A modest proposal

This post won’t describe my preferred tax regime.  Rather I’ll describe two reforms that would greatly improve economic welfare and leave the distribution of taxes almost unchanged.  Both parties should support the plan, although I doubt either actually would.

1.  Remove all income tax loopholes.  All of them.  Reduce tax rates enough so that each income decile pays the same amount as before.

2.  Eliminate all capital taxes for people with less that $100,000 in capital income.  I.e. on the first $100,000 of passive capital income. Make up the lost revenue (which would be surprisingly little) by modestly raising the Medicare payroll tax on those making more than the Social Security cut-off point (roughly $110,000/year.)  The tax cut would mostly benefit the affluent, but some benefits would go to those making less than $110,000 in wage income.  All of the tax increase would fall on the affluent.  The net effect would probably be to make the system a tiny bit more progressive.

The combined effects of both plans would reduce MTRs for everyone. More importantly, the net effect of these two changes would be that 99% of non-self-employed people would not have to file income tax forms.  The IRS would simply withhold the appropriate amount of wage and salary income, and that would be the end of it.  For those lucky people (like me!) the income tax would become essentially identical to the payroll tax, except with a more complex rate structure.

This would cause huge numbers of tax-preparers to lose their jobs, freeing up labor for other more useful jobs like gardening and cleaning swimming pools.  Also more dog psychologists.  It would end my dread of the month of April.  It would boost capital formation, for reasons Matt Yglesias discusses in this post.  It would also be much fairer, as high savers are currently taxed at much higher rates that spenders with equal lifetime wage incomes (for reasons Yglesias hints at in the preceding post.)

Most people with capital incomes below $100,000 work for a living.  The big hedge fund guys would still have to fight it out with the IRS.  Is their income a return of capital, or on services rendered?

But please, leave me out of that fight.  There’s no reason for the IRS to bother the rest of us.

PS.  I don’t have time today to blog on monetary policy, but I’d point you to some excellent David Glasner posts (here and here), criticizing the hard money folks.  And Brad DeLong pushes back against an unusually weak argument by John Taylor and Phil Gramm.



71 Responses to “A modest proposal”

  1. Gravatar of Morgan Warstler Morgan Warstler
    23. September 2012 at 10:58

    If the donut eater has an argument against Taylor, he needs to make it better than he does.

    Simpley, the donut eater doesn’t think we have “bad fiscal and regulatory policy”

    And by fiscal we mean too much spending on wagon riders and rent seekers.

    It means he views QE as important FOR THAT REASON, to keep the wagon riders in the wagon, and then try to make the economy recover.

    1.3M on disability for “mood disorders”?

    Again DeKrugman is not for NGDPLT unless it starts off with make-up, which is not actually being for NGDPLT in and of itself, on its own merits.

    And since Scott won’t answer WHY he’ll take no make-up if he has to, we can’t get to the bottom of the argument.

    Why or why can’t we get an honest answer from econ bloggers?

  2. Gravatar of JL JL
    23. September 2012 at 11:10

    Ah, finally a tax proposal from Scott that I can broadly agree with!

    Up until now I thought you wanted to abolish all taxes on capital, greatly benefiting the Paris Hilton’s and Koch brothers at the expense of the working men like you, me and Joe the Plumber.

    Do note that closing all tax loopholes is easier said than done.
    Consider that the Swedes can’t manage to tax Ingvar Kamprad (IKEA)…

    But though it is hard, I do believe the US could accomplish it: the US is uniquely capable of just bullying all the tax havens in submission.

  3. Gravatar of foosion foosion
    23. September 2012 at 11:12

    By income tax loopholes do you mean all deductions? Would you also eliminate all tax credits? Would munis continue to be tax-free?

    Just curious, as nothing like this has any chance of becoming law.

  4. Gravatar of jk jk
    23. September 2012 at 11:21

    This is a great post. Sad about the 0% chance of being passed. But I wonder if you’ve said exactly what you mean, in one case — and whether or not I agree would depend on the answer. You say:

    > Reduce tax rates enough so that each income
    > decile pays the same amount as before.

    But wait. I imagine (I am no kind of expert and don’t know) that those of us lucky enough to be in some upper decile, many of us having bought expensive houses — that our decile in fact pays a shockingly low rate. That is, the mortgage interest deduction probably makes de facto rates horribly regressive.

    I think this is a bug in the current system. So I think the ideal would eliminate it. So I would say:

    > Reduce all tax rates, keeping fixed the relative sizes
    > of the current brackets, so that the total income
    > tax paid by everyone in sum is the same as before.

  5. Gravatar of johnleemk johnleemk
    23. September 2012 at 11:30


    I was wondering the same thing until I got to the para where Scott emphasised that this would eliminate the need for most people to file income tax returns. On that basis, I’m pretty sure Scott wants to eliminate virtually every deduction and credit in the tax code. It’s a great idea, but hell has a better chance of freezing over than any chance this policy has of being implemented.

  6. Gravatar of Saturos Saturos
    23. September 2012 at 12:09

    Scott Sumner: Busy day, no time to blog, I think I’ll just leave an offhand note on how to end partisan war over taxes…

  7. Gravatar of Saturos Saturos
    23. September 2012 at 12:10

    4 years later: mainstream press picks up note, partisan war actually ends.

  8. Gravatar of Ram Ram
    23. September 2012 at 12:14

    I would say that the first step is to eliminate taxation of investment income. Allow businesses to report only income from sales under the corporate income tax, and allow workers to report only income from labor under the personal income tax. Eliminate the capital gains tax, the dividend tax, the estate tax, etc.

    The second step is to eliminate double taxation. Allow businesses to deduct purchases from other businesses, as well as labor expenses.

    The third step is to broaden the tax base. Do not allow businesses or workers to deduct anything else from their taxable income.

    The final step is to lower marginal tax rates at the top so that we end up with lower and fewer rates, but the same level of revenue.

    There is some face-value political support for each of these steps in both parties, and if they were executed to a large extent we would converge upon either the flat tax or the X tax. No other taxes would be needed for purposes of raising revenue of adjusting the distribution of wealth. (Other taxes may be desired for other purposes, such as discouraging socially destructive activities–e.g., pollution).

