, the bigger the task in the long run.
fn2. with the partial exception of Greece, the present round of the crisis is caused by unaffordable bank bailouts)
fn3. I’m using this rather than GDP on the assumption that the proceeds of foreign investment can’t be taxed in a way that reduces returns below that of the global market.

{ 69 comments }

1

P O'Neill 06.20.10 at 4:57 pm

I think that this recent working paper from IMF is relevant, with the usual proviso that working papers do not outline the institution’s policy. But the basic point is that the economics conventional wisdom is fighting the last war on fiscal consolidation, trotting out the prescription that you should cut spending rather than increase taxes — when all the evidence from this crisis is that revenue has tanked and is not returning to its old level, under existing tax policy, any time soon. Thus the political power of the rich will be running into persistent budget deficits, and, perhaps, taxes back on the table.

2

Tim Worstall 06.20.10 at 6:00 pm

Sorry, could you explain a few more details here?

“And I’ll assume that the top quintile gets half of national income,”

Really? According to the ONS the top quintile of households (in the UK) gets an average income of £70 k. 25 million households, so that’s a gross income to top quintile households of £350 billion. GDP is £1.4 trillion.
http://www.statistics.gov.uk/pdfdir/taxbhi0608.pdf
That £350 isn’t far off 50% of total household incomes….but it’s a long way from 50% of national income.

Or have I just got confused again and national income means total household income?

Further, the 20% rise. Is this 20 percentage points? Or 20% of current tax rates? With UK top marginal rates (ignoring the new 50% rate on very high incomes) at 40%, that puts income tax at either 48% or 60%, depending. Add in employers’ NI (which I think we would all agree is, in the end, bourne by labour? And which in the UK has no upper limit)) of 12% or so, that puts marginal income taxation rates at 60% to 72%.

I get what you say about the OECD, tax havens and the rest, but are we absolutely certain that at those sorts of rates the labour/leisure tradeoff will stay static? There was a brave attempt in a TUC paper to say that such tax rates would actually increase the supply of labour from high earning households (formerly housewives going out to work to boost the family coffers) but that isn’t, to put it mildly, the normal assumption.

3

Bruce Baugh 06.20.10 at 6:03 pm

John, I have this cynical thought that I find it much easier to believe in taxes going up for you folks in the second quintile and the bottom half of the first than for the folks above you.

4

bjk 06.20.10 at 7:15 pm

Best way to get the well-off and most connected and powerful to pay would be to cut private sector salaries and benefits by 50% so that they’re in line with the rest of the workforce.

5

bjk 06.20.10 at 7:16 pm

Make that “public sector”

6

James Kroeger 06.20.10 at 7:19 pm

John Quiggin:

The big problem then, is the politics.

Indeed it is, John. One has to wonder if some of the resistance to tax hikes would fade away if the wealthy could be made to understand that progressive income taxation is actually the ideal method of taxation for the wealthy, for it collects revenue from the populace in a way that does not deprive any of them of any of their purchasing power? Individual taxpayers are spared the decline in purchasing power that each of them would otherwise have experienced if only they had been obligated to pay the tax bill.

The reason why this is true is the fact that purchasing power is determined by more than just the accumulations of dollars/pounds that particular individuals might be able to amass. Your disposable income’s purchasing power would not change at all under a new tax regime if all those who had smaller pre-tax incomes than you STILL ended up with smaller disposable incomes than you after taxes (and all those who had more pre-tax income than you still ended up with more disposable income than you).

Whenever an individual household is able to increase its disposable income, its purchasing power will either increase, decrease, or not change at all depending on what has happened to the disposable incomes of all other households. If your disposable income remains the same next year but everyone else’s income declines you will actually see the purchasing power of your stagnant income increase. Suppliers would be forced to drop their prices and you would discover that you have acquired a bidding advantage over others. Even if your income were to drop next year, you would still be better off if everyone else’s income dropped even more.

That is precisely the outcome you end up with when taxes on ALL forms of income (gross amounts) are taxed at graduated/progressive rates. The wealthy as a group would not be able to afford to spend as much on the scarcest ‘experience opportunities’ and so they would cut back—in the short term—on their expenditures. What this means is that suppliers of luxuries would be forced to drop their prices to levels that the wealthy could afford.

Because the marketplace works, the wealthy can never be deprived of their claim to the scarcest goods and services that the economy produces, as long as they still have more disposable income to spend than others. Under a higher-tax regime, the sellers of luxuries would have no choice but to drop their prices to clear their inventory. They would then put pressure on their suppliers to drop their prices, for they would not have as much to spend, now would they?

The quantity of luxury goods and services would not decline just because a little deflation is occurring in the luxury markets. The rich would still have the most money to spend and those suppliers would still be chasing after it. In the medium-to-long-run, the wealthy as a class would still be consuming the same amount of luxury G&S they consumed when taxes were lower.

When you look at the fact that prices would drop for the wealthy at the same time that their tax obligations were increasing, it becomes clear that the wealthy would actually lose nothing in terms of lost purchasing power if they were to pay taxes at dramatically higher rates. The wealthy would discover that their smaller pile of after-tax cash would still buy them the same quantity/quality of stuff that their bigger piles of cash used to buy them.

At the same time, if governments were to spend these extra tax dollars on real economic investments (infrastructure, human capital) the wealthy would enjoy the vision of a fully productive nation, one that is producing real wealth at a rate that cannot be exceeded. Real economic investment levels would be at cyclical highs. With all those [formerly] idle poor people working, they would have much less to fear from class discontent.

