A common mistake in tax analysis

Many progressives like to point to the fact that labor supply curves are backward bending.  That is, people tend to work less as countries get richer.  Leisure is a normal good.  That’s all true.  But then they forget that this backward-bending curve is not an income-compensated labor supply curve, and hence has no bearing for aggregate tax analysis.  Here’s Paul Krugman:

This is not a crazy position: “backward-bending” labor supply is a staple of economics textbooks, because income effects work against substitution effects. Raise my wage rate, and the payoff to working more increases; but I also get richer; and one of the things people consume more of when they get richer, other things equal, is leisure. So a higher wage could lead either to a rise or fall in labor supply, and a lower wage similarly could work in either direction.

.  .  .

But this argument applies just as much to the rich as to the poor. And strange to say, you never do find conservatives arguing that we shouldn’t worry about higher tax rates on the rich, because they’ll just work harder to be able to afford those luxury goods; or that a higher inheritance tax probably expands work effort, because it would force the Paris Hiltons of this world to go out and get real jobs.

Funny how that works.

It would be funny if true, but in fact his comments are slightly misleading.  A tax increase doesn’t have any first order effect on national income.  (Even if it does reduce national income, that’s not much of an argument for higher tax rates.)  Thus the standard assumption in public finance is to use income-compensated labor supply curves.  This means higher tax rates will unambiguously reduce national income, as all you have is the substitution effect.

I presume Krugman would respond that he’s making an argument for income effects within some sub-groups, such as the rich.  But that doesn’t strengthen Krugman’s argument very much, for three different reasons:

1.  What matters is aggregate employment.  In recent years the problem of falling labor force participation is increasing concentrated among the non-rich.  At a minimum, Charles Murray is right about that.

2.  The Paris Hilton example actually works the other way.  With a 90% tax rate on the rich (as in the 1950s) there was little incentive for the wives of wealthy people to work.  They had little incentive to work.  As rates came down, labor force participation of women in high income families increased.  I don’t even know if Paris Hilton is married, but if you are one of those people who so driven by envy that you are obsessed with seeing that sort of woman “get a job,” high MTRs for the rich is the last thing you should be rooting for.

3.  Supply-siders claim that higher MTRs for the rich won’t raise much revenue, as they’ll just find more loopholes.  I don’t completely buy that argument, but there’s certainly some truth to it.  For instance, the huge fall in MTRs for the rich between the 1950s and the late 1980s didn’t seem to cost revenue, but we don’t really know if this is because the lower rates on the rich caused their REPORTED pre-tax incomes to rise sharply, or whether they rose for some other reason (in which case the tax cuts did cost revenue.)  Conversely the 1990s works in progressives favor, but we don’t know if that was helped by an exogenous tech bubble.

To summarize, supply-siders are not obsessed with getting the rich to work longer hours.  They want Americans to work more, save more, and invest more.  And to the extent they make that labor supply claim for tax cuts for the rich, it’s using an income-compensated assumption, i.e. the Laffer curve.  You may not buy that argument, but Krugman has not found any logical inconsistency in supply-siders touting Murray’s findings.

PS.  I’m no dogmatic libertarian.  I’m fine with a progressive payroll tax, plus luxury taxes on these sorts of homes:


Tags:

 
 
 

48 Responses to “A common mistake in tax analysis”

  1. Gravatar of foosion foosion
    13. February 2012 at 10:47

    Krugman is saying the income effect and substitution effect apply to everyone (rich and poor) and that we can’t determine a priori which effect dominates. He then criticizes those who insist on an income effect for one group and a substitution effect for another, as if both positions were obvious, non-contradictory and didn’t require evidence.

    What do you find wrong with that?

  2. Gravatar of Mike Sax Mike Sax
    13. February 2012 at 10:59

    “The Paris Hilton example actually works the other way. With a 90% tax rate on the rich (as in the 1950s) there was little incentive for the wives of wealthy people to work. They had little incentive to work. As rates came down, labor force participation of women in high income families increased. I don’t even know if Paris Hilton is married, but if you are one of those people who so driven by envy that you are obsessed with seeing that sort of woman “get a job,” high MTRs for the rich is the last thing you should be rooting for.”

    I’m a progressive, but actually not very obsessed with seeing “that sort of woman” get a job. I really have no problem with women who don’t haev to work-that’s their business or at most they and their husband. Also, in passing, I note that you are confusing Paris Hilton-a wealthy woman in her own right-with a woman married to a wealthy guy.

    Actually the historic rise of the feminist movement-Simon Beuvoir’s “Second Sex” , etc-came in a demand for women to work which had nothing to do with wanting to earn more money, and came during the period of high income tax rates. Women wanted to work, in large part because they were-well, bored for one thing. In any case it wasn’t an economic argument.

    I think top tax rates whould rise somewhat-not ncessarily as high as they were in the 50s-because I believe in a certain level of redistribution of income and because I believe there shold be a social safety net-someone has to pay for it.

    In my view I’d rather tax the wealthy more than the nonwealthy-not out of envy as such, I’m not even a pure economic egalitarian-because first I think it’s fairer-in my view tax progressvity is fairer-and secondly taxing the nonwealthy less is stimiuluative for demand as it puts more money in their pockets.

    The wealty consume less of their income. I don’t buy the argument that “savers are punished” to the contary, today’s taxation schemes with it’s increasing consumption taxes and lowering taxes on the wealthy punishes consumers. As 70% of economic activity is driven by consumer demand this is wrongheaded. Hermain Cain’s tax plan in partiuclar was a horror show.

  3. Gravatar of Benjamin Cole Benjamin Cole
    13. February 2012 at 11:49

    OT, but worth getting depressed about: “The key to correcting the underperformance of the American economy and American job creation does not rest with the Federal Reserve. It is in the hands of those who make fiscal and regulatory policy.”–Richard Fisher, 1/12/12

  4. Gravatar of Wadolowski Wadolowski
    13. February 2012 at 13:13

    As I was reading IMF report about Greece

    http://www.imf.org/external/pubs/ft/scr/2011/cr11351.pdf

    I found data that might interest you professor. On page 56 there are NGDP projections till 2015. And you can observe that NGDP growth between 2011 and 2015 is projected to be 0%.