    It is funny that there is very broad support among non-economist intellectuals for many of these ideas, and yet the flat tax is usually viewed as a right-wing obsession/fantasy like the gold standard. In theory, a 100% rate flat tax, together with one-size-fits-all rebates, would effect complete equality. I don’t favor that, obviously, but the point is that there is nothing in the flat tax/x tax reform proposals that is inegalitarian, properly understood.

  9. Gravatar of John David Galt John David Galt
    23. September 2012 at 12:30

    Before you can simplify the tax code in any way at all, and have it stick, you’ll first need to rid Washington of all lobbyists. Thus, my own modest proposal is to ban all incumbent politicians, at any level of government, from raising funds for future runs for any office. This will mean no consecutive terms, but that’s OK with me. Legislation ought not be for sale to anyone with a sack of bribe money, and lobbyists’ only function is to hold those sacks.

  10. Gravatar of David S. David S.
    23. September 2012 at 13:12

    Question: Why do you want to lower tax rates? I understand the theoretical reason that if you’re on the wrong side of the Laffer curve, lower rates leads to more revenue and more output, but does anyone think we’re on the wrong side of the Laffer Curve? The only workers that face high marginal tax rates in this country are low-income workers whose assistance programs phase out as their income rises, providing a substantial disincentive to make more money. That is a serious problem that needs to be addressed. But the idea that a 35% or 39.6% top marginal income tax rate is strangling effort, I find implausible. Cap deductions for high earners, phase out some deductions (mortgage interest, employer provided coverage) while making sure you’re not blowing up housing or health care policy. That’s a big part of my ideal tax reform.

    I don’t understand why “eliminate deductions and cut rates” is the standard tax reform proposal. Yes, cutting rates at the margin increases incentives to work because people get more for each dollar, but it also decreases incentives as many people will get to their desired income levels with less work. At the same time, eliminating deductions sounds great, but we make a lot of policy through the tax code. What happens to employer-provided health care, or housing? What happens to programs like the EITC and CTC that increase labor force attachment for low-income workers?

    Meanwhile, with respect to lowering rates, does anyone really think we’re on the wrong side of the Laffer curve? Why not limit deductions and keep the rates that we have? That gives more revenue and a more efficient system.

  11. Gravatar of David S. David S.
    23. September 2012 at 13:13

    Ahh, well, the bottom two paragraphs of that weren’t meant to be included in the actual comment. Oh well.

  12. Gravatar of Major_Freedom Major_Freedom
    23. September 2012 at 14:32

    Eliminating all tax loopholes would require politicians to break their promises to their campaign contributors. If advocating for a politically infeasible plan does not make one an ideologue, then I propose ending the IRS altogether. After all, if we are going to be extremists, we might as well reduce federal taxes to zero.

  13. Gravatar of Jon Jon
    23. September 2012 at 14:41

    But the idea that a 35% or 39.6% top marginal income tax rate is strangling effort, I find implausible. Cap deductions for high earners, phase out some deductions (mortgage interest, employer provided coverage) while making sure you’re not blowing up housing or health care policy. That’s a big part of my ideal tax reform.

    Do you make more than the social security cap? I do, and the moment I cross the cap and my take home goes up, I feel more joy and satisfaction. So I think you are wrong. I often consider taking a lower paying job with more regular responsibilities and more regular 8-5 hours rather than having responsibility to catch all the loose balls and solve problems on the line that I had little prior control over. My take home pay definitely changes my long run choices.

  14. Gravatar of JVM JVM
    23. September 2012 at 15:28

    Maybe once the fed adopts NGDP-LT you can start a new blog dedicated to switching over the US to a pure progressive consumption tax.

    The income illusion maybe?

  15. Gravatar of ssumner ssumner
    23. September 2012 at 16:48

    I think a lot of people mistinterpreted this post. The ideal system would eliminate all taxes on capital, as Ram indicated. That’s what I favor. Here I was merely proposing a modest reform, which no one in either party should object to. I could see lots of people objecting to the “ideal” tax plan.

    David S, I don’t enjoy spending endless hours filling out stupid tax forms. Apparently you do.

  16. Gravatar of ssumner ssumner
    23. September 2012 at 16:50

    JVM, Yup, Once I “save the American economy” it’s on to “saving the American taxpayer.” 🙂

  17. Gravatar of ChargerCarl ChargerCarl
    23. September 2012 at 20:50

    “Haha! Now you see my true form!”

    -Scott without his Irving Fisher super suit on

  18. Gravatar of Bill Ellis Bill Ellis
    23. September 2012 at 21:58

    Scott, I really like your proposal.
    That it basically keeps everyone paying the same (at least by decile, but not within the upper deciles. ) and simplifies everything, should, in a rational world, be an easy sell…but sadly it is not.

    Too many elite special interests on one end of the spectrum that benefit from fine tuning the tax code to their needs with congressmen in their pockets.

    On the other end of the spectrum there is a different problem…I really think a plan like this could be an effective populist vote getter… ‘cept for one thing…

    It preserves lower taxes on the capital income for the elite compared to the higher taxes on labor of hard working common folk.

    Did you notice Matt Yglesias’ post…”Why Mitt Romney’s Effective Tax Rate Is So Low And Why It Probably Should Be.” ?

    Matt’s post makes the argument that Mitt’s tax rate is good because low rates on capital provide the best utility for the economy overall…kinda awkwardly…not his best writing.

    It got over 1800 comments…most of them telling Matt he was full of crap.

    For sake of argument let’s say you and Matt are right …Lower taxes on capital are better for the economy.

    But I have to ask …Is utility the only legitimate way to look at taxes? Is there an issue of fairness that transcends utility?

    I realize that doing what ends up being the best for everyone, even if it comes from giving preferential treatment to some, can be seen as fairest approach…

    But giving one group preferential treatment is a hard sell. It asks the individual to submit. It asks the individual admit to themselves that their utility is inferior. And their POTENTIAL utility is inferior because they will see their discriminatory tax status as a personal barrier on their future utility.

    In short economists are asking people who derive their income from labor to ignore their own best individual interests and needs to make a sacrifice for the good of society at large…the collective. Ironic.

    Funny how no-one who advocates for low/no capital taxes ever seems to look at it that way…Kinda elitist…Those poor dumb workers just can’t see the big picture.