So the question is, John, would the wealthy as a class give up their objection to steeply progressive income taxes if they understood that they wouldn’t really be making any sacrifice at all, in real terms?

7

Russell L. Carter 06.20.10 at 7:25 pm

bjk got it right the first time. Just double the top income tax rate.

8

Barry 06.20.10 at 7:53 pm

“The big class of beneficiaries of the neoliberal era have been those in the top quintile of the income distribution, a class that includes me and a fair chunk of CT’s contributors and readers. Since no-one much thinks of themselves as “rich”, I’ll use the term “well-off”. Particularly in English-speaking countries, this group has benefited both from an increase in the inequality of market income and from less progressive taxation.”

Actually, it’d be the top 1%.

9

Tim Worstall 06.20.10 at 8:00 pm

“Actually, it’d be the top 1%.”

Top 0.01% even….according to Pikketty and Saetz.

10

Billikin 06.20.10 at 8:00 pm

I wonder about the idea of making the well off pay. Hasn’t at least one recent poll indicated that the well off think that they should pay more than they are? (OC, that would vary from country to country.) The assumption that they would resist could engender resistance by bringing forth calls to make them pay.

OTOH, this is the sort of ideological question that leads lawmakers to ignore the wishes of the electorate.

11

Jim Place 06.20.10 at 8:17 pm

Good point. I have held on in my business with out having to lay off anybody. That keeps 20 people employed. If you would like to raise my taxes 20% I can live with it. I will be laying 4 people off the day after you pass that increase. Believe me you can’t have it both ways. You choose. I will not take the risk and work 60 to 70 hours per week.

12

novakant 06.20.10 at 8:45 pm

Sod that – the banks should never have received a penny of taxpayer’s money and now you want people to bail out the state that bailed out the banks, meh. It’s not going to work anyway, because the really wealthy are an international bunch and will just relocate.

13

Antoni Jaume 06.20.10 at 9:48 pm

Top 0.01% even….according to Pikketty and Saetz.

Shouldn’t it be [Thomas] Piketty and [Emmanuel] Saez?

http://economistsview.typepad.com/economistsview/2007/01/thomas_piketty_.html

14

ScentOfViolets 06.20.10 at 9:53 pm

As someone else as already noted, the chief reason that the top 20% have done so well is that this includes the top 5% or top 1%. The other part of the equation is to cut spending. I’m guessing that discretionary spending could be cut quite a bit if the choice was made between that and higher taxes on “the rich”, enough in fact to balance the budget over the long term. The big question then is, what is to get cut?

15

Robert 06.20.10 at 10:06 pm

I have no idea why John thinks deficits are a problem.

I think that higher taxes on the rich might be a step towards a more equal distribution of income, at least. And a more even distribution is needed to keep consumer demand growing in sync with increased productivity. The failure of wages to grow after the end of Bretton Woods is, to me, a major cause of the collapse of the post-war golden age and the increased instability of the last, say, third of a century.

In these opinions, I draw on such scholars as Eric Hobsbawm, Michal Kalecki, and Richard Goodwin, instead of the nonsense taught by orthodox economists.

16

Martin Bento 06.20.10 at 10:10 pm

I’m much skeptical than you of the possibility of eliminating tax havens in a broad sense. In the sense of places you park your money without living there yourself, sure. But this isn’t the Eisenhower era. The actual rich, not just the well-off, could go live in Malaysia or Chile, very well, renouncing citizenship if need be. Their money can buy the lifestyle they want, particularly if they cluster, which they will. However, corporations will still want access to first world markets, and the defense of first-world laws (when convenient). Instead of going after the individuals, then, go after the corporations. Effective corporate tax rates in the US are very low, and things like carbon and financial transactions taxes can bring in a lot of revenue with positive externalities.

17

James Kroeger 06.20.10 at 11:25 pm

Jim Place, 11:

I have held on in my business with out having to lay off anybody. That keeps 20 people employed. If you would like to raise my taxes 20% I can live with it. I will be laying 4 people off the day after you pass that increase.

I love it when when business owners disingenuously try to persuade us that they would lay off employees without hesitation if they are required to pay more in taxes. They state this malarkey as though they actually have some people on their payrolls that they don’t actually need to run their businesses, and that is a joke.

Any business owner who wants to remain in business in a competitive market does not keep any individual on his payroll that he does not need. They do not hire people as an act of charity. They hire people because they need them in order to provide the products/services they sell.

(A very few are hired in the anticipation that they will be needed in the near future, but that is done for a good reason. If an uptick in future sales is expected, or if a higher level of service is needed in order to compete, then it would be foolish to not hire them.)

That is why Jim Place’s comment is little more than an empty threat. If he actually does employ people that he doesn’t absolutely need in order to sell his product/service, then he is a very poor businessman who is not likely to be in business much longer.

For policy makers, it is safe to assume that all employers will only hire people when the sales outlook justifies it. The notion that employers keep a lot of ‘charity hires’ on their payrolls during a recession is pure nonsense. If Jim’s tax bill is doubled, he will continue to employ his current staff, so long as demand for his product/service is maintained. His threats can be safely dismissed as rubbish.

