Tax luxury, not wealth or income

I favor very high marginal tax rates on the super rich, say 70% to 80%. But I am also opposed to all income taxes and all wealth taxes. Why?

Let’s start with the conservative argument that taxes on the super rich will deter work, saving, and investment, by reducing the incentive to build more wealth. Is it true? The answer will depend on the type of tax.

If you look at the behavior of superrich people like Bill Gates and Warren Buffett, they tend to spend only a few extra pennies on consumption, for each extra dollar they earn. Thus it does not seem like extra consumption is an important motivation for the superrich, beyond a certain point. So perhaps high taxes are not a disincentive.

Warren’s (relatively) modest house

Ah, but you might argue that they have other motivations. They like to be big time philanthropists, or they like to build their business empire up to greater and greater heights. That’s their real motivation, and a punitive tax rate would therefore discourage them from putting in the extra effort that we want to get from talented people. I agree.

But that proves my point! You don’t want a punitive tax on income or wealth; you want a punitive tax on very high consumption—say beyond $50,000,000/year. Gates and Buffett would still be able to use their income for charity and investment purposes, with no almost deterrent effect from high taxes. They’d only be punished for an excessively lavish lifestyle.

Now admittedly there might be a few billionaires that would be deterred by a high consumption tax, say Larry Ellison. But even there, the deterrent effect would be less than you might think. That’s because a lot of the high-end consumption is positional goods.

Let’s suppose that currently the biggest yacht is a 400-foot monster, and Larry Ellison wants a 500-foot one—to impress his friends. Also suppose that a steep consumption tax prevents Larry from getting this mega-yacht. You might argue that this reduces his utility, and would discourage his effort to make Oracle the best company it can be.

Ellison purchased this 453-foot yacht (then sold it to David Geffen)

But here’s what you are missing. The high tax rates would not just apply to Larry Ellison, but to all the superrich. Thus if Larry had to scale back from a 500-foot yacht to a 400-footer, his closest rival would scale back from a 400-footer to a 320-footer. The relative ranking of consumption would be roughly unchanged. Ditto for real estate, where the exact same people would still live on the ocean in Malibu, but the price of land would fall to reflect the lower consumption of the superrich. Ditto for fine art.

Larry Ellison can enjoy parties on a 400-foot yacht surrounded by young Ukrainian beauties just as much as he can enjoy parties on a 500-foot yacht, as long as his closest rivals only have 320-foot yachts. That’s how human brains work, and that’s why even a 70% or 80% tax on consumption doesn’t really deter work effort from the superrich, or at least not as much as conservatives fear.

I’m not sure the best way to implement a progressive consumption tax. One could imagine two systems, one for employees of companies and one for the self-employed. Company employees would simply pay a progressive payroll (FICA) type tax. Very simple—no forms to fill out, even for LeBron James. A wage tax is identical to a consumption tax, in the long run.

The self-employed would pay an income tax with unlimited 401k privileges (which is effectively a consumption tax). So they’d only be taxed when they consumed their income. Income from any shares you own in your own company would be viewed the same as income earned by the self-employed—i.e. “wage income”.

The heirs of the rich would receive their inheritance in 401k-type accounts, and they’d pay taxes as they pulled the money out of those accounts to consume it.

There’s a difficult issue in determining how to tax existing stocks of wealth, at the point the new system goes into place. Perhaps a compromise where existing stocks of wealth above a certain threshold are put into a 401k-type structure, but taxed at a lower rate—in recognition of the fact that a part of the wealth has already been taxed.

If your country needs to raise large sums of money (and it shouldn’t–see Singapore), you need multiple tax systems; otherwise there will be too much evasion. These might include VATs, property taxes and carbon taxes. The property tax is a sort of tax on housing consumption, to make up for the fact that VATs don’t include housing. Currently, the superrich in places like New York pay a far lower rate of property tax than average homeowners, whereas they should pay a far higher rate. The fact that even liberal cities like New York are this regressive is an indication of the confused nature of our debate over taxes. Commenter “dtoh” has proposed a VAT where the poor are rebated what a poverty line person would spend on consumption, so that the tax is not regressive.

Read the debate in the blogosphere and you’ll see that people are horribly confused by taxes; they aren’t even debating the right issues. They talk piously about the need to tax capital income, which is the worst possible way to think about taxes. Meanwhile Larry Ellison will continue to enjoy his 500-foot yacht, with the extra 100 feet made of steel and employing labor that could have been used to provide dozens of cars for average people.

Sad!