    Is the Utility of a low/no capital tax worth that ? (I don’t know. How much is it worth? )
    At the very least, the utility needs to be highly significant to ask people to submit to a discriminatory tax policy that benefits wealthy comfortable investors over struggling working folks.
    I don’t think you will be able to sell lower capital taxes for the elite until the working man is truly socially secure…then it would be easy…But until then it is not fair to ask a guy who can’t count on being able to provide for his family to sacrifice for the greater good.

  19. Gravatar of JL JL
    23. September 2012 at 23:55

    Agree with Bill Ellis,

    It boils down to: taxing capital reduces incentives to form capital.
    Looking at how much capital is locked up in unproductive assets (excess reserves, gold, bonds), then I fail to see why that is a bad thing, but let us assume it is.

    If you do not tax capital, then you must tax labor and/or consumption, which reduces incentives to perform labor or to consume.

    And this too will also reduce utility.

    Progressive consumption taxes are optimal, so I would favor eliminating or reducing taxes on capital AND labor in favor of increased taxes on consumption.

    But Scott and Yglesias (both of which I admire greatly) agree in favor of taxing labor more heavily than capital and the logic is simply not clear to me.
    How does society gain by reducing the incentives to work?

    Consider the two brothers: the spending brother will work until he dies to maintain his lifestyle, but the saving brother could eventually retire on his investment income and society will thus lose his labor.

    Or the saving brother may cease his normal labor in order to work on his investments and this work will not be taxed as labor income, e.g. Steve Jobs famously received a $1 salary from Apple and thus paid no income tax. Steve only paid capital gains on his Apple shares, but who can deny that his labor was worth more than $1?

  20. Gravatar of David Krych David Krych
    24. September 2012 at 00:03

    Totally agree. It was a revelation to move to the United Kingdom, where only the self-employed fill out tax returns. The capital gains limit is just $16,000, however, unlike your proposal.

    To the extent that the government here actually wants to subsidize something (tuition, homeownership etc.) they send money directly. You don’t have the “spending through the tax code” that occurs so often in the US– “I’m doing interventionist social policy, and it’s a tax cut to boot!” Charities have a system where you fill out a form (just name and address) with your donation, the government sends the charity the tax you paid on the money that you donated.

  21. Gravatar of Saturos Saturos
    24. September 2012 at 00:57

    Bill Ellis, capital income earners (“capitalists”, if you will) are not a seperate group. Anyone can purchase capital income, by saving. Richer people will be able to purchase more, of course, just like any other good. See these Steven Landsburg posts: http://www.thebigquestions.com/2010/09/14/getting-it-right/
    Scott did a post once too, but I can’t find it (it’s a wonder I can find anything on this site).

    If you want to tax rich people more progressively, then it makes no sense to execute any given level of progressivity and revenue with a more inefficient system rather than a less (making the pie smaller), unless you have some sort of Marxist bias against the very existence of capital income. And no one is asking lesser income/working class people to sacrifice anything; Scott’s proposal makes the burden of taxation more progressive.

    There’s no explanation for general support of capital gains taxation other than irrationality (ignorance is not an excuse).

    Chargercarl, was that a DBZ reference? Or perhaps South Park?

  22. Gravatar of acarraro acarraro
    24. September 2012 at 03:35

    I must say I am not convinced by the zero-marginal tax on capital. Models that reach that conclusion always seem to assume that there is an infinite amount of possible positive value investments and no uncertainty. I think that’s a rather unlikely hypothesis.

    On the two brothers parable, doesn’t it depends on who pays the tax? If there is a lack of capital (in relation to opportunities), the borrower (and not the frugal brother) will pay the tax, so even a high tax rate will not discourage saving as gross rates will be high enough to make net rates attractive. But it will reduce viable investments.

    Another issues would be risk aversion. Taxable investment income means you can offset gains with losses. This means that the state is effectively take a slice of the losses in any investment. If you are risk averse, that might be a net benefit (as the compensation for a loss is more valuable than the tax on profit).

    Finally, I work in finance and I think it’s weird to consider any investment income not the result of additional labour. Most of the time you need to devote a lot of time to decide what to invest in. So it seems arbitrary to tax it differently. We wouldn’t blink about taxing more one of the brothers if he decided to work 20% more time in his job. Why are we happy not to tax him if he spends that 20% studying possible investment opportunities?

  23. Gravatar of Morgan Warstler Morgan Warstler
    24. September 2012 at 04:39




    On taxes, I think it is sensible to distinguish between labor saved dollars generating income vs. investment returns generating investment returns.

    If you work, earn and save $500K on labor, and that savings earns $100K which you also invest…

    I’m fine with taxing future returns you make on the $100K at labor rates.

  24. Gravatar of Mike Sax Mike Sax
    24. September 2012 at 05:37

    I agree with Bill Ellis and JL.

    Saturos I disagree with you. I don’t see why taxing capital gains is inefficient. What is clear is that most capital gains are realized by rich people. Like Romney said he’d give people making under $200,000 a year a capital gains tax cut, or even reduce it to 0. But as few people under that level have capital gains that doesn’t do much.

    Indeed, if he intended that to be a marginal rate cut, that would really be benefitting those who make much more than $200,000 by abolishing taxes on their first $200,000 of capital gains.

    To me it depends what you mean by “effcient.” Over the last 30 years we’ve seen lots of capital formation with a capital gains tax, so this sounds like the solution to a nonexistent problem.

    To me the most efficeint plan if progressivity is truly what you want is to cut payroll taxes and make them progressive-right now they’re the most regressive taxes in the U.S. federal code

  25. Gravatar of D.Gibson D.Gibson
    24. September 2012 at 05:59

    I think the idea of not taxing capital returns is horrible. The fact that the majority of the “47%” pay a higher federal tax rate than Mitt Romney is totally backwards. Not only should we tax all income (labor, capital, …) the same, but we should also have a wealth tax! If we are allowed the ideal, there would be zero income tax and a 10% sales tax with a 1% wealth tax (on wealth >$100K). No forms for folks with no assets. All the incentives are in the right direction and distortions are minimal.

  26. Gravatar of JL JL
    24. September 2012 at 06:22

    I am pretty sympathetic to this modest proposal by Scott, especially because it reduces costly, unproductive paperwork.