18

roger 06.21.10 at 12:25 am

The wealthy living in chili or whereever could be very easily taxed in the U.S. – if that is where there stream of revenue comes from – and it would be a relief to have them living in Chili. A nominal residence isn’t really some gotcha that the state can’t figure out – it is unlikely that the rich are going to try to make their money, after all, off Chilean hedge funds. As long as the money is made in the U.S., it is easy enough to expropriate it.

19

Cheryl Rofer 06.21.10 at 12:51 am

The best argument for higher taxation on the rich is in the graphs in this post.

20

Martin Bento 06.21.10 at 1:24 am

Roger, only if you are taxing the business, not the individual. People do have a right to leave the country and renounce their citizenship. Denying them this is the hallmark of totalitarian regimes. If they are not citizens and not residents, on what basis do you tax them? They are, at that point, foreigners, and could only be taxed as non-resident foreigners.

21

John Quiggin 06.21.10 at 4:01 am

It’s true that the top 1 per cent has gained more than anyone else, but everyone in the top quintile has benefited relative to everyone below. Here’s a reasonably detailed study focusing on the top decile

http://www.voxeu.org/index.php?q=node/1245

and here’s Wikipedia where you can look at the 80th percentile

http://en.wikipedia.org/wiki/File:United_States_Income_Distribution_1967-2003.svg

22

ejh 06.21.10 at 6:28 am

I love it when when business owners disingenuously try to persuade us that they would lay off employees without hesitation if they are required to pay more in taxes. They state this malarkey as though they actually have some people on their payrolls that they don’t actually need to run their businesses, and that is a joke.

Any business owner who wants to remain in business in a competitive market does not keep any individual on his payroll that he does not need. They do not hire people as an act of charity. They hire people because they need them in order to provide the products/services they sell.

Quite.

23

alex 06.21.10 at 7:25 am

@17, 22 – so you outright deny the idea that an employer might keep people on, people s/he works alongside every day, because s/he feels some responsibility for their well-being, or thinks that they are in it together, or because s/he knows the trauma of unemployment and has no desire to inflict it on anyone if it can be avoided by some temporary, shared retrenchment?

What a cold, dark world you live in.

24

Earnest O'Nest 06.21.10 at 8:56 am

@12: I don’t think they will relocate. They enjoy the public services in the West whilst taking the tax breaks elsewhere. The only solution is a supranational one – or at least a Western one where people are denied citizenship when they hold money – in countries on ‘the list’.

(it would obviously only be fair to hold the Western countries to a 0.7% redistribution (at least) of their wealth to countries not ‘on the list’)

25

novakant 06.21.10 at 9:06 am

I really don’t get this: only recently we threw trillions at useless, parasitic scum like Goldman Sachs et al without batting an eyelid and now people want to squeeze small business owners who actually generate value and provide people with employment.

26

ejh 06.21.10 at 9:53 am

@17, 22 – so you outright deny the idea that an employer might keep people on, people s/he works alongside every day, because s/he feels some responsibility for their well-being, or thinks that they are in it together, or because s/he knows the trauma of unemployment and has no desire to inflict it on anyone if it can be avoided by some temporary, shared retrenchment?

…takes out onion….

27

Earnest O'Nest 06.21.10 at 10:04 am

@25: boo-hoo-hoo! What I don’t get is what is so upsetting in asking people to be open about the rent they extract out of their businesses. It isn’t like we would need to tax on labour and businesses as much as we do if everybody that didn’t want to move to – e.g. Liechtenstein – would not hide their money there.

28

conall 06.21.10 at 10:17 am

What’s wrong with Cable’s Mansion Tax? This could be the prelude to a full-blown Land-Value Tax. The distribution of assets is even more skewed towards the richest. This land is our land, make ’em pay for it!

29

Ronald Brak 06.21.10 at 10:45 am

I don’t understand why increasing the rate of personal income tax for the top quintile would cause small businesses to sack people. Surely this would result in an incentive for them to invest more in their businesses to avoid paying the higher tax rates and so increase the value of their businesses. Then they’d only have to pay the capital gains rate if they sold it. On balance shouldn’t this result in more people being hired not less?

30

Bunbury 06.21.10 at 10:46 am

Top 20% by wealth? By wages? By income? Adjusted for generational issues? These are significant issues. For example, focus entirely on income and ignore capital you could completely scotch social mobility. The redistribution caused by housing bubbles and the collapse in interest rates are at least as significant as any regressive income tax reforms.

It also doesn’t seem healthy or fair to categorise people so simply and as if their income level was necessarily some kind of rent. I agree with the general drift but I don’t think you can make a convincing argument without being a lot more detailed. This kind of discussion tends to Golgafrinchan problems too.

31

alex 06.21.10 at 10:49 am

@26 – I see, no actual argument, then? Ho-hum…

32

Chris E 06.21.10 at 11:11 am

@6

In a variant of this, I wonder if the case needs to be mde that a lot of the advances in living standard comes from silicon/biology, both of which are volume industries which rely on large numbers of consumers. So really working wages at the lower end cannot stay still forever, without the rich getting fewer and fewer new goodies as time goes by.

That said, for someone who isn’t playing the long view, conspicuous consumption almost seems to be the aim, and for that no amount of money will ever be ‘enough’. If you aren’t a billionaire , you can’t afford a 200 metre yatch.

33

Tim Worstall 06.21.10 at 11:13 am

“What’s wrong with Cable’s Mansion Tax? This could be the prelude to a full-blown Land-Value Tax.”

Well, because the Mansion Tax taxes the buildings on the land while the Land Tax is supposed to tax the land underneath the buildings not the buildings upon the land?

