Income: A meaningless, misleading, and pernicious concept

And now, finally, my post on the optimal tax regime.  It will be nice to finally get this off my chest, as you can’t imagine how enraged I get reading progressives talk about the “principle” that all forms of income should be taxed equally (which is like a “principle” that all fruit should sell at the same unit price.)  Or when they discuss Gini coefficients of inequality based on meaningless income data (not to mention ignoring the fact that the economic incidence of a tax is totally different from its legal incidence.)

Bear with me as I start from first principles; this is an important post.  I will try to convince my progressive readers that they should favor complete abolition of all personal and corporate income taxes, as well as all inheritance taxes.

Suppose 2 brothers both make $100,000 a year.  One spends his income on watermelon, and the other spends it on blueberries.  Would it make sense to decry the inequality of this society, merely because the blueberry eater got to consume a larger number of “fruits” (because their unit price was lower?)  Clearly not, and for two very good reasons. 

1.  They are each free to buy either type of fruit.

2.  The higher unit price of watermelon indicates they are more highly valued (per individual fruit.)

Now assume it’s possible to invest income at a real rate of interest that allow one to quintuple one’s wealth between age 25 and 65.  (Say a 40 year zero coupon real bond yielding around 4%.)  In this example let both brothers consume nothing but blueberries.  One brother chooses not to save at all, the other saves 40% of his income.  One eats $100,000 worth of blueberries today; the other eats $60,000 today and saves $40,000.  After 40 years the thrifty brother gets to eat $200,000 worth of blueberries.  Both also get some social security at 65.  Here’s my question:  In this society is there any economic inequality?

I don’t see how anyone could say there is.  Both have exactly the same wage income at age 25.   Yes, they do different things with it, but that’s their choice.  At age 65 one has zero income outside social security, and the other has $160,000 in capital gains, which is generally considered “income.”  But nonetheless there is complete equality for two reasons:

1.  Both are free to choose whether to save or not, so we have no evidence that one brother had more utility than the other.

2.  In present value terms their total lifetime consumption of blueberries is identical.

The mistake is assuming that blueberries in 40 year are the same thing as blueberries today.  Future blueberries only cost 1/5th as much, as they are much less valued than current blueberries.  They are different goods just as much as watermelon and blueberries are different goods.  That $160,000 gain is not “income” in the way most people think of the term, i.e. as some sort of goodie available for spending.  Rather it reflects deferred consumption.  The $200,000 received at 65 is exactly equal in present value to the $40,000 saved today.  Indeed it is the very same wealth, simply measured at a different point in time.  It is nonsensical to say the thrifty brother has income of $100,000 today plus another $160,000 at age 65, you’d be counting the same income twice.  

Studies of economic inequality should completely ignore all capital income, and measure only labor income, or consumption.  Indeed the present value of labor income should equal the present value of consumption.  And as we will see, a labor tax (like the 2.9% Medicare tax) is identical to a consumption tax (like a VAT.)

Consider how a 50% payroll tax would affect the previous example.  Every figure would be cut in half.  The spendthrift would consume $50,000 today, and the thrifty guy would consume $30,000 today and $100,000 at age 65.   An equal-sized VAT would have an identical effect, cutting consumption for each person in half, at each point in time.

But now consider a 50% income tax.  The spendthrift would be affected in exactly the same way as with the other two taxes.  But the thrifty guy would pay a much higher tax.  He’d save $20,000, and that would produce $100,000 in 40 years.  The government would then take $40,000 of the so-called capital “income” in taxes, leaving him with only $60,000 for consumption.  If he wants to prepay his future tax liability, he must save $8,000 today in order to pay a $40,000 tax bill at 65.  That means $8,000 of his current saving goes to pay future taxes, and only $12,000 goes toward future consumption.  His total tax is then (in current dollars) $50,000 plus $8,000, or $58,000.  His tax rate is 58%, against 50% for his spendthrift brother.  And all because they have different preferences, not because one brother is in any meaningful sense “better off” than the other brother.  It’s no different from putting a higher income tax rate on a brother who eats blueberries, as compared to one who eats watermelon, merely because he has more blueberries in numerical terms.

At this point you might be thinking “Yes, but wouldn’t eliminating all income and consumption taxes be a giveaway to the rich?”  No, it would be restoring fairness by taxing the thrifty and spendthrift at equal rates.  If we think the rich should pay more tax, then let’s put a progressive consumption tax into effect.  This is easy to do, just turn the regressive FICA into a progressive payroll tax, with much higher rates for those with high wages and salaries.  This sort of tax can achieve any desired degree of progressivity.   Unlike most libertarians, I think a progressive payroll tax is desirable for simple utilitarian reasons.  I don’t buy the “I worked hard for it, it’s my money” argument, for two reasons:

1.  Most of your income comes from luck.  If you’d been born in a poor peasant household in Asia or Africa, your income would be low no matter how hard you worked.  You hit the jackpot just being born in a developed country.

2.  Our wealth comes from living in a highly functional society, thus part of your wealth is due to the fact that your neighbors don’t go around raping and pillaging as in the old days, but rather peaceably go to polling stations to vote.  Am I saying; “It Takes a Village?”  Sort of, more precisely “it takes a civic-minded culture.”

At this point my progressive readers might be willing to go for the progressive consumption tax for those who worked hard and saved their money.  But surely not for that deadbeat trust fund kid, who is living off daddy’s wealth?  Surely there should be an inheritance tax so that those with inherited wealth don’t go through their entire life without paying any tax? 

If this is what you are thinking, you are still confused.  I will show that, if anything, we should be subsidizing those trust fund deadbeats.  

First recall that if we have an optimal payroll tax then the money they inherit is all after-tax money.  And if we had a VAT, then the heirs would have to pay taxes on their consumption.  Now let’s go back and look at the case of the two brothers.  Suppose both have arrived at age 65 with $10,000,000 in wealth.  Also assume that we have a steeply progressive payroll tax, so they are considered morally justified in spending the wealth they have accumulated after paying those taxes.  The only issue being considered is whether we should have an inheritance tax on top of the payroll tax.  So let’s assume a 50% inheritance tax is introduced.  Compare the follow two scenarios:

1.  Brother A spends the entire $10,000,000 on fancy sports cars, yachts, champagne, glamorous parties, etc.  Brother B spends $5,000,000 and gives $5,000,000 to his only child.  Who should pay more tax?  We’ve already agreed that the guy who consumes all his wealth has already paid his dues through the progressive payroll tax. If not, then make it more progressive.  The other guy would have to pay $2,5000,000 in inheritance taxes, leaving his kid with $2,500,000.  It seems to me that on both efficiency and moral grounds the more generous dad should not pay more, but rather should actually pay less taxes than the other guy:

1.  He is less selfish, so virtue ethics favors the one who makes bequests.

2.  Because of diminishing marginal utility, it’s better to share your wealth with one other person.  He wins on utilitarian grounds.

3.  The inheritance tax discourages saving, and thus reduces the capital stock.  This lowers the real wage of workers who work with physical capital.

Brace yourself.  The optimal policy is a negative inheritance tax.  At age 65 both rich guys should be forced to put some amount (let’s say $100,000) into a government fund.  When they die, the $200,000 should go to the kid who also inherited the rich guy’s money.  I know what you are thinking—why not give the $200,000 to the poor?  Because we already assumed the existence of a progressive payroll (or consumption) tax, which is redistributing the optimal amount of money to the poor.  This extra tax is just trying to make things a bit more equal among two old rich guys, and one worthless trust fund baby. 

[Yes, I'm sort of joking here---just trying to rigorously apply the logic of egalitarianism.  (For my trust-fund kid readers--I have nothing against you, I am just parroting society's prejudices.)  But I am serious about favoring a progressive consumption tax.  Indeed I favor it so much that I would prefer it even if it meant I paid more in taxes than I do right now.  You will never find me complaining that I can't get by on a family income of over $250,000.]

I think people have a huge mental block about these ideas, because they grossly misunderstand the actual incidence of taxes.  For instance, most people think consumption is much more equal than income, and hence that consumption taxes are regressive.  Actually, consumption taxes are proportional to consumption, which is the only meaningful benchmark.  Income is meaningless gobbledygook.  And most people think wealth is much less equal than income.  But how can both of these perceptions be correct, when wealth is nothing more than the present value of all future consumption for you and your heirs!  Actually, inequality of wealth and consumption are exactly equal, when properly measured in present value terms.  OK, to make this true I have to treat gifts from the rich is part of their consumption.  But even in a society where the wealthy made no gifts, most people would be shocked to find out that wealth and consumption inequality are equal.   And the reason is that our minds are being twisted and distorted by a meaningless concept—income.  People find it hard to shake the notion that income is actually measuring something meaningful.   So we use it as a sort of benchmark for everything from tax progressivity to Gini coefficients.

The beauty of the progressive consumption tax is:

1.  No tax forms for 90% of Americans, it’s automatically collected like FICA.

2.  It’s fair to high savers, treating them equally to spendthrifts.

3.  It encourages more saving and less consumption, which America desperately needs.  This raises economic growth. 

The ideal tax system would be:

1.  Externality taxes such as a carbon tax.

2.  A land tax

3.  A progressive consumption tax, preferably on wages and salaries (as the VAT is harder to make progressive.)

4.  If we opt for the high-tax Nordic model, you might also need a VAT.

But why go for the high-tax model, when the lowest-taxed developed country entity in the world has the best infrastructure?  And the second lowest-taxed rich country also has enviable infrastructure plus universal health care combined with a Japanese-level life expectancy? 

It would only take four things to make me become a card-carrying Democrat:

1.  If they dumped Keynesianism and favored using monetary policy to target NGDP

2.  If they favored replacing our current tax system with a progressive consumption tax

3.  If they favored replacing the public school monopoly with universal vouchers.

4.  HSAs through forced saving plus subsidies for the lower incomes

Progressive blogger Matt Yglesias already agrees with me on the first two, and Sweden adopted the third.  Singapore combines the 4th with universal health care.  So how can any progressive call me a reactionary Chicago-school economist?  

I suppose what’s holding back vouchers in America is liberal sensitivity regarding our troubled racial history, and also a fear of religious schools.  But that’s for another post. 

So why the inflammatory title of the post?  I hope I showed that “income” is meaningless if it includes capital income.  It is misleading because it leads people to talk about the share of “income” earned by the top 1% as if it is all actual labor income, whereas it is often mostly capital income, aka deferred consumption and not income at all.  And it’s harmful because it leads to the establishment of an extremely annoying, inefficient, and sometimes even repressive system called the income tax.  And it punishes thrift and rewards spendthrifts.

PS.  Of course there are real world problems with estimating wage income.  How should we deal with the self-employed?  One option might be to tax income from proprietorships, allowing the expensing of investments.  I hope commenter Mark can help me out here, as it’s been 30 years since I read any public finance and am relying on my feeble memory.

Update:  A commenter pointed out that Steve Landsburg did a similar post just a few days ago.


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133 Responses to “Income: A meaningless, misleading, and pernicious concept”

  1. Gravatar of Wonks Anonymous Wonks Anonymous
    21. September 2010 at 12:41

    Steve Landsburg already made the same argument about capital gains.

    If Robert Frank is right that much of the consumption of the rich is zero-sum positioning, taxing those goods (regardless of whether the spending comes from capital) could be a free lunch.

  2. Gravatar of Wonks Anonymous Wonks Anonymous
    21. September 2010 at 12:44

    One reason progressives might be hesitant toward signing on is that the big growth in inequality in recent years has come from finance, an industry also implicated in the crash and perceived as having been bailed out. I wonder why the field has stayed so renumerative. Economics usually suggests that new entries should join until MR = MC or something like that. Is there some bottleneck in finance, like the AMA’s grip on med schools & drug patents on medicine?

  3. Gravatar of ssumner ssumner
    21. September 2010 at 12:54

    Wonks Anonymous, I don’t agree with Frank, but even if I did it wouldn’t affect my argument. I’m already calling for a progressive consumption tax.

    You may be right about finance being inefficient, but if that’s keeping progressives away from a progressive consumption tax then they need to study public finance, as it’s a completely unrelated issue. Note that Matt Yglesias is a progressive and he favors a progressive consumption tax.

    I would think the events of the last decade show how important it is for Americans to save more. Any progressive should favor pro-saving policies. I hope my post showed that the debate over consumption vs income taxes has absolutely NOTHING to do with income equality–because there is no such thing as “income.”

  4. Gravatar of Benjamin Cole Benjamin Cole
    21. September 2010 at 13:50

    I am all in favor of consumption and PIGOU taxes. Not sure how taxing wages fits the model.

    Would not a national sales tax, perhaps exempting food and medical services, work better? Supplemented by gasoline, recreational drug, and pollution taxes?

  5. Gravatar of Joe Joe
    21. September 2010 at 14:35

    Professor Sumner,

    I too want universal freedom for k-12 schooling, but I think vouchers would be a mistake. The government would still have great power over the school because they would create rules, regulations, and price controls. Since they are the ones paying up, they would still maintain control in order to have “accountability and fairness.” But we want the government to have no control.

    I think I can convince you of this, a better system would be one of tax credit. Every household would have a tax credit for sending their kids to school. For poor kids, every household and corporation would get a tax credit for a donation to a scholarship to send the poor to private school.

    Florida is currently doing this,

    http://www.cato.org/pub_display.php?pub_id=11734
    http://www.cato-at-liberty.org/floridas-education-tax-credit-program-helps-public-school-students/

    Best,

    Joe

  6. Gravatar of Wonks Anonymous Wonks Anonymous
    21. September 2010 at 14:37

    Robin Hanson would consider not taxing medical services a terrible idea. Better to give poor people a lump-sum transfer, let them spend it on what they wish, but not distort relative prices through taxes. Unless, as with pollution, we want to distort.

  7. Gravatar of Benjamin Cole Benjamin Cole
    21. September 2010 at 14:48

    Wonks–point conceded.
    On the other hand, sometimes human emotions and a sense of morals get in the way.

    Something about taxing medical services bothers me–it might be because I have never really accepted the idea of medicine for profit. I understand I am badly out of touch with the times on this score….

    On the other hand, can we tax religion twice or even three times? I meant to include religion in my list of PIGOU taxes….

  8. Gravatar of beamish beamish
    21. September 2010 at 14:53

    Did anyone call you a reactionary Chicago-school economist? You can call yourself a liberal if you want. No one will mind.

  9. Gravatar of Bret Bret
    21. September 2010 at 15:05

    To make your case, you hold certain variables constant that would vary.

    For example, if in the no tax case you assume a quintupling over 40 years, in the 50% tax case wouldn’t interest rates be substantially higher because after tax NPV is adversely affected (meaning less people will invest meaning the cost of money is higher)?

    Don’t get me wrong, I’m all for low taxes, but your argument doesn’t seem quite accurate to me.

  10. Gravatar of John John
    21. September 2010 at 15:10

    A this point I feel like I agree with you on all possible topics. Where are people like you in politics? I guess Mike Bloomberg maybe, but that’s about it.

  11. Gravatar of James Davies James Davies
    21. September 2010 at 15:18

    You say “I will try to convince my progressive readers that they should favor complete abolition of all personal and corporate income taxes”.

    You don’t mention corporate income taxes later in the piece. My understanding of corporate income taxes is that it is a voluntary tax that is paid to the government in exchange for the privilege of limited liability granted to the corporation by the government – i.e., corporate status. If shareholders did not feel that the value of these privileges was greater than the tax, then they could restructure corporations as partnerships, which are not subject to a separate income tax on profits. In other words, it is a fee for the legal gift of limited liability.

    How does your argument address this?

    Interesting, clear-headed post.

  12. Gravatar of Jon Jon
    21. September 2010 at 15:21

    Maybe if we taxed David Koch’s inheritance at 100%, you would be the influential figure on the right, instead of him. It could be you, not him, funding think tanks and alternative political parties. Without that head start, it would be the Sumner Theatre where the New York City Ballet performs, not the Koch Theatre.

    I, for one, would prefer this hypothetical world…well, at least the Sumner part of it.

  13. Gravatar of scott sumner scott sumner
    21. September 2010 at 15:23

    Benjamin, Actually, a wage tax is identical to a consumption tax. In the example in the post both taxes reduced present and future consumption by equal amounts.

    Joe, I agree on the tax credit idea.

    Wonks Anonymous, I agree on taxing medical care. Although I prefer to do a consumption tax through taxing wages, but the effect would be the same.

    beamish, I call myself a right wing liberal. Some of my commenters think I am a evil right wing reactionary.

    Bret, Yes, but none of my qualitative conclusions rest on that assumption. If the tax on saving forces me to change my behavior (and you are right it would) than I am worse off than the guy who doesn’t save.

    John, You’d be surprised how few people understand the ideas in this post. Obviously any public finance professor knows a wage tax is equivalent to a consumption tax, and much better than an income tax. But outsiders find these ideas very counter-intuitive. It seem like common sense that people should have to pay a lot of tax if they have billions in capital income.

  14. Gravatar of scott sumner scott sumner
    21. September 2010 at 15:34

    James Davis, I don’t know enough tax theory to give you a definitive answer, but off the top of my head it seems like the difficult problem is how to tax partnerships, not corporations. With corporations it seems like it would be easy to separate income earned by workers and managers, from income earned by owners. Although even in that case I suppose you’d have to worry about valuing stock options for employees. I don’t recall how the IRS solves that issue right now. But in any case it doesn’t seem that abolishing the corporate income tax would raise any new problems. With partnerships you need to separate capital and labor income. In the post I speculated that one approach would be to tax all business income, and then allow expensing of investments. But don’t rely on my speculation, a tax expert could give you a better answer.

    Jon, I’d also prefer to be rich, but it won’t happen no matter how big the inheritance tax. A 100% inheritance tax on billionaires would make all Americans poorer, by reducing the capital stock. Well, actually yacht makers might be better off.

  15. Gravatar of Ram Ram
    21. September 2010 at 15:35

    I cannot speak for every American liberal or every Democrat, but I too prefer consumption taxes to personal income/corporate income/capital gains/dividend/inheritance taxes. Additionally, I favor a private education system (in my view, however, vouchers ought to be conditional; e.g., only schools with lottery-based admission procedures would be voucher-eligible). If dumping “Keynesianism” includes dumping New Keynesian DSGE models of the business cycle, then that is where we part ways. Your blogging, however, suggests what you really oppose is pessimism about the efficacy of monetary policy for the purposes of macroeconomic stabilization. If so, we’re on the same page. Finally, while I supported the health care reform bill, flaws and all, ideally I prefer a system more along the lines of what Brad DeLong laid out in his widely-cited post on the ‘health care opportunity’. So we’re not too far apart on that issue, either.

    And yet, when I complete a typical policy survey (for example, http://www.electoralcompass.com), I usually find that I am moderately liberal (in the American sense) as well as a reasonably good fit with the Democratic Party. By contrast, I hardly fit in with the Republican Party at all, even though I support free trade and most other elements of the so-called Washington Consensus. I don’t mean to doubt your right-wing credentials, Prof. Sumner, but I sometimes wonder whether you’re really as right-wing as you think. I’d like to know, if you get a chance, where you come out on a survey like the one I mentioned above. My suspicion is that you have more in common with center-left Democrats (like most Democratic economists) than with right-wing Republicans (including many Republican economists).

  16. Gravatar of Benjamin Cole Benjamin Cole
    21. September 2010 at 15:37

    Okay, we tax wages but not capital gains, interest or dividends.

    So people mask wages as capital gains.

    How is small business income treated?

    For example, I buy an abused antique chair, fix it up, and sell it for profit. Do I report the profit as on labor, or as a capital gain on a smart investment? (The latter of course).

    Seems to me a simple national sales tax solves many problems of administration.

    KISS is my favorite rule.

  17. Gravatar of Wm Tanksley Wm Tanksley
    21. September 2010 at 15:41

    I’m also confused regarding how a tax on wages is a consumption tax. Isn’t that by definition an income tax? I may be badly uninformed; my economics reading is limited to a few old books like “Human Action” and such.

    What would it mean to have a progressive consumption tax? One answer would be to raise the nominal tax rate, and distribute a per-capita “refund”. This would work perfectly well with a VAT, I would think.

  18. Gravatar of Jason Jason
    21. September 2010 at 16:00

    I think I agree on the progressive consumption tax, except that there is one point on which I tend to argue either way to myself:

    In the brothers example, in the one-good society of blueberries, the brother that spends all his money today on blueberries is more beneficial to me than the one who saves 40% of his money to spend later on blueberries — he’s buying my blueberries.

    Or in the case of the real world, he’s buying a larger basket of goods than his brother some of which goes to support my income.

    Analogously the trust fund kid could be making my coffee; if he is subsidized, I’ve lost the benefit of his labor providing goods and services.

    The optimal strategy from a societal perspective then to tax some consumption and some savings (probably savings less than consumption since people have a tendency to not save enough) — potentially changing the mixture as recessions and booms hit the economy (i.e. dropping the consumption tax to zero as fiscal stimulus**).

    ** Regardless of its actual efficacy vis-a-vis monetary policy :)

  19. Gravatar of Nick Rowe Nick Rowe
    21. September 2010 at 16:30

    Scott: you are basically right, I think. And beautifully clearly explained.

    1. But why tax land? Isn’t that just like taxing savings? Why should it matter if people save in the form of land or capital? (Of course, I’m biased.)

    2. Couldn’t someone argue that much of capital gains is luck too, just like labour income? So capital income should be redistributed from the lucky to the unlucky? Or would you argue that people could have insured their savings in advance, but chose not to? (We can’t insure our labour income in advance, because we can’t make contracts before we are born.)

  20. Gravatar of Nick Rowe Nick Rowe
    21. September 2010 at 16:32

    Just realised: you are using “land” in the Ricardian sense – the unimproved whatever of the soil. Henry George and all that. But if you tax it now, you are nevertheless imposing a once and for all capital loss on current holders.

  21. Gravatar of scott sumner scott sumner
    21. September 2010 at 16:58

    Ram, I consider myself a right wing liberal–someone with liberal values but a different worldview from left wing liberals. You sound rather centrist.

    Outside of economics I am closer to the Dems, although I find them too paternalistic on some non-economic issues.

    I am puzzled by the lottery idea–the whole point is to have schools compete based on quality, and also specialize to serve different populations with different needs. Indeed I think specialization is such a no-brainer that even liberals who say they oppose it, deep down support it. As when in DC they send their kids to private schools.

    I also love DeLong’s health care idea. I should have cited him, he has much more impeccable progressive credentials than Singapore’s government.

    Benjamin, There’s already a huge incentive to do that capital gains dodge, but I’ve never worked for a place that does it, nor known anyone else who does. Surely the IRS can monitor that and reduce outright fraud to a low level.

    You asked:

    “How is small business income treated?”

    Just to be clear, we already have a wage tax, called a payroll tax. I’m no expert on how they determine small business wages, but I suppose whatever method they now use would continue to be used.

    I agree with the KISS idea, but VATs are also a bit complicated in the real world.

    You asked:

    “For example, I buy an abused antique chair, fix it up, and sell it for profit. Do I report the profit as on labor, or as a capital gain on a smart investment? (The latter of course).”

    That’s why in the post I said for small business they may want to tax income, and allow the businesses to expense all investments. In that case you’d only be able to write off the cost of the chair, and the materials used in fixing it. An income tax where all investments are expensed turns into a consumption tax.

    Wm Tanksley. The difference between a consumption tax and an income tax is as follows:

    1. A consumption tax is like FICA, only taxing wage and salary income.

    2. An income tax taxes both wage income and capital income (dividends, interest, rents, etc.)

    Jason, It’s a misconception that consumption creates more jobs than saving. Recall that saving equals investment. And investment creates jobs constructing machines, buildings, etc. Trust me, people much smarter than me have looked at these issues, and there really isn’t any good argument against consumption taxes.

    Nick, Speaking of people smarter than me…

    Interestingly the land question is similar to the question of whether when making the transition we should do a once and for all tax on existing capital, since that would have no incentive effects–it’s already built. To me that seems like cheating, if we did it once, people would expect us to do it again. But that idea did get published somewhere in a top journal

  22. Gravatar of Rebecca Burlingame Rebecca Burlingame
    21. September 2010 at 17:12

    I’d like to deal with the title of the post straight on, as this has really been on my mind the last 24 hours. (Absolutely agree with taxes being too indirect and ill conceived, although I question the tax on land, people are already being hit hard for property taxes.)

    Progressives constantly equivocate as to whether incomes are fair, and much of the unnecessary complexity of taxation arises out of these constant adjustments for “fairness” or lack of. But how is it even possible to have an environment where incomes are actually the same? As far as I can see, it isn’t. Sure, we could all try for the same income but who has the ability to make something like that happen? No one. I realize this may be too abstract for the post, but if I could better understand how to explain the benefit of different incomes, I too might have my own argument for progressives, in arguing for simpler forms of taxation.

  23. Gravatar of Richard W Richard W
    21. September 2010 at 18:01

    In the inheritance example what if the inheritance was entirely through an increase in the land prices a property happened to stand on. For example, the local government builds a good school and a commuter railway line nearby. It is the efforts and taxes of others that caused the land prices to rise. The inheritors did not cause the land to increase in value so why should the inheritors gain from the unearned income?

    Therefore, I agree that taxes should be raised from economic rent in a Land Value Tax, consumption and Pigovian taxes. The correct rate of tax on labour is zero. There was an discussion thread on LVT here.

    http://blogs.ft.com/martin-wolf-exchange/2010/07/12/why-were-resources-expunged-from-neo-classical-economics/#more-456

  24. Gravatar of Liberal Roman Liberal Roman
    21. September 2010 at 18:09

    Well as the token liberal blog, I thought I’d weigh in.

    I guess in theory I agree with everything you say since you would accomplish the liberal goal of a progressive tax system without putting a disincentive on income.

    However, from what I’ve read the biggest gripe with a progressive consumption tax is how exactly would it be enforced? How will you keep track of how much consumption people are doing? Won’t it be a much easier system to game and if not require even higher level of compliance and paperwork than the current system? Tell me why I am wrong here…

  25. Gravatar of Liberal Roman Liberal Roman
    21. September 2010 at 18:09

    Oops, meant to say, “token liberal on this blog”

  26. Gravatar of Liberal Roman Liberal Roman
    21. September 2010 at 18:14

    BTW, OT but there has been little comment so far on the latest Fedspeak.

    I was surprised that so little was made of the fact that the Fed seemed to commit itself to its own inflation target. Normally, this wouldn’t be a big deal, but as you have pointed out Scott, they are not even meeting their own mandate.

    I found it encouraging that they at least acknowledged that the inflation rate is lower than they would like and that they are committed to returning inflation to their target.

    Not much of a reaction from the market or from the punditry about that, but I felt that that statement was good progress.

  27. Gravatar of RobertB RobertB
    21. September 2010 at 18:36

    What about a guy who invests in his youth in med school or a law degree? Obviously a large portion of his future earnings are returns to the human capital he acquired in his education. Should you not exempt this portion of his wages from tax?

    More broadly, people’s wages typically increase as they get older and more experienced. This is because, in addition to their money wages, they are receiving human capital that produces returns in their later working years. To get an accurate picture of their labor income, we should increase their taxes in their early years, to reflect the non-money, human-capital wages they are received, and reduce their later income to reflect the portion of their wages that reflects returns to human capital. So long as they are working in the same job, they should be taxed on a single effective wage, no matter how many dollars they are receiving.

  28. Gravatar of Benjamin Cole Benjamin Cole
    21. September 2010 at 18:44

    Well, not to belabor a point, KISS is why I like a national sales tax, only on final retail sales.

    If something is not sold to a consumer, likely it is an investment (a large piece of manufacturing equipment, for example), or going to get taxed at the final retail level anyway.

    Also, speaking from the viewpoint of an average guy, I understand a sales tax, and how to productively modify my behavior to avoid it (consume less, invest more).

    But a wage tax? Earn less? Frankly, I don’t understand the incentive.

    Scott, of course you know ways in which income is changed or masked. Sheesh, sometimes corporations do share buybacks instead of dividends. Management gets payment in the form of cars instead of wages, or access to participate in a special very lucrative limited partnerships. They get “paid” in the form of capital gains on partnerships. This is child’s play.

    I have run small businesses, and I can report owner’s draw. I could also plow money into inventory or product or real estate, and sell the business in a couple years to record a larger capital gain.

    Jeez, there are million ways to mask income. Really, a national retail sales tax makes more sense. No one could sell retail without a license and a medallion, and we would have to be strict about it.

    But the only record-keeping would be on gross retail sales–a simple math problem of addtion. Millions of accountants would go out of business (anyone with a calculator can add).

    And PIGOU taxes–which I thought you would mention.

  29. Gravatar of Benjamin Cole Benjamin Cole
    21. September 2010 at 18:46

    Liberal Roman-
    Moreover, according to the Boskin Commission, and Milton Friedman, the CPI overstates inflation.

  30. Gravatar of Brett Brett
    21. September 2010 at 19:30

    I suppose what’s holding back vouchers in America is liberal sensitivity regarding our troubled racial history, and also a fear of religious schools. But that’s for another post.

    That’s part of it. I think a number of topics (particularly evolution) need to be taught more thoroughly and aggressively, and I’m concerned about what will happen to the level of scientific education in a system where a good chunk of your students might be attending conservative religious schools (assuming they are allowed to take advantage of the voucher without restraints on curriculum, like they do in France).

    A bigger part is some of the difficulties implementing it. I’m honestly not sure how you’d move towards a voucher system without the public schools ending up as a dumping ground for all the problem and dysfunctional students. That’s a big advantage that private schools currently have – they can kick students out.

    Moving to all-private schools doesn’t necessarily solve that problem either, since it’s becomes difficult politically to fail students en masse (probably due to the drying up of high school dropout work outside of the agricultural/menial labor sectors). What do you do with the problem kids?

  31. Gravatar of Dan Dan
    21. September 2010 at 19:34

    Maybe someone could explain one point I find a little odd… How are capital gains not income? In the case of stock dividends or interest earned holding a bond, you are essentially providing a service (the lending of money) to a customer (the company/government issuing the stock or bond), who is paying you for said service. You got taxed on the money you made that you used to invest in the stock or bond, sure, but then you only get taxed again on the interest, which is money you had not made before (as this is the money being paid to you for your investment).

    In the case of selling (to a willing buyer) a smart investment that has appreciated in value while you held it, explain how it differs from the following scenario: John is a luthier, who buys wood from which he makes a violin. He sells the violoin, and is taxed on the amount of the sale, minus the cost for the wood etc (which he writes off). On the one hand, someone purchases an asset, which they do nothing to for several years, then sell for a profit because the asset has increased in worth. On the other, someone purchases an asset, which they actively transform, then sell for a profit because it has increased in worth. In both cases, the seller is only taxed on the difference between the price at which the asset was sold and the price at which they bought it. Yet somehow John is supposed to pay taxes for selling the violin he has made, while profits made on the sale of stocks are not to be taxed?

    I can see arguments against a capital gains tax on account of it disincentivizing thrift, but then the arguments apply equally to a productive enterprise like making instruments, and it just becomes an argument for lower taxes in general.

  32. Gravatar of greg ransom greg ransom
    21. September 2010 at 19:50

    Why not random confiscation of wealth?

    We could spin a wheel and randomly take 3/4 of the assets of anyone who’s number comes up — along with 3/4 of their income and wages or surcharge on any of their purchases, for one year.

    Otherwise, the government leaves you alone.

  33. Gravatar of greg ransom greg ransom
    21. September 2010 at 19:53

    Why not reimpose serfdom?

    Serfdom required only 3 weeks of work in France.

    The government would save trillions on prison guards and DMV clerks and pensions — replacing government workers who make 50%+ more than private sector workersmwithnserf labor.

    And taxpayers would spend far less of their lives working for the state.

  34. Gravatar of greg ransom greg ransom
    21. September 2010 at 19:59

    Watch out, Scott.

    Before you know it you’ll rediscover why capital theory was once at the heart of economic science, esp. concerningnthe problem of just “distibution”, which is really at the heart of tax policy.

  35. Gravatar of Ram Ram
    21. September 2010 at 20:03

    Not to derail the discussion, but the point of lottery based admissions is to prevent schools from competing for vouchers by choosing the best students, rather than by providing the greatest educational value-added per dollar spent. When schools are free to choose their students, this obscures the cause of differences in student aptitude across schools, making it hard for parents to hold schools accountable for educational value-added. I believe two Columbia economists wrote a paper about this. Of course, there are benefits to specialization, which is why parents would be free to apply their voucher to the eligible school of their choosing. In any case, this is perhaps not the only desirable regulation to impose upon voucher-eligible schools. And of course parents would be free to send their kids to schools that are not voucher eligible if they pay out of pocket.

  36. Gravatar of Ram Ram
    21. September 2010 at 20:32

    Here is the paper I had in mind:

    http://www.nber.org/papers/w15112

    The paper is mostly concerned with modeling the phenomenon I mentioned as a kind of adverse selection in reverse, but the motivation for the model are the disappointing findings about real-world voucher programs around the world. By comparison, Caroline Hoxby (for example) has shown that charter schools show significant value added increases over public schools, and what is noteworthy about the charter schools she studies (and if I’m not mistaken most charter schools) is that the admissions are lottery based. This paper isn’t the end of the issue but it seems to me to point to possible oversimplifications in the usual case for a pure voucher system.

  37. Gravatar of cassander cassander
    21. September 2010 at 20:42

    I too don’t quite understand the logistics of a consumption tax. Any tax exclusively on wages creates huge incentives to dodge the tax, and the alternative of keeping track of what everyone spends seems impractical. Taxing all income regardless of source at the same rate seems a nice middle ground.

    [quote]A bigger part is some of the difficulties implementing it. I’m honestly not sure how you’d move towards a voucher system without the public schools ending up as a dumping ground for all the problem and dysfunctional students. That’s a big advantage that private schools currently have – they can kick students out.[/quote]

    Incorporate all existing public schools as private/charter schools run by their existing school boards / principals. Eliminate all their funding, but have all their current students enrolled for at least a year with their voucher money. Then require that any school that accepts vouchers admit some large percentage (say, half or 75%) of their students using a lottery. That gives them enough discretion to get rid of problem kids but not enough to let them cherry pick their whole class.

  38. Gravatar of cassander cassander
    21. September 2010 at 21:01

    I suppose what’s holding back vouchers in America is liberal sensitivity regarding our troubled racial history, and also a fear of religious schools. But that’s for another post.

    You’re also forgetting that schools are, and always have been, massively potent tools for indoctrination. Older progressives outright proud of this intention. Taylorites and Fordists explicitly said they wanted to train people to be good workers, but even softer progressives like John Dewey said things like “It is not enough to teach the horrors of war and to avoid everything which would stimulate international jealousy and animosity. The emphasis must be put upon whatever binds people together in cooperative human pursuits and results, apart from geographical limitations. The secondary and provisional character of national sovereignty in respect to the fuller, freer, and more fruitful association and intercourse of all human beings with one another must be instilled as a working disposition of min”. Today, the language is more opaque, but the exact same desire is behind efforts at teaching multiculturalism or “critical social thinking” to elementary school kids.

    Of course, if conservatives ran the schools, they would try to do the exact same thing. One might even say that they do with some religious schools. But, by and large, the modern American school system was designed by progressives and has been run by progressives and they will never willingly give up that power.

  39. Gravatar of William William
    21. September 2010 at 21:04

    Scott,

    It appears I’m late to this party but just wanted to point out that Armen Alchian would take issue with your suggestion to measure inequality by counting only labor income. After all, to what can we attribute the increased salary of a doctor if not a return on past investment in human capital?

    Imagine two people graduate high school and each gets a job right away. One goes to college and uses his income to pay tuition. The other saves two-thirds of his income and buys bonds. At age 25 this person is getting significant capital income, while the first person isn’t getting any. Yet they are both receiving returns to investment.

  40. Gravatar of MW MW
    22. September 2010 at 03:43

    How the school system works in Sweden (for those that don’t already know):
    http://news.bbc.co.uk/2/hi/uk_news/education/3717744.stm

    “Sweden’s school choice system was introduced in 1992. It is based on a virtual “voucher” which is equivalent in value to the average cost of educating a child in the local state school.

    Parents can use this “voucher” to “buy” a place at the school of their choice. The idea is that funding follows the pupil and, in this way, the state supports the schools that are most popular with parents.

    …the Swedish voucher cannot be “topped up”. In other words, any private school participating in the scheme cannot charge any additional fees.

    Nor can the private schools select pupils on any basis other than first-come-first-served.”

    And note (!): “The Swedish Teachers Union, Lärarförbundet, supports the school choice policy.”

  41. Gravatar of StatsGuy StatsGuy
    22. September 2010 at 04:21

    I’m afraid this is missing a few quite important pieces… Um, HUGELY important pieces.

    1) A real interest rate that exceeds economic growth rate means that, over time, inherited wealth will own an increasing portion of the economy. Laywers sometimes call this the tyranny of the dead. In translates into consolidation of economic and political power.

    Imagine a situation where the wealthy live modestly, consuming only 0.5% of their wealth (which expands in a real sense at 3.5% while the economy grows in a real sense at 2%). The poor, by definition, consume a greater share of their wealth (they may even be at subsistence). Over time, wealth will concentrate, and there is no upper limit to this concentration.

    Well, I suppose that’s not quite true – eventually, the upper limit is hit when society has saved so much that (like Japan) real domestic interest rates become negative. Risk free investments have slightly negative returns, which can only happen if we’re using a fiat money supply that ensures nominal expansion. (Now you know why real conservatives want hard money and no investment/inheritance tax.) This would draw substantial political opposition from a group that your suggested policies would have made very wealthy and very politically powerful. It would also cause capital flight to commodity assets which are used to arbitrage currency value loss.

    Note that in a hard money situation (money does not expand), if the real interest rate declines below zero due to low real economic growth, and there is no nominal currency to force a loss of the value of currency, then we’ll see deflation. At the point deflation starts, he with the most wealth and lowest consumption wins.

    Hypothetical? Not really.

    2) You are missing the exit option – that is, the option of spending money in areas with low consumption taxes after that wealth has been accumulated (e.g. paying no taxes your whole life, then retiring as an expatriot). Or, are you considering an excise tax on wealth fleeing the country?

    3) You write: “He is less selfish, so virtue ethics favors the one who makes bequests.”

    This is simply not true. He is NOT less selfish. He is simply relatively more concerned about future consumption than present consumption. You can argue this is virtuous – but that is a value judgment, and really depends on the investment/consumption balance of the economy and the different situations of the brother. It may or may not be beneficial for others in the economy to claim future consumption instead of present consumption.

    Think of it this way – this behavior makes future consumption relatively more expensive. Imagine I’m nearing retirement. I would want to buy more future consumption, and sell more present consumption. But an aggressive wealthy saver is spending all his purchasing power on future consumption, so my sale price of present consumption is lower and my buy price of present consumption higher. All in all, in the above situation, I would be better off if other people would consume more today.

    If you wanted to put a “virtue” label on the tradeoff between future/present consumption, it would need to (at the minimum) be contingent on the social environment. Is the country developing and full of youth, and thus in dire need of investment capital? Is it developed, low growth, and suffering from demographic imbalances?

    Let me give you another hypothetical situation. Let’s say the US had a savings rate of 30% for the past 40 years, and a positive trade balance. Given existing reality in developing countries, do you think developing countries with export oriented growth would be better off than they are today? [I expect your response has something to do with "Yes, if these countries all had appropriate monetary policies" - which is asking for quite a lot from a country that is only one famine away from civil war.]

  42. Gravatar of Ryan Ryan
    22. September 2010 at 04:56

    Prof Sumner, I enjoyed the first part of your argument, but I think you said a couple of things that are seriously problematic:

    1. Most of your income comes from luck. If you’d been born in a poor peasant household in Asia or Africa, your income would be low no matter how hard you worked. You hit the jackpot just being born in a developed country.

    Sorry, but that is a little too loopy for me, and thwarts every hard-working immigrant in the USA who rose from 3rd-world nothingdom to US millionaire status. (Yes, it still happens.) The notion that our income is a function of luck and that our choices play only a minor role in that is, frankly, preposterous, and I think you know it, too.

    2. Our wealth comes from living in a highly functional society, thus part of your wealth is due to the fact that your neighbors don’t go around raping and pillaging as in the old days, but rather peaceably go to polling stations to vote. Am I saying; “It Takes a Village?” Sort of, more precisely “it takes a civic-minded culture.”

    Civic-minded cultures don’t “spread the wealth around” at the point of a gun. To see the hole in your reasoning more clearly, ask yourself why those with lower incomes should be less civic-minded and owe less to their “village” than those with higher incomes. Are you really arguing that civic duty is a function of one’s ability to pay? That is pretty obviously anti-democratic.

    Frankly, this point of view can only make sense if you believe that but for pure luck and high income, we would all be out raping and pillaging each other. This is actually a slight to the poor, when you think about it, this idea that they are more likely to rape and pillage the rest of us unless we buy them off with a progressive income tax scheme.

    You kind of jumped the shark on that one. You made some good points otherwise.

  43. Gravatar of Tax Links « Daniel Smith Tax Links « Daniel Smith
    22. September 2010 at 05:55

    [...] interesting posts on tax incidence and tax “equity”. One by Steve Landsberg and one by Scott Sumner. They are [...]

  44. Gravatar of Brooke Allen Brooke Allen
    22. September 2010 at 06:51

    I am the lone wolf on this one but I favor a flat tax. Everyone would pay the same rate on their income. That would go a long way at stopping this silly argument about the rich vs the middle class when it comes to taxes. It would be very simple and efficient. You would no longer need tax preparers. The volume on tax guidance would go from an entire bookshelf to something that would fit neatly in a 3 ring binder. If Congress wants to raise or lower taxes everyone – rich or poor will feel the effects – postive or negative. No deductions. All income no matter what the source would pay the same rate.

  45. Gravatar of StatsGuy StatsGuy
    22. September 2010 at 06:56

    “Note that in a hard money situation (money does not expand), if the real interest rate declines below zero due to low real economic growth”

    should read “if the necessary real interest rate declines below zero due to low real economic growth, and there is no nominal currency to force a loss of the value”, so hopefully the paragraph makes sense now.

    I guess a lot of my points end up in the same place: You are advocating a set of policies that need to be bundled. That is, if you’re going to shift to a consumption tax and get rid of the inheritance tax, you had better darn well have a monetary policy that is setup to avoid deflation and wealth concentration, you may need a tax on wealth leaving the country, and you better hope that developing countries can build their polities, economies, and property rights infrastructures without relying on massive trade surpluses.

  46. Gravatar of Justin Justin
    22. September 2010 at 06:58

    “Most of your income comes from luck. If you’d been born in a poor peasant household in Asia or Africa, your income would be low no matter how hard you worked. You hit the jackpot just being born in a developed country.”

    Scott,

    To add to Ryan’s point here, I’d modify your claim to say that good portion of one’s income *potential* comes from luck. An American who fails to take advantage of the opportunities here can easily wind up in the lowest decile of the income distribution. For example, a guy from my high school who didn’t bother to go to class failed to graduate and today makes ~$10/hr. Had he a little more motivation a decade ago, this guy would probably be making several times that amount today.

    Furthermore, the luck/inequality dilemma cuts across many dimensions. Take physical attractiveness. Someone who is born unattractive simply doesn’t have the same opportunities as someone who is born very attractive. I don’t think this is grounds for the government to intervene – perhaps via forced plastic surgery – and partially offset the differential between the very attractive and the very unattractive.

    But suppose that an unattractive person successfully runs a software company and has become fairly wealthy, and one of his high school friends is very attractive and enjoys the benefits thereof, but was unsuccessful and works earns $25,000/yr in a dreary job. Why does government policy only try to offset the consumption inequality (which even a flat consumption tax would do, let alone a progressive one), when the attractiveness inequality remains?

  47. Gravatar of Wonks Anonymous Wonks Anonymous
    22. September 2010 at 06:59

    Nick, I had thought about referencing the Georgist angle before but forgot. Is there an argument somewhere summarizing the consensus view of economists on why the single-tax is misguided? Otherwise it seems odd it receives so little attention.

    Liberal Roman, I believe StatsGuy and Benjamin Cole are both liberals.

    StatsGuy, notice he said “bequests”. That’s not the same individual’s future consumption, but someone else’s. You might argue that giving money to your own children is still selfish though.

  48. Gravatar of Andrew C. Andrew C.
    22. September 2010 at 07:12

    I’m a little surprised that you consider a payroll tax equivalent to a consumption tax. Doesn’t a payroll tax discourage work the same way an income tax discourages savings?

    You could tell a similar story about two brothers with different preferences about how many hours to work each week. The brother who prefers to work more would be taxed more under your system.

    Perhaps you think people’s labor supply decisions aren’t that sensitive to taxes. But then, are you really that different from progressives who think people’s savings decisions aren’t
    that sensitive to income taxes?

    By the way, I’m a progressive and I would have no problem with a progressive consumption tax as long as it actually taxed consumption and was done in a progressive way. It just seems hard to implement.

  49. Gravatar of mbk mbk
    22. September 2010 at 08:24

    Statsguy,

    this here made me chuckle: “You are missing the exit option – that is, the option of spending money in areas with low consumption taxes after that wealth has been accumulated (e.g. paying no taxes your whole life, then retiring as an expatriot).”

    This has precisely been an issue in Singapore with its high taxes on certain forms of consumption, such as cars, and its high real estate prices. There was talk some time ago that the middle class might just be tempted to cash out once it reaches a certain comfortable level of wealth, and to consume it somewhere else where that wealth buys you more. Don’t know if the migratory effect was ever numerically important. BTW, “expatriot” – “expatriate” – sounds like a Freudian lapse if there ever was one…

  50. Gravatar of ssumner ssumner
    22. September 2010 at 08:38

    Rebecca, I agree you don’t want to overdo making incomes more equal, as they reduce incentives to work and invest in human capital.

    Richard W, I agree that there is a lot to be said for land taxes, and agree they are superior to labor taxes. My only warning is to be careful when saying some “windfall” is due to luck and thus is undeserved. In the real world most investment windfalls are returns earned by people who are willing to take on extra risk. For every asset that rises more than the average rate of return, another asset rises less.

    Liberal Roman, I see now that I wasn’t very clear with the post. I guess many readers don’t know that a payroll tax is identical to a consumption tax like a VAT. It is easy to make a payroll tax progressive.

    Yes, I agree on the Fed statement. Haven’t had time to post on it yet. It confirmed my view of the Jackson Hole speech, that Bernanke was drawing a line in the sand at 1% inflation. This statment pretty much confirmed it. Of course I think they need to do much more.

    RobertB; You said;

    “What about a guy who invests in his youth in med school or a law degree? Obviously a large portion of his future earnings are returns to the human capital he acquired in his education. Should you not exempt this portion of his wages from tax?”

    Good point. I was thinking of this issue, but didn’t know how to address the issue. One solution would be to allow education to be tax free. Unfortunately that messes up the beautiful simplicity and elegance of the payroll tax, which current has no deductions. If we want to keep the payroll tax pure, another option would be for the government to subsidize education at the average tax rate. But you are right, if they don’t do those things, then a payroll tax does discourage the formation of human capital, a point I discussed in an earlier post, where I pointed out that much of the tax on high-paid doctor’s incomes is actually paid by patients, in the form of higher medical coats.

    Benjamin, You said;

    “Scott, of course you know ways in which income is changed or masked. Sheesh, sometimes corporations do share buybacks instead of dividends.”

    No problem, share buybacks are a way of producing capital gains. But there would be no tax on either cap gains or dividends.

    But I do agree that the VAT is a bit easier to enforce. Of course it couldn’t be made progressive, so there is zero chance the Dems would go along. That’s why I think the payroll tax is best. We already have it, and it works pretty smoothly (well, compared to the income tax.)

    Brett; I’m not at all concerned about evolution. Any kid interested in becoming a scientist will quickly pick up what he needs to know. Don’t forget the public schools are also religious schools, teaching religions like socialism, feminism, and environmentalism. For instance, my daughter is not presented with the pros and cons of recycling, but only the pros. Yet, studies show it hurts the environment. So they’re just as much “faith-based” as any private school.

    You said;

    “A bigger part is some of the difficulties implementing it. I’m honestly not sure how you’d move towards a voucher system without the public schools ending up as a dumping ground for all the problem and dysfunctional students. That’s a big advantage that private schools currently have – they can kick students out.

    Moving to all-private schools doesn’t necessarily solve that problem either, since it’s becomes difficult politically to fail students en masse (probably due to the drying up of high school dropout work outside of the agricultural/menial labor sectors). What do you do with the problem kids?”

    Regarding the first point, I’d abolish all public schools. Yes, I agree problem kids are a problem for private schools, but there are an even bigger problem in public schools (which don’t discipline them as well as private schools.)

    But I do agree that vouchers wouldn’t magically solve all our social problems. But it would make our dsyfunctional educational system much less expensive. If someone has a way to make the public schools work as well as those in Finland, I’d love to hear it.

    Dan, I agree that capital gains is income just like interest and dividends. My point is that income is a meaningless concept, it doesn’t measure what we think it does. In the example I used the person paid a 50% payroll tax. That meant he had 50% less to invest, and hence for any given rate of return he would end up with 50% less wealth, and future consumption, than w/o the payroll tax. So in that sense he’s already paid taxes on his capital gains. Taxing him again would be double taxing. BTW, this isn’t just my theory, I should have mentioned that it is standard economic theory that the income tax double taxes saving.

    Regarding the violin example, that would be the same, if the stock investor could write of the investment cost when he purchased the stock, just as the violin maker writes off the cost of wood. Then a capital gains tax would be fair, indeed you’d pay tax on the entire value of the stock sale. And this isn’t just theory, it’s precisely how 401k’s are done. If one could put unlimited funds into 401ks, it would convert the income tax into a consumption tax.

    Greg, Um, because they be bad ideas?

    Ram, Interesting idea, I’d have to study it a bit more. BTW, the strongest evidence for vouchers isn’t school quality (the test scores are mixed) but rather lower cost. Private schools can deliver the same educational qwuality at a lower cost.

    cassander, You said;

    “I too don’t quite understand the logistics of a consumption tax. Any tax exclusively on wages creates huge incentives to dodge the tax, and the alternative of keeping track of what everyone spends seems impractical. Taxing all income regardless of source at the same rate seems a nice middle ground.”

    But you are overlooking the fact that real world consumption taxes such as FICA, or the European VATs, work far better than the income tax, with far less paperwork and evasion.

    I agree on schools and indoctrination—see my reply to Brett that gives some examples.

    William, You are correct, see my previous reply to WilliamB (above).

    MW, I’m not thrilled with the no “topping off” idea, but I could live with it.

    More to come . . .

  51. Gravatar of Jason Jason
    22. September 2010 at 08:54

    Scott, After some reading, I realize I apparently just reinvented the paradox of thrift argument in my comment above. Its validity is apparently above my pay grade.

  52. Gravatar of Justin Justin
    22. September 2010 at 09:25

    “Nick, I had thought about referencing the Georgist angle before but forgot. Is there an argument somewhere summarizing the consensus view of economists on why the single-tax is misguided? Otherwise it seems odd it receives so little attention.”

    Wonks Anonymous,

    I’m guessing the single-tax doesn’t receive a whole lot of attention because there would be a whole lot of practical difficulties in raising the amounts required for a modern welfare state from just a land tax.

    “I’m a little surprised that you consider a payroll tax equivalent to a consumption tax. Doesn’t a payroll tax discourage work the same way an income tax discourages savings?”

    Andrew,

    A consumption tax discourages work as well, as most work is for the purpose of earning income to be used for consumption.

  53. Gravatar of ssumner ssumner
    22. September 2010 at 10:04

    Statsguy, I don’t worry about monetary policy, because money is neutral in the long run–and doesn’t affect real variables.

    I am also not particularly worried about wealth piling up in a few families. The phrase poorhouse to poorhouse in three generations certainly overstates things, but in general the children of highly talent people are much less successful than the parents, as there is a sort of regression to the mean. They will usually tend to consume much more then 0.5% of wealth, and the super-rich like Gates and Buffet give almost all their wealth to charity. If that turned out to be a problem in the long run, you could revisit the issue, but right now the problem is that we don’t save enough.

    I didn’t follow your argument about developing countries–they’d certainly benefit from more American saving as it would reduce their cost of capital, and allow for faster economic growth.

    We’ll have to agree to disagree on virtue. I think most people would agree with me that it is more virtuous to share you wealth with your children, rather than consume it all yourself. But even if you throw out that argument, I presented two other arguments as to why bequests are in the public interest.

    I think people often see the income/consumption tax argument through the lens of inequality, but the two issues are completely unrelated. It’s about treating savers and spenders equally, whereas our current tax system unfairly and inefficiently discriminates against savers. A progressive consumption tax can be just as egalitarian as any income tax.

    Ryan, You said;

    “Sorry, but that is a little too loopy for me, and thwarts every hard-working immigrant in the USA who rose from 3rd-world nothingdom to US millionaire status. (Yes, it still happens.) The notion that our income is a function of luck and that our choices play only a minor role in that is, frankly, preposterous, and I think you know it, too.”

    Just the opposite. If I had been born in a poor household in Bangladesh I’d almost certainly be poor right now, no matter how hard I worked.

    I’m a utilitarian, so I’m not concerned with artificial concepts like duty, but rather favor policies that maximize utility. I think a certain amount of income redistribution (but not too much) can help achieve a higher total utility. Of course other famous libertarians like Milton Friedman and Hayek also favored some income redistribution.

    You said;

    “Civic-minded cultures don’t “spread the wealth around” at the point of a gun.”

    Some studies suggest that Denmark has the most civic-minded attitudes of any country, and they certainly spread the wealth around.

    You misunderstood my rape and pillage comment, I was pointing to an increase in civic-mindedness, not a fear that the poor would attack us if we didn’t give them money.

    Brooke, All income taxes are profoundly evil, even flat taxes.

    Justin, You raise a good point, and several authors have explored the physical attractiveness inequality. I agree that in modern societies that can be a bigger source of inequality than income. And health is a bigger cause than either of them. And mental health is a bigger source of inequality than any of the three others. But I think on pragmatic grounds it make sense to do some redistribution, mostly to help out those at the bottom. It’s easier to move money around than good looks. I do think libertarians that oppose all government redistribution have a decent argument, I just don’t happen to agree with it.

    More to come . . .

  54. Gravatar of Philo Philo
    22. September 2010 at 10:06

    “You hit the jackpot just being born in a developed country.” And it is unfair that those born elsewhere are not allowed to migrate to a developed country; the developed countries are practicing invidious discrimination against citizens of underdeveloped countries.

    Still, you probably deserve the income you work for in your developed country. The residents of underdeveloped countries deserve more income than they are getting, but that does not mean you deserve less than you are getting.

    The conclusion would be different if you were (solely) responsible for the fact that the people from underdeveloped countries are not allowed to immigrate to your country. But you are not thus responsible (your political power is minuscule).

    I have assumed, above, that desert is an absolute notion; what you deserve depends on what you do, regardless of the situations of other people. Perhaps there is also a relative notion of desert: what you deserve depends (somehow) on how your actions and your rewards compare with those of other people. (Which other people, exactly? All other people alive now? All other people who have ever lived or ever will live? And where is the line to be drawn between people and non-people?) Or perhaps the notion of desert is too woolly to be usable in serious discussion.

  55. Gravatar of Ryan Ryan
    22. September 2010 at 11:09

    Prof. Sumner,

    First, Bangladesh is a bad example to use because I’m married to someone who disproves your point. :) Long story short, a person’s hard work and choices make a real impact on their result in life. This debate is often termed “locus of control.” Libertarian individualists tend to have an internal locus of control and believe life is what they make of it; Statists tend to have an external locus of control and believe that their lives are predominantly the result of outside forces acting upon them.

    Second, you misunderstood what I meant about being civic-minded. I was suggesting that forcing your neighbor to pay extra is the very opposite of being “civic-minded.” Civic minded people are those who choose of their own volition to spread their own wealth around without having to be coerced into doing so. You are doubtless aware of the strong negative correlation between tax rates and charitable contributions.

    Third, I didn’t misunderstand your rape and pillage comment, I suggested a contrary possibility – i.e. that the reason we don’t rape and pillage each other these days is because we are allowed to generate wealth and mostly keep what we earn. That, compared to societies of literal slavery or serfdom, where all production is forfeit for the king and crime runs rampant (here, a comparison to Bangladesh would be quite apt).

    So what I’m actually suggesting is that you have identified a causality relationship, but you’ve gotten it backwards. You say that because we don’t live in chaos, we owe some money to the village. I say the fact that we now get to keep more of our money than (practically) ever, that is why we don’t live in chaos.

  56. Gravatar of Benjamin Cole Benjamin Cole
    22. September 2010 at 11:15

    Another question:

    Like all of Scott’s fans, I prefer consumption to income taxes.

    But in a world of global capital gluts, is this the right course anymore?

    What if the pool of savings is too large? Interest rates can only go to zero–but what if people keep saving, for cultural reaons, or because they are going to retire and need the money, no matter the interest rate?

    Could we actually come to a situation in which we need to encourage consumption/ And tax investment?

  57. Gravatar of ssumner ssumner
    22. September 2010 at 12:23

    Wonks Anonymous, I’m a bit skeptical that a single land tax could work except in a very small government economy. But I am probably much more sympathetic to the land tax than most economists. I’m not really sure why they reject it. It may be making the perfect the enemy of the good. Originally people argued it was perfect because it had no disincentive effects. It turns out that’s not quite true, but it is still highly efficient compared to any other tax.

    Unfortunately, it is difficult to suddenly implement, because some people would lose relative to others.

    Andrew C, You asked:

    “I’m a little surprised that you consider a payroll tax equivalent to a consumption tax. Doesn’t a payroll tax discourage work the same way an income tax discourages savings?”

    Yes, but a consumption tax has an equal disincentive on work.

    mbk, You quoted statsguy:

    “this here made me chuckle: “You are missing the exit option – that is, the option of spending money in areas with low consumption taxes after that wealth has been accumulated (e.g. paying no taxes your whole life, then retiring as an expatriot).”

    That’s another advantage of the payroll tax over the VAT.

    Jason, After even more reading you’ll find the paradox of thrift is a bogus idea.

    Philo, I have two problems with the “deserts” argument. First, it has not place in utilitarianism. And second, I don’t think it is right. Consider sports. A superstar in baseball gets much more money that an average baseball player. Yet both probably try roughly as hard. Much of the difference is that one is lucky being born with a high skill level. I agree that hard work also plays a huge role in success, and that’s why I favor continuing to have large differences in income. Even Sweden (which redistributes more than I would favor), still allows people to accumulate billions of dollars. There are some extremely rich people in Sweden.

    Ryan, I am married to someone from China who worked incredibly hard. But that’s the point–I achieved the same economic success hardly trying. And for people in rural China they might have worked as hard as my wife and still not made it. How else do you explain why some countries are so poor? Are people in North Korea much lazier than South Korea? Everyone agrees the answer is no–it’s the system. I can’t imagine how someone could say that a person born in South Korea is not much luckier than one born in the North.

    You seem to be merely assuming that the Danes are not civic minded, because they have a welfare state. But that assumes the answer. I am saying if you look at who is civic-minded using measures having nothing to do with economic systems, then those countries also tend to have big welfare states. For instance, survey questions one whether it is ok to accept government benefits to which you are not entitled.

    Reagrding crime, why is the crime rate so low in countries that have extremely high tax rates, like the Nordic countries?

    But I do know where you are coming from, as I used to have exactly the same views. So you might be right. But I’m a pragmatist, I figure even if I am wrong about complete laissez-faire, my ideas would produce a much better society than what we have now, and that’s worth shooting for.

    Benjamin, I am not sure there is a global capital glut. The reason we don’t build more high spreed rail, or other similar projects is that capital is too expensive. If we saved more those projects would become much more profitable. Ditto for environmentally friendly buildings. We have enormous energy waste because we don’t spend money today that would save lots of energy in the futre. Lower interest rates would encourage more of that.

    Also, much of the inefficiency of our economy is due to things like government involvement in health care and unemployment insurance, and those occur partly because we save too little as a society. And then there is Social Security.