    > And no one is asking lesser income/working class people to sacrifice anything; Scott’s proposal makes the burden of taxation more progressive.

    But that is false. Scott proposes to raise taxes on the affluent working class, e.g. a doctor earning >$110K who works hard and spends his money, thereby contributing to AD – the real trickle down!
    The proposal benefits the rentier class like Paris Hilton, who perform no labor, but merely live off of their investments, which are sometimes detrimental to society (NY taxi medallions) and sometimes good (but even in the latter case, society loses access to their labor – and the tax on that labor!).

    Also, are we so ignorant of Econ 101 that we forget the concept of ‘opportunity costs’?
    Every penny in reduced tax on capital income is a penny that could have been used to reduce payroll taxes for the working poor.

    > There’s no explanation for general support of capital gains taxation other than irrationality (ignorance is not an excuse).

    Obviously there is: the working masses would prefer to pay less tax on their labor, therefore they tend to elect politicians who will tax other things, like capital.

    In this regard the working masses behave like rational, self-interested agents IMHO.

  27. Gravatar of Morgan Warstler Morgan Warstler
    24. September 2012 at 06:23

    D. Gibson, the issue is status.

    If you try to raise the status of non-businessmen over businessmen, the best and brightest simply become non-businessmen.

    The specific people you “like” right now who are not businessmen they will get pushed out of their roles the moment the status of their job increases.

    The same asshole winners win, it doesn’t matter what the game is. Change the rules, the same guys win.


    As such, the question is WHAT do we want the best and brightest doing?

    An the answer is economic growth, trade, invention, start ups, the things that actually improve people’s lives.


    It is understandable that non-businessmen would like to raise their relative status…

    But it is impossible, their lot in life is set by their relative abilities, not by rules of the game.

  28. Gravatar of Mike Sax Mike Sax
    24. September 2012 at 06:23

    I also think it should be pointed out that the money invested does not get taxed twice, only the profit on the investment

  29. Gravatar of Mike Sax Mike Sax
    24. September 2012 at 06:30

    Morgan you assume that those with the “most abliities” if fixed in stone. However, if those with the highest status are at one time investment bankers and then in antoehr doctors, then in another still, teachers, how do you know the same people wlll always rise to the top?

    You seem to have a theory that those with the most skills are static. This ignores the division of labor. None of us, no matter how skilled would ncessarily be skilled in every area.

    It’s almost like Marx’s dream of someone who farms in the morning, is a blacksmith, in the afternoon, writes a novel in the evening, then criticizes.

    In truth no one is omni skilled in everything. How can you assume that someone who’s a great hedge fund manager would also be a great high school teacher? This is clear when you consider athletes. they are paid very handsomely for their skills.

    But if tomorrow suddenly sports lost its “status”-unlikely in reality but this is hypothetical-would these athlestes all be able to go out and become great lawyers?

  30. Gravatar of JL JL
    24. September 2012 at 06:52

    Also, these words by Mark Cuban are very relevant, on whether to increase or decrease the current tax rates by 5-10%:

    “Bill Gates didn’t monitor the marginal tax rate when he dropped out of Harvard and started MicroSoft (btw, it was a ton higher than it is today).

    The impact of tax rates on productivity and development is something economists masturbate about, enterpreneurs don’t waste their time thinking about it. We have business to do.”

  31. Gravatar of Adam Adam
    24. September 2012 at 07:07

    “It would also be much fairer, as high savers are currently taxed at much higher rates that spenders with equal lifetime wage incomes”

    Nice little swichteroo there. “Savers” are only taxed at “higher rates” if you ignore the fact that “savers” have higher incomes. If you consider all of “savers'” income, shouldn’t the effective rates be much lower?

  32. Gravatar of Morgan Warstler Morgan Warstler
    24. September 2012 at 07:26


    you miss my point.

    Imagine we are going to pay teachers more money, this has two possible consequences:

    1.assuming no more $ will be spent, a higher quality teacher who makes more money will be teaching more students. This is a productivity story.

    2. assume we’ll have the same number of teachers, we will require nothing more of them, but we will pay them more money. In this circumstance THE SAME new guy goes and teaches, he just DOES NOT deliver the productivity gain.

    Overtime, talent goes where the money is (status), the only question is whether we get something from the talent.


    The truth is that historically, a government job was for a lesser status guy, and he made lesser pay, and we just said, “good enough for government work.”

    This was OK, because of the 80 / 20 rule, where 20% of the population essentially carries the 80% on their back, drags them along, whatever.

    What can’t doesn’t work is to have the 20% put themselves into status jobs where they can no longer drag the 80%, because they aren’t in the private sector.

    Until progressives comes to terms with the imperative of the top 20% constantly and always making giant YOY productivity gains the economy is gong to be in the shitter.

  33. Gravatar of Morgan Warstler Morgan Warstler
    24. September 2012 at 07:29

    Mark Cuban will say where the topic is taxes, that things can be jiggered.

    But the LARGER issue will continue to be that the relentless forces of productivity gains have to be thrust upon the public sector.

    Taxing the rich will NEVER solve for the larger issues we face.

    BUT you can solve most all of our problems with a government that runs as efficiently as the private sector.

  34. Gravatar of Floccina Floccina
    24. September 2012 at 07:51

    Why not blow the cap off IRA contributions and allow people to pay progressive taxes only on what they do not put in their IRA + any withdrawals. Then all consumption is taxed at the same rate and taxes are greatly simplified.

  35. Gravatar of Saturos Saturos
    24. September 2012 at 08:03

    Adam, our system taxes high-income savers at higher rates than equally high-income non-savers. All capital taxation is double taxation. See the links I posted earlier. So, NO.

    Mike Sax, efficiency is about the First Welfare Theorem. It’s about making the most output from given inputs. (Since the value of output is of course subjective to consumers, this formally involves Kaldor-Hicks or pseudo-Pareto improvements.) Unless you agree that equality is so important that it would be worth it to make everyone equally impoverished (Maoism), at some point (more points than you think) efficiency will trump equality if you want to seize every Pareto-improvement. Capital taxation kills both productive and allocative efficiency intertemporally; i.e. it makes the pie smaller and less tasty, regardless of how you cut it up.