34

James Kroeger 06.21.10 at 12:10 pm

alex 23:@17, 22 – so you outright deny the idea that an employer might keep people on, people s/he works alongside every day, because s/he feels some responsibility for their well-being, or thinks that they are in it together, or because s/he knows the trauma of unemployment and has no desire to inflict it on anyone if it can be avoided by some temporary, shared retrenchment?

What a cold, dark world you live in.

The cold, dark world that I’m referring to is not one that I live in; it’s one I grudgingly came to accept as a consequence of my studies in economics. Economists make generalizations, which means that there are nearly always exceptions, but those exceptions do not negate the value of the generalization.

Yes, I’ll admit that there are a few exceptions to be found, mostly in industries that are not competitive—monopolies and oligopolies—but in truly competitive markets, business owners have no choice but to eliminate all of their unnecessary costs, or else they’ll be driven out of business. Whatever compassion they might truly feel will be forced aside when demand for their products drops in favor of some competitor’s products.

One of the problems we have in pursuing economics discussions these days is the tendency of conservatives to pick some variable—like compassion—that has some small role to play in hiring practices and then exaggerate it’s importance as though it were THE determinant variable that we are dealing with. (An example of this in the U.S. is the Republicans’ #1 health care cost issue: malpractice insurance, even though that particular variable only accounts for less than 1% of health care costs in America.)

The fact that a few employers may—at the margin—put off the decision to sack employees another week means very little in the big picture. It in no way justifies the false generalization that higher tax rates would merely ‘force’ employers to reduce their work forces in order to sustain a particular level of disposable income that they desire.

I hope this answers your question.

35

Henri Vieuxtemps 06.21.10 at 12:17 pm

They do not hire people as an act of charity.

No, but during especially tough times they might have to let butler’s assistant go. And then all is lost.

36

Earnest O'Nest 06.21.10 at 12:38 pm

One should be charitable for the butler’s boss, for it is only he who can decide to give a butler his assistant.

37

Barry 06.21.10 at 12:42 pm

John Q, thanks for those links. However, what is the top quintile? I’m certain that I’m not in it, an d probably nobody who reads this blog is in it, either. You are for some reason trying to pull in the middle class to a group which is at the lowest the upper middle class, and really the upper class. As even Tim Worstall has pointed out, the really big boys are the top 0.1%

Paul Krugman has pointed this out repeatedly, and also that it demolishes the ‘education’ theory to increasing income inequality.

38

Tim Worstall 06.21.10 at 1:31 pm

“However, what is the top quintile? I’m certain that I’m not in it, an d probably nobody who reads this blog is in it, either.”

Oooh, I dunno. The figures John links to show that in the US $80,000 a year as a household income gets you there. In the UK a single income of over about £40,000 puts you in the top decile of taxpayers. The top quintile have an average (mean) household income of £70,000 in the UK (making the lower bound of that quntile much lower of course).

To get to these sorts of numbers you’d need, say, one doctor in a family? Certainly a GP in the UK would be. A two academic family would almost certainly qualify….well, OK, perhaps a two professor family….in either country.

In the US a two nurse family would be in the top quntile…..some specialist nurses would make it on their own.

http://www.bls.gov/oes/current/oes291111.htm

I’d say that pretty much all of the middle aged readers of this blog would be in the top quintile of the income distribution: certainly almost all of those part of a dual earning household.

39

SqueakyRat 06.21.10 at 1:49 pm

Mmmmmm … living in Chili.

40

hix 06.21.10 at 1:54 pm

“People do have a right to leave the country and renounce their citizenship. Denying them this is the hallmark of totalitarian regimes. If they are not citizens and not residents, on what basis do you tax them?”

Why is it necessary to deny that? Just tax appropiate. Young leavers could be demanded to pay an education tax that covers the costs of the education, in particular those with expensive higher education – say chemistry or medical degrees for example . For all age groups, an asset tax would be apropiate. The contrary system would be the authoritarian one, the system where people can become incredible wealthy thanks to the infrastructure of a social democracy, but then deny the people of that country the right to tax the gained wealth.

41

Jim Place 06.21.10 at 3:28 pm

We did maintain employees that we should have laid off and it did cost. You are probably right a better decision would have been to let them go early in this down turn. It is very easy to use terms like rubbish and malarkey when you don’t own the business. The decision was way easier for me to accept when what I was saving was the jobs of people I know and care for. The more taxes I pay the less likely I would make the same decision again if and when we see the next down turn. Why do people find it so difficult to believe that there is a tipping point for what some small business owners are willing to endure? By the way there days out there after 27 years of owning this company that I consider myself not only to be a bad business owner but a terrible one. Here’s hoping I do better tomorrow.

42

Shaun 06.21.10 at 4:27 pm

A surprising number of people retain from childhood the idea that there is a fixed amount of wealth in the world. There is, in any normal family, a fixed amount of money at any moment. But that’s not the same thing.

When wealth is talked about in this context, it is often described as a pie. “You can’t make the pie larger,” say politicians. When you’re talking about the amount of money in one family’s bank account, or the amount available to a government from one year’s tax revenue, this is true. If one person gets more, someone else has to get less.

