Hands off the rich ?

by John Quiggin on February 12, 2021

The idea that we should tax the rich to fund public services and transfers to the poor seems obvious from an egalitarian perspective, at least as long as we are in a society with significantly unequal incomes. But it has been challenged recently by some advocates of Modern Monetary Theory.

[note: The meaning of ‘rich’ is rarely spelt out, and isn’t very helpful. Hardly anyone is willing to admit to being rich, so the discussion tends to focus on a handful of cases like Bill Gates, rather than on people in the top 1 per cent or 10 per cent of the income distribution. So, from now on, I’m going to use the term ‘high-income’ and refer to proposals raising taxes on some subset of the top 10 per cent.]

Over the fold, an extract from my book-in-progress, The Economic Consequences of the Pandemic

The argument that we don’t need to tax people on high incomes works in two stages.

First, following the functional finance arguments made by Abba Lerner in the 1940s, MMT advocates argue that taxes aren’t needed to ‘fund’ public expenditure. Rather, for a given level of public expenditure, taxes should be set to ensure that aggregate private and public demand is equal to the total productive capacity of the economy.

That’s one way of presenting the standard Keynesian model and useful in a lot of ways. But it doesn’t do as much work as many MMT advocates would like. Suppose the government balanced aggregate demand and supply, and now wants to introduce a new spending problem program. To maintain balance, private spending (consumption and investment) needs to be reduced by an equal amount. That requires tax revenue roughly equal to the amount of the new spending.

The second part of the argument is that, if taxes are meant to reduce consumption, there’s no point in taxing high income earners because they won’t change their consumption in response to changes in their income. (By contrast, the poor will spend their entire income).

The claim that high incomes won’t change their consumption in response to changes in their income has some merit when we are talking about short-run stabilization, for example an economic stimulus during the pandemic. People who can manage their financial assets and liabilities won’t change their spending much in response to a once-off payment or tax increase. Rather they will reduce their savings to absorb a tax increase and use once-off payments to increase savings or pay down debt. By contrast, people on low incomes are typically ‘credit constrained’, meaning that they can’t borrow (at least at reasonable rates of interest) to meet current needs. So, they are more likely to spend any windfall gain, which makes them more responsive to short term stimulus payments (and also more likely to reduce spending when the payments stop)

Permanent changes in spending and taxation raise quite different issues. Unlike the case of temporary changes, households at all levels will respond to these changes. The only question is whether the responses of high-income and low-income households differ enough to matter. One way to answer this question is to ask whether, in the long run, high income households save a large share of their income than low income households. This question turns out to be surprisingly difficult to answer.

For our purposes, the most interesting approach is to look at the way changes in income distribution affect aggregate savings. If high income households save much more, a redistribution of income that reduces their share will increase aggregate consumption. In this case, the claim made by Kelton and others, that taxing the rich does not provide extra resources

In reality, however, studies at the aggregate level find no such effect. Changing the distribution of income does little or nothing to affect aggregate savings. Studies at the household level find some effect, but not enough to matter. To quote an influential recent study

“policies that redistribute across income groups can have real effects on saving [BUT] the differential saving effects of typical government transfer programs are not so large as to make a measurable dent in aggregate saving” Dynan et al, Do the Rich Save More? DOI 10.1086/381475

This claim that high income earners don’t spend their (permanent) income is commonly associated with MMT. However, it isn’t inherent in any of the intellectual strands of thought that go into MMT – functional finance, Minsky crisis theory, post-Keynesian macro. Rather it’s been added on by MMT supporters who want to avoid the need for tax increases, either because it seems politically too difficult, or because they don’t want to alienate potential allies in the financial sector.

To restate, the current debate about pandemic stimulus. Here the need is to hand out lots of money on a temporary basis to people who will spend it now. That implies an expenditure program targeted at low income earners. Once the economy has recovered, it will be time to look at permanent new spending programs and raise taxes to provide the necessary resources.

—– Taxing to level down —-

Some opponents of taxing high income earners to fund (or resource) government programs say that they nevertheless support progressive taxes to reduce the excessive incomes of ‘the rich’. On the arguments above, that doesn’t provide any extra spending capacity, so the only purpose of the tax is to reduce inequality by levelling down.

This position is, whether its proponents realise it or not, a rhetorical dodge. The implied policy program now is one in which permanent spending programs are introduced now, without any increased tax on high income earners. The inequality-reducing tax, which is a much harder program to sell politically in the absence of any plan to spend the proceeds, will be deferred indefinitely.