    That indicates severe depression. I’ve asked myself, if ECB allow to growth Greece NGDP by 7% per year, their situation would be so much better.

    Depressing.

  5. Gravatar of Major_Freedom Major_Freedom
    13. February 2012 at 13:41

    “I’m no dogmatic libertarian. I’m fine with a progressive payroll tax, plus luxury taxes on these sorts of homes:”

    Oh, so you’re a dogmatic resentful hater of the wealthy.

    Why do dogmatic resentful haters of the wealth call libertarians who are against initiations of violence “dogmatic”, while they fail to see the dogmatism in advocating for more violence against those better off than they, not because they harmed others, but simply because they have more?

    What if some poor person in Africa advocated for higher taxes on you, and see your relatively modest home compared to what they have, the way you see that mansion compared to what you have?

    Or does your dogmatism only extend out to arbitrary borders that just so happen to coincide with “countries”? After that, beyond those arbitrary borders, progressive income tax that benefits the relatively poor, and higher taxes on relatively large houses that benefit the relatively poor (but only in the short run of course as wealth is systematically destroyed) becomes a figment of someone’s imagination?

    Speaking of dogmatism, all monetarists should read this article:

    http://www.garynorth.com/public/8807print.cfm

  6. Gravatar of Bogdan Bogdan
    13. February 2012 at 14:04

    I agree esthetically with the second part of the post-scriptum : they don’t make homes like this anymore :) http://www.hongkiat.com/blog/40-most-beautiful-castles-around-the-world/

  7. Gravatar of Floccina Floccina
    13. February 2012 at 14:27

    Bogdan,
    I used to live across from some the New Port RI mansions, we considered them a positive externality. My father used to say we get the better view they have to look across to us.

  8. Gravatar of Steve Steve
    13. February 2012 at 15:12

    Scott, sometimes you lose me on the economics lingo, but I’ve done a LOT of thinking on these issues from a practical standpoint.

    1) Capital Gains taxes are VOLUNTARY. People make capital allocation decisions based on expected after-tax returns, not pre-tax returns. A high marginal CG tax means people asset park, smooth tax realizations, and REALLOCATE to static investments like apartment buildings or tax-free munis rather than dynamic investments like stocks and businesses.

    2) Higher CG tax rates tend to lower asset valuations until such time as the prospective after-tax returns are high enough.

    3) There’ve been a lot of people postulating a wealth tax as well. They take Buffett’s $50B and assume a 2% wealth tax could raise $1B a year. Initially, yes. But if such a tax had been in place for Buffett’s 50-year career, he’d only be worth $18B today and the tax would raise only $360 million. Of course, that ignores countervailing effects; asset prices would likely have been lower over time, so Buffett’s return might have been higher.

    4) There’s also a CULTURAL component. A society that villifies high incomes as evidenced by high income MTRs is likely a society where ambitious people find less social positional capital from accumulating wealth. Ambitious people may respond not to the higher MTR, but to the lack of social status afforded by extreme wealth.

    5) Yes, there are huge marriage distortions involved in higher MTRs. This, however, is primarily an issue of the so-called top 5%, the 100K-500K set. Once one person is earning over a million, their spouse would likely not work (outside of a passion) regardless of the MTR.

    6) Paris Hilton does work in my view. She’s a media/fashion/cosmetics/(self)brand entrepreneur. It’s just not the kind of work that many people are familiar with.

  9. Gravatar of Tommy Dorsett Tommy Dorsett
    13. February 2012 at 18:28

    Another issue here is what the government is going to do with the money; if it’s perceived to be dumped in the ocean (low or negative ROI), the top of the Laffer Curve may be shallower than if, say during war time, revenues were used to defeat an enemy that would otherwise end civilization as both the rich and non-rich know it. In other words, the Laffer Curve probably shifts around depending on a whole host of factors. We seemed to be near the peak under Clinton tax rates, but we don’t know for sure as you pointed out there was an influence from the tech bubble. In general, the 70-90% MTRS the Progressive Left has wet dreams over did not seem to bring in much revenue, and that was at a time when the US faced far less global competition and both capital and labor were less mobile than they are today. If they failed then, they would surely fail now. I think we could push up the top rate a bit without suffering revenue loss, but the 70% crowd (D&S) is absolutely f$&*#%# nuts.

  10. Gravatar of StatsGuy StatsGuy
    13. February 2012 at 18:32

    “Thus the standard assumption in public finance is to use income-compensated labor supply curves. This means higher tax rates will unambiguously reduce national income, as all you have is the substitution effect.”

    When you can get a different result by changing the assumptions, then the assumptions are by definition meaningful. I was trying to find something that specified exactly what is implied by these assumptions… However, the explanations I was able to find were entirely circular.

    http://www.econ.berkeley.edu/~saez/saez-slemrod-giertzJEL10final.pdf

    “In most of what follows, we assume away income effects so that the income function z does not
    depend on E and depends only on the net-of-tax rate. In the absence of compelling evidence
    about significant income effects in the case of overall reported income, it seems reasonable
    to consider the case with no income effects, which simplifies considerably the presentation of
    efficiency effects. It might seem unintuitive to assume away the effect of changes in exogenous
    income on (reported taxable) income. However, in the reported income context, E is defined
    exclusively as virtual income created by the tax/transfer budget constraint and hence is not
    part of taxable income z. Another difference is that the labor component of z is labor income
    (wl) rather than labor hours (l); this difference requires us to address the incidence of tax rate
    changes (i.e., their effect on w)”

    I would be very curious if you could point to a resource – or perhaps offer one yourself – explaining the implications of income compensation for labor supply in a variety of situations. particularly in situations near the zero bound, if one were to consider various slopes of the AS curve.

    Let me offer an example – assume 10% of the population is unemployed construction workers, and we could employ half of them without seeing prices go up (humor me). Govt. taxes non-construction workers (who respond in the way the micro models tell us – which is barely at all) to fund more projects to improve the country’s abysmal water management systems. Let’s say government programs actually work the way they’re expected to (e.g. maybe New Zealand suddenly took over the Obama administration).