I can remember believing, as a child, that if a few rich people had all the money, it left less for everyone else. Many people seem to continue to believe something like this well into adulthood. This fallacy is usually there in the background when you hear someone talking about how x percent of the population have y percent of the wealth…

Suppose you own a beat-up old car. Instead of sitting on your butt next summer, you could spend the time restoring your car to pristine condition. In doing so you create wealth. The world is– and you specifically are– one pristine old car the richer. And not just in some metaphorical way. If you sell your car, you’ll get more for it.

In restoring your old car you have made yourself richer. You haven’t made anyone else poorer. So there is obviously not a fixed pie. And in fact, when you look at it this way, you wonder why anyone would think there was.

http://www.paulgraham.com/wealth.html

43

Shaun 06.21.10 at 4:32 pm

There some other good essays by Paul Graham that this readership might be interested in. I recomend starting with “How Art can be Good”
http://www.paulgraham.com/goodart.html

And the following up with “Inequality and Risk”
http://www.paulgraham.com/inequality.html

Here are all of his essays:
http://www.paulgraham.com/articles.html

44

Barry 06.21.10 at 5:06 pm

Jim, we find it hard to believe this sort of stuff because ‘going Galt’ is sooooooo 2009.

45

Jim Place 06.21.10 at 5:19 pm

sooooooo2009. Good news Barry ” for you ” being a elitist jack ass never goes out of style.

46

Hektor Bim 06.21.10 at 5:20 pm

Paul Graham’s articles are designed to limit constraints on startups. His model of the business world is based on two kinds of companies: startups and boring static large corporations. He wants more startups, so he wants to limit the taxes on rich people. He ignores the rent-seeking behavior of rich individuals that over time tends to limit the growth and progress of the economy. There have been plenty of rich people in Brazil, Mexico, and Argentina over the last hundred years, but historically they weren’t bastions of growth. Studies consistently show that more-equal countries grow faster and do better in life indicators. So there is no trade-off here – reducing inequality is better for everyone.

47

Jeff R. 06.21.10 at 5:31 pm

It’s always a mistake to use taxes on income to target wealth. And it is, incidentally, a mistake that tends to strongly favor the interests of entrenched, old money over those of the current generation of entrepreneurs and innovators that drive the economy. This is, as they say, no coincidence…

48

Substance McGravitas 06.21.10 at 5:34 pm

It’s always a mistake to use taxes on income to target wealth. And it is, incidentally, a mistake that tends to strongly favor the interests of entrenched, old money

So inheritance taxes: always a mistake or a curtailment of the interests of entrenched old money?

49

ScentOfViolets 06.21.10 at 6:25 pm

When wealth is talked about in this context, it is often described as a pie. “You can’t make the pie larger,” say politicians. When you’re talking about the amount of money in one family’s bank account, or the amount available to a government from one year’s tax revenue, this is true. If one person gets more, someone else has to get less.

I can remember believing, as a child, that if a few rich people had all the money, it left less for everyone else. Many people seem to continue to believe something like this well into adulthood. This fallacy is usually there in the background when you hear someone talking about how x percent of the population have y percent of the wealth…

Uh-huh. Looking at
this chart, we see that real GDP was about $3.5 trillion in 1970, and about $13 trillion for 2010 (roughly). So one would expect around a three-fold gain in real median income since 1970. But from this chart, we see that real median income was about $38 k/yr in 1970, and three times this is $114 k/yr. Since median income was only $51 k/yr in 2007 (which was something of a high-water mark), I’d say that your theory is badly mistaken in some crucial particulars.

You seem to be implying that even if you are twice as productive as the year before on the account of your hard work and expertise, if you only get one cent of every extra dollar of revenue you generate with the other 99 cents going to the guys at the very top, this is still an excellent example of “the pie not being fixed”. Whereas to me, it looks like some sort of theft.

50

ScentOfViolets 06.21.10 at 6:36 pm

There have been plenty of rich people in Brazil, Mexico, and Argentina over the last hundred years, but historically they weren’t bastions of growth. Studies consistently show that more-equal countries grow faster and do better in life indicators. So there is no trade-off here – reducing inequality is better for everyone.

What’s telling here is that for a long time there was debate on whether or not the policies that fostered more inequality in the United States also resulted in more growth. The argument went that as long as median income was higher over time in the scenario with more inequality (all other things being equal, starting at $10 k at 6% growth will eventually beat starting at $20 k with 4% growth ) , that was all that mattered and anything else was just envying the rich for their just desserts. But now that the tide seems to be rather definitively turning on matter in academia, ie, that policies that emphasize more equality rather than less results in higher growth than otherwise, the argument is changing and the standard refrain seems to be that individuals can’t become as wealthy in the less inequality scenarios – precisely the opposite of what they were arguing before.

Anything, of course, to favor elite patterns of income and consumption.

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chris 06.21.10 at 7:13 pm

@SoV 49: I believe you’re ignoring population growth, which would reduce but not eliminate your argument.

More fundamentally, the problem with Shaun’s post is that it is too simplistic. If some owners, some managers and some workers get together and produce some added value, the size of that pie *is* fixed, and how to divide it between the different groups who collaborated to produce it is very much a zero-sum game; even though many divisions leave all three groups better off than if they hadn’t made any pie at all, they may do so to vastly different extents.

And when the managers are doing all the slicing with little effective input from the owners and none from the workers, the idea that *all* criticism of the resulting division can only come from envy is ludicrous.

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Jeff R. 06.21.10 at 7:15 pm

So inheritance taxes: always a mistake or a curtailment of the interests of entrenched old money?