The problem is that, one way or another, the need for real resources to support public programs will become evident. Either access to programs will be delayed and rationed, or charges of one kind or another will be imposed, or inflation will be allowed to erode the value of benefits. Real public programs require real resources and that means taxing the people who have the resources to pay (the apocryphal words attributed to Willie Sutton, when asked why he robbed banks, are apposite here).

{ 18 comments }

1

J-D 02.12.21 at 8:37 am

Suppose the government balanced aggregate demand and supply, and now wants to introduce a new spending problem.

Here are some other Web pages on which the phrase ‘spending problem’ appears:
https://www.youneedabudget.com/3-ways-to-curb-a-money-spending-problem/
https://www.thebalance.com/help-for-spending-issues-2385809
https://www.psychologistanywhereanytime.com/addiction_psychologist/psychologist_addiction_spending.htm
https://en.wikipedia.org/wiki/Double-spending
(Ai guest yew where jest replying in yore spill chequer too fined miss steaks.)

2

Robespierre 02.12.21 at 9:54 am

Even allowing that the rich save more (which is not the same as saving 100%), should we accept that saved money just disappears? Does it not finance investment? It would be very worrying if every year some 20% of gdp vanished into the dragon’s cave.

3

MM 02.12.21 at 10:04 am

I feel that any arguments for “more taxes (on the rich or on everyone)” should state what baseline they are advocating increasing from. The overall tax burden on the high income earners in the US is lower than in much of the rich world, yet taxation there is quite progressive so the tax burden on low and middle incomes is even lower. Taxation is less progressive in the UK, but still more progrssive than in continental Europe.

So: do you feel taxes on high incomes should go up in the US, while keeping the low taxes on low and middle incomes? Or should they go up in the UK (from already quite high levels, relative to comparable economies)? Or should they go up in Europe, in a context where the overall tax burden (and therefore the size of the state) is already quite large?

I recognize that the context John may have in mind is the Australian one, about which I do not know much.

4

Pittsburgh Mike 02.12.21 at 10:10 am

On what planet do high income people not save a higher percentage of their income than medium or low income people?

Speaking from personal experience, our household income has varied between high and very high over the last 20 years. Sometimes it was randomly high, with little expectation it would remain at the new level for more than 2 years, and other times the increase was likely to be a new floor.

But our expenditures have basically been constant, modulo inflation and rising tuition, and all the rest has gone to savings and charitable gifts. When our income goes up, it all goes to savings. When our taxes go up, they all come from savings.

5

John Quiggin 02.12.21 at 10:30 am

Robespierre. That’s correct and I mention briefly that private spending is consumption + investment. But I haven’t had time to work through the links between household saving and investment, so I skipped over that point.

6

Articulate Source 02.12.21 at 10:38 am

Thanks for the article. I love your work.

now wants to introduce a new spending problem

I feel like this sentence wants to say:

now wants to introduce a new spending program

But I do agree it does create a problem demand problem.

I do wonder about this:

That requires tax revenue roughly equal to the amount of the new spending.

Or increase the capacity of the economy.

Or increase compulsory superannuation (or any savings).

Or reduce some other spending.

My perspective is that we are running way below our people capacity, and way above our environment capacity.

Under and unemployment is at close to 20%.

Measured under and unemployment under estimates real spare capacity of discouraged workers.

Cost and availability of childcare reduces the work parents can do.

Lots of people are in not particularly productive jobs.

The employment structure does not accommodated students and the old very well.

And as wealth has becomes ever more concentrated I wonder how unpopular taxes need to be. The Warren and Sanders wealth taxes did not attract a great deal of condemnation that I saw. So starting on wealth above $30 Million seems plausible politically.

Toward the end of the Ian Macfarlane podcast:

https://josephnoelwalker.com/101-the-rise-and-fall-of-monetary-policy-ian-macfarlane/

Ian Macfarlane tries to explain recent stagnation.

There might be some association between inequality, debt and reduced demand.

Maybe William Randolph Hurst, Larry Ellison, or Elon Musk might have extravagant tastes, but other billionaires might really struggle to spend their income. Some level of income may really be less spendable. And historic studies may miss this because this level of wealth was less common then.

Kelton in her book talks about assessing the specific real resource requirements / inflationary impact of each piece of spending and how to accommodate that, rather than PAYGO. I am thinking that right now, paying otherwise underused (because of no international students) university workers to do research, or tutor school kids, would fit into this kind of thing. Where as building more infrastructure would not because infrastructure workers are already employed.