    So what useful information does income compensated labor supply tell us here? And why?

  11. Gravatar of Benjamin Cole Benjamin Cole
    13. February 2012 at 19:10

    Maybe there is hope.

    SF Fed’s Williams: ‘Vital To Keep Mon Pol Throttle Wide Open’
    By Market News International || February 14, 2012 at 02:50 GMT
    || 0 comments || Add comment
    –Missing Targets on Employment and Inflation Mandate
    By Steven K. Beckner
    (MNI) – San Francisco Federal Reserve Bank President John Williams
    said Wednesday the Fed is “missing” on both of its statutory mandates
    and hence needs to “keep the monetary policy throttle wide open.”
    Not only is the unemployment “very far” from “maximum employment”
    levels, but inflation is too low relative to the Fed’s 2% target, said
    Williams, a voting member of the policymaking Federal Open Market
    Committee.
    And so it is imperative the Fed strive to return employment and
    inflation to “mandate consistent” levels “quickly to minimize total
    economic damage,” he said in remarks prepared for delivery to Claremont
    McKenna College in Claremont, California. The longer the Fed misses its
    objectives the worse the damage will be, he warned.
    Williams once again seemed to be strongly suggesting an openness to
    further monetary stimulus, saying “everything points in the same
    direction.”

  12. Gravatar of Jon Jon
    13. February 2012 at 21:04

    Mike Sax writes….

    Actually the historic rise of the feminist movement-Simon Beuvoir’s “Second Sex” , etc-came in a demand for women to work which had nothing to do with wanting to earn more money, and came during the period of high income tax rates. Women wanted to work, in large part because they were-well, bored for one thing. In any case it wasn’t an economic argument.

    Certainly that was a first-order effect. A second-order effect was that two working parents became an economic necessity as the price of certain goods (the best schools) were bid upward.

    I think top tax rates whould rise somewhat-not ncessarily as high as they were in the 50s-because I believe in a certain level of redistribution of income and because I believe there shold be a social safety net-someone has to pay for it.

    What do “high rates” have to do with the safety net? Consider that Singapore has a very elaborate, full safety net yet the income tax is around ten percent.

    In my view I’d rather tax the wealthy more than the nonwealthy-not out of envy as such, I’m not even a pure economic egalitarian-because first I think it’s fairer-in my view tax progressvity is fairer-and secondly taxing the nonwealthy less is stimiuluative for demand as it puts more money in their pockets.

    All money not hoarded is spent. The wealthy do not hoard cash from their present income stream. There simply isn’t a reason to hold much cash. The wealthy for the most part already have the cash on hand they want. The poor likely do not. So, the poor tend to hoard more of their income stream that the wealthy.

    Ergo in short, the marginal propensity to hoard is lower for the rich, not higher. Therefore money distributed to the rich is more stimulative (and about the same for anyone above abject poverty).

    The wealty consume less of their income.

    If you don’t consume your income you aren’t eating society’s pie. You’ve done some work (or your parents did) for the benefit of society but you aren’t trading in your chits as much (lower propensity to consume). That’s a service to society–it is sort of like working for free.

    I don’t buy the argument that “savers are punished” to the contary, today’s taxation schemes with it’s increasing consumption taxes and lowering taxes on the wealthy punishes consumers.

    Any tax incidence on saving discourages savings relative to a regime without taxes on saving. Second, the same income is usually taxed several times over. So taxes on deferred consumption are higher than they are on present consumption. Both points contribute to what is meant by punishing savers.

    Somehow the taxes have to be paid. Yes, most the world has moved in a direction of placing more tax incidence on consumption. So yes, consumption is getting punished more–that does not mean that investment isn’t punished too.

    As 70% of economic activity is driven by consumer demand this is wrongheaded. Hermain Cain’s tax plan in partiuclar was a horror show.

    What does the share of economic activity have to do with it? Some how the taxes have to be paid. Taxes should be as broadly based as possible to avoid creating distortions and avenues of evasion.

    I don’t think it is fair that someone who chooses to defer his consumption today until tomorrow should be taxed more aggressively than someone who consumes today–but this is exactly what our system of taxation does when it subjects income derived from capital to taxation. That taxation is a double tax (corporate taxes are a triple tax on top of that).

  13. Gravatar of Steve Steve
    13. February 2012 at 21:38

    http://www.taxfoundation.org/blog/show/27972.html

    “Buffett Rule” Would Cause Marginal Tax Rate of 90%

    “The rate gets as high as 90% at the upper end of the phase-in range before dropping back down to 30% for as long as the taxpayer is affected by the minimum tax. Combined this with state and local income taxes, as well as the new 3.8% tax on investment income beginning in 2013, and the marginal tax rate on investment income could plausibly exceed 100% within a narrow range. In other words, taxpayers in this range would have an incentive to lose money”

  14. Gravatar of Morgan Warstler Morgan Warstler
    14. February 2012 at 04:53

    Jon,

    You are right on so much, but wrong on this:

    “taxation is a double tax (corporate taxes are a triple tax on top of that).”

    Forget corporate taxes, I agree those should be zero.

    Example:

    $100K invested
    1 year later sells for $1.1M
    Capital gain of $1M

    Where was the $1M taxed?

  15. Gravatar of StatsGuy StatsGuy
    14. February 2012 at 05:02

    @Ben

    I don’t think that’s a shift, it’s just a change in composition of the board – Yellen, also SF Fed, has been taking that line for years. If inflation stays at ~2% and “real” gdp comes in at 1.5-2% in the next quarter, we’ll get a good test of whether the Fed is purely inflation targeting or is really paying attention to both mandates.

  16. Gravatar of ssumner ssumner
    14. February 2012 at 05:45

    foosion, No, he’s saying there’s an inconsistency with the fact that there is a backward bending labor supply curve, and the belief of many supply-siders that MTR cuts will boost hours worked. And there is no inconsistency.

    Mike Sax, I’m afraid you and President Obama are both wrong about savers, they are taxed at higher rates than consumers, as I’ve shown in numerous posts. Buffett’s attempts to compare tax rates on wage income and investment income merely shows that he’s never taken a basic course in tax theory.