If you’re in the business of redistributing wealth, they’re a somewhat better tool, in theory at least. In practice, that part of the code attracts enough loopholes that it doesn’t seem to work all that well. (Jockularly, inheritance taxes also have the benefit of taxing something we actually want less of [Death]. )

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ScentOfViolets 06.21.10 at 7:31 pm

@SoV 49: I believe you’re ignoring population growth, which would reduce but not eliminate your argument.

Ouch!! You’re right, of course. There are other offsets in other directions, of course, such as the median household only having one income earner in 1970 vs 1.X in 2010. But that is a big correction.

More fundamentally, the problem with Shaun’s post is that it is too simplistic. If some owners, some managers and some workers get together and produce some added value, the size of that pie is fixed, and how to divide it between the different groups who collaborated to produce it is very much a zero-sum game; even though many divisions leave all three groups better off than if they hadn’t made any pie at all, they may do so to vastly different extents.

And when the managers are doing all the slicing with little effective input from the owners and none from the workers, the idea that all criticism of the resulting division can only come from envy is ludicrous.

Yeah, the coffin that is the theory that “value is defined as just what someone is willing to pay” is a lot more nail than wood, these days. Logically, it would seem that a lot of productivity gains would come from the bottom, the inherent nature of automation being that it replaces the simplest tasks first. But somehow productivity gains seem to mostly go to the top where presumably automation is the hardest . I wonder why that is ;-)

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chris 06.21.10 at 8:41 pm

Jockularly, inheritance taxes also have the benefit of taxing something we actually want less of [Death].

It’s not completely a joke — people don’t stop dying to avoid the tax, but the very fact that people can’t change the taxed behavior in response to the tax makes it preferable in some respects to taxes that change the economic incentives for some behavior and thus distort the economy. (Except when the distortion is itself benign, because it remedies a contrary distortion that would otherwise exist (e.g. Pigouvian taxes on externalities) or restrains an irrationally self-destructive tendency in human behavior (e.g. taxes on addictive drugs or dietary fats and salt).)

Except, of course, that the behavior taxed is not actually death, but death while owning a lot of money — which people *do* avoid via a variety of schemes for transferring their wealth nominally out of their own hands before dying, when they are old enough or ill enough to foresee upcoming death.

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James Kroeger 06.21.10 at 9:39 pm

Shaun 42:

<iA surprising number of people retain from childhood the idea that there is a fixed amount of wealth in the world. There is, in any normal family, a fixed amount of money at any moment. But that’s not the same thing.

I think the best way to illustrate the difference between real wealth and money wealth is to imagine what the world would be like if it were possible—as conservative theorists like to suggest—for all of us to somehow become fabulously rich in dollars some day and then all of us billionaires decided to retire and live off of our accumulated “wealth.” What we would soon discover is that we didn’t actually possess any real wealth at all, for no one would be producing anything of value that we might want to buy.

The only reason why money has any value to us is because it gives us a claim on the productive efforts of others. How wealthy you actually are depends more on what others are doing than it does on your personal accumulations of paper notes. An economy’s real wealth is the productive behavior of its people; it is the actual goods & services that people are producing and trading and consuming. You cannot ever be truly ‘wealthy’ unless a lot of other people are out there producing the real wealth you’d like to consume.

Paul Graham understands the difference between money wealth and real wealth; what he doesn’t understand is that there really is a optimal amount of real wealth that a nation, and its citizens can ‘have.’ That optimum is experienced when every able-bodied and able-minded member of the society is producing something of value. (Production choices can sometimes be changed to increase the total amount of real wealth that a nation produces/consumes, but the first priority should always be to do whatever you can to get everybody working.)

When formerly unemployed people begin working for the income they are spending, they are actually doing something that benefits everyone else. This is because the unemployed never stop consuming; they just don’t produce any of the stuff they consume. Somebody else does. As a society, we all become richer in real terms when all those who are idle become productive. If part of your productive output is no longer needed to provide for the basic consumption needs of the unemployed (because they are now producing for themselves), then that means more of your output becomes available for your own consumption.

Wealthy conservatives fail utterly to understand that when they hand over more of their gross income to the government through progressive income taxation, and the government uses that money to eliminate ‘idleness’ through investments in infrastructure and human capital, they are actually acting to optimize the amount of real wealth they are able to experience in their lifetimes, and it doesn’t cost them anything in terms of lost purchasing power (see 6 above) to make such an investment.

Any time the government is short of the money it needs to employ the unemployed in productive activities, the wealthy should be eager to give up some of their ‘excess savings’ to the government, since all rich people would (in a tax code without loopholes) be making the same sacrifice, and that means—because we have a market economy—that none of them actually makes any [purchasing power] sacrifice. (The prices of all of those things the wealthy buy would simply drop to a level that they’d then be able to afford. No other outcome is possible in a market economy.)

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James Kroeger 06.21.10 at 9:45 pm

Jim Place 41 We did maintain employees that we should have laid off and it did cost…The decision was way easier for me to accept when what I was saving was the jobs of people I know and care for.The fact that you felt compassion for your employees was a good thing. But then, the statement you made (that if the government were to tax you substantially more, you would ignore those compassionate feelings and sack your employees without hesitation) defines you quite differently. The government’s actions would change the way you feel toward your employees?

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david g 06.22.10 at 12:05 am

John, nothing stops you from voluntarily paying a few tens of thousands more dollars to the state. Are you doing that? For it appears to be your prescription.