I don’t really know how much of the spending I want can be accommodated by monetised spending. And I am not against tax reform. I am against the insistence that the taxes must come first.

I do think the anxiety about the debt levels of governments with fiat currencies seems misplaced. And reading the deficit myth was helpful. If Australia has $2 Trillion in federal debt, that just means we need $80K in government bonds or cash in our super funds each, which does not seem scary to me. I think the government is a natural issuer of lifetime, inflation indexed, retirement annuities, because anyone else will either rip us off, or go broke, depending on what happens to investment returns or life expectancy.

7

Trader Joe 02.12.21 at 12:15 pm

I find that most politicians focus too much on “tax rate” and not nearly enough on producing an efficient tax code. Wealthy people have an a near infinite number of ways to deploy wealth so as to avoid taxes on it – everything from Trusts and S-Corps and mortgage deductibility on 1st homes + investment property, to more readily available financial products like 401ks 529s and annuities.

401ks are a relatable example – an over 50 person can save $25,000 in a 401k and avoid tax at about a 40% fed/state rate at least 10k of taxes are avoided and the $25,000 is likely less than 5% of annual income. If person making 100,000 – still a quite good wage – saves 5% the tax benefit is about $1000. So the rich guy gets 10x the tax benefit of a middle class person and likely an infinite benefit relative to the person who can’t afford to save much of their salary at all and likely pays little tax on it anyway. One of the great tax breaks to wealthy ever.

All of these tax dodges are fully legal within the existing code and the benefits substantially accrue to Top 10% wealth holders. Congress will propose changing the top rate from 35% to 40% but all of that is moot on the income that’s protected from tax altogether. Sure, some incremental revenues would be raised but peanuts compared to the potential from other means and most likely some portion of the increase will be avoided by expanded use of available tax minimization tools.

The way you “tax the wealthy” is to define income in the simplest possible terms – get rid of all the tax preferences – and then actually LOWER the effective rate on the expanded definition of income. If there’s no place to hide, collections will go up even on a lower rate. Its a beautiful thing too because Congress-persons can lower the rate and raise revenue at the same time.

8

Larry Hamelin 02.12.21 at 1:05 pm

I have a very different interpretation of the MMT position on taxing the rich.

I read the position as emphasizing the “in order to” connective: We don’t need to tax the rich in order to increase socially useful spending.

The MMT position is that the implied causality is just not there. Even if rich people could withhold their monetary wealth (and they have the motivation and political power to do so), we can still create the money to fund social spending. Social spending does, of course, reallocate scarce resources, but the money itself is not one of those scarce resources.

MMT adherents argue that the opposite message, that social spending requires funding, that rich people are hoarding a scarce resource, money, that must be obtained in order to reallocate it to social spending, is simply false.

The harder problem, of how to actually account for the effect on the allocation of scarce real resources of social spending, remains hard. However, I don’t think we can use a simple macro model of marginal propensity to save/consume to analyze the effects.

First, MMT advocates seem to clearly argue that they do not believe that all government spending is created equal. The sophomore Principles of Macro model, where there is one G and one multiplier (or even just a multiplier as a function of income), is too simplistic. Trying to quote from memory, Wray often says, “You have to buy a lot of missiles to employ an unemployed teenager in Harlem.” Hence the MMT emphasis on the JG.

Second, we have to account for money hoarding, especially banks hoarding currency in reserves and the ultra-rich households and corporations hoarding bank money in both domestic banks and offshore tax havens. Money not in circulation (we can rewrite M×V as Mh×0+Mc×Vmax) can be taxed retroactively, when and if the ultra rich try to spend (or repatriate) the hoarded money.

Third, MMT advocates argue that the money supply and interest rates are not the most important determinant of investment spending; instead, demand drives investment. Regardless of how much money is floating about and how cheaply firms can get it, firms won’t invest if there’s no demand to support an increase in output, and if there is demand to support an increase in output, the money will appear.

I tend to look at MMT claims at three levels. As an economics teacher, it’s just true (and in all the standard macro textbooks) that money itself is not a scarce resource. MMT just takes that truth seriously and doesn’t try to paper it over with the myth of sound government finance.

As a progressive, I think that the JG sounds pretty good if it were properly implemented, and creating new money to fund the JG is a pretty good way of making it happen.