    The tendency of wealthier women to work more was caused by changing incentives. Cultural change can also result from economic changes.

    If Paris Hilton has lots of “unearned income” then my argument applies to her even if she isn’t married. BTW, I never said she was married in my post. I was talking about wealthy women who have little wage income.

    Ben, Yes, depressing.

    Wadolowski, Yes, but keep in mind that the ECB has no ability to target Greek NGDP. But you are right that they need a more expansionary policy—I think they should be targeting eurozone NGDP.

    Major Freedom, I certainly agree that an African would have the right to ask that I pay higher tax rates than he does.

    BTW, contrary to the implication of your comment, I never called for higher taxes on the rich.

    Bogdan and Floccina, I agree.

    Steve, I don’t think talking about taxes as “voluntary” is very helpful. Yes, all taxes are voluntary in a sense, you can avoid them by not doing the thing that is taxed.

    I agree with most of your comments.

    Tommy, I agree.

    Statsguy, Yes, of course you could make Keynesian arguments that income rises, but in that case Krugman is even more wrong than in the case I described.

    Public finance theory usually abstracts from the business cycle because we are interested in the long run effect of taxes. It’s assumed that in the long run it doesn’t affect the cycle.

    Ben, That’s good.

    Jon, I agree about Singapore being a low tax welfare state, and often cite the example in my blog.

    Steve, Yes, Buffett doesn’t really understand tax theory.

    Morgan, It was taxed as wage income before it was invested.

  17. Gravatar of dtoh dtoh
    14. February 2012 at 06:38

    Scott,
    How would you tax the mansions? Acquisition tax? Consumption tax based on imputed rent? Or just a straightforward property tax?

    BTW – I agree with mostly but would not support any kind of income (production) tax whether it’s on capital or wages.

  18. Gravatar of StatsGuy StatsGuy
    14. February 2012 at 06:43

    Scott:

    “Public finance theory usually abstracts from the business cycle because we are interested in the long run effect of taxes. It’s assumed that in the long run it doesn’t affect the cycle.”

    That’s a very odd assumption – I’m wondering how it applies to Japan, which was at one point the second largest economy in the world.

    In any case, I don’t care to defend (or attack) Krugman – I just don’t get how economics can rely (with such forceful concensus) on a theory which ASSUMES that government spending can never be productive to prove that taxation inevitably reduces national income.

    Too much Kool Aid for me…

  19. Gravatar of Andy Harless Andy Harless
    14. February 2012 at 07:15

    It’s not clear to me why you would want to use income-compensated labor supply curves, unless you think that the uses of tax revenue are substitutes for private consumption. Obviously this would be true if the use is to reduce lump-sum taxes, but in the real world thee are no lump-sum taxes. Assume instead that the budget is balanced and that taxes are used to finance government purchases. In that case, the income effect of a tax increase will matter in aggregate to the extent that the associated new government purchases do not substitute for private consumption.

  20. Gravatar of MP MP
    14. February 2012 at 07:43

    Scott,

    I can see what you’re getting at in aggregate and the relevance of the income-compensated approach to that analysis. But Krugman doesn’t seem to be coming at this from an aggregate approach; his argument is more micro. It isn’t about working less as countries get richer, but individuals working less as they get richer (at least beyond a certain point).

    So, if a tax policy is strictly distributional, an income-compensated aggregate analysis would show no impact. But looking at the different responses by individuals along different parts of the curve might get you to a different result.

    Now, I haven’t done any work in public finance theory, so maybe you can point me to what I’m missing, but it seems the micro perspective has something important to offer here.

    P.S. As far as I’m concerned, the less you know about Paris Hilton, the better for your credibility.

  21. Gravatar of Morgan Warstler Morgan Warstler
    14. February 2012 at 08:38

    Scott, no as I stated the $100K was taxed as income.

    The new $1M capital gain, after 1 year, has not yet been taxed.

    Scott, your wave of the hand on this is wrong.

    Look, say you go to work for a start-up and you get a salary + equity.

    The company sells, and your equity is worth $1M, has that $1M been taxed?

    No.

    Look at the difference between between the $100K (after tax) of the investor invested and the sweat equity (completely deferred income) of the start up employee.

    The employee is the HIGHER BEING, and the tax code must accept this as first principle.

    So unless you can show where the employee paid taxes on their sweat equity, you cannot will not be able to show where the investor paid taxes on the $1M.

  22. Gravatar of Greg Ransom Greg Ransom
    14. February 2012 at 08:54

    Looks to me like you should support the random “big wheel” siezures of houses which are “too big”.

  23. Gravatar of Greg Ransom Greg Ransom
    14. February 2012 at 08:58

    Morgan, don’t bother Scott with facts. Scott don’t like no stinking facts.

  24. Gravatar of Morgan Warstler Morgan Warstler
    14. February 2012 at 09:58

    Scott,

    this is why you are wrong:

    http://www.avc.com/a_vc/2012/02/the-other-co-founder-your-family.html

    Investors are LESS IMPORTANT than entrepreneurs, and that you don’t:

    1. understand this
    2. believe this

    makes anything else you say on tax policy off by that assumption.

    You like to assert EMH.

    If EMH is true as you describe it, investors are just lucky, entrepreneurs are winning with skills.

    So, under your own assumptions, we’d gain more in utilitarian society (greater gains) by accepting:

    Sweat Equity > Cash Investment

    And under that assumption, your double taxation analysis is undeniably wrong.

  25. Gravatar of dtoh dtoh
    14. February 2012 at 10:49

    Morgan, Scott,

    Fundamentally, I don’t think there is much difference between sweat equity and cash equity. Also, the fundamental nature of wage income and capital income is not much different. (You can easily create capital out of labor starting with no or negligible capital.)

    The main difference between wage income and capital income is the degree of asymmetry of expected returns and thus the shape of the Laffer curve (with highly asymmetric expected pre-tax returns resulting in negative expected after-tax returns even at low nominal tax rates). This has an implication on the efficacy of taxation.

  26. Gravatar of Becky Hargrove Becky Hargrove
    14. February 2012 at 10:50

    Morgan,
    It’s going to take more than flowers and chocolates to get ‘the girls’ on board with the dogmatic libertarians!