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Chris 06.22.10 at 12:18 am

Any time the government is short of the money it needs to employ the unemployed in productive activities, the wealthy should be eager to give up some of their ‘excess savings’ to the government, since all rich people would (in a tax code without loopholes) be making the same sacrifice, and that means—-because we have a market economy—-that none of them actually makes any [purchasing power] sacrifice. (The prices of all of those things the wealthy buy would simply drop to a level that they’d then be able to afford. No other outcome is possible in a market economy.)

ISTM that you’re assuming zero overlap between goods rich people buy and goods everyone else buys, and even worse, zero overlap between the ingredients that go into those goods. Otherwise, the effect on prices of goods for rich people is going to be imperfect because some of those goods will be repurposed for non-rich people. Relative price shifts will affect some production patterns and therefore consumption patterns, because as you point out, you can’t consume something unless someone produces it.

Even for the rich, not all goods are purely positional. (Ok, maybe for the *obscenely* rich.)

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Chris 06.22.10 at 12:22 am

@57: If he did, would it force everyone else of the same wealth level to follow suit? Because otherwise he’s voluntarily making himself worse off so that others can freeload off him. I don’t think that’s what he’s prescribing at all.

Taxes are a society-wide solution to the distributional (i.e. free-rider) problems with voluntary donations. Even if you think it would be better for society for everyone including yourself to pay more, that doesn’t imply that you would or should want to pay *more than everyone else is paying*.

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Ronald Brak 06.22.10 at 12:30 am

Jim Place, I don’t understand why an increase in the upper levels of personal income tax would cause you to sack people. I can see how an increase in personal income taxes could result in you working less hours to avoid entering a higher tax bracket, and I can see how it could result in you paying yourself less in order to invest more into your business, but I don’t understand how you would get any benefit from sacking people.

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Charles St. Pierre 06.22.10 at 4:35 am

James @ 6, etc. You got it: It is actually in the interests of the well to do to pay more taxes. Everyone prospers.

Unfortunately, the wealthy have too much political power to allow this to happen. The inability of our government to effectively address long range problems is a symptom, as it is the conflicting interests of the powerful which have led to its paralysis. The exceptions are when powerful interests can be pandered to, as the insurance industry was with healthcare ‘reform.‘

Rather than pay taxes, the wealthy, having seized control of the government, force the government instead to borrow from them. The likely result: They will kill the goose to get those golden eggs.

The wealthy have too much power for their own, and our, good.

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novakant 06.22.10 at 11:04 am

All this talk about redistribution and equality is totally vacuous if you ignore where these tax dollars actually go. And if you bother to look that up, you’ll find out that vast amounts of money are redistributed to the military-industrial sector and that 1.000.000.000.000 of those tax dollars have been sunk in Iraq and Afghanistan. Congratulations!

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ScentOfViolets 06.22.10 at 3:29 pm

Unfortunately, the wealthy have too much political power to allow this to happen. The inability of our government to effectively address long range problems is a symptom, as it is the conflicting interests of the powerful which have led to its paralysis. The exceptions are when powerful interests can be pandered to, as the insurance industry was with healthcare ‘reform.‘

Yeah, “the death of organizations”. From enterprises as diverse as the Ford motor company to the Roman empire, there appears to be a pattern of healthy growth facilitated by competent men (and women, of course) in positions of power and influence. Then there’s the bit where the organization isn’t really growing any more and the men (and women, of course) who are at the top get there with a completely different skill set that’s big on personal intrigue, blame-shifting and credit-grabbing techniques, carefully fostering allies and enemies, and so on and so forth. Unfortunately, the skill sets for personal advancement and the skill sets for efficiently running a productive enterprise don’t have to overlap for any particular reason (in fact, running a productive enterprise comes to be a second-tier expertise, most suited to underlings), and so the organization undergoes a prolonged period of decay that ends with an entrenched, decadent, and out of touch monarchy squabbling over the scraps.

Surely this is a well known theory of historical cycles? Not my thing, I’m a math guy, but it would be interesting to read up on.

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Alex 06.22.10 at 3:53 pm

31: Here’s an argument. So your hypothetical employer is all these things…but also so bitterly resentful of income tax that they would be willing to chuck the lot of them out of the window. That’s wildly self-contradictory; someone like that wouldn’t be any of those things.

Also, income tax isn’t a payroll tax. If you were arguing that it might deter them from expanding the business at the margin, you might have a theoretical point. But your premise is that they are retaining labour for noneconomic, or at least non-short term economic, reasons – by definition, then, they could increase profits by sacking the guy.

If they were as psychotically tax-averse as your assumptions require, they would be desperate to hire in order to avoid paying income tax.

I will now accompany EJH and his onion on the world’s smallest violin.

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James Kroeger 06.22.10 at 10:46 pm

Chris:
ISTM that you’re assuming zero overlap between goods rich people buy and goods everyone else buys, and even worse, zero overlap between the ingredients that go into those goods. Otherwise, the effect on prices of goods for rich people is going to be imperfect because some of those goods will be repurposed for non-rich people.

What you’re not noticing, Chris, is that there doesn’t need to be zero overlap in order for my point to hold. Yes, some of the things that rich people buy are non-positional (e.g., toothpicks, gasoline), but depriving the rich of some of the extra money they use to outbid poorer folks for higher quality products does not deprive them of that bidding edge.