    But it’s OK if you don’t get it, you really need an economics degree to fully comprehend it. (Like the mathematics of infinite sets.) Trust me when I say that even Marxist economics PhDs understand what I’m saying is true. Even Joseph Stiglitz understands it ;D

    There’s a tradeoff between equity, defined as progressivity, and efficiency. Redistribution occurs with a leaky bucket, as they say. And capital taxation is like doing it with a dirty bucket, when there was a clean one right next to it.

    Of course most capital gains are realized by rich people; most (measured) gains are realised by rich people, period! But if you want to penalize/more greatly burden richer people, then penalize rich people! Don’t penalize saving in an attempt to penalize rich people! That’s like the fallacy of taxing gas-guzzlers instead of taxing carbon! It’s a recurring theme in economics; people not organizing their incentives to target precisely what they mean to target, causing waste in the process.

    D.Gibson, as Scott would say, you shouldn’t care about income at all. You should care about consumption. And all forms of consumption should be taxed the same, for efficiency and equity. See the links I posted (particularly the third one).

    To put it another way, capital income isn’t really income at all, if income is defined as the whole content of the consumer budget constraint prior to taxation (your real purchasing power).

    God people are irrational… (irony noted)

  36. Gravatar of johnleemk johnleemk
    24. September 2012 at 08:21

    NPR polled 5 economists across the political spectrum for their thoughts on economic policy slam dunks — things that virtually no economist would disagree with: http://www.npr.org/blogs/money/2012/07/19/157047211/six-policies-economists-love-and-politicians-hate

    5 out of 6 proposals they endorsed have to do with tax policy in some way, and most of them align with what Scott’s recommending. The only area where I see potential disagreement is that they’re far less immodest than Scott; they propose eliminating all income and payroll taxes.

  37. Gravatar of Floccina Floccina
    24. September 2012 at 08:23

    Of course something short of my proposal would be to allow people to put pretax money into their IRA up to some lifetime total. I.e. you can make lifetime pretax contributions to your IRA up to $500,000 or maybe $1,000,000. For most people who invest that would save them reporting all their stock sells and dividends.

  38. Gravatar of Saturos Saturos
    24. September 2012 at 08:32

    Thanks johnleemk, I saw that too, should have thought of posting it.

  39. Gravatar of Doug M Doug M
    24. September 2012 at 08:34

    I see where you are comming from in principle.

    However, I would like to suggest that rather than cutting the tax rate on investment income and capital gains, I would suggest instead we move the dedution to the corporate ballance sheet. Cut corporate income taxes — or at the very least make dividends dedcutible from corporate taxes, and leave them fully taxable by the recipient.

    Investments made by hedge funds mangers with their own captial are investements. Management fees and bonuses should be income. I don’t know how they created the loophole that the 2/20 is an investment and not a fee.

    One loophole that bothers me is the Larry Ellison loophole. His salary is $1. The value of his holdgins are emense. However, rather than selling his shares and paying taxes, he borrows agains them. The intrest on the loan secured by his shares is tax deductible. His taxable income is zero.

  40. Gravatar of Saturos Saturos
    24. September 2012 at 08:42

    Doug M, yes moving from triple taxation to double taxation would be an improvement, but it would be better to find a revenue + progressivity neutral way to eliminate all capital taxes. Though when Scott said “eliminate all capital taxes” I’m not sure if he was including the corporations tax…

  41. Gravatar of Brian Brian
    24. September 2012 at 09:02

    Saturos: How exactly is capital taxation double taxation when only the gains are taxed? Yes, dividends are double taxed since the parent company can’t deduct them but capital gains (assuming the money was reinvested in business expenses) and interest expenses are definitely deductible. Rather than get rid of the whole system, the easy and more politically feasible fix seems to be making dividend payouts deductible.

    In the regards to the main topic: there lies real danger in tax-advantaging one form of creation over an another. When a business makes a decision in how to produce a good or service, it makes a choice between labor and capital: a worker costs X dollars while a machine to do the work costs Y. While labor itself is tax-deductible, we know that tax costs paid by either the buyer or the seller are generally split 50/50 due to the taxes’ impact on the price of the good (labor) so between the income taxes paid by the workers and the payroll taxes paid by both parties, labor has significant tax expense. The other option is a machine whose cost is part labor, part capital gains. If the gains are tax-free, as many here have suggested, then that machine will be significantly advantaged over labor for no other reason than the fact that it is a capital cost rather than a labor expense. This is not an efficient dispatch of our resources and, given a marker and a whiteboard, should show deadweight loss. Furthermore, at a time when capital markets have flooded interest rates down to almost nothing and the real unemployment rate is safely in double digits, now is definitely not the time to further advantage investors over workers.

  42. Gravatar of Mike Sax Mike Sax
    24. September 2012 at 09:47

    Saturos you may be right-that ir requires a PHD to get it. I will just point out that my goal is not so much to punish rich people as to stop punishing poor and middle income people.

    “Of course most capital gains are realized by rich people; most (measured) gains are realised by rich people, period! But if you want to penalize/more greatly burden richer people, then penalize rich people! Don’t penalize saving in an attempt to penalize rich people! That’s like the fallacy of taxing gas-guzzlers instead of taxing carbon!”

    While it’s true that most gains are realized by rich people it’s true of capital gains esepcially so. What I never get with supply side arguements is why other tax cuts completely disinterest supply siders. Why do they care nothing for lowering our most regressive taxes-payroll taxes?

    To the contrary they want to raise labor and consumption taxes to pay for the cuts in capital gains.

    Put it this way, very few people who make less than $200.000 a year would gain peronsally by a capital gains tax cut. They would gain a lot by a payroll tax cut.

    Yet Supply Siders find such tax cuts very unsexy.

    For the record I don’t desire anything near absolute equality. I don think though the last 30 years have gone in the wrong direction to too much ineqaulity. It’s less even the inequality that matters to me than that upward mobility is basically gone. It happens but the odds are more against it.

    Again, maybe the argument is above my “pay grade” to understand but I’m still not going to simply submit to experts. Until I’m convinced of this argument myself I will continue to question it.

    What I do notice is that everyone who believes it always ends up calling anyone who questions it “irrational.”