  27. Gravatar of Major_Freedom Major_Freedom
    14. February 2012 at 11:55

    ssumner:

    “Major Freedom, I certainly agree that an African would have the right to ask that I pay higher tax rates than he does.”

    LOL, oh how moral and virtuous of you. You think that Africans have the right to speak.

    How about you actually paying higher taxes so that Africans can get more of what you earn? Since there are so many in need there, and since your salary is not enough to feed everyone, then it is possible for you to be taxed to such a degree that you have only enough to remain in poverty (but you can survive), and the rest of your earnings go to the Africans. Would you support that? Or does your generosity only extend to such a degree that you will trade off 50 deaths in exchange for having nice clothes and a nice house and a nice car? Those things alone if sold could easily save the lives of upwards of 50 children.

    BTW, contrary to the implication of your comment, I never called for higher taxes on the rich.

    You said:

    “I’m fine with a progressive payroll tax, plus luxury taxes on these sorts of homes”

    That is calling for higher taxes on the rich than on the middle class or poor.

    Or did you think I meant higher in the sense of being raised from where they are now? No silly, I already know that you believe they are fine where they are. You don’t want to sound like a progressive for calling for increased taxes on the wealthy, and you don’t want to sound like a dogmatic libertarian for calling for decreased taxes on the wealthy.

  28. Gravatar of Cthorm Cthorm
    14. February 2012 at 11:58

    @StatsGuy

    “In any case, I don’t care to defend (or attack) Krugman – I just don’t get how economics can rely (with such forceful concensus) on a theory which ASSUMES that government spending can never be productive to prove that taxation inevitably reduces national income.”

    I don’t think any economist “assumes” that government spending “can never be” productive. That’s an absolute statement, and it’s usually easy to find an example that disproves such a hard-and-fast rule (e.g. Gov’t spending on ARPAnet certainly had a multiplier greater than 1). But those anecdotes aren’t relevant because you’re talking about an aggregate, or alternatively an *expected* value, so you have to judge based on Bayesian probabilities.

    Consider everything you know about how funds our allocated in Washington. How likely is it that a marginal dollar will be spend productively? I would generously estimate at 0.1%. I would say the more narrowly defined the spending goals are, the more likely the funds will be used productively. E.g. transfer payments vs DoE block grants.

  29. Gravatar of Major_Freedom Major_Freedom
    14. February 2012 at 11:59

    Becky:

    “It’s going to take more than flowers and chocolates to get ‘the girls’ on board with the dogmatic libertarians!”

    Why do you think there are a significantly fewer number of female libertarians than male libertarians?

  30. Gravatar of kebko kebko
    14. February 2012 at 12:28

    Morgan,

    All equity value is derived from expected after tax profits. If there is a stable 30% corporate tax rate, the government is essentially a 30% partner in the firm. So, if you invested $100,000 and then sold it for $1.1 million, then in a tax-less world the investment presumably would have been worth $143,000 and $1.57 million. Your gain would have been $1.43 million. The tax is applied through the government’s partnership position, which has claimed $430,000 of your gains (30%).

  31. Gravatar of Becky Hargrove Becky Hargrove
    14. February 2012 at 12:41

    Major Freedom,
    It’s a cultural discussion that hasn’t really happened yet. Everyone knows government is struggling to provide services that once were provided by family and community, and going further in debt in the process. Some people look at (long term) inflation and see such services as part of the problem. A lot of women don’t really question the government provisions, because there needs to be some sense of order about knowledge based services which makes sense to everyone. What we need more than anything is just a shift in perspective, because no one really wants to go back to the old culture, but to instead have a culture that makes sense to everyone at a basic level and is sustainable at the same time. We need to be able to actually create knowledge based services at local levels and yet still maintain the open global economy that works best for physical resources. In other words, libertarianism can work best by creating spontaneous structures that still have some sense of understandable order.

  32. Gravatar of StatsGuy StatsGuy
    14. February 2012 at 14:14

    Cthorm – I’m not accusing all of economics of assuming govt. spending is always unproductive. However, it seems that income compensated supply curves inherently assume this, and then go on to claim this as something they show empirically through elasticity estimates.

    Something’s rotten in Denmark.

    You are correct about transfer payments – it’s fair to assume this with regard to transfers, which admittedly is 65% of the budget and rising. This has been one of my chief complaints about the conservative financial agenda. They’re gutting all the programs which have any possibility of productivity to preserve transfers.

  33. Gravatar of Cthorm Cthorm
    14. February 2012 at 14:52

    Cheers Stats.

    “They’re gutting all the programs which have any possibility of productivity to preserve transfers.”

    So are you in favor of keeping transfer payments? I’m reading it that way. While I recognize that simple things like transfer payments the gov’t will likely be rather effective at, I don’t necessarily think the programs are structured in an efficient way to accomplish their goals.

    Medicare/Medicaid is a mess, but my first preference is to completely scrap the system and replace it with a non-means tested universal catastrophic insurance program, along with eliminating the tax-exempt status of medical insurance (the goal being to move to a system where people pay out of pocket for most things, so supply-demand relationships are less obfuscated).

    Social Security is a simpler beast, in that it is a transfer program from workers to the elderly. But the structure of the system is such that it is an enormous waste of capital. I would much rather have a forced-savings system based on individual accounts, like Chile.

  34. Gravatar of ssumner ssumner
    14. February 2012 at 15:59

    dtoh, A wage tax is identical to a consumption tax, except at the point of implementation. The effect on the economy is identical. Indeed a wage tax is a consumption tax.

    I’d probably just do a regular property tax. But I have an open mind on the subject.

    Statsguy, You said;

    “In any case, I don’t care to defend (or attack) Krugman – I just don’t get how economics can rely (with such forceful concensus) on a theory which ASSUMES that government spending can never be productive to prove that taxation inevitably reduces national income.”

    You are misrepresenting the standard view. Economists tend to look at issues one at a time. Thus taxes have certain effects, and spending has certain effects. For the total effect you add up the various partial effects. Obviously some government spending may be so productive that it outweighs the dead-weight loss of taxes. That’s very plausible.

    Japan didn’t shrink, China grew.

    Andy, In the modern state most government spending is simply tax money recycled back to the public via benefit programs. But I’m perfectly willing to assume that government spending is wasteful, and makes the public feel poorer. In that case they might well work much harder. A good example is Mao, who made China very poor, and as a result the Chinese people are now working really hard to get rich. If Mao had not wasted so much money, the Chinese would be working less hard today. (However they didn’t actually work hard during Mao’s time, as the MTRs were near 100%.)

    I think the best argument for taxes is that the money is used for something worthwhile, and doesn’t make the country poorer. But in that best case scenario, there is a substitution effect away from labor.

    MP, You might be right about Krugman, but then I’d suggest he learn something about supply-side economics before actually criticizing it, as no serious supply-sider would deny that individual groups might behave differently from the aggregate. The Laffer Curve argument assumed no change in net taxes paid.

    In other words, if you’re right then he took a cheap shot.

    Morgan, How big would the $1 million gain have been if the $100,000 had not been taxed as income?

    Major Freeman, I already pay as much taxes as 20 people in Africa, so we are 1/2 way toward achieving your wish. Now all we have to do is convince the US government to spend less of that money on the military, and emulate Bill Gates, spend more on helping the poor in Africa. I’m all for that. Please go convince Obama to do that.

    You said;

    “That is calling for higher taxes on the rich than on the middle class or poor.”

    Yes, but not more than they pay now. Suggestion for future posts: read my posts twice to make sure you understand them. 90% of your comments misinterpret what I say.

    Statsguy: You said;

    “This has been one of my chief complaints about the conservative financial agenda. They’re gutting all the programs which have any possibility of productivity to preserve transfers.”

    Reasonable criticism, but would liberals accept a compromise?

  35. Gravatar of StatsGuy StatsGuy
    14. February 2012 at 16:53

    Cthorm, ssumner –

    “So are you in favor of keeping transfer payments?”

    “Reasonable criticism, but would liberals accept a compromise?”

    No (not near current levels), and sadly, no. However – my prediction – nothing happens on this front till 2017, which is around when the boomers cease to be the majority of the voting population and GenY takes over. California pension system is the epitomy of generational theft.

  36. Gravatar of Morgan Warstler Morgan Warstler
    14. February 2012 at 17:12

    “Morgan, How big would the $1 million gain have been if the $100,000 had not been taxed as income?”

    $1M, because only $100K was invested. What you did with the other extra money is of no concern to our discussion.

    kebko,

    I don’t disagree and you 100% miss my point.

    Scott, wants to assert the $1M in capital gains has already been taxd, not by corporate taxes, he means that since the first $100K was taxed as income – the $1M was taxed.

    My proof he’s wrong takes two steps:

    1. Sweat Equity is higher order than investment equity (because entrepreneurs are the utilitarian bestest and Scott’s EMH says investors are just lucky, but entrepreneurs have skills)

    2. Since the $1M in Sweat Equity has not yet been taxed (yes I get it happens later), we cannot accept Scott’s pretending the tax on the $1M capital gain has already been paid (it violates #1).

    It is a pretty simple proof.

    Since Scott’s argument undermines the supremacy of entrepreneurs (which Scott has learned over time to endorse), we can’t allow his claim that capital gains is double taxation.

    Scott is dancing around it, first he tries to suggest over long term investor has sacrificed (by inflation etc) consumption equal to the tax, and now tries to weasel some guy’s budget for his wife’s jewelry into a 10X return after Scott knows for sure it is a winner.

    The exclusive point is:

    $1M in Capital Gain off cash investment VS.
    $1M in gain off Sweat Equity

  37. Gravatar of Jon Jon
    14. February 2012 at 23:04

    Morgan writes:

    “Jon,
    $100K invested
    1 year later sells for $1.1M
    Capital gain of $1M

    Where was the $1M taxed?”

    In the aggregate, the net present value of a capital asset is equal to its future stream of payments (I say in the aggregate because risk variance means that a given capital acquisition might yield above or below but across the society, it must net out such that the yield equals the time preference).

    So that 1M was taxed when the 100K of income was earned before being invested. i.e., if your example is representative, then the value of $1M in a year is the same as the value of $100K today on a marginal basis.

  38. Gravatar of J.V. Dubois J.V. Dubois
    15. February 2012 at 01:27

    Scott, I really do not understand what are you suggesting here. This is what Murray says “Why would you not work a full forty hours [even if your wage came down from $40 000 to $28 000] if the hours were available? Why not work more than forty hours?”

    Clearly, I do not understand your argument of income compensated labor supply curve. If we assume that income means “after tax real income”, then Krugman’s argument is true in a sense that if Murray really believes that lowering your (after tax real) income makes you work more, then logically, taxing more should incentivize people to produce more.

    As for your income-compensated labor supply curve, it almost think that you assume the conclusion. You say “A tax increase doesn’t have any first order effect on national income”. But that is exactly the opposite what Murray seems to believe. Murray believes that lowering real income means working more. Logically, taxing the same people more should have the same result as lowering their income – they should work more to keep their previous level of incom and consumption.

  39. Gravatar of Morgan Warstler Morgan Warstler
    15. February 2012 at 03:00

    No Jon, sorry there bub, see what you did?

    You took an argument about the aggregate, the same kind of argument about EMH that Scott makes to call investing luck, ad you used it to demean those who invest sweat equity.

    Let me put it clearly: stop hiding behind repeated DEFINITIONS and ASSUMPTIONS.

    My claim is:

    sweat equity > investment equity

    sweat equity has not yet been taxed

    so you have to rejigger your entire thinking to admit that the $1M hasn’t been taxed.

    Where macro violates micro, macro is wrong. EVERY TIME. We do not make tax policy based on the aggregate, we make it based on each real individual…. no matter your definitions.

    To respond, you have to explain why my logic under my assumptions is wrong.

  40. Gravatar of Jon Jon
    15. February 2012 at 09:15

    Morgan, what you just described is labor income. You can be sure that the IRS expects you to divide your business income into a labor component that compensates you at market rates. If you know someone who has been cheating on this, there is an IRS tip line you can call.

    Now you can find businesses where there is cash generated in excess of what labor is due and in excess the real return to capital. This is nothing more than the heightened return on risky capital investment and if you look across a wider sample you’ll find that the returns on average net out such that the yield equals the real rate.

    I’m pretty certain that if capital income were granted more preferred status, the IRS would get a lot more aggressive about enforcing the distinction than they are now.

  41. Gravatar of Andy Harless Andy Harless
    15. February 2012 at 09:21

    Scott,

    I wouldn’t equate the proposition that government purchases are not substitutes for consumption with the proposition that those purchases are useless. The question is not whether government purchases increase total utility but whether (and how) they reduce the marginal utility of consumption. It’s easy enough to write down a utility function U = u1(C) + u2(G), where u1 and u2 are both concave but the cross-derivative is zero. In practice some government purchases are probably substitutes for consumption and some are probably complements, but it’s not obvious how closely they substitute (or complement) on the margin.

  42. Gravatar of Major_Freedom Major_Freedom
    15. February 2012 at 10:56

    ssumner:

    “Major Freeman, I already pay as much taxes as 20 people in Africa, so we are 1/2 way toward achieving your wish. Now all we have to do is convince the US government to spend less of that money on the military, and emulate Bill Gates, spend more on helping the poor in Africa. I’m all for that. Please go convince Obama to do that.”

    But the US dollar cannot give you your relatively fancy clothes and nice house and car without the US military forcing oil rich countries to sell their oil in US dollars. For a Monetarist to say “The US military should spend less on the military” is like an airline passenger saying “The plane could go faster if only it were lighter so I’m all in favor of removing the engines.”

    And of course you would focus on the number 50, rather than the uncomfortable principle I was clearly trying to get across. The principle I was getting across, and which your last response made perfectly clear, is that you don’t want your own taxes RAISED to help the poor in Africa. You want them to stay where they are, and you only want to redirect the existing government spending. Oh yeah, you’re all so generous about wanting to redirect existing spending and not having your own taxes raised.

    Also, by virtue of your choices, you are clearly NOT in favor of helping enough poor in Africa, and would rather have nice clothes, plenty of food, a house, a car, etc instead. I am not saying you ought to do otherwise, I am just pointing out what it is you are doing versus what it is you are saying. Notice how you said your taxes get us to 20 people in Africa, but then you didn’t say your taxes should be raised to get it to 50, but deftly switched to getting the government to pay for the difference out of current taxation and spending? Did you think that wouldn’t be so incredibly obvious?

    I said: “That is calling for higher taxes on the rich than on the middle class or poor.”

    “Yes, but not more than they pay now. Suggestion for future posts: read my posts twice to make sure you understand them.”

    Here’s a better suggestion. Read MY posts more than once to make sure you understand them. I quite clearly said:

    “Or did you think I meant higher in the sense of being raised from where they are now? No silly, I already know that you believe they are fine where they are. You don’t want to sound like a progressive for calling for increased taxes on the wealthy, and you don’t want to sound like a dogmatic libertarian for calling for decreased taxes on the wealthy.”

    Maybe you should take your own advice. Not only are you incredibly hypocritical in allegedly wanting “the rich” to help “the poor”, not by your additional help of course, but by others wealthier than you, but you also tell me to read more carefully and yet it is obvious you didn’t read the above at all where I made it explicit what I know you meant by “higher.”

    “90% of your comments misinterpret what I say.”

    99% of your comments are wrong, including that one right there.

  43. Gravatar of Morgan Warstler Morgan Warstler
    15. February 2012 at 11:31

    Jon,

    I’m discussing two specific situations:

    1. tech start ups – where sweat equity and capital investment can over quickly turn over in into big liquidity events in short time horizons. I favor this, I want to see more of it, as such I want to explain the sweat equity (which hasn’t been taxed) proves the invested money hasn’t been taxed either.

    2. Out in the real world, the SMB space the top 2% of SMB owners generate 50% of SMB revenue, and much of this all occurs as pass-through, so income taxes.

    I view this as capital gains on sweat equity, and I’m sure so do the SMB owners.

    My point on this is the current structure pushes them to keep profits inside a mature SMB rather than taking their profits out tax free and putting them into entirely new biz ventures.

    Since I grew up around these kinds of folks, successful Main Street entrepreneurs, I know that you can kind of get stuck, the local market is saturated, Akron, Ohio doesn’t need another Blimpie’s, and you’d rather be launching and growing another venture with different partners.. but tax law has the incentives lined up the wrong way.

    If we view these guy’s labor as capital investment, and let them essentially earmark only personal consumption as their salary, but freely move profits from one SMB structure to another…

    My thinking is that we’re seeing more and more combining of 1 and 2, and that this will lead to a greater adoption of Internet Main Street businesses.

  44. Gravatar of ssumner ssumner
    16. February 2012 at 07:13

    statsguy, Won’t most voters still be boomers in 2017?

    Morgan, But without a wage tax you would have invested more.

    J.V. Dubois, The income-compensated labor supply curve is a standard tool in economics. It simply looks at the substitution effect, ignoring the income effect.

    Andy, Yes, as soon as you make that sort of “real” argument, one can always derive any solution in theory. The question is whether (as Krugman claims) the supply-siders are making illogical arguments. I think the income compensated labor supply curve is a very reasonable assumption for supply-side tax reforms. Recall that many supply-side proposals don’t even envision any change in revenue, and at the margin almost all growth in government spending in recent decades has been transfers. So while I agree there are cases where certain types of government output leads to different labor supply conclusions, I certainly don’t think that makes Krugman’s criticism valid. He’d have to make the argument you are making, not that they ignored backward bending labor supply curves. As a first approximation the income compensated curve is the right one.

    Major Freeman, You said;

    “Also, by virtue of your choices, you are clearly NOT in favor of helping enough poor in Africa,”

    This is off topic for all sorts of reasons. It has nothing to do with your original claim, which I refuted. And you know nothing about what sort of actions that I do take, nor what sort of actions that I could take that would be most helpful to Africans. I’m not sure if I know myself.

    Arab countries don’t sell us oil because we force them to, then sell it because they want money. In any case we could easily cut the military in half and still keep the straits of Hormuz open.

    And I do read your entire posts, I just ignore the parts I wish to ignore.

  45. Gravatar of Major_Freedom Major_Freedom
    16. February 2012 at 11:31

    ssumner:

    “Major Freeman, You said;

    “Also, by virtue of your choices, you are clearly NOT in favor of helping enough poor in Africa,”

    “This is off topic for all sorts of reasons.”

    Abort! Abort!

    “It has nothing to do with your original claim, which I refuted.”

    No, you did not refute my original claim. You refuted a straw man. You said that I incorrectly interpreted your usage of the word “higher”. You said that by “higher”, I attributed to you the position that you want the wealthy to pay higher taxes than they currently pay. But like I showed you, and thus like I refuted you, I know that you don’t want taxes on the wealthy to be higher than they are now. You’re attacking a straw man.

    “And you know nothing about what sort of actions that I do take, nor what sort of actions that I could take that would be most helpful to Africans. I’m not sure if I know myself.”

    Indeed, but I can infer what you do by what you say. I noticed in your words that you think your taxation should not be raised, on the basis that you’re already paying as much taxes as 20 poor Africans. Then, in order to get that number to 50 (which is a red herring), you would rather existing government spending and thus existing taxation be redirected, than pay more taxes.

    The reason why I am seemingly pestering you over this is because of your cowardly and false virtue declaration of being so virtuous that you want higher taxes than you on the wealthier than you, and you want higher taxes than you on those who own larger homes than you, and yet, you refuse to even contemplate having your own taxes raised to help those less fortunate than you. You just want the government to spend less on the military and more on charity. In other words, you want the poor to be helped by getting others get less income (e.g. military industrial complex).

    I don’t like it when people pretend to be all generous and virtuous, but then when the layers are peeled back, there is just a “I got mine, let others pay for it” mentality. You attacked the wealthy when you explicitly called for them to pay higher taxes than you. Where is that attack coming from?

    “Arab countries don’t sell us oil because we force them to, then sell it because they want money.”

    I have to be frank here, I don’t think you know what’s going on in the world around you.

    The Saudi Arabian dictators for example sell their oil in US dollars in exchange for protection and support from the US, with the caveat that the US can establish bases and military posts across the country. This has had the blowback of Muslims hating the US government for occupying what they consider to be their holy land. It has fomented hatred and encouraged terrorism. Remember, the 9/11 hijackers were almost all Saudis.

    In Iraq, after being allies with armed by the US to fight Iran in the 80s, Saddam Hussein, acquired enough power to defend Iraq’s oil fields from Kuwait’s drilling of oil underneath Iraqi territory. Hussein tried diplomacy, then he tried threats, but the Kuwaitis balked.

    The US then planned for Hussein to invade Kuwait, and use that as a pretext to invade Iraq and overthrow Hussein. Hussein asked the US if he could invade Kuwait, to stop them from taking Iraqi oil, and the US said yes. The plan was set. Hussein invaded Kuwait, the US then double crossed him, and used the opportunity to invade Iraq. That was 1991.

    After being bombed for the better part of 10 years, Hussein had finally had enough. Feeling betrayed by the US, he threatened to sell Iraqi oil in euros, instead of dollars. That is where the financial interests in Washington took notice, and they needed an excuse to change the Iraqi regime, so that Iraqi oil is once again sold in US dollars. Thus the NY Fed, from 2003-2008, secretly sent over $40 billion to Iraq, to “invest” in keeping Iraq stable and keeping Iraqi oil being sold in dollars.

    The very first thing that the US military did after the 2003 invasion was secure the oil fields and ensure that oil was sold in dollars. The NY Fed financed the “reconstruction” after the military did its role.

    Now in 2012 we have Ahmadinejad in Iran being constantly threatened and provoked by the US and Israel, the media is again banging the war drums. And wouldn’t you know it? Ahmadinejad is also threatening to sell oil in euros and not dollars. Notice a pattern yet?

    “In any case we could easily cut the military in half and still keep the straits of Hormuz open.”

    And risk the US backed Arabian dictators being overthrown by anti-US democratic revolutions? Not a chance. They’ll reduce the standard of living of the middle class even further before they do that. And you wonder why the banker controlled Congress won’t cut a dime from the military budget?

    “And I do read your entire posts, I just ignore the parts I wish to ignore.”

    Then you not have said that I misinterpreted your usage of the word “higher.” I clearly said, and then repeated, that I know you’re not talking about raising the taxes on the wealthy from where they are now. I was crystal clear about that.

    Serious question: How much do you really know what the Fed is doing, other than of course failing to maintain a silly aggregate statistic that you need to waste the years away talking about? Do you have any idea of the corruption and lies that truly characterize its existence? Do you have any idea about the Fed buying off the economics profession?

  46. Gravatar of ssumner ssumner
    17. February 2012 at 06:39

    Major Freeman, You are still misunderstanding my point, I do think I should pay higher taxes than poor Africans–even higher tax rates.

    And I don’t believe your bizarre conspiracy theories that we wanted Iraq to invade Kuwait.

  47. Gravatar of ssumner ssumner
    17. February 2012 at 06:39

    And I never claimed to be virtuous.

  48. Gravatar of Major_Freedom Major_Freedom
    1. March 2012 at 22:54

    ssumner:

    Major Freeman, You are still misunderstanding my point, I do think I should pay higher taxes than poor Africans–even higher tax rates.

    Then why aren’t you right now? You’re free to send the IRS weekly checks that exceed your tax obligations.

    I don’t believe your claim that you believe you should pay higher taxes than you are paying now.

    And I don’t believe your bizarre conspiracy theories that we wanted Iraq to invade Kuwait.

    I didn’t say “we” did, I said the US government did. It is documented and on record that the US was OK with Iraq invading Kuwait.

    It’s a conspiracy, yes. Conspiracy is after all just an association between religious, political, or tribal officials to further their own ends, usually by intrigue.

    The Golf of Tonkin incidence was a false flag conspiracy to get the US involved in Vietnam.

    You seem to have a very naive view of history. Tsk.

    And I never claimed to be virtuous.

    You didn’t have to say so explicitly. It’s reading between the lines.

Leave a Reply