PS. Some people like the following analogy. On Christmas Eve, people bring presents and put them under the tree. The next morning, people show up and grab presents from under the tree. Should we tax those who put them under the tree, or those who take them away the next morning? Based on how much you produce or how much you consume?

PPS. This post is on the superrich. I’m not sure how to handle the far more numerous ordinary rich–perhaps a 50% MTR on consumption. That sounds bad, but don’t forget the unlimited 401k privileges for the rich self-employed. That sort of tax would actually be less than 50% of one’s income. If they are rich wage earners, you can view the system as unlimited Roth IRA privileges.

PPPS. This post was a bit unfair to Larry Ellison, as he sold his 453-foot yacht to David Geffen and bought a smaller one, which could access more ports. And he has far more sophisticated taste than Trump. But I still maintain that high-end consumption is largely about positional goods.

Right bias steering and right side deviations

If tight money is defined as below target NGDP, in what sense can below target NGDP be said to be “caused” by tight money? I’ll use an analogy to answer this question.

Imagine a ship crossing the ocean. The goal is to cross in a straight line, but the captain makes occasional mistakes and these result in a wavy path across the sea. Deviations from the straight line are called “right side deviations” and “left side deviations”. They are costly, resulting in excess fuel usage.

Steering mistakes that result in right side deviations are called “right bias steering”, and vice versa. Is there any other way to usefully define steering bias, other than by the evidence of path deviation? You can’t simply look at the steering wheel setting, because it may be turning right or left to offset wind and waves. This may not reflect steering errors.  In most cases, you can only spot biased steering by the results.

However, one can imagine a scenario where the force of waves is so powerful that even turning the steering wheel to the limit is not enough to stay on the desired path. The ship might be “trapped” away from the path by the enormous force of liquid waves pushing against it. Let’s call that situation a . . . oh I don’t know . . . how about a “liquidity trap”.

Now we have two possible causes of right path deviation. There might be right bias steering, and there might be a liquidity trap.

Now assume there are two schools of thought when it comes to steering ships. The pessimists worry that the force of waves may occasionally be so strong that the steering mechanism is unable to maintain the desired path. The pessimists argue that path deviations are caused by multiple forces, and that right side path deviations are especially likely to result from liquidity traps, because the strongest storms tend to push ships to the right.

The optimists believe that ships always have enough engine power for the captain to maintain a straight course if he does his job properly, setting the wheel at a position expected to keep the ship on the desired path. They believe that drunken captains occasionally use the “liquidity trap” theory as an excuse for incompetent steering. They scoff that the only liquidity problem is the liquid contained in the captain’s whiskey bottle.

The optimists believe that 100% of path deviations are caused by biased steering. Because there is no way to identify biased steering other than by observing path deviations, the optimists have become famous for equating biased steering with path deviations. Right side deviations aren’t just caused by right bias steering; they are effectively identical to right bias steering. Not because they are identical in a deep philosophical sense (one is a wheel setting and the other is a path), rather because as a practical matter one always implies the other.

This wasn’t true in the “Golden Age” of sailing, but it is today, especially given the widespread use of powerful modern ship engines built by the Italian firm Fiat, which are more that strong enough to offset any wind and waves.  Indeed some optimists seem to reject the laws of physics, claiming that Fiat engines have virtually infinite power, able to reach hyper-speeds.

The analogies could of course be taken much further.  Right bias steering tends to push a ship into dangerous waters, where liquidity traps are more likely.  This explains why the more competent captains are skeptical that liquidity traps even exist; they almost never see them.  Indeed one famous Australian captain never saw one during his entire 100-year career.

Here’s another analogy.  Pessimists tend to define steering bias in terms of whether the wheel is turned to the left or the right, not in terms of the setting of the wheel relative to what’s needed to keep the ship on course.

Here’s another.  Pessimists occasionally call for tug boats to nudge the ship back on course.  Optimists claim that tugboats are useless, as any competent captain will already be steering the ship back on course, and thus will “offset” the force of the tugboat.

PS.  I don’t know if this post was helpful.  For those who didn’t follow, the straight path across the water is stable NGDP growth, and right side deviation is falling NGDP.  (Left side is excessive NGDP.) Right bias steering is tight money (often associated with the political right), while left bias steering is easy money.

Optimists (i.e. market monetarists) define tight money as falling NGDP, and they also believe that falling NGDP is caused by tight money.  However, they understand that this definition only makes sense if monetary policy has infinite power to influence nominal aggregates.  And that’s only true with Fiat . . . I mean fiat money.

PPS. I suppose “port” and “starboard” deviations would be better, but I don’t want to confuse landlubbers like me.

