Income is meaningless, example #388

Matt Yglesias has a good post showing one more reason why income is meaningless:

One issue this poses is that analysis of political issues in terms of “income” quartiles can get pretty misleading. A married couple where dad earns $65,000 a year and mom works part time bringing home $15,000 a year is in the fourth quartile of the American income distribution. A 70 year-old widower whose $2 million in savings bring him an annual income of approximately $80,000 is also in the fourth quartile. But their policy-relevant economic interests are unlikely to have very much in common since in reality their financial situations are entirely dissimilar.

That’s right—and let’s go a bit further.  Suppose the old guy with $2 million earned $200,000/year for 40 years, and was a high saver.  Suppose his twin brother had the exact same income, but spent all his money. The twin brother lives on Social Security.  Who is better off?  Neither.  Both had the same lifetime wage income, and hence equal resources.  Economists take a “lifetime consumption” perspective. The only difference between these brothers is one chose to spend the money when young and the other chose to spend it when old.  It’s as if one lived by himself in a house and the other lived with roommates in an apartment.  No sensible person would say you are better off (than someone who choses to live alone) because you share an apartment with others and thus pay less rent.  These are consumption CHOICES.

[Now of course people might be better or worse off because of the way their brains are wired, but that’s far outside the scope of public policy—even far beyond Mankiw’s “tax the tall” reductio ad absurdum.  At least you can measure tall people; you can’t measure brain wiring.]

The guy with $2 million has already been fully taxed on that wealth, and should of course pay no tax on his capital income.  That’s why smart progressives like Yglesias favor progressive consumption taxes, at least where it’s possible to clearly identify and separate wage and capital income, as with someone surviving on their 401k mutual funds.

In all probability the guy with $80,000 in retirement income earned far more wage income when younger than the hypothetical family discussed by Yglesias, where each member made an average of $40,000/year. So on utilitarian grounds he should have paid a higher rate of wage tax during his earning years than the hypothetical family making a total of $80,000 in wage income.

PS.  There was some discussion of marriage penalty at the end of a recent post.  A few points.  I am aware of the “progressivity/treat households as a single unit” dilemma, except that it has no bearing on the marriage penalty.  If that was a valid argument, it would call for applying the marriage penalty to any two people who live together, and it would not apply to married people who live at separate addresses.  But it doesn’t.  It’s a tax on marriage, and has nothing to do with the claim that “two can live as cheaply as one” which is of course false.

And even if the argument were true, it would be irrelevant.  People who eat dog food have more money to spend on other stuff than people who consume human food, but that DOESN’T mean they should have to pay a higher percentage rate of income tax.  That’s a lifestyle choice.  Single people who live alone presumably enjoy it more than single people who share an apartment with others.  It makes no sense to assume the latter group is better off because they have more income after paying rent, and tax them more. I preferred to live alone when single, and didn’t ask for a tax break.  So I had this view even when it went against my interests.

And even if you wanted to argue the tax system should try to figure out who’s better off by virtue of consuming more wisely, the marriage penalty ignores an even greater inequality.  Even with a flat tax, and no formal marriage penalty at all, a family with two people each making $100,000 is much worse off than a family where one makes $200,000 and the other is a homemaker.  That’s because the homemaker’s output is completely tax free.  Or if you prefer, the two income household would have to hire a maid to duplicate the consumption bundle of the one income household.  The marriage penalty takes this existing unfairness to double income households, and makes it even worse by making the tax system progressive.

There is no justification for the marriage penalty.  None.  I suspect many Dems would joins the Swedes in allowing people to file separately, but maintain progressivity.  I suspect the GOP would agree to eliminate progressivity.  But the two parties cannot agree on a solution, so we end up with a monstrous absurdity—a tax on marriage.

PS.  As usual, I will not defend the claim that capital income should not be taxed. If you have taken a course in public finance and understand the reason but don’t accept it, I’ll listen to your concern.  If you say; “why shouldn’t all income be taxed” your comment will be ignored.  In other words consider this a “wonkish post” addressed to other economists or well-informed amateurs.


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45 Responses to “Income is meaningless, example #388”

  1. Gravatar of Morgan Warstler Morgan Warstler
    17. December 2013 at 18:12

    We’ve done this before Scott, you refuse to admit that if an entrepreneur works for 3 years and sells a startup, that money is capital gain, but he deserves to pay a smaller amount than people who invested cash.

    If you invest $10 in my start up and I hand you back $1,000 in 3 years. You have NOT paid taxes on that return.

    AND more than that, you deserve to pay a higher amount than the entrepreneur.

    Forget consumption taxes blah blah. Forget interest and inflation blah blah.

    There is a clear simple change we can make to tax code, that favor sweat equity over all other kinds.

    And you did not pay income tax on that $990.

    Let me give you another example:

    You save $1000 that’s your “principal”

    You principal goes out and earns $1000 over 5 years.

    You paid income taxes on your principal, you have not paid income taxes on the 2nd $1000.

    NOW your $2000 earns $500.

    We now know you didn’t pay on second $1000 and you didn’t pay on the $250 it earned.

    Compound interest dontcha know.

    —–

    The reason I hate this stuff is the unwillingness to make moral judgements and build them into the tax code.

    Savers? Better than Spenders. Ok.

    NEITHER as good as entrepreneurs.

    The system should be set up first to favor people who go start their own thing.

    The tax code should serve their interest.

    Because it isn’t a “choice,” it is the real life expression of Heinlein’s Starship Troopers.

    Like we won’t even let you vote if you haven’t started a company.

    Ok not that aggressive, but you get the point.

    Entrepreneur > Married with children > Savers > Yada > Yada > Eggheads

    We can make moral judgements. America is better than others BECAUSE….

    And what has made America dominate is entreprenuers.

    Building that into our tax code, even if we can get your thing, is more important.

  2. Gravatar of Morgan Warstler Morgan Warstler
    17. December 2013 at 18:14

    Actually is goes:

    Yada > Yada > Eggheads > Public Employees

  3. Gravatar of Morgan Warstler Morgan Warstler
    17. December 2013 at 18:18

    Scott your problem is you think about the masses investing in stocks and bonds and you apply EMH and kinda shrug and say inflation.

    I only think about guys starting franchises, and landscaping businesses, and 3D print shops, and Internet start ups.

    I could care less about Fortune 1000 management, Wall Street, or pension funds.

    American was built on big fish in small ponds, and the SYSTEM should be set up encode favor my kind of people, so that DC shrinks.

  4. Gravatar of Garrett M Garrett M
    17. December 2013 at 18:54

    I’m sure you’ll love this article professor:

    http://www.theguardian.com/society/2013/dec/17/living-standards-survey-institute-fiscal-studies

    “Born after 1960? Then you’re probably poorer than your parents”

  5. Gravatar of Dustin Dustin
    17. December 2013 at 19:07

    It’d be great if you had some sticky post that just included a running list of shortcomings with these sorts of income distribution measurements.

  6. Gravatar of Michael Byrnes Michael Byrnes
    17. December 2013 at 19:19

    I don’t exactly agree with the whole of your post, but it seems pretty clear that a well-designed consumption tax would sidestep many of these issues.

    It would not, however, address the issue of one-worker vs. two-worker families – a two worker family with kids would pay an enormous tax on consumption of child care services.

  7. Gravatar of Morgan Warstler Morgan Warstler
    17. December 2013 at 19:25

    Garrett,

    That guys and idiot BECAUSE of technologists doing starts ups.

    While Scott’s and DC’s eggheads have tripped over themselves for 50 years stagnating incomes…

    My guys have made sure that being paid less money IS STILL BETTER than what people had in 60’s-70’s.

    The nominal wage vs. CPI DOESN”T MATTER.

    Which is WHY the system should FAVOR the gods who deliver human improvement while’s academics and politicians massively screw up the monetary economy.

    How exactly do you run macro, when more and more of the real growth (productivity gains) causes massive price deflation?

    I think the answer is 1% NGDPLT.

    But Scott still doesn’t understand what I mean about real growth causing deflation.

  8. Gravatar of ssumner ssumner
    17. December 2013 at 19:31

    Thanks Garrett, Britain was a pretty bleak place back in 1979. The current generation is much better off.

    Dustin, Each year I plan to do that next year. But it’s a lot of work given my thousands of posts.

  9. Gravatar of Benjamin Cole Benjamin Cole
    17. December 2013 at 20:34

    Well, I wouldn’t say income is “meaningless,” but there is enough play in the wheel that I wouldn’t steer by it.

    Tax consumption—consumption roughly expresses the burden or share of fruits an individual or family is placing on, or taking from, society. A large consumer is using more resources, and probably using more public resources, such as roads, police and fire services, national defense etc.

    My only worry is that now we face a world of capital gluts and low demand.

    We don’t need more capital. We need way more demand, consumption.

    OT: Krugman latest post is about the econo-debate being now solidly bloggified. I was disappointed Krugman did not mention Market Monetarism, but certainly Scott Sumner, Marcus Nunes, Lars C. and others have brought Market Monetarism to the world.

  10. Gravatar of Bob Murphy Bob Murphy
    17. December 2013 at 21:36

    Why stop at “income” Scott? These 388 examples all show that numbers are meaningless. Look at how much people are confused by the use of numbers! Meaningless. What the heck is “80,000” anyway?

    (For a more serious defense of the economic concept of income, see this article.)

  11. Gravatar of Scott Sumner Wants to Take Income Away From All of Us Scott Sumner Wants to Take Income Away From All of Us
    17. December 2013 at 21:41

    […] a post titled, “Income is meaningless, example #388″ Scott quotes from Matt Yglesias who […]

  12. Gravatar of ssumner ssumner
    17. December 2013 at 21:44

    Bob, It may be possible to come up with a coherent definition of income, I’m talking about how income is defined and interpreted in the real world.

  13. Gravatar of Jim Glass Jim Glass
    17. December 2013 at 21:45

    There was some discussion of marriage penalty at the end of a recent post. A few points. I am aware of the “progressivity/treat households as a single unit” dilemma, except that it has no bearing on the marriage penalty.

    It would seem that the mathematical impossibility of treating both households and individuals equally in a progressive tax system has everything to do with the “marriage penalty”. Is pretty much the whole story.

    As I pointed out in my earlier comment, your desired formula has already been tried in practice — it was the law in the US for a good stretch of time — but it failed the test of political sustainability. This is a fact that should be considered.

    You wish the law to be changed (backwards) so that married persons are taxed separately on their individual incomes — so two married persons with equal income each will be taxed at the same rate as a non-married with the same income. Which is reasonable enough on its face. But it also requires that married couples with the *same* total income earned unequally (most or all by one spouse) will face much *higher* tax bills than your married couples receiving that amount of income through equally divided earnings.

    Most Americans believe that it is unfair for two married couples with the same income to be taxed very unequally. When this was the law in the past the tax bill differences on the same amount of income varied by as much as 40% or more — which is a lot, and beyond the limit of political tolerance in a society where most people believe households should pay equal tax on equal income.

    Now, Professor, please don’t repeat that I am wrong — when I report what most people believe I am right (and when you take what most people believe as what I believe you are certainly confusing things. I dare say I could name a great many more rampant absurdities and gross abuses in the tax law than most anyone else around here, if it came to what I believe.)

    As Ms. Postrel stated, it is mathematically impossible to have a progressive income tax system that treats both individuals equally and households equally. Pick two of three.

    Your argument is that individuals should be treated equally and households unequally. You can make that case, and I might agree with you (as I am one of a two-professional-earners couple too). But the political system has already tried and rejected that — not least because even in our new two-earner world most household couples remain with income that is very unevenly earned.

    You can look at them and say *they* are wrong, couples with equal income should be treated very unequally if it is required to tax individuals equally on their income. But they can look back at you and say you are wrong, couples should be taxed equally on equal income, even if individual members of a couple are treated unequally. And they outnumber you (us). In fact, politically, it is “been there, done that”.

    It’s a tax on marriage…

    It’s plainly not a tax on marriage — if it were, then everyone who married would incur the tax. To the contrary, in many if not most cases marriage reduces the tax of a couple, as even today most couples have very unequal earnings even when not just one earner. It *is* a tax on the household as an economic unit.

    …and has nothing to do with the claim that “two can live as cheaply as one” which is of course false.

    Nobody serious says “two can live as cheaply as one”. Everybody serious knows two can live together more cheaply than two apart. The Census says two can live together as cheaply as 1.4.

    There is no justification…

    The majority in the US think there is no justification for households with equal incomes to pay tax bills 40% different in size (as they did when tax was individual-based). You say there is no justification for treating the household as an economic unit when assessing taxes. The majority think there is no justification for disregarding the reality of the household being an economic unit when assessing taxes. That’s the hurdle you have to jump. The opinion you have to swing.

    (BTW, there are over a thousand federal laws that determine/pay/assess benefits/contributions/taxes, etc, on a household/joint basis, Social Security and all the rest, so that is quite a hurdle, convincing most people that income tax should be different.)

  14. Gravatar of Geoff Geoff
    17. December 2013 at 21:50

    NGDP is meaningless because it doesn’t tell us exactly how many resources and what specific resources should be put into the production of money, and how many resources and what specific resources should be put into the production of everything else.

    A non-market established rate of growth of NGDP, for example one brought about by individual counterfeiters called criminals, or state sanctioned counterfeiters called central banks, cannot reveal via observation of history, what the relative resource allocation mix between money and everything else should be.

    As a result, there is a constant antagonism between such counterfeiters and the market economy.

    Sumner is not here clamouring for more silicone chips, or cars, from their providers. He isn’t claiming that the world is messed up because silicone chip manufacturers or car manufacturers are not producing enough chips or cars. Why? Because he hasn’t brought himself to believe that there should be 4.5% growth in chips or cars every year, like he has with money. It is precisely because the rate of money growth is not set according to market forces, that there is the very problems Sumner unwittingly senses in money!

    If money was produced in the market, then if there isn’t enough money at a moment in time, then market forces of supply and demand will work to reverse the insufficiency, but unlike the counterfeiter solution, will tend to be on a correct path of correction.

    Every socialist who has ever lived, has always blamed the problems of socialism itself, on the people failing to live up to the requirements of it (which is of course impossible). Not even perfect NGDPLT will make the problems go away. There will still be financial crises, recessions, unemployment swings, the business cycle, and, if the non-market money activity persists, then at some point, monetary rejection.

    This almost happened in Australia in the mid 1970s, then again in 1990, and one more in 2009: for each time, the rate of money growth accelerated to a growth rate of over 20% per yea(!), before the RBA came to its senses each time by dramatically lowering inflation, which of course revealed the malinvestments, and unemployment significantly increased.

    These spikes in money supply growth were necessary to keep aggregate spending rising in a world of increasing structural problems caused by previous inflation. More inflation is needed to counteract the effects of previous inflation, which causes more structural problems, which requires even more inflation to prop up, and so on, accelerating upwards until the currency invariably collapses.

    The boom bust cycle will not go away with NGDPLT. Indeed, if NGDPLT is maintained in the long run, then the rise in the money supply would have to reach such great heights that the central bank would have to hyperinflate the money supply and lose control of NGDP.

    In other words, NGDPLT is untenable even if the counterfeiters tried.

  15. Gravatar of ssumner ssumner
    17. December 2013 at 22:01

    Jim, You said:

    “Most Americans believe that it is unfair for two married couples with the same income to be taxed very unequally.”

    Can I help it if most Americans are idiots? How do they feel about two gay people? Does it matter whether the two gay people are married? If you can show me a poll that says two gay people who each make $100,000 a year should pay a higher tax rate if they are married than if they are living together as partners, I’ll accept your claim. If not, then not. I’ve never met anyone with such a bizarre opinion. Whenever I discuss the marriage penalty with people they agree with me, nearly 100% of the time. Polls will give you any result you want, depending on how the question is framed.

    You said;

    “As Ms. Postrel stated, it is mathematically impossible to have a progressive income tax system that treats both individuals equally and households equally.”

    Again, this has no bearing on the marriage penalty, as I explained in this post.

    You said;

    “Nobody serious says “two can live as cheaply as one”. Everybody serious knows two can live together more cheaply than two apart. The Census says two can live together as cheaply as 1.4.”

    That’s the “eaters of dog food are lucky” fallacy, as I pointed out in this post. Living together doesn’t make living cheaper, it’s a consumption choice. If I have a Ford and my neighbor has a Lexus, he doesn’t have a higher cost of living, he has simply chosen a different consumption bundle. That should have no bearing on how much income tax he pays.

    You said;

    “BTW, there are over a thousand federal laws that determine/pay/assess benefits/contributions/taxes, etc, on a household/joint basis, Social Security and all the rest, so that is quite a hurdle, convincing most people that income tax should be different.”

    You keep saying households when you really mean married units. The government should pay no attention to whether people are married, it’s a purely private decision that is none of their business. It should not be a legal concept.

  16. Gravatar of Jim Glass Jim Glass
    17. December 2013 at 22:07

    On the other hand, I more than agree with you on the “income” issue. In fact you are too soft, you let it retain too much meaning! 🙂

    My poor impoverished widowed mother in her last years had no income at all (as per govt accounting that goes into income-inequality measures) and so presumably had to resort to eating cheap brands of cat food as she consumed her mid six figure savings in her fully paid off high six figure home. She was counted right down there among the bottom-dwellers in the income inequality tallies.

    And I’ve been even worse! As a self-employed I’ve been in all 10 deciles, as well as both the top few and bottom few percentiles — bottom to top to bottom to top to bottom (hope it doesn’t stop here!) … my own personal income inequality measure is enough to make me socially aghast at myself!

  17. Gravatar of W. Peden W. Peden
    18. December 2013 at 00:06

    On this issue, there was an article in the Sunday Times last week noting that while the UK is one of the less equal economies in the developed world in terms of income, we’re in the upper half of economies in terms of wealth equality (more equal than France or Germany).

    Not everything that can be counted counts and not all that counts can partly due to the fact that there are more statistics out there for it. Inequality of power is more important, but how does one do an index for the relative power (as compared with their subjects) of Kim Jong Un vs. Rameses III?

  18. Gravatar of Saturos Saturos
    18. December 2013 at 00:39

    “At least you can measure tall people; you can’t measure brain wiring”

    Yet…

  19. Gravatar of Vivian Darkbloom Vivian Darkbloom
    18. December 2013 at 01:07

    “That’s right””and let’s go a bit further. Suppose the old guy with $2 million earned $200,000/year for 40 years, and was a high saver.”

    I’ll ignore the likelihood that this old guy was a “high saver” (unless he was also a very poor investor) but it is most likely that this old guy is reported as having a lower effective tax rate than he actually incurs, particularly if his savings were directed to tax deferred accounts.

    When “tax policy experts” get around to calculating “average effective tax rates” they count “income” twice. Tax deductible/excludable contributions to pension plans, 401(k) plans, IRA’s, etc and even the tax deferred buildup are often counted as “income” and the subsequent distributions from those same plans are counted too. This inflates “income” and deflates the “effective tax rate” for nearly everyone.

    http://taxvox.taxpolicycenter.org/2013/12/12/where-are-tax-rates-headed/

    And, in case you missed it, Greg Mankiw has a great little “cautionary tale” on measuring “changes in income” which should be a must read for anyone interested in the subject:

    http://gregmankiw.blogