Bob Murphy thinks he has 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 now ready for your inspection. Flowers and condolences can be sent to Scott Sumner’s widow, c/o Bentley University.
Not so fast there partner, I’m not dead yet. Here’s a comment from his essay:
In the comments section of his first post, I asked Sumner if he had a problem with the standard definition of income. I reminded him that it is the amount of consumption that one could afford, without reducing the value of capital. Sumner replied, “I do not object to your definition. … I guess ‘meaningless’ was a bit strong, but what possible use is there for a concept that measures how much consumption one could do [without] impairing one’s wealth?”
This reply actually flummoxed me; it’s akin to asking what possible use there is for the concept of profit. Specifically, a household needs to calculate its income, in order to know if it is “living beyond its means.” We can make the analysis more esoteric if we wish. For example, one of the key issues in Austrian business-cycle theory is that people during the boom period enjoy a false prosperity — a high standard of living — because they are unwittingly consuming their capital. These crucial issues are dependent on the basic definition that Sumner finds useless.
I hate it when people quote my comments; often my brain is fried by the time I answer my 100th comment in a day. But I’ll stick by this one. Profit is useful because it tells firms whether to enter or exit an industry. Positive economic profit suggests you should enter, and negative economic profit is a signal to exit. But income is a signal for . . . what? Surely not for consumption. Yes, it tells you how much you can consume without digging into capital, but why would you want to consume that much? I had negative income in 2008, but I didn’t decide to do negative consumption. I dug into my capital—which Bob suggests is violating the recommendation of Austrian business cycle theory. Entschuldigen sie bitte! (That’s ‘sorry’ in Austrian.)
Bob also finds an inconsistency in my critique of income taxes.
By the same token, I could challenge Sumner’s own argument for a tax on consumption. Imagine two identical people who could each hold a $100,000-per-year job. Person A goes to work, and spends his entire income on goodies each year. Because the government imposes a Scott-Sumner-approved 11 percent tax on consumption, this man pays $10,000 to the government, and actually only consumes $90,000 worth of goodies.
On the other hand, person B decides to be a drifter. He only works occasionally at odd jobs; he spends most of his days hitchhiking, watching the sunset, and working on his great American novel. He doesn’t cheat on his taxes, though: out of the $10,000 in annual income that he earns, he saves none of it, sends $1,000 to the government, and consumes the remaining $9,000 in goodies.
I could very easily condemn this hypothetical consumption tax, and along Sumnerian lines. After all, the two men had equal abilities at the start of their adulthood. Person B could have chosen to work in the office and earn enough money to spend $90,000 each year on consumption. But instead, person B chose a different path. So why in the world should the government tax him far less than it is taxing the “equivalent” person A?
So far, so good. I am showing that the (immoral and inefficient) consumption tax cannot hold up to scrutiny; it isn’t really true that people who “consume” more are necessarily “richer” and therefore able to pay more, as Scott Sumner and other advocates of the consumption tax seem to think.
But what if I went further? Suppose I went on to argue, “Indeed, the very concept of labor income is meaningless, misleading, and pernicious. In our example, person A earned ten times as much ‘labor income’ as person B, but there is no reason to suppose that person A somehow has a better life, since person B could have made the same choices. Indeed, ‘labor income’ is really just forfeited leisure. The drifter could have devoted his hours to office work, but instead he chose to ‘purchase’ $90,000 worth of his time from himself. Therefore, to count ‘labor income’ as a form of freebie flow of wealth is to count the same hours twice.”
Now, regardless of how one feels about the validity of a consumption tax, does anyone want to go so far as to say that a paycheck isn’t really a form of income after all? I submit that Sumner made an analogous mistake in his own analysis. Just because we can imagine scenarios in which an income tax (that includes interest and capital gains) is patently unfair, does not mean that interest income therefore isn’t “really” income. Rather, it simply means that the conventional calls for progressive income taxes are misguided.
OK, whenever I lose an argument on logical grounds, I fall back on pragmatism. I agree that consumption doesn’t really measure the theoretically relevant concept. People get utility from goods, services, and leisure. In practice it’s hard to tax leisure, or even measure leisure, so we tend to estimate living standards based on consumption, and we tend to tax consumption despite the fact that it distorts the labor/leisure choice. We could avoid the distortion with a head tax, but that is probably too regressive. On the other hand a land tax just might work.
Of course Bob will say the tax discussion is off-topic (I always use sleight of hand when losing); he showed that my argument against income could just as easily apply to consumption on purely logical grounds. And I admit that my critique was more about specific uses of income (taxes, Gini coefficients, etc) than the concept itself. Consumption is also less than perfect, as a tax base and as a way of judging living standards. But I still think it’s much better than income. So income is truly evil, and consumption is just a little bit naughty.
Oh, and my wife says she’d prefer red roses.
Part 2: Richard Thaler tries to defend the indefensible
First, it is incorrect to say the estate tax amounts to double taxation. The wealth in many large estates has never been taxed because it is largely in the form of unrealized — therefore untaxed — capital gains. A 2000 study found that for estates worth more than $10 million, unrealized capital gains represented 56 percent of assets. For estates with active farms and businesses, the percentage is much higher. If no estate tax is imposed, capital gains taxes can be avoided indefinitely.
In fact, any tax on capital income is double taxation of labor income. That’s why a consumption tax is best. What Thaler should have said is that the estate tax is not necessarily triple taxation. Triple taxation would occur if you earned some labor income, paid taxes, saved some of the remainder, earned capital gains on the saving, paid capital gains tax, and then was taxed when you died and left the remainder to your niece. We need to abolish the estate tax and replace it with a progressive consumption tax (i.e. payroll tax.)
Greg Mankiw replies to Thaler, and has much better arguments.