Then and now

In 1969:

Leftists: Free speech on campus!

Conservatives: Ban speakers with communist sympathies.

In 2019:

Conservatives: Free speech on campus!

Leftists: Ban speakers with non-PC views.

(OK, I’m cheating a bit—conservatives don’t like anti-Israeli speech.)

In 1969:

Conservatives: Cut your hair and conform to society’s norms.

Leftists: I’ll wear my hair any way I choose.

In 2019:

Leftists: Stop braiding your hair and conform to your ethnic group’s norms.

Conservatives: I’ll wear my hair any way I choose.

It seems like leftists and conservatives are constantly disagreeing and constantly changing their views. Not so, they agree with each other and never change their views. Both conservatives and leftists agree that those with the most power should tell the rest of us how to live. The only thing that changes is the balance of power.

Central bankers and the Great White Whale

Here’s the Financial Times:

Global economy: Why central bankers blinked

It’s been 18 years since I read Moby Dick, but I vaguely recall that Captain Ahab made the mistake of anthropomorphizing the white whale.  Ahab had a sort of steely-eyed gaze—and didn’t blink when seeking revenge.

Central bankers need to work hard to avoid anthropomorphizing the market.  Better to view market forecasts as a sort of natural force, like wind and waves.  If market forecasts change (as they did late last year), then by all means “blink”.  

It’s nothing personal.

What I’ve been reading

The Mercatus Center has a new paper by Stephen Matteo Miller and
Thandinkosi Ndhlela
, which examines the Zimbabwe hyperinflation. Here is the abstract:

Unlike most hyperinflations, during Zimbabwe’s recent hyperinflation, as in Revolutionary France, the currency ended before the regime. The empirical results here suggest that the Reserve Bank of Zimbabwe operated on the correct side of the inflation tax Laffer curve before abandoning the currency. Estimates of the seignorage maximizing rate derive from a short-run structural vector autoregression framework using monthly parallel market exchange rate data computed from the ratio of prices from 1999 to 2008 for Old Mutual insurance company’s shares, which trade in London and Harare. Dynamic semi-elasticities generated from orthogonalized impulse response functions indicate that the monthly seignorage-maximizing rate equaled 108 to 118 percent, generally exceeding monthly inflation.

One often thinks of hyperinflation as showing the weakness of fiat money. But in a strange way it also shows the enormous value of fiat currency. The fact that the revenue maximizing rate of inflation is so high is an indication that people really value their traditional fiat currency, and will only abandon it under the most costly forms of hyperinflation.

2. It seems like ideas take about 10 years to go from whacky MoneyIllusion posts to conventional wisdom. In early 2009, I said the Fed should consider negative interest on reserves, an idea that was widely dismissed at the time. A new study Vasco Cúrdia of the San Francisco Fed suggests that the actual lower bound was more like minus 0.75% (100 basis points below the Fed target), and that having negative interest rates on reserves would have allowed the Fed to achieve a higher inflation rate and a faster economic recovery.

Some people will complain that they hate the idea of ultra-low interest rates, which punish savers. They overlook another argument I frequently make, which is also widely ignored. A more expansionary policy means higher interest rates over any extended period of time. Take a look at this graph in the Cúrdia paper:

If you want higher interest rates in the future, pray for easier money today.

3. In a previous post I discussed a David Beckworth interview with Adam Ozimek, discussing the “hidden recession” of 2016. Now Ozimek and Michael Ferlez have an online paper with a more in depth explanation of what happened. The basic idea is that the Fed raised rates prematurely in late 2015, and this sharply slowed the recovery in 2016.

It is clear from comparing past projections to the current one that the Fed made a numerically significant error in underestimating the amount of labor market slack over the past few years. How consequential this error was depends upon on how the error maps to monetary policy decisions. We utilize two approaches to demonstrate how the Fed might have differed the path of federal funds rates if it had not underestimated labor market slack: a revealed preference approach and a rules-based approach.

This paper provides an excellent case study of why we need the sort of “look back” accountability process that I’ve recently been advocating.

Note: I’m am not saying that 2016 was an actual recession—it wasn’t. Rather it was an unwarranted slowdown in NGDP growth (which may have cost Hillary the election):

HT: David Beckworth

Update: I also recommend this Greg Mankiw review of Trump’s economic policies. I’ve seen Mankiw’s essay mischaracterized as claiming no long run growth effect from the recent tax cuts. That’s not quite accurate, especially under the plausible assumption that the cut in corporate tax rates will be extended beyond 10 years. Mankiw is a moderate supply-sider, as am I.