  58. Gravatar of JeffreyY JeffreyY
    22. September 2010 at 13:02

    One point arguing for “wealth” taxes over income or consumption taxes is that “wealth” is something like an option to receive goods (as opposed to a futures contract), and options generally cost more than futures when acquired in the market. Now, inflation itself counts as such a wealth tax, and at 2-4% it’s probably as big as most option premiums. Now if the Fed would just keep inflation in the 2-4% range…

    I’d contest your claim that “money is neutral in the long run–and doesn’t affect real variables.” Certainly the price level is neutral in the long run, but the inflation rate isn’t. The inflation rate adjusts between people’s tendency to hold nominally-safe assets like cash and their tendency to make riskier but more socially valuable investments.

    Nonetheless, count me as a leftist who you’ve convinced that a progressive consumption tax is a good idea. I’m not (yet?) convinced that payroll taxes are equivalent to consumption taxes or that inheritance taxes are a bad idea.

    Economically, I think I see the argument, but socially, both consumption taxes and inheritance taxes serve to drain wealth away from the rich, while payroll taxes and free inheritance allow wealth to accumulate at the top (as StatsGuy pointed out). I believe (admittedly without much evidence) that high wealth inequality reduces GDP overall because the wealthy get more political power with which they seek rents. My goal would be to balance this GDP reduction against the GDP reduction from taxing accumulated wealth (==savings==mostly investment).

    Maybe it makes sense to treat inheritance as consumption and tax it at the same rate. After all, you do say, “I have to treat gifts from the rich [as] part of their consumption.” That’s attractive to me because it gives me a way to think about what the “right” level of inheritance tax is, while at the moment I don’t see a way to construct a solid argument for any particular level.

  59. Gravatar of Brett Brett
    22. September 2010 at 14:31

    Brett; I’m not at all concerned about evolution.

    You should be, seeing as how it touches every aspect of your life and those around you.

    Any kid interested in becoming a scientist will quickly pick up what he needs to know.

    It’s not just about training scientists. This is the same voting public that is going to be deciding issues ranging from vaccination, to drug policy, and so forth. Widespread ignorance of evolutionary processes is dangerous enough as it is (never mind open hostility).

    I also find that attitude rather callous. How exactly is a kid interested in this going to find this information if his family’s been pumping him full of creationist nonsense for his entire life? Where would he even know to start? And no, google is not a substitute.

    Don’t forget the public schools are also religious schools, teaching religions like socialism, feminism, and environmentalism. For instance, my daughter is not presented with the pros and cons of recycling, but only the pros. Yet, studies show it hurts the environment. So they’re just as much “faith-based” as any private school.

    “Environmentalism” is not a religion, unless you think respect for the natural environment is one. I find the idea that you think Feminism is a religion laughable, unless you’re conflating the most radical varieties with the idea that women deserve equal rights and treatment. Socialism is an economic system, with its own set of flaws and concepts.

    And you say you’d fit right in with the Democratic Party? That’s hilarious.

  60. Gravatar of StatsGuy StatsGuy
    22. September 2010 at 16:08

    mbk:

    “BTW, “expatriot” – “expatriate” – sounds like a Freudian lapse if there ever was one…”

    I wish I could say that was intentional satire, but alas, no.

    I was not aware of the trend in Singapore, but it stands to reason – any tax system that is not a fully closed loop will tend to leak. Not unlike regulatory arbitrage… Anti-tax and anti-regulation folks like this aspect of a chaotic international system for obvious reasons.

    But tax-arbitrage is not unique to Singapore. Actually, the case I was thinking about was John Kerry’s yacht.

  61. Gravatar of Bonnie Bonnie
    22. September 2010 at 16:41

    “Also, much of the inefficiency of our economy is due to things like government involvement in health care and unemployment insurance, and those occur partly because we save too little as a society. And then there is Social Security.”

    Which came first, too little saving or big brother? It might have been a little of both to start out with, but after generations of giveaways it seems more like big brother provides some incentive for reduced saving. Why save for the future if someone else is going to pick up the tab for medical expenses when I’m old, even pay for all my drugs.

    That reminds me about the $500 screwdrivers and $1000 toilet seats, etc… price distortion problem whenever the government buys/administers anything — it sort of sticks a fly in the ointment in the redistribution/utility argument. Just to whom are we redistributing? My guess is only a small fraction of everything for which we’re obligated actually serves its purpose with the rest going to that unholy alliance between politics and enterprise. The higher the concentration of power, the more corrupt and inefficient it becomes. That seems like a good enough reason for the 10th amendment to me.

  62. Gravatar of cassander cassander
    22. September 2010 at 18:55

    But you are overlooking the fact that real world consumption taxes such as FICA, or the European VATs, work far better than the income tax, with far less paperwork and evasion.

    With regards to FICA, I still don’t see how relying purely on payroll taxes wouldn’t result in a massive shift away from wage compensation. Of course, the money would still get taxed eventually, but I can’t see how the effect wouldn’t be hugely distorting. It seems to me that an ideal system would encourage cash compensation, since cash compensation is the most economically efficient and transparent form of compensation.

    As for a VAT, I don’t think our government has the energy to implement a radically different system, it’s far to ossified under its own weight. I can’t imagine us having a system that doesn’t rely mostly on individual reporting, and my understanding is that the European systems are administered very differently than ours, though I agree that they seem much more efficient.

  63. Gravatar of greg ransom greg ransom
    22. September 2010 at 20:33

    Tax policy is driven by the impulse to achieve hightened social justice via the redistribution of wealth — lets stop penalizing the production of wealth (via income and capital gains taxes).

    The whole poont is to redistribute wealth, so go for it. Confiscate the majority ofmthe wealth fo Gates and Buffett and the rest in a one time random grab.

    This is the quickest and cleanest way to achieve the real goal — and you do an end run around Buffett and Gates massive tax dodge (i.e. giving themselves power over mega billions of tax free foundation money — which allows them to excercise power outside of the penalty system of taxes.)

  64. Gravatar of MW MW
    23. September 2010 at 01:29

    “paying no taxes your whole life, then retiring as an expatriot”

    The HEART Act, passed by Bush in 2008, imposes an exit tax on those renouncing US citizenship. Google for details.

  65. Gravatar of spencer spencer
    23. September 2010 at 04:02

    Nice academic approach to the subject.

    As I see it taxing savings at a lower rate has two consequences.
    One,it increases the return to savings.
    Two, it generally generates greater income inequality.

    For some 30 years the US has been implementing piecemeal actions to make savings tax exempt.

    But the results have been an increase in inequality and a sharp fall in personal savings.

    Why have the results been contradictory to what theory forecast?

    There is the classic approach that greater returns leads to greater supply– in this case of savings.

    But there is also the behavioral approach that on balance savers have a goal — a million dollar stock portfolio at retirement, for example. If you increase the returns to savings and savers are goal oriented the increased returns means that they do not have to save as much to achieve that goal. so providing greater returns to savings leads to less savings.

    For 30 years we have seen that in the US providing greater returns to savings has lead to less not more savings.

    So the data implies that the behavioral approach is a more realistic approach rather than the classic approach.

    So my question is do you have any hard data or real evidence that you proposal would generate a different result than the past 30 years US experiments with tax exempt savings has generated.

    If not, It would just appear that you are just proposing that we repeat a failed experiment.

  66. Gravatar of spencer spencer
    23. September 2010 at 04:41

    P.S. I would just point out this is also what happens with corporate as well as state & local government pension funds, a major source of private savings.

    If the market has a great year the contributor says the required balances have been achieved and that it is unnecessary to make as large a contribution to the fund.

  67. Gravatar of Joe C Joe C
    23. September 2010 at 06:48

    All I have to say is that every time someone, Like Scott, proposes a different tax regime than is currently in place it gets nit-picked to death. The same happens to me whenever I try to explain to people that we should implement a national sales tax or some other option that taxes consumption. People focus on its minor drawbacks without realizing that consumptions taxes are MUCH BETTER in both an economic and fairness sense than income taxes.

    We are a country of “pickle-suckers”

  68. Gravatar of scott sumner scott sumner
    23. September 2010 at 07:14

    JeffreyY, You said;

    “Economically, I think I see the argument, but socially, both consumption taxes and inheritance taxes serve to drain wealth away from the rich, while payroll taxes and free inheritance allow wealth to accumulate at the top (as StatsGuy pointed out).”

    I’m afraid you don’t see the argument, a consumption tax is the same as a payroll tax. Both tax consumption goods but not investments goods.

    Yes, inflation is a tax on cash balances, which is one reason why a high rate of inflation is a bad idea.

    Under a fiat money system, large real cash balances are not socially costly, as cash can be produced at almost zero cost. Hence it doesn’t reduce other types of economic activity like investment in capital goods.

    You said;

    “One point arguing for “wealth” taxes over income or consumption taxes is that “wealth” is something like an option to receive goods (as opposed to a futures contract), and options generally cost more than futures when acquired in the market. Now, inflation itself counts as such a wealth tax, and at 2-4% it’s probably as big as most option premiums. Now if the Fed would just keep inflation in the 2-4% range…”

    You are missing the point of this post. Neither of the two brothers is wealthier than the other. It’s just that one chooses to spend his money early, and the other one spends it later. They have the same wealth, the same present value of consumption. There is no point in having one pay $50,000 in taxes, and the other pay $58,000 in taxes.

    Brett, You said;

    “I also find that attitude rather callous. How exactly is a kid interested in this going to find this information if his family’s been pumping him full of creationist nonsense for his entire life? Where would he even know to start? And no, google is not a substitute.”

    If you want a kid to learn something, make it forbidden. There is no better way. My view is that all religious fundamentalists are aware of evolution, they just reject it. This is also true of close to half of all kids that went to public schools. Indeed I doubt that private schools students differ much at all from public school students in terms of their belief in evolution.

    You said;

    ““Environmentalism” is not a religion, unless you think respect for the natural environment is one. I find the idea that you think Feminism is a religion laughable, unless you’re conflating the most radical varieties with the idea that women deserve equal rights and treatment. Socialism is an economic system, with its own set of flaws and concepts.

    And you say you’d fit right in with the Democratic Party? That’s hilarious.”

    These subjects are not taught from a pro and con perspective. Don’t you think students should be exposed to scientific studies arguing against the view that recycling helps the environment? How about scientific studies showing innate differences between the minds of men and women? Or should only one side of the argument be presented? Around here, only one side is presented.

    One reason I oppose public schools is that I fear the teachers might be like you, someone who simply ridicules arguments that they are unfamiliar with, calls them “laughable” and teaches students they are bad people if they don’t re-cycle. That they don’t “respect the natural environment” to use your term. That’s precisely the problem; thank you for making my point more effectively than I could.

    statsguy, Again, his Singapore example is not applicable to my proposal.

    Bonnie, I agree.

    Cassander, The IRS currently taxes all compensation in the form of things like stock options. There may be better ways to do it, I’m no expert. They don’t tax health benefits, but they easily could. If they did, firms would stop offering non-cash benefits.

    More to come . . .

  69. Gravatar of Lee Kelly Lee Kelly
    23. September 2010 at 09:06

    This is a really excellent post.

    Let the present value of a widget today be $5. Suppose that $100 is saved at an interest rate with a return of $500 in five years.

    What is the present value of a widget in five years time?

    Principal / Principal + Interest * WidgetToday = Widget+5yr

    100 / 100 + 400 * 5 = 1

    The present value of a widget in five years time is $1.

    By deferring consumption, savers get a discount proportional to the interest rate. They still pay $5 for widgets, but each widget only cost them $1 of income because they postponed consumption. They consume no more than a spenthrift, because they are purchasing fundamentally different products — a widget today is not the same thing as a widget in five years.

    It seems as though the saver is consuming more because he spends more money in the long run. This is something like another money illusion.

    Taxing the interest earned would unfairly penalise savers merely for preferring to purchase a different product i.e. future widgets instead of present widgets. In the above example, a 25% tax would reduce the return to $400, and thus raise the present value of widgets in five years to $1.25. Meanwhile, the present value of a widget today remains at $5, but why?

  70. Gravatar of Lee Kelly Lee Kelly
    23. September 2010 at 09:11

    When I write “return” above I mean the principal + interest. That might be confusing, since “return” usually refers only to the interest earned, I think.

    I am no accountant! Nor an economist, for that matter.

  71. Gravatar of Scott Sumner Doesn’t Know What Income Is Scott Sumner Doesn’t Know What Income Is
    23. September 2010 at 10:38

    [...] No, I’m not saying he doesn’t know what his income is. I’m saying, Scott Sumner doesn’t know what the concept of income is. Check it out: [...]

  72. Gravatar of Bob Murphy Bob Murphy
    23. September 2010 at 10:55

    Scott, there is a lot of good stuff in this post, but I think you are just making a basic economic/accounting mistake at the ground floor. Sure, taxing income is dumb/inefficient because it distorts the consumption/saving decision. But that’s a different claim from saying “income is a meaningless concept.”

    Let’s say I have $1 million that I keep rolling over in 12-month bank CDs at 5%. So every year, I get to consume $50,000.

    I want to say my capital (or wealth) every year is $1 million, and my income is $50,000. What do I “mean” by income? I mean, that’s how much I get to consume, without impairing my wealth.

    In contrast, if my consumption one year is $100,000, then next year my starting capital/wealth will be $950,000. That’s because I consumed my whole income ($50,000), and then on top of that consumed $50,000 of my capital.

    You seem to have no problem with the concepts of wealth and consumption.

    But income is simply a relation between those two concepts. Specifically, income in a period is how much you can consume, without making your wealth fall from this period to the next.

    Do you object to any of the above?

  73. Gravatar of sourcreamus sourcreamus
    23. September 2010 at 11:07

    What would the rates need to be to make up for the tax income lost by not taxing capital gains and corporate income?
    This is a great idea but without numbers it is not actionable.

  74. Gravatar of Scott Sumner Scott Sumner
    23. September 2010 at 11:55

    Greg, I’d much rather have Gates spending his money on the poor, than having our federal government spending the money on who knows what.

    MW, Yes, I heard about that. I’m surprised there wasn’t more debate. It certainly changes the nature of citizenship.

    Spencer, you said;

    “Nice academic approach to the subject.

    As I see it taxing savings at a lower rate has two consequences.
    One,it increases the return to savings.
    Two, it generally generates greater income inequality.”

    Actually it doesn’t as I tried to show with the example. The issue of income equality is completely separate from the issue of taxing saving, at least if you are using “inome equality” in the way most people use the term, as inequality in economic resources, or something like economic inequality. Technically, measured income may be more unequal, but that has no implications at all, as true economic inequality would not be affected.

    I don’t agree that we have been increasing the returns to saving. And that empirical question has no bearing on my argument for eliminating the tax on capital. Even if saving did not increase by one dollar, which is highly unlikely, I would still favor the proposal on all sorts of other grounds. It would greatly reduce economic waste. I just spent $610 paying someone to do my taxes this year–that’s complete economic waste. I spent zero hours doing my FICA taxes. Then there is the unfairness issue, an income tax results in two people with identical wage income paying very different tax rates merely because of when they choose to spend their money.

    BTW, I also favor forced saving schemes, to replace various social programs. Those have been show to boost savings rates in other countries.

    Joe C. Well put.

    Lee Kelly, You said;

    “It seems as though the saver is consuming more because he spends more money in the long run. This is something like another money illusion.”

    Yes, it is kind of like the money illusion. I guess I am drawn to these examples.

    Bob, That’s a good point, and I am certainly aware of that. I do not object to your definition. A few comments.

    1. Let’s be very clear that the concept of “income” that you describe” is NOT the concept of income that is taxed by the federal government.

    2. What I meant is that people believe income is something it’s not. In the back of their minds people believe that income is a statistic kind of like wealth or consumption, something that can be used for interpersonal comparisons to show who is better off. Or something that it might be reasonable to tax.

    But yes, I did know that income is defined by economic theorists as the amount of consumption you could do without impairing your wealth. And in my whole life I’ve never seen people use it that way in the real world, instead they talk about income in ways that are unrelated to what it really means. As when Krugman shows of graph of incomes by quintile.

    I guess ‘meaningless’ was a bit strong, but what possible use is there for a concept that measures how much consumption one could do w/o impairing one’s wealth? I could create a new term “blingcome” and call it how much jewelry one could buy without causing their wealth to fall by more than 2%. Would “blingcome” be an interesting concept?

    Sourcreamus, The actual tax rate would not be higher than at present, but the apparent tax rate might be higher. In the example I give the saver seemed to face a 50% tax rate, but actually faced a 58% rate.

    Of course because you’d close all “loopholes”, that would tend to sharply reduce tax rates. I am assuming total amount of taxes paid would be the same, for the sake of comparison. Of course I prefer a much more low tax regime, like Singapore and HK.

  75. Gravatar of TheMoneyIllusion » Income: A meaningless, misleading, and … « How to Beat the Taxman TheMoneyIllusion » Income: A meaningless, misleading, and … « How to Beat the Taxman
    23. September 2010 at 12:33

    [...] more: TheMoneyIllusion » Income: A meaningless, misleading, and … Related Posts:Secondary Sources: Income Tax, Basel III, Bankruptcy – Real Time … – [...]

  76. Gravatar of Bob Murphy Bob Murphy
    23. September 2010 at 12:54

    Scott wrote:

    “But yes, I did know that income is defined by economic theorists as the amount of consumption you could do without impairing your wealth….I guess ‘meaningless’ was a bit strong, but what possible use is there for a concept that measures how much consumption one could do w/o impairing one’s wealth?”

    I don’t know, but I’m just saying it’s a bit weird to see you rant against a “meaningless” concept because Krugman doesn’t use it properly.

    And anyway, if we’re going to talk about meaningless concepts that lead to horrible policy recommendations, how about NGDP? I mean, do you know how many friggin’ problems there are with that, even in principle?…

  77. Gravatar of Silas Barta Silas Barta
    23. September 2010 at 15:36

    @scott_sumner: I agree with 90% of what you’ve said here, especially about interest taxes being a double-tax on wages. Still, if you tax interest at 0%, and wagest at, say 30%, that creates an obscenely huge incentive to re-classify any wage income as interest income, and some of the most creative minds would be put to work finding

    So I think there’d be a sort of Goodhart problem going on — the economy would reorganize itself so as to blur the distinction between wage and interest income, to the point that it’s no longer even a useful technique to view those as relevant spending categories.

    See the problem with hedge fund managers classifying their income as interest rather than wages? Now multiply that by a million.

    Just a thought…

    @Bob_Murphy: And anyway, if we’re going to talk about meaningless concepts that lead to horrible policy recommendations, how about NGDP? I mean, do you know how many friggin’ problems there are with that, even in principle?…

    ROFL! Well done. NGDP takes all the problems of GDP, and puts them in hyperdrive.

  78. Gravatar of Lucas Lucas
    23. September 2010 at 15:47

    “1. Externality taxes such as a carbon tax.
    2. A land tax
    3. A progressive consumption tax, preferably on wages and salaries (as the VAT is harder to make progressive.)”
    This liberal (or left-wing utilitarian in your parlance) agrees with your ideal tax system as a first-best policy [1]
    Your proposal has several points in common to the one proposed by ecological economist (yep, that’s another heterodox school of though) Herman Daly [2, 3]

    “3. If they favored replacing the public school monopoly with universal vouchers.”
    I’m a little sceptical of school vouchers. Would you accept free/subsidized preschool education as a compromise?
    Which are your views regarding asset-based egalitarianism [4]?

    1- http://rodrik.typepad.com/dani_rodriks_weblog/2007/08/why-do-economis.html
    2- http://www.theoildrum.com/node/3941
    3- http://www.theoildrum.com/node/5464
    4- http://en.wikipedia.org/wiki/Asset-based_egalitarianism

  79. Gravatar of scott sumner scott sumner
    23. September 2010 at 15:57

    Bob, Krugman was just an example, lots of people use income the wrong way. The only ones who use it the right way are people like Will Wilkinson, who ignore it and use consumption instead.

    In contrast, NGDP (despite all its flaws, which are real) is the best way of measuring the stance of monetary policy.
    Silas,

    Silas, You said;

    “@scott_sumner: I agree with 90% of what you’ve said here, especially about interest taxes being a double-tax on wages. Still, if you tax interest at 0%, and wagest at, say 30%, that creates an obscenely huge incentive to re-classify any wage income as interest income, and some of the most creative minds would be put to work finding”

    This isn’t as easy as you think, at least for most companies. Remember, people go to jail for tax fraud. If the company does it publicly, the IRS will demand taxes. If they cheat and do it secretly, they risk going to jail. There is already a huge incentive, as much of capital income has a top rate of 15%, and labor income currently has a top rate of 38%. So I’m not sure the cheating would be much worse than what we already have. And eliminating all loopholes would allow for slightly lower tax rates.

    So it’s a good point, but not insurmountable.

    You said;

    “ROFL! Well done. NGDP takes all the problems of GDP, and puts them in hyperdrive.”

    Exactly the opposite, NGDP is 100 times easier to measure than GDP. For NGDP they just look at spending on total goods. For GDP bureaucrats have to look at every single toaster, computer, car, etc, and estimate how much better it is than last year’s model. GDP and the price level are a socialist’s dream and a libertarian’s nightmare–the government can make them whatever they want them to be.

    So get up off the floor right now!

  80. Gravatar of scott sumner scott sumner
    23. September 2010 at 16:19

    Lucas, Interesting comment.

    I won’t defend vouchers in detail, except to say that I look at education differently from most intellectuals (except perhaps Robin Hanson). Intellectuals (both liberal and conservative) look at education from an intellectual perspective, from a love of learning perspective. But I think it is actually about many other things, and we shouldn’t impose our views on society. That’s why I like choice and competition. It may end up being more about teaching discipline, or about sports, or the arts, or teaching average high school boys how to fix machines, than we now imagine. I’d rather let the market figure it out.

    I think I’d need to think a bit more about asset equality. There is a big efficiency advantage, as it greatly reduces MTRs for the working poor. I do fear that a significant number of poor people would quickly lose their money one way or another, although I’m not sure if this fear is just due to prejudice on my part, or is real. And I’m also not sure what would happen if this occurred, would people feel obligated to provide some basic welfare for those who lost everything? I think so, and that creates a moral hazard problem which might lead the program to eventually revert to income maintenance. So I’ll reserve judgment until I’ve given it more thought.

  81. Gravatar of Silas Barta Silas Barta
    23. September 2010 at 17:38

    @scott_sumner: This isn’t as easy as you think, at least for most companies. Remember, people go to jail for tax fraud. If the company does it publicly, the IRS will demand taxes. If they cheat and do it secretly, they risk going to jail.

    But I’m not talking about cheating [with my suggestion that people would spend effort re-classifying wages as interest], where they just try to *label* one as the other. I’m talking about where they fundamentally restructure the relationship so that it’s difficult to see why such a purported classification (of a wage as interest) is wrong in the first place!

    Right now we know the difference — because there isn’t such a sharp difference, and so many people are in lower brackets, that we don’t bother to blur the distinction. But if you could get rid of *all* your taxes (as your plan would allow) by getting wages to count as interest, then you would have incentives to do much more advanced things. For example, firms could require employees to put up $X dollars of capital for “special issue bonds” and then pay them “interest” equal to the “effective ROR on their sector of the company”, which just happens to be equal to what a worker would normally get as wages. This would, in turn, require more intrusiveness in one’s business to determine the exact nature of a relationship.

    “ROFL! Well done. NGDP takes all the problems of GDP, and puts them in hyperdrive.”

    Exactly the opposite, NGDP is 100 times easier to measure than GDP.

    And 100 times less meaningful, too. The NGDP is simply how many units changed hands one time. That inherits every problem of GDP (like the issue of how much to count “growth” from repairing hurricane damage), plus deletes all information about how valuable the growth is.

    So if all you want to do is goose a meaningless number, then *great*! NGDP is just the thing for that! But some of us tend to judge an economy by how well it satisfies individual preferences. (We’re old-fashioned like that.)

  82. Gravatar of Silas Barta Silas Barta
    23. September 2010 at 17:40

    Just to clarify, the second paragraph of my response should be:

    “Right now we know the difference [between labor and investment] — because there isn’t such a sharp difference [in the tax treatment], …”

  83. Gravatar of MikeSandifer MikeSandifer
    24. September 2010 at 05:01

    This is a great post. Even if one doesn’t agree, it makes for some interesting reading.

    This is a very simple argument, and yet I’ve seen it nowhere else.

  84. Gravatar of Greg Ransom Greg Ransom
    24. September 2010 at 07:58

    Let’s get real, Scott.

    They’ve already spent it. And they’ve already mandated it.

    You don’t get this option. If you are talking about the actual world.

    Scott.

    “Greg, I’d much rather have Gates spending his money on the poor, than having our federal government spending the money on who knows what.”

  85. Gravatar of Greg Ransom Greg Ransom
    24. September 2010 at 08:07

    Scott, your social justice tastes are not the topic.

    The spending choices of Congress are already on the books.

    And the choice for massive redistribution has also been made.

    We’re looking for the best way to achieve these two goals at the same time.

    You remarks below are non-responsive to the issue.

    Leaving Gates with the money leaves him with massive power over wealth. And Federal spending and mandates are a given of the problem set.

    Scott wrote,

    ““Greg, I’d much rather have Gates spending his money on the poor, than having our federal government spending the money on who knows what.”

  86. Gravatar of Floccina Floccina
    24. September 2010 at 10:56

    The income tax also taxes the labor of wives of high earners at a high marginal rate, encouraging them to opt to provide tax free goods and services for in family consumption rather than working in the tax paying economy. A progressive payroll would not have this problem.

  87. Gravatar of scott sumner scott sumner
    24. September 2010 at 16:10

    Silas, We’ll just have to agree to disagree. There is a big difference in tax rates now, and the IRS has very clear rules. There’s no way you can easily blur the line and claim you didn’t know you were violating the law. All compensation would be taxable; health benefits, interest income that’s payment for labor, everything.

    You said;

    “For example, firms could require employees to put up $X dollars of capital for “special issue bonds” and then pay them “interest” equal to the “effective ROR on their sector of the company”, which just happens to be equal to what a worker would normally get as wages. This would, in turn, require more intrusiveness in one’s business to determine the exact nature of a relationship.”

    No firm would be nutty enough to do that. The IRS would be all over them, making their lives a nightmare. And to get a salary if even $50,000 you have to put up something like a million dollars on first being hired. What young worker can do that? I assure you, it won’t happen except in very unusual cases, not enough to cause a big problem.

    You said;

    “And 100 times less meaningful, too. The NGDP is simply how many units changed hands one time. That inherits every problem of GDP (like the issue of how much to count “growth” from repairing hurricane damage), plus deletes all information about how valuable the growth is.”

    Completely wrong. The hurricane damage problem only applies to RGDP, as that is used to measure living standards. It doesn’t distort NGDP at all, as NGDP is not used to measure living standards, it is used to stabilize the business cycle.

    Mike Sandifer, You said;

    “This is a great post. Even if one doesn’t agree, it makes for some interesting reading.
    This is a very simple argument, and yet I’ve seen it nowhere else.”

    Thanks. BTW, I don’t want anyone thinking these are my ideas. This is all standard public finance theory. But in the real world I find many don’t know it, have forgotten, or never really understood the full implications. But it’s not at all controversial among both liberal and conservative tax experts. There are lots of other examples. Tax experts agree that the VAT doesn’t distort trade, but I find most people think it gives an unfair advantage to exports.

    Greg, I don’t follow your point. Are you saying we can’t meet our entitlement obligations without an inheritance tax on Gates? Even some of the Northern European countries lack an inheritance tax (I forget which ones), and they have much higher tax burdens.

    Floccina, Yes, last month I did a post on the marriage penalty.

  88. Gravatar of Scott Greene Scott Greene
    25. September 2010 at 09:56

    This country has been indoctrinated into thinking that the Income Tax system is the way to fund the government.

    But the Income Tax system is a corrupt mess and only gets worse as time goes on.

    Eventually the whole Income Tax system is going to collapse on itself as it gets larger and larger, more paper intensive, more confusing and mind numbing.

    If you add in the fact that the Income Tax code itself is close to 70,000 pages long plus the hundreds of thousands of pages that make up Income Tax Revenue Rulings, Private Letter Rulings, Tax Memorandums, Tax Publications and Tax Court cases, you can see that the whole system has turned into a complicated and unintelligible mess.

    The Income Tax system is also extremely inefficient.
    That’s why there has been and always will be a “tax gap”.

    Plus the Income Tax code is NOT always progressive for extremely wealthy individuals and corporations.
    That is because of all the Income Tax credits, deductions and loopholes that is written into the code itself.
    Extremely wealthy individuals are able to zero out their extremely high taxable income by taking advantage of these credits, deductions and loopholes because of this “system”.

    Finally, according to President Obama’s tax commission, citizens of this country pay close to 140 BILLION DOLLARS in tax preparation fees on a yearly basis.
    They also spend over 7 BILLION HOURS in Income Tax record keeping.on a yearly basis.

    And on top of all this, Treasury Secretary Geithner (who is in charge of the Income Tax) and Congressman Rangel (who writes Income Tax policy) both don’t know how to correctly fill out their own Income Tax returns.

    So when those who write Income Tax law and those who are in charge of administering Income Tax policy don’t know how to correctly fill out their own Income Tax return, what hope is there for the rest of us?

    The time has now come for an open and honest debate on what to do about this screwed up current Income Tax system.

    In a recent survey of foreign companies, 80% of them would build their next factory in the United States if the Income Tax system was abolished and another 20% of them would would relocate their whole company back here entirely.

    That means jobs and manufacturing coming back to the United States.

    The current and corrupt Income Tax system does NOT work.
    It fails to collect all taxes due, it is NOT always progressive and it is made up of complicated, confusing, paper intensive and mind numbing rules and regulations that are explained in hundreds of thousands of pages that nobody actually understands.

    It needs to be replaced now

  89. Gravatar of scott sumner scott sumner
    26. September 2010 at 06:45

    Scott, All very good points.

  90. Gravatar of Greg Ransom Greg Ransom
    26. September 2010 at 09:30

    “Greg, I don’t follow your point.”

    Maybe bullet points will help.

    * Taxation is part of a system aimed at creating “social justice” and the redistribution of wealth.

    *If we want to go after the inequality — go after the inequality. Go after the wealth. And don’t set up systems that directly penalize income or capital returns. Let people generate as much wealth as efficiently as possible. Then randomly appropriate a big chunk of the wealth from those who “win” the most in the game of economics — i.e. wealthiest.

    *The spending side is under-funded.

    *You don’t reduce inequality — the kind that bothers people — unless you seriously go after the 1% at the top.

    *Taxing the income and capital gains of those in the range after the top 1% ers doesn’t touch the inequality that interests folks.

    *You could take the assets of 1/2 of the 1% and use those assets to fund all of the unfunded government pensions and medical and old age programs. Inequality is reduced. Capital gains income remains. We end the taxation of income and capital gains.

    So what is it you don’t follow? It might not work, but that is a different issue. If you want to discuss that, well, lets change the topic to that.

  91. Gravatar of Greg Ransom Greg Ransom
    26. September 2010 at 09:33

    The key points are these:

    * Taxation is part of a system aimed at creating “social justice” and the redistribution of wealth.

    *You don’t reduce inequality — the kind that bothers people — unless you seriously go after the 1% at the top.

    *I agree with you. We want to pursue a tax plan that furthers the given goal of the system (i.e. reduce inequality and redistribute wealth) without penalizing income and capital gains.

    I have a plan for doing that. I don’t see that you do.

  92. Gravatar of Greg Ransom Greg Ransom
    26. September 2010 at 09:42

    The ideas is — have the equivalent of an inheritance tax on a random slice of the 1% ers _before_ they die.

    Take the assets and put them a managed account funding all of the mandates and unfunded pensions of the Federal government and the states.

    Don’t penalize annual income and annual capital gains — get serious about reducing inequality and redistributing wealth, with a purely random lottery system, targeted at the 1%ers, the only ones who really matter when it comes to serious inequality.

  93. Gravatar of Tracy W Tracy W
    26. September 2010 at 16:00

    1. Most of your income comes from luck. If you’d been born in a poor peasant household in Asia or Africa, your income would be low no matter how hard you worked. You hit the jackpot just being born in a developed country.

    Your conclusion does not follow from your premise. I had the good luck to be born into a comfortable NZ household, but if I did no work my income would still be low. Clearly most of my income comes from work. (Yes, there is a dole in NZ, but it’s a low income). This logic is just as good as your logic that most of my income comes from luck, so by your logic my income is overdetermined.

    More generally, this sort of argument is silly. For most of us, both good luck and hard work are essential for earning a good income (excepting of course lottery winners and heirs to large fortunes). Breaking them up into percentages, even as roughly as “most”, is meaningless on a conceptual level, just like it’s meaningless to say that most of your x years of life comes from water, not food – if you never ate you’d be as dead now as if you never drank. I am lucky to be able to earn a good income, and I work for it. I am alive because I drink water and because I eat food.

    2. Our wealth comes from living in a highly functional society, thus part of your wealth is due to the fact that your neighbors don’t go around raping and pillaging as in the old days, but rather peaceably go to polling stations to vote. Am I saying; “It Takes a Village?” Sort of, more precisely “it takes a civic-minded culture.”

    I can’t see that this bears any relevance to taxes. Yes, part of my wealth is due to the fact that my neighbours don’t go around raping and pillaging as in the old days, but part of their wealth is due to the fact that I don’t go around pillaging as in the old days, so as far as that goes, my neighbours and I are quits. Unless of course you wish to argue that women should be taxed at a higher rate than men, because we on average are less competent at rape and pillaging and thus benefit more from a general refraining from such behaviour.

  94. Gravatar of VABALOG » Blog Archive » Intresside ja dividendide maksustamisest VABALOG » Blog Archive » Intresside ja dividendide maksustamisest
    27. September 2010 at 05:33

    [...] Landsburg (1, 2, 3) ja Scott Sumner on mõlemad viimaste nädalate jooksul kirjutanud maksudest. Kui täpsem olla, siis intresside ja [...]

  95. Gravatar of ssumner ssumner
    27. September 2010 at 07:57

    Greg, You said;

    “*If we want to go after the inequality — go after the inequality. Go after the wealth. And don’t set up systems that directly penalize income or capital returns. Let people generate as much wealth as efficiently as possible. Then randomly appropriate a big chunk of the wealth from those who “win” the most in the game of economics — i.e. wealthiest.”

    That seems a contradiction. How can you “randomly” only go after the rich? If you only go after the rich, it’s not random, and hence it is a disincentive to create wealth.

    Greg; You said;

    “*You don’t reduce inequality — the kind that bothers people — unless you seriously go after the 1% at the top.”

    Inequality at the top doesn’t bother me in the slightest, I’m only bothered by poverty at the bottom.

    Tracy, You said;

    “Your conclusion does not follow from your premise. I had the good luck to be born into a comfortable NZ household, but if I did no work my income would still be low. Clearly most of my income comes from work. (Yes, there is a dole in NZ, but it’s a low income).”

    Your income, even adjusting for cost of living differences, would be much higher on the NZ dole, that what the average person in Bangladesh earns after working really really hard. And for every one person in NZ, there are 40 in Bangladesh.

    Here’s another way of making my point. Donald Trump might say he’s earned his income because he’s worked really hard. But isn’t it partly because he’s worked with a lot of very talented people? Suppose he had to do everything on his own? And suppose he lived in a country where people who could not pay their debts were put into prison? He once went through bankruptcy, didn’t have to pay his debts, and has now bounced back to being a billionaire. The system has helped Trump hugely, he’s not some Robinson Crusoe who did everything on his own.

  96. Gravatar of Tracy W Tracy W
    27. September 2010 at 09:57

    Your income, even adjusting for cost of living differences, would be much higher on the NZ dole, that what the average person in Bangladesh earns after working really really hard.

    1. If no one in NZ worked, then my income on the NZ dole would not be much higher than what the average person earns in Bangladesh. It would shortly be zero, once the government ran out of the ability to borrow money and sell assets. Labour is necessary for the level of wealth a developed nation enjoys. If everyone in the world stopped working, the ability of the NZ government to borrow money and sell assets would be irrelevant. Work is necessary for high incomes as well as luck.

    2. The income that the average person in Bangladesh earns after working really really hard is higher than what said average person would earn if they did no work at all.

    I’m not arguing with you that luck is a vital factor for enjoying a high income. I’m arguing that work is also a vital factor for enjoying a high income. Both are essential, and thus it’s nonsensical to say that our incomes mostly come from luck. They equally mostly come from work. I don’t think we can determine in what proportions our incomes come from luck and what from income, I think it is a meaningless question.

    Donald Trump’s income is dependent on luck, and it’s dependent on work. I’ve seen him on TV, he’s working, he might be enjoying himself but he’s also working.

    As for the “working with very talented people”, this is as irrelevant as the “raping and pillaging” argument. The very talented people provided services to Donald Trump, and Donald Trump hopefully provided services to the very talented people, so they’re quits, just as my neighbours not raping and pillaging me is balanced out by me not raping and pillaging them. (There is a possibility that Donald Trump, or anyone else, is in fact an incompetent or a scam artist who didn’t provide valuable services, but the solution to that is to change the rules of the game to provide better incentives to act to help your neighbours in a market economy, not to raise taxes on high earners independently of whether they’re harming or helping society. For example, in an open-access fishery, fishermen harm society’s economic interests by overfishing, the correct solution to that is to change to a closed-access fishery, not to raise top marginal tax rates).

    The system has benefited Donald Trump, and Donald Trump has, hopefully, benefited the system. To take a simpler case, J. K. Rowling has benefited from society, and she has also created huge wealth in the form of an imaginary world that people enjoy and find further enjoyment in discussing and creating in with others (see fan sites). Yes, J. K. Rowling’s gotten bloody rich, but in a market society she’s also made lots of people better off too. There’s no call for extra taxes on J. K. Rowling, she’s quits, or probably we’re in debt to her. On a more moderate level, take the farmers who make the food I eat, they save my life, in return for what? £50 a week from me? Huge value created by them, not by some undefinable system, but by real people. And, after those farmers have provided that massive value to their fellow human beings, what argument is to tax them to provide any more? What further duty do they have? Yes, they’ve benefited from society, but they’ve benefited society. Society is obliged to them, not the other way around.

    By your logic, we shouldn’t be taxing the Donald Trumps or the J.K. Rowlings of the world, or the farmers. We should be taxing the severely disabled who can’t work, the slackers, the incompetent marginal workers. They’re the ohes who benefit from society’s economy without contributing in an economic sense. However, as they don’t earn much, we need to find another principle on which to tax. Your tax principle is a failure in the practical sense.

  97. Gravatar of Greg Ransom Greg Ransom
    27. September 2010 at 17:46

    Scott, your normative values aren’t of interest — were trying to come up wih the best policies within the normative constrains already expressed by vast majorities and by the intellectual elite.

    Again, you change the topic to avoid confronting the issue. Your value tastes are ofd topic.

    Scott writes,

    ““*You don’t reduce inequality — the kind that bothers people — unless you seriously go after the 1% at the top.”

    Inequality at the top doesn’t bother me in the slightest, I’m only bothered by poverty at the bottom.”

  98. Gravatar of ssumner ssumner
    27. September 2010 at 17:59

    Greg, I’d comment on your proposal, if I understood it. You seem to be claiming that it’s possible to redistribute wealth without reducing people’s incentives to create wealth, and it isn’t.

    Tracy, I agree that rich people tend to earn their marginal revenue products. So in that sense I differ from those on the left. Where I differ with those on the right is that I don’t think the concept of MRP has any moral implications at all. It’s just a number. Almost all output is produced jointly. Just because someone’s MRP is $X dollars, doesn’t mean they are morally entitled to $X. I agree we don’t want to do too much redistribution, but not because taxation is theft, rather because we’ll kill the goose that lays the golden eggs.

  99. Gravatar of Greg Ransom Greg Ransom
    27. September 2010 at 19:50

    No. I’m not claiming that.

    But what we _are_ trying to do is to redistribute wealth in a way that does the least to reduce people’s incentive to create wealth.

    That can be the only point of your original post — the point of which was come up with a system of massive taxation (i.e. what we have) which didn’t overly penalizing wealth creation — income and capital gains.

    And the massive tax system we have is aimed mostly to redistribute wealth — both by the taxing and by the spending of it.

    It’s this simple.

    The goal of the tax / spending system is to redistribute wealth.

    That is a given.

    With that as a given, how what sort of tax system will redistribute wealth in a way that satisfies people’s sense of social justice — will doing the most to make the pie bigger.

    Scott wrote,

    “you seem to be claiming that it’s possible to redistribute wealth without reducing people’s incentives to create wealth”

    And I don’t think it is arguable that super wealth is the thing that stands behind the social justice intuitions that drive the tax side of the American redistribution system.

    See, for example, Thaler and Thoma:

    http://economistsview.typepad.com/economistsview/2010/09/the-great-income-shift.html

  100. Gravatar of Greg Ransom Greg Ransom
    27. September 2010 at 19:53

    A VAT tax simply doesn’t achieve social justice or a redistribution of power and wealth.

    That isn’t your aim. But it is the aim of the American redistribution system.

    It this a normative project you are laying out, or one of positive economics?

    Or are you muddling the two?

    Unmuddling things would help sort out the value judgments from the economics.

  101. Gravatar of Scott Sumner Scott Sumner
    28. September 2010 at 05:50

    Greg, You said;

    “And the massive tax system we have is aimed mostly to redistribute wealth — both by the taxing and by the spending of it.
    It’s this simple.”

    That may be the ideal, but it’s certainly not the system we have. Most of the money is taken from the middle class, and redistributed back to the middle class.

    Regarding your second point, I’m not advocating a flat VAT, I am advocating a progressive payroll tax. The later does redistribute just as effectively as an income tax. That’s what I tried to show in the post.

    Regarding the Thaler and Thomas post, that’s exactly the sort of thing I am criticizing. The data is all nonsense, adding up blueberries and watermelons as if they are the same thing. Garbage in garbage out. We won’t be able to come up with any intelligent fiscal policies until we stop thinking in terms of income, and start thinking in terms of consumption.

  102. Gravatar of Tracy W Tracy W
    28. September 2010 at 07:42

    Where I differ with those on the right is that I don’t think the concept of MRP has any moral implications at all.

    On the one hand, one can’t get from an “is” to an “ought” statement. On the other hand, one has to start somewhere when it comes to deciding what to do, such as who to tax and how much.

    Just because someone’s MRP is $X dollars, doesn’t mean they are morally entitled to $X.

    And typically, in a well-functioning market society, we get less than our MRP, with the exception of whichever workers are at the margin (and, practically, some lucky sods who get more than their MRP and really should be fired).

    I agree we don’t want to do too much redistribution, but not because taxation is theft, rather because we’ll kill the goose that lays the golden eggs.

    So you reject the starting point that taxation is theft, and embrace the starting point that the wealth belongs to government, who may be wise not to tax it all away, but certainly has the moral right to?
    That’s as an arbitrary starting point as the “taxation is theft”.

  103. Gravatar of Greg Ransom Greg Ransom
    28. September 2010 at 09:03

    It’s the massive inequality of power and wealth that folks want to “correct”.

    It’s impossible for Soros and Gates and Buffett, etc. to consume the the bulk of their wealth in personal consumption.

    Taxing income, payroll, capital gains, etc. is a direct penalty on dedicating goods and labor to production and creation and work.

    If you want to redistribute wealth (which is exactly what intent is) you redistribute wealth — you go after the wealth (Sweden long had a 1.5% wealth tax on the very rich — like a property tax. Luck plays a role in the achievement of massive wealth, and I’m proposing “luck” as a means for randomly taxing massive wealth — which all agree is some measure is a product of various forms of luck, as you yourself have argued.).

    And what you say about redistributing middle class money to the middle class is false — we in part redistribute upper middle class money to the lower middle class and to the lower class. But we also redistribute masses of top 1% income / capital gains to the rest of the population.

    Scott wrote.

    “We won’t be able to come up with any intelligent fiscal policies until we stop thinking in terms of income, and start thinking in terms of consumption.”

  104. Gravatar of TheMoneyIllusion » Income and wealth inequality data: Nonsense on stilts TheMoneyIllusion » Income and wealth inequality data: Nonsense on stilts
    29. September 2010 at 05:04

    [...] keep running across blog posts showing the inequality of income and wealth in America.  In a recent post I already discussed one reason why this data is fatally flawed, capital income is nothing like [...]

  105. Gravatar of Income and Wealth Inequality Data: Nonsense on Stilts Income and Wealth Inequality Data: Nonsense on Stilts
    29. September 2010 at 09:06

    [...] keep running across blog posts showing the inequality of income and wealth in America.  In a recent post I already discussed one reason why this data is fatally flawed, capital income is nothing like wage [...]

  106. Gravatar of Barry Ickes Barry Ickes
    29. September 2010 at 10:31

    I manage a hedge fund. I take a management fee and share of returns. The government calls this capital income. You say this should not be taxed because it is the income from past savings. But not my past savings. It is a return to my management effort but you think it should not be taxed. I don’t understand why not? How does this differ from your labor as a professor?

  107. Gravatar of ssumner ssumner
    29. September 2010 at 12:23

    Tracy, You said;

    “So you reject the starting point that taxation is theft, and embrace the starting point that the wealth belongs to government, who may be wise not to tax it all away, but certainly has the moral right to?
    That’s as an arbitrary starting point as the “taxation is theft”.”

    Yes, it is equally arbitrary. My bedrock assumption is utilitarianism, not natural rights. And like all bedrock assumptions, it is arbitrary. I wouldn’t say money “belongs” to the governemtn, I define ‘government’ as “those with a monopoly on force.” They have the power to tax. My view is that they should do it wisely, and at low levels.

    Greg, You said;

    “But we also redistribute masses of top 1% income / capital gains to the rest of the population”

    I don’t accept this, because I don’t buy any of the estimates of the incidence of taxation. Many assume “the rich” absorb most of the corporate income tax, for instance. I think it more likely that they pass the tax on to consumers.

    Barry, You said;

    “I manage a hedge fund. I take a management fee and share of returns. The government calls this capital income. You say this should not be taxed because it is the income from past savings.”

    I see why you thought I said this, but in fact I think it probably should be taxed. You are providing a service, and your income is paid out of the capital income of the investors. Your income should be taxed, just as if he spent his capital income on getting a haircut, the barbers income should be taxed.

    Having said this, I am not an expert on taxation, and I don’t doubt that there are some difficult choices with any system, including a progressive consumption tax. I favor taxation at the level of payroll taxes, which in the US apply both to ordinary wages, and also wages paid in the form of stock options, etc.

  108. Gravatar of JeffreyY JeffreyY
    29. September 2010 at 14:15

    Oops, you’re right that payroll taxes (properly arranged, without a cap, etc.) are equivalent to consumption taxes (properly arranged). I forgot to think about the incidence of the taxes, even though your post told me to. The evolution of the taxes is likely to be different since they hinge on questions with different intuitive answers: What’s consumption? vs What’s payroll? For example, is buying the services of a hedge fund consumption? Is compensation for providing it payroll? Is CEO compensation payroll? How about profits of an S-corporation? It’s possible to answer all of these so that payroll taxes==consumption taxes, but I suspect in the real world they won’t be, so the choice of what to call it matters. Renaming “payroll” to “compensation” might help bring them closer together.

    On the brothers’ final level of wealth I’m not so sure. At the start, certainly they were equally wealthy, but 40 years later, the one who saved has more assets, consumption, wealth, and power than the one who consumed early. He “deserves” this windfall, but I still think such power disparities are bad for society, and I’m not sure exactly what to do about them. It’s even worse if each brother leaves their accumulated assets to their kids, since the kids don’t deserve the windfall, even though the parents deserve to dispose of their assets however they like.

    Intertemporal problems are hard.

  109. Gravatar of Greg Ransom Greg Ransom
    1. October 2010 at 20:58

    I’ve never understood this argument.

    It seems a throwback to pre-marginalist thinking, where costs determine prices.

    “Many assume “the rich” absorb most of the corporate income tax, for instance. I think it more likely that they pass the tax on to consumers.”

  110. Gravatar of ssumner ssumner
    2. October 2010 at 08:13

    Jeffrey, So you’re saying it’s morally OK for a rich guy to blow his wealth on wild orgies, but not give it to his children?

    Greg, I think prices are determined by marginal costs. But tax incidence theory is fiendishly complex, and the honest answer is that no one knows for sure.

  111. Gravatar of In which I take a huge steamy link dump | Andrew Bensley In which I take a huge steamy link dump | Andrew Bensley
    1. November 2010 at 21:54

    [...] McArdle on why the corporate income tax should be done away with. Best read in conjunction with this piece by Scott Sumner on income and [...]

  112. Gravatar of Thinking Clearly About Capital, Interest, and Income Thinking Clearly About Capital, Interest, and Income
    8. November 2010 at 07:33

    [...] few weeks ago I promised to “eviscerate” Scott Sumner’s blog post, in which he claimed that income was a “meaningless, misleading and pernicious” [...]

  113. Gravatar of TheMoneyIllusion » Comment on Murphy and Thaler TheMoneyIllusion » Comment on Murphy and Thaler
    14. November 2010 at 10:39

    [...] an argument that blows away my critique of income: A few weeks ago I promised to “eviscerate” Scott Sumner’s blog post, in which he claimed that income was a “meaningless, misleading and pernicious” concept. It is [...]

  114. Gravatar of Scott Sumner’s Funeral: A Shovel-Ready Project Scott Sumner’s Funeral: A Shovel-Ready Project
    25. November 2010 at 20:42

    [...] is meaningless and pernicious.” To refresh your memory, Scott first advanced this thesis here. Then I criticized his view [...]

  115. Gravatar of 収入: 無意味でミスリーディングで有害な概念 by Scott Sumner  – 道草 収入: 無意味でミスリーディングで有害な概念 by Scott Sumner  – 道草
    8. December 2010 at 08:16

    [...] by Scott Sumner  // 原文はScott Sumner のブログから Income: A meaningless, misleading, and pernicious concept(Sep 21st, [...]

  116. Gravatar of Einstein Brain – Randomness of life Einstein Brain – Randomness of life
    6. May 2011 at 12:19

    [...] will have to re-read Sumner’s brilliant post on income, and think about the justification for progressive income [...]

  117. Gravatar of TheMoneyIllusion » Warren Buffett faces a 90% plus tax rate TheMoneyIllusion » Warren Buffett faces a 90% plus tax rate
    9. September 2011 at 15:11

    [...] been arguing that his tax rate is equal to the amount of tax paid, divided by his income.  As I argued here, income is a nearly meaningless concept in economics.  All tax incidence questions need to be [...]

  118. Gravatar of TheMoneyIllusion: Warren Buffett faces a 90% plus tax rate « The Spamlist TheMoneyIllusion: Warren Buffett faces a 90% plus tax rate « The Spamlist
    9. September 2011 at 15:56

    [...] arguing that his tax rate is equal to the amount of tax paid, divided by his income.  As I argued here, income is a nearly meaningless concept in economics.  All tax incidence questions need to be [...]

  119. Gravatar of Tom Tom
    10. September 2011 at 18:41

    First of all I agree with you and would support a system exactly like the one you laid out.

    However, my only quibble with this post involves the estate tax and the assumption that someone can target how much they spend before they die. That is a very uncertain variable. While they could buy a security which yielded a certain amount of income until their death with all their money (or some subset based on how much they want to pass on to their children), we’ve seen people rarely do this (ignore if this is a rational action or not). I see that it is a double tax, but I’m very suspicious of your two points:

    2. Because of diminishing marginal utility, it’s better to share your wealth with one other person. He wins on utilitarian grounds.

    3. The inheritance tax discourages saving, and thus reduces the capital stock. This lowers the real wage of workers who work with physical capital.

    Regarding number 2, if it’s better to share your wealth with one person it’s even better to share it with more people (You stated earlier: “Because we already assumed the existence of a progressive payroll (or consumption) tax, which is redistributing the optimal amount of money to the poor.” I would posit that optimally, every child started out with the exact same amount of wealth and prospects for advancement).

    Regarding number 3, I think this is just one side of the coin. If you want your children to have a certain amount of wealth, then you would have to save even more if there was an estate tax to target this amount. That would result in more investment and higher growth. I don’t have evidence that this occurs or doesn’t, but I don’t see your statement as convincing; it’s only one of the two possible outcomes. Any studies that prove/disprove your statement? Mankiq made a similar statement in a NYT article he wrote but provided no evidence as to why his assumption was the correct one either.

    Thanks for your time if you got through this whole post. I know it comes down to this being a double tax, but I’m not yet convinced that it is distorting, taking into account the uncertainty of a person’s time of death.

  120. Gravatar of Warren Buffett Faces a 90% Plus Tax Rate | Tax News Warren Buffett Faces a 90% Plus Tax Rate | Tax News
    10. September 2011 at 23:31

    [...] that his taxation rate is equal to a volume of taxation paid, divided by his income.  As we argued here, income is a scarcely incomprehensible judgment in economics.  All taxation occurrence questions [...]

  121. Gravatar of Tom Tom
    11. September 2011 at 03:43

    I’ve come up with what may be a loophole in your tax regime. What if someone starts a business, IPOs it, but keeps 90% of the stock for himself. He pays his taxes on the current value of that stock. Now he pays himself enough to get by in salary, but no more; all the rest of his company’s gains go into stock price appreciation. He gets off never paying labor income on the gains that are a direct result of him not paying himself salary but instead letting the money cause the company’s value to increase (and thus his stock portfolio). What do you do in this instance?

    I would assert this is like Warren Buffett in that he owns a large piece of Berkshire and his compensation comes through the appreciation of this asset due in no small part to his labor which he is not paid a market wage for. He accepts this below market wage because his labor goes directly into stock price appreciation, making him richer. It’s actually a pretty good tax dodge even in our current system come to think of it.

  122. Gravatar of ssumner ssumner
    12. September 2011 at 14:32

    Tom, I don’t think taxing saving will encourage people to save more, but I don’t have any studies in front of me.

    I agree that it is better to share your wealth with more than one person, but I don’t see that as affecting my argument.

    The case of self-employed income is tricky. I believe they are currently required to pay the payroll tax on this income, and I would favor continuing that system. I agree that it may be difficult to define labor income precisely, but that’s equally true of our current system.

  123. Gravatar of UJncle Jeffy UJncle Jeffy
    13. September 2011 at 19:03

    Oh. My. God. Worst example of sophistry I’ve ever encountered.

    Apparently your Ph.D. readings at Chicago skipped Deirdre McCloskey’s “The Rhetoric of Economics.” If rhetoric is how economists debate amongst themselves, then clearly you missed that text and its lessons.

    Start with “…the “principle” that all forms of income should be taxed equally … is like a “principle” that all kinds of fruit should sell at the same unit price.” Just be sure not to smoke around this straw man.

    Sp: Two Texas brothers each have $1,000,000 in cash in their pockets. One brother’s cash comes from the ownership of a (privately held) pipeline company. The other brother’s income comes from the sweat of his brow, playing quarterback for the Dallas Cowboys. Both men enter a Ferrari showroom and each plunks down $240,000 for a new Ferrari 458 Italia. The salesman happily hands the keys to an Italia to the quarterback, but declines the business-owner brother’s cash with a sneer – explaining that, after all, “there’s no such thing as income.”

    Tell ya what: if there’s no such thing as income, hand all of yours over to me.

  124. Gravatar of ssumner ssumner
    14. September 2011 at 16:31

    Jeffy, You said;

    “Apparently your Ph.D. readings at Chicago skipped Deirdre McCloskey’s “The Rhetoric of Economics.” If rhetoric is how economists debate amongst themselves, then clearly you missed that text and its lessons.”

    No, I’ve read it, but you obviously haven’t. McCloskey approves of the use of rhetoric in debates.

    Have no idea what the Ferrari example means, but then maybe rhetoric isn’t your strong suit.

  125. Gravatar of Archibald Archibald
    27. November 2011 at 14:11

    A few questions:

    1- What do you think of a financial transaction tax? Could VAT or equivalent be extended to financial transactions?

    2- What do you think of revenues from investment (ie. bond revenue or dividends from state owned enterprises (eg. for US TVA))

  126. Gravatar of Follow-Up on Labor versus Investment Taxes Follow-Up on Labor versus Investment Taxes
    19. January 2012 at 19:25

    [...] a fan of the work of Bohm-Bawerk on capital & interest, I recoil in horror when somebody like Scott Sumner declares that “income is a meaningless concept.” It’s true, Steve Landsburg didn’t [...]

  127. Gravatar of Income and Consumption: It’s OK to Be Different Income and Consumption: It’s OK to Be Different
    27. January 2012 at 21:23

    [...] example below demonstrates), and Steve merely says, “Point extremely well taken.” (B) Sumner actually wrote a post saying the very concept of income was “meaningless, misleading, and [...]

  128. Gravatar of AG AG
    6. March 2012 at 19:25

    I think there is a loophole in this tax regime.
    Consider this: A citizen inherits a lot of wealth, so much that he’s able to live entirely of capital income. For simplicity, lets say all his capital is in government bonds. How much does this citizen pay in taxes compared to someone who works for a living? Only what comes through VAT, estate and externalty taxes. If this citizen uses public infrastructure and services to the same degree as everyone else, then it’s obviously unfair. Expand the example to a piont where say 25% of the citizenry lives of capital income, and state revenue starts to fall compared to expenses.
    This problem would be solved by having only VAT, instead of taxing wages.

    You mentioned capital stock gets destroyed by an inheriteance tax. Why is this?

  129. Gravatar of TheMoneyIllusion » Initial thoughts on the deal TheMoneyIllusion » Initial thoughts on the deal
    2. January 2013 at 15:37

    [...] Update:  Or my earlier post. [...]

  130. Gravatar of Paul Paul
    7. January 2013 at 15:12

    Long time reader, first time commenter here. I know I am responding to a very old post here, but I found it via your link on “Initial thoughts on the deal”.

    I agree with your logic on the two brothers example. There should be no tax on savings in your example. But I am curious to your thoughts on a slight twist to it.

    What if both brothers save 40% of their income, but one invests as you say and quintuples his money over 40 years investing in a zero-coupon Treasury bond. The other invests the same amount of money but is able to decuple his money over the same period. So, whereas the first brother has $100,000 at age 65 (he paid 50% in taxes at 25), the other has $200,000. Should this excess $100,000 be taxed?

    Does it matter if the excess return was due to skill or luck? In my example, one brother clearly is wealthier than the other, even on an NPV basis. With a real consumption tax, he would be taxed on this extra wealth as he consumed it. With the payroll tax, he is not taxed on it at all. So, I am a bit confused by the idea that a payroll tax is equivalent to a consumption tax.

    I think the correct and fair tax here is to tax the extra $100,000 at 50% regardless if it is due to skill or luck. For one, it does represent extra future consumption, so it is more consistent with a consumption tax to tax it. Secondly, it is not fair to characterize this as an increase in nominal lifetime income due merely to a preference to consume later as the first brother shared that preference. It is not derived merely from the time value of money. Lastly, if it was from skill, it really is wage income in a sense. If it was from luck, there is no utility in favoring the lucky by not taxing them.

    This line of reasoning leads me to believe that we should be taxing investment income that is beyond the market risk-free rate. This is especially true for the carried interest of hedge fund managers.

    I would really appreciate your thought on this.

  131. Gravatar of Classical Values » Inequality and Iniquity Classical Values » Inequality and Iniquity
    23. January 2013 at 12:36

    [...] Income/wealth inequality isn’t a real problem, that notion is rooted in a false zero-sum view of the economy — most of the wealth around today was newly created over the last 50 years, and your neighbor getting richer doesn’t actually make you poorer. Consumption inequality is a bit more logical (and is fun to get angry about) but it doesn’t really matter much (especially if you look at absolute consumption levels over time, which are always rising for all quintiles). In a sensible discussion of inequality, the focus needs to be on production inequality — consumption has always been limited by available production, since the first humans started making food and tools. [...]

  132. Gravatar of Lake Atlantic-begone | It Don't Mean Much, These Seats are Cheap. Lake Atlantic-begone | It Don't Mean Much, These Seats are Cheap.
    11. March 2013 at 19:00

    [...] Scott Sumner’s magnum opus on taxes, and recent commentary on the wealth tax. Scott and I are on the same page, but I should note that [...]

  133. Gravatar of How to Analyze Taxes | azmytheconomics How to Analyze Taxes | azmytheconomics
    12. March 2013 at 12:04

    [...] Further Reading: Garett Jones on taxing capital Robert Frank on the Progressive Consumption tax Scott Sumner on the optimal tax [...]

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