  43. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    24. September 2012 at 09:51

    ‘I thought you wanted to abolish all taxes on capital, greatly benefiting the Paris Hilton’s and Koch brothers at the expense of the working men like you, me and Joe the Plumber.’

    Who has a higher income, a ditch digger with only a shovel, or one with access to a backhoe (aka, capital)?

    ‘Do note that closing all tax loopholes is easier said than done.
    ‘Consider that the Swedes can’t manage to tax Ingvar Kamprad (IKEA)…’

    It would be easy if we abandoned the idea of taxing profit, and instead taxed revenue at a very low rate. Which is what is done in Washington state. As Scott said, it eliminates jobs for tax preparers, but it’s a lot easier and less painful for the rest of us.

  44. Gravatar of Doug M Doug M
    24. September 2012 at 10:12

    Mike Sax,

    The supply siders believe that it is cuts in marginal taxes that spur growth. A payroll tax cut does not cut marginal taxes for people who make over $106,000.

    Personlly, I think the payroll tax is somewhat evil. It is just a way to make middle class income tax rates look lower than they really are. Middle income earners pay a higher marginal tax rate (payroll + income tax) than high income earners do. Kill the payroll tax entirely, move the tax burden to income taxes (or consumtion tax, or whatever your ideal taxed vehicle is, but only tax one thing tax it one time.)

  45. Gravatar of johnleemk johnleemk
    24. September 2012 at 10:47

    Mike Sax,

    Saturos isn’t crazy. Here’s Yglesias again, noting that when DeLong advocates taxing only consumption and abolishing taxes on capital gains income, left liberals are generally receptive: http://www.slate.com/blogs/moneybox/2012/09/24/tax_reform_tax_consumption_not_investment_.html

  46. Gravatar of johnleemk johnleemk
    24. September 2012 at 10:51

    Since Romney derives his income from savings, as Dylan Matthews of the Washington Post wryly notes, “the disagreement among economists isn’t about whether people like Romney are paying too little. It’s about whether or not they’re paying too much.”


    The flipside of that is that economists would probably agree that people like Paris Hilton are paying too little. I think Scott once floated the idea of a top MTR of 90% on consumption.

  47. Gravatar of Adam Adam
    24. September 2012 at 11:27

    Saturos – I’m not sure what you are driving at. The hypo compared two groups of people with equal lifetime wage incomes, with Scott claiming that high savers are taxed at higher rates. Perhaps I’m missing something, but that doesn’t sound right to me.

    Both groups pay the same rates on their equal lifetime wages. The savers also pay dividend and capital gains rates on their non-wage income. Because those rates are lower than the rates paid on wage income, the savers will be taxed at lower, not “much higher” rates of their total income than non-savers. Even more so if the non-savers are also paying sales taxes on the marginal amounts that the savers are saving instead of consuming.

    Now, sure, you can do what Landsburg does and assume that all investments were made with income that was taxed at wage income rates, but that’s just factually wrong (not to mention that he also got his math wrong in the “Getting It Right” post). People inherent money, but more importantly, people also earn money to invest through returns on capital.

    Note, btw, that Landsburg also leaves out the sales tax likely paid by the non-savers for some inexplicable reason.

  48. Gravatar of Floccina Floccina
    24. September 2012 at 12:22

    @Doug M

    according to yahoo:

    Mr. Lawrence J. Ellison Co-Founder, Chief Exec. Officer and Director made $14,890,000.

  49. Gravatar of Floccina Floccina
    24. September 2012 at 12:41

    ADoug M.

    I found more

    Oracle CEO Larry Ellison, the sixth richest man in the world, got a nice boost in his annual compensation during the Redwood City tech giant’s last fiscal year.

    The company’s directors increased his annual compensation from $77.559 million in fiscal 2011 to $96.16 million in fiscal 2012, according to a regulatory filing by the company on Friday.

  50. Gravatar of Doug M Doug M
    24. September 2012 at 14:02


    The numbers on one of your links is understed. The 14.96 number that you link to on the yahoo profile ignores $60 million in options he received last year. The $96million is for this year. It is all deferred compensation. His salary is $1. The deffered money is not taxed until he receives it, and the option are taxed when they are exercised.

    Larry’s tax liablity is effectively zero.

  51. Gravatar of ssumner ssumner
    24. September 2012 at 18:07

    Everyone, I hate to pull rank but I’ve studied public finance theory and (if you disagree with me ) you haven’t. There’s no dispute that taxing capital imposes an extra and higher tax rate on savers than non-savers. If you prove me wrong I GUARANTEE you will win a Nobel Prize in economics.

    Here’s the progressive Matt Yglesias quoting the progressive Brad DeLong (both of whom do understand public finance theory) making the same point.


    The way to think about these things is to compare a no-tax and an after-tax consumption level, under both a flat income tax and a flat consumption (or wage) tax. You’ll see that taxes on capital are unfair to savers.

    In this post I called for excluding only the first $100,000 in capital income. So all the comments about rich capitalists have no bearing to the argument made in this post.

  52. Gravatar of Major_Freedom Major_Freedom
    24. September 2012 at 20:13


    Everyone, I hate to pull rank but I’ve studied public finance theory and (if you disagree with me ) you haven’t.

    I always suspected this is the ultimate foundation for your worldview.

  53. Gravatar of Saturos Saturos
    24. September 2012 at 21:08

    Adam, think how much capital “income” the saver could have had if he hadn’t paid the wage tax. Then reread those links I posted. And johnleemk’s links. Read the comments on the Landsburg posts, where your objections are raised and addressed. I remember having a similar argument with college Marxists. Where did the income originally come from? Usually, from wages that were taxed. If the original income evaded taxes, that’s not the fault of this system.

    Mike, let me just edit your sentence (the old, replace subject of sentence with “black people” trick):

    “While it’s true that most consumption is realized by rich people it’s true of deferred consumption especially so.”

    we could just as well say that

    “While its true that most vehicles are realised by rich people it’s true of luxury vehicles especially so”.

    This is taxing some types of consumption (not amounts, but types) more heavily, and discouraging capital formation to boot. We can show mathematically that it’s inefficient; in fact that’s exactly what Chamley and Judd did.

    Think of it like this: if everyone with $100 can go to the market and buy $100 of apples or $100 of bonds, and everyone pays the same percentage wage tax (in fact rich people pay more), then an extra tax on the benefit from buying bonds is double taxation (even if the principal is untaxed, part of the present value of your savings was double-taxed).

    Btw I’d like to abolish the payroll tax.

    To the contrary they want to raise labor and consumption taxes to pay for the cuts in capital gains.

    I’d be happy to raise labor taxes only on higher incom brackets to compensate, or make consumption taxes more progressive.

    “Put it this way, very few people who make less than $200.000 a year would gain peronsally by a capital gains tax cut.”

    Everyone would make more on their retirement savings. And national savings would go up, the national steady-state capital stock would get closer to the “Golden-rule” level, labor productivity would rise and total intertemporal consumption would be so much higher that all lifetime-income groups would benefit.

    I hoped I wouldn’t have to do this, but here’s Milton Friedman:

    (Love that one. The kid’s fairly smart, too, I like him. Gives me the shits when he says “FORCE-IBLY”, though.)

    MF, lol. But you do understand why capital taxation is double taxation, don’t you?

  54. Gravatar of johnleemk johnleemk
    25. September 2012 at 04:21

    The most eminent scholars in public finance who disagree the most with Scott are probably Emmanuel Saez and his frequent co-authors, like Thomas Piketty — yet as Dylan Matthews of the Washington Post pointed out, even Saez and Piketty support lower tax rates on capital gains income.

    Saez and Piketty have done a lot of work in the area of income inequality. They are the most-respected scholars in the field who have come closest to the Occupy crowd in terms of their stated findings and policy recommendations. Yet even they can’t find good basis for taxing capital gains income at the same rate as wage income.

    I mean, hell, DeLong — J. Bradford DeLong — wants to abolish all income taxes and replace them with a progressive consumption tax. Scott’s proposal is extremely, extremely modest! If you don’t want to listen to him, listen to Saez or DeLong — you’ll still come out with more or less the same policy ideas.

  55. Gravatar of Floccina Floccina
    25. September 2012 at 06:05

    I think that many people forget that it is considered 3% better to consume now than next year.

  56. Gravatar of Dophus Dophus
    25. September 2012 at 07:00

    Thanks for the excellent blog. I have only been reading for a short while, it is refreshing to see a clearly written analysis of a complex subject, not a lot of that on the web!

    I am not an economist, just a former employee and a current small business person, but to me your approach just seems logical. If one is employed or a business owner I think it is safe to conclude that we would much sooner our wages or sales remain the same or go up, even if only in “nominal” dollars. I can cope with increasing costs, within reason, but I will do everything I can to keep my staff with me for if I (and many others) lay them off who will buy our products and services?

    Seems obvious to me, a non-expert, that unemployment is the root cause of the current economic environment, and any policy that does not attempt to deal with this is immoral. Drastic reductions in GDP are real people-let’s get real about that.

    PS I have never before posted in any comment section on the web. Keep up the good work.

  57. Gravatar of More from Sumner « Blog of Rivals More from Sumner « Blog of Rivals
    25. September 2012 at 07:01

    […] Sumner was the sole source of AM Reads this morning and here he makes his second appearance on the blog today.  Writing about tax policy he makes a suggestion […]

  58. Gravatar of Adam Adam
    25. September 2012 at 07:34

    Saturos – Scott is absolutely right that I have not studied the issue, and perhaps I’m missing something, but it just doesn’t seem right to me to compare to a “no tax” world that does not and basically has never existed.

    In Landsburg’s example, Bob (or whatever his name was) had $1.50 income and paid $0.55 in taxes (which should have been $0.525 had he done the math right). That’s a rate of 37%.

    I don’t understand why we ignore those actual numbers and instead say, yes, but he would have had $2 of income in our fantasy world, so the real cost to him is higher. There are a lot of assumptions that may not be valid buried in that hypothetical world.

  59. Gravatar of Adam Adam
    25. September 2012 at 07:39

    Oh, and, I do think it’s the fault of the system if the “original income” evaded wage taxes, although it’s a different part of the system.

    And btw, I’m not disagreeing necessarily with the notion of reduced taxes on capital income, or specifically with Scott’s or Brad’s proposals, just the notion that capital income is always taxed at higher rates.

    But to be perfectly frank, I’ve not spent a lot of time thinking about Scott’s or any other proposal because they aren’t happening anyway, even if they should.

  60. Gravatar of johnleemk johnleemk
    25. September 2012 at 07:58

    Adam, my intuition is that #2 (raise the floor on capital gains tax) could probably happen, coupled with a VAT or other changes to the tax system. #1 (abolish all income tax credits and deductions) is the one that would never happen in the US, though it’s certainly happened for the most part in some other developed countries.

  61. Gravatar of Adam Adam
    25. September 2012 at 08:22

    At the risk of turning into Major Freedom and taking over the thread, it seems that what Landsburg argues is “right” is actually just asking a different question. It’s, “how much does the tax code reduce potential consumption (compared to a not tax world)” instead of “how much of a person’s income is paid in taxes?”

    It seems to me that the answers to both questions may have value, as, for the reasons I’ve mentioned, neither question perfectly reflects reality.

  62. Gravatar of JL JL
    25. September 2012 at 08:55

    What DeLong says and what Yglesias/Scott are saying is different.

    DeLong says: “no distinction between whether the income comes from wages or dividends or capital gains” and “if the income is saved, it escapes tax”

    I strongly agree with DeLong.

    Then Yglesias says “using consumption as your exclusive tax base and using labor income as your exclusive tax base are theoretically equivalent”.

    Theoretically, not in practice. There are 1001 ways to make labor income look like capital income, e.g. Steve Jobs worked 80 hours/week for a salary of $1, 100% legal.

    And this is the giant loophole that needs to be closed.

  63. Gravatar of JL JL
    25. September 2012 at 09:03

    Also, DeLong/Scott/Yglesias will fail to tax luck.

    Consider two brothers who both save. Both invest in similar enterprises, but then through pure luck, e.g. earthquake destroys one of the brothers factory, assume the risk could not be cost-effectively insured and a priori both brothers were exposed to the same risk.

    Now, one brother realizes a ROI of 50% (due to reduced competition!), while the other one of -50%.