As a socialist, I see the enormous political problems that seem inescapable in a capitalist society. Being capitalist economists, MMT advocates do not, I think, take most of these problems as seriously as I do. A JG in a capitalist society could very easily settle into dystopian make-work acting as yet another avenue of rent extraction for monopolists. However, the myth of money itself as a scarce resource seems pretty close to a keystone of capitalism; subvert that myth and capitalism becomes considerably less stable.

9

Richard M 02.12.21 at 1:10 pm

Real public programs require real resources

Surely the central claim of MMT is that money is not a real resource? If so, how does that still apply?

Real projects that are worth doing lower overall demand for real resouces, by e.g. building a bridge so people have less far to drive.

Simple redistribution involves minimal direct use of non-monetary resources; a few computers and office buildings.

The only problematic case is if you were planning on doing a project that wasn’t inherently worthwhile, and hoping for redistribution as a side-effect.

10

Ish 02.12.21 at 1:10 pm

The savings of the wealthy generally don’t stay in bank accounts. They either get stored as savings in gov bonds(implifed FDIC) those might go the gov sector and be recirculated through economy. Isn’t negative bond yields kind of a show that we have a lot of “savings” and a negative coupon essentially a wealth tax for the reduced risk exposure.

11

Anarcissie 02.12.21 at 5:00 pm

Isn’t there a problem here with considering money to have a certain kind of solidity which it actually lacks? Among the poor, the thing that makes money operative is that it is hard for them to get, hence they are willing to exchange labor and labor-derived goods for it. However, at a higher level, the rich can obtain money at very low or zero interest, or make enormous profits based on rents or luck. That money does not actually represent anything, as the money of the poor does. So taxing the rich seems like an attempt to pump air out of a vacuum. If you move a billion dollars from Bill Gates to a million poor people at $1000 apiece, they will go out and spend it, and inflation will result, because Mr. Gates did not produce anything to correspond to his billions. Nor will equality be enhanced, because the government will simply lend him more at zero percent if he can bother himself to ask for it.

12

Gregory J McKenzie 02.12.21 at 6:10 pm

The rich, even when they do not admit to being rich, are quite capable of looking after them selves. The tax havens around the world are evidence of this fact. It is better to manipulate their behavior by taxing their own consumption. So taxes on expensive goods, value added tax regimes that zero rate essential final goods, customs duties targeting imported luxury good and taxes on internet selling of non-essential items is the best way to ‘soak the rich’. They benefit from the protection of a police force and legal system, often much more than lower income deciles. This they should pay for as it is not meant to be a free rider. Their domestic property is protect by national defense forces. As they have more property that needs such protection, they should pay more taxes for access to this collective service. Finally they benefit from public infrastructure when running business for profit. They should be subject to both income taxation on such profits and a super profit tax. Domestic savings data may not be appropriate for the rich as they often send savings out of the country’s banking system. This is why the rich only needed up to nine months, in 2020, to restore their cash balances worldwide. At the very top the super rich economic units increased their combined wealth despite the pandemic. As Piketty has pointed out, if there is no inheritance tax then rich families will hoard savings in the long term,

13

Kiwanda 02.12.21 at 10:42 pm

Rather, for a given level of public expenditure, taxes should be set to ensure that aggregate private and public demand is equal to the total productive capacity of the economy.

This is a concise, crisp statement; what does it mean? Is there a simple explanation or description for the ignorant non-economist of what this means or implies? Despite having some inkling of the meanings of the words, I’m reduced to guessing. If taxes were zero, then would people have more money to spend than there is stuff to buy? If taxes were confiscatory, would the government run out of things to spend on? Wouldn’t people still need to eat, still have some demand (or would demand be zero because they have no money)?

14

JimV 02.13.21 at 2:32 am

The rich can use their money to buy power and use it for good or evil. The good they do could be more efficiently done by government. E.g., malaria blankets distributed with the assistance of embassies. A democratic government with checks and balances and auditors will have more difficulty doing evil unless most of its society wants to do evil, but in that case we’re screwed anyway. Whereas the solitary evil billionaires can do whatever they want, or even the semi-billionaires like Trump. At least make them pay enough taxes to keep their money and power from snowballing, before it is too late.

(It’s one for you and nineteen for me, I’m the Taxman, sounds about right.)

(I saved about 50% of my lifetime salary earnings and it has snowballed. Tax me more also. Just don’t make school-teachers’ children take out student loans of $50K to get a college degree., so I won’t need the money for them.)