They may be get less profit from their rich customers in a high tax regime, but suppliers of luxury G & S would still be able to outbid the suppliers of non-positional G & S for the best quality ingredients, components, materials because the state is not taking that much money from them. Price differentials across the spectrum of consumables would shrink, but they would not disappear.

The scarcer resources would still end up being consumed by the same people because they’d still be able to outbid the ‘small people.’ All we’re talking about is reversing the pure inflation that has occurred in all the markets that serve the rich over the past few decades of Republican rule in America.

Rich Republicans may have thought that they were better off when the R’s cut their taxes, but the rich, as a class, are actually no better off than they would have been if no Republican tax cut had ever been passed by Congress. All those tax cuts did was set off a round of inflation in the markets that serve the rich. The most glaring examples: the financial assets markets, the art market, real estate market.

A sweeping gift of disposable income to ALL rich people does nothing to increase the supply of the scarce resources that are used to service the upper classes. This is because an all-out effort to gather scarce resources for the rich would still have taken place if the tax cuts had never passed. Suppliers of luxury G & S would have done this because the rich would still have had the most money to spend, and suppliers of luxury markets will chase those dollars/pounds, no matter what.

More on this later…

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PaulB 06.23.10 at 9:24 pm

>>> fn2. with the partial exception of Greece, the present round of the crisis is caused by unaffordable bank bailouts)

Is it? According to HM Treasury, the net cost to the UK of the bank bailout as of March was £6bn – not trivial, but not in itself the cause of a crisis.

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chris 06.24.10 at 2:54 pm

What you’re not noticing, Chris, is that there doesn’t need to be zero overlap in order for my point to hold.

Yes, there does. You’re not accounting for shifts in the composition of production to follow the shifts in demand created by the shrinking gap between the rich and non-rich. (Or growing gap, in the opposite direction.)

Suppose that with the same amount of construction contractor labor I can build two modest-size houses or one McMansion. (Some of the materials for the McMansion will be more expensive, but some will be the same, like structural materials, wiring, pipes, etc.) If the rich have relatively more money and the prices of high-end houses go up, I’m more likely to find it more profitable to build the McMansion. If the rich have less money (relative to the middle class) and high-end houses slump, I’ll build the two middle-class houses. Then middle-class housing will deflate a bit too — and the middle class now have more money for other things. In the meantime, my refusal to build a McMansion has slightly decreased the excess McMansion stock and they drop less than they would have otherwise.

The effect is even stronger when the rich and middle-class use the exact same good, like gasoline. If the rich lose income relative to the middle-class, because there are few of them, the overall demand for, and price of, gasoline doesn’t change much, so unless the rich change their consumption habits (i.e. lifestyle), they pay about the same for gas as they did before — and therefore, a larger percentage of their income. Gas isn’t a very large percentage of their income to start with, but there’s a lot of similar commodities, and a lot of other goods indirectly have prices like gas included as part of their distribution costs.

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engels 06.24.10 at 11:25 pm

Fortunately those of us in Britain don’t need to debate whether it is the richest 20% or the richest 1% should be squeexed, as the Liberal-Conservative government has already decided who should pay for the crisis: the poorest workers and benefits claimants.

We’re all in it together but some of us are going to be a lot more in “it” than others.

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James Kroeger 06.26.10 at 7:41 pm

chris: You’re not accounting for shifts in the composition of production to follow the shifts in demand created by the shrinking gap between the rich and non-rich.

Actually, chris, I do allow that ‘over-reactions’ can/will occur in the short-run, but in the long-run, they are corrected.

You need to keep two things in mind: (1) no actual [new] shortage would be occurring, and (2) markets work. Also, remember that it is always wise to phase-in more steeply progressive income taxes over a fairly long period of time (ten years?) to minimize any panic that could possibly occur among the misinformed.

Yes, it is predictable that some rich people will want to show their displeasure by postponing some purchases, but this would be rather short-lived, for they will soon notice that all other rich people are just-as-poor-as-they-are, and that prices are beginning to drop into the ‘real bargain’ range.

Now some contractor may misjudge the drop in prices to mean that he will no longer be able to make a ‘good enough’ profit, but the reality will be that he will still be able to make a profit, for mansions will still sell [at a lower price], and it will be a price that still exceeds long run costs. If not he, then some other contractor will recognize the opportunity to make money off of rich people, and build the mansion.

The effect is even stronger when the rich and middle-class use the exact same good, like gasoline.

I don’t understand what you are trying to say here. The non-positional goods that rich people consume can be utterly dismissed from the conversation, for they are a constant that is unaffected by changes in the disposable incomes of rich people.

Whether they are rich or only middle-class, they will always consume the same quantities of N-P goods because they can afford them. Remember, members of the middle-class buy non-positional goods—even though their cost accounts for a greater % of their budgets—because they can afford to buy them.

It is the scarcer [positional] G & S that are affected by changes in disposable income. If you have enough disposable income to outbid others for the privilege of consuming them, then you will consume them. If you don’t, then you won’t. Suppliers will drop their prices, but not so low that non-rich people are suddenly able to afford a mansion, for nothing has occurred that will increase the supply of mansions.

Yes, it is possible that a temporary over-supply of mansions could occur if some rich people were to take themselves out of the market, and yes, prices could then drop low enough for some of the near-rich to afford them, but those opportunities would cease to appear once the real-rich have returned to the market for mansions.

I don’t know, chris…it’s starting to sound like you really don’t have much faith in markets…

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