  64. Gravatar of Saturos Saturos
    25. September 2012 at 09:12

    Adam, consider how much capital income is lost to you as a consequence of having to pay a wage tax alone (Think about it carefully.)

    Wage taxes are worse than consumption taxes, as the money is taken from you as soon as you receive it, reducing total savings.

    Who said it’s necessary to tax luck? Wouldn’t it be far more productive to tax height: http://scholar.harvard.edu/mankiw/files/Optimal_Taxation_of_Height.pdf

  65. Gravatar of johnleemk johnleemk
    25. September 2012 at 09:18


    DeLong says: “no distinction between whether the income comes from wages or dividends or capital gains” and “if the income is saved, it escapes tax”

    I strongly agree with DeLong.

    And that means to the extent you disagree with Sumner, it’s because you’re asking for the abolition of the capital gains income tax while Sumner just wants a floor on the capital gains income subject to tax.

    Recap: DeLong says there should be no distinction between where your income comes from. He says that you should not tax any income that is saved. All income that is not saved is consumed. Ergo, you should only tax consumption — not wage income, not capital gains.

    Any income tax (be it on wage or capital income), to the extent that a taxpayer saves the taxable income, is also a tax on saving, and explicitly undesirable in the DeLong framework, where, verbatim, “if the income is saved, it escapes tax”.

  66. Gravatar of johnleemk johnleemk
    25. September 2012 at 09:24

    The most persuasive immodest proposal I’ve seen for eliminating income taxes and replacing them with consumption taxes comes from Robert Frank, who’s pretty unabashedly left liberal. I suspect it comes closest to DeLong’s vision too. The idea is for a tax return to consist of three lines:

    * How much did you earn (from any source) in the last year?
    * How much did you save and/or invest?
    * Take the difference of the two and pay a progressive tax on this amount

    As far as pragmatism goes, it’s I think easier to implement than it sounds. IRS auditors will have a good idea of who to go after for tax evasion. Consumption by nature is often highly visible. And since this tax is intended to be highly progressive, you will also get the biggest bang from your buck by going after those who spend flagrantly.

  67. Gravatar of JL JL
    25. September 2012 at 09:38

    > Ergo, you should only tax consumption “” not wage income, not capital gains

    I can agree with that, BUT if we are going to tax wage income, then capital gains should be taxed at the same rate, even if that rate is 0%.

    What Scott and Yglesias are proposing is to tax capital gains at a rate less than wage income, which is also the status quo.

    DeLong isn’t proposing that.

  68. Gravatar of Adam Adam
    25. September 2012 at 09:57

    Saturos (I’m sure I’ve spelled that six different ways, if so, sorry) – You highlight one of the assumptions that make me most uncomfortable about that line of analysis.

    I don’t really know how much capital income is lost as a result of the wage tax, because I don’t know to what extent capital returns are influenced by the tax structure. If wages were untaxed, perhaps capital returns would be lower.

    I get how if I assume that the tax structure makes no difference to returns, I’ve lost whatever percentage of my future capital income is paid in wage taxes, to the extent that my capital investments are made with money that comes from earned wages. But that’s not the real world.

    As I mentioned before, I’m also uncomfortable with the assumption that all capital investment was ultimately earned and taxed as wages at some initial starting point. Mitt Romney is the poster boy for why that isn’t necessarily true. Work at a hedge or PE fund, or potentially even own a small business that’s incorporated and you may well be able to structure the bulk of your compensation as capital income in the first place, so no, you are in no way taxed at a higher rate. And yes, I get that maybe each of those scenarios requires some initial equity that comes from taxed wages, but leverage and investing other people’s money may make that amount trivial.

    Finally, it’s certainly wrong to assume that wages would be the same in a world with no wage tax.

    Which is why I’m uncomfortable with fully embracing comparing against an untaxed world as anything other than a hypothetical exercise. But if you accept those assumptions, then sure, capital income is taxed at higher rates than wage income.

    Maybe those assumptions are fair true for Scott personally. They probably are for me. Maybe they are for nearly everyone. But not literally everyone.

  69. Gravatar of Mike Sax Mike Sax
    25. September 2012 at 14:49

    johnmleenk I certainly don’t think Sautors is crazy. He’s a smart guy and that’s why I’m trying to pick hsi brain.

    Doug I agree with you on the payroll tax

    Scott, this is how I remember all our discussions about “public finance”

    You always lose patience at some point and just say “I know what I’m talking about, you do not.”

    Even if you’re right it doesn’t help me. I’m not trying to play gotcha I honestly am trying to understand what you’re getting at with this.

    Do you feel that no layperson can have an intelligent convseration about public fiance?

  70. Gravatar of Mike Sax Mike Sax
    25. September 2012 at 15:09

    “I mean, hell, DeLong “” J. Bradford DeLong “” wants to abolish all income taxes and replace them with a progressive consumption tax. Scott’s proposal is extremely, extremely modest! If you don’t want to listen to him, listen to Saez or DeLong “” you’ll still come out with more or less the same policy ideas.”

    Does Krugman support lower tax rates on capital gains?

  71. Gravatar of Saturos Saturos
    4. October 2012 at 02:47

    Adam, so you should also believe:

    “I get that orange consumption is lost to me with my income tax, as whatever amount of my orange consumption I can no longer buy as a result of paying the tax. But I don’t know how much orange prices are influenced by the tax structure. If all those taxes were refunded and not replaced by anything else, perhaps all that rebated income would be spent on oranges, driving up the relative price of oranges. Then you would have to calculate the price elasticity of orange demand and supply, so it gets tricky. Plus who knows what would happen to my income if that reform were effected, I might start selling oranges? But that’s not the world we live in.”

    If the non capital income which is used to purchase capital income is inadequately taxed, then this is not the fault of the capital taxation regime (perhaps some other part of the tax regime).

    Mike, my posts on this page, and Landsburg’s posts, are I think a pretty good laymanization of the mathematical argument. It’s pretty intuitive, actually, if you’ve ever taken an intermediate micro class, or have a mathematical brain to begin with.

    Failing that, I suppose you could just believe whatever Krugman tells you. Not thinking for yourself feels pretty good, or so I’ve heard.

Leave a Reply