15

Forrest Leeson 02.14.21 at 4:30 pm

The rich do spend — on political influence, to acquire more money (i.e. their point score), which is why campaigns are so expensive. Hence the phrase “We tax the rich to constrain their power, all others to constrain inflation.”

16

snuffcurry 02.15.21 at 10:48 am

So taxing the rich seems like an attempt to pump air out of a vacuum. If you move a billion dollars from Bill Gates to a million poor people at $1000 apiece, they will go out and spend it, and inflation will result, because Mr. Gates did not produce anything to correspond to his billions.

Good lord. That’s not how levying taxes and distributing public money works, poor people spending money on the things they’ve gone without and on the debt they’ve had to accumulate while operating on a pittance is not how any measurable amount of inflation is caused, Bill Gates has not accrued his billions from “producing” things and he has advocated repeatedly (for what it’s worth) for raising tax on capital gains, and he continues to generate the kind of wealth that outpaces what annual tax he does pay. I repeat, good lord.

17

Peter T 02.16.21 at 12:34 pm

Surely it’s worth asking if one actually could ensure “aggregate private and public demand is equal to the total productive capacity of the economy”. Presumably to do so one would have to know the total productive capacity of the economy was – a moving target, and a composite of many inter-related capacities (efforts to raise productive capacity usually turn out to be a series of problem-solving exercises as bottlenecks in one area after another are identified and addressed). Private demand – is there not usually a fair amount of unmet private demand?

A second point is that any theory which assumes any direct or unvarying correspondence between money and capacity is assuming a great deal. Money does not measure everything; still less does the amount of money in circulation correspond to productive capacity – this should be obvious in that in recent years central banks have created enormous amounts of money with little apparent effect on inflation or productive capacity.

18

steven t johnson 02.16.21 at 1:26 pm

“Rather, for a given level of public expenditure, taxes should be set to ensure that aggregate private and public demand is equal to the total productive capacity of the economy.” I gather the reason that these need to be equal is to preserve the value of money, a matter of grave importance to those who have a lot.

But assuming for the moment hard money (as measured by budget deficits, apparently) is unquestionably true and just…What is this total productive capacity? A level of output sufficiently low enough that wage increases due to a tight labor market cannot threaten profit margins? Or a level of production that reveals hitherto unsuspected inadequacies in particular spheres of production, which is to say, shortages of key products? Even more, given the uncertainties in such a figure, how can tax rates be sensibly planned to match?

“The claim that high incomes won’t change their consumption in response to changes in their income has some merit when we are talking about short-run stabilization, for example an economic stimulus during the pandemic.” Is it possible to meaningfully assess this without numbers about what constitutes a high income? My intuition is that luxury spending does change for high incomes when their income drops. But does economics dare to pronounce on what is or is not luxury? That’s awfully similar to distinguishing productive and unproductive labor, or even worse, needs and wants, isn’t it?

“Permanent changes in spending and taxation raise quite different issues. Unlike the case of temporary changes, households at all levels will respond to these changes. The only question is whether the responses of high-income and low-income households differ enough to matter.” But isn’t it much more to the point how productive capacity changes in the long term? The MMT people agree with every other acceptable economist that the continued existence of a capitalist class with ever expanding wealth is either the cause of or compatible with an increase in real consumption. Possibly lurking in the background is a notion that a stationary economy is inevitable—for environmental reasons?—but if so, it is not clear that MMT is the wrong idea that all good men must rise to fight.

“This claim that high income earners don’t spend their (permanent) income is commonly associated with MMT….added on by MMT supporters who want to avoid the need for tax increases, either because it seems politically too difficult, or because they don’t want to alienate potential allies in the financial sector.” A third possibility is that MMT supporters do not imagine that high income people are putting their money into banks etc. and this money is funding capital investment, either new or replacement. But that capital funds are largely created by banks as credit.

“To restate, the current debate about pandemic stimulus. Here the need is to hand out lots of money on a temporary basis to people who will spend it now. That implies an expenditure program targeted at low income earners. Once the economy has recovered, it will be time to look at permanent new spending programs and raise taxes to provide the necessary resources.” It is not clear to me why the current downturn, which first showed signs of beginning before the pandemic was known, isn’t regarded as another world depression. And that there will not likely be any more return to previous trends after this than there was after 2008. Recovery means return to profitability. Although the need to attack MMT is clear enough, it is not clear how what MMT says about profit is any worse than what acceptable economics says. (The last time I looked, none say much of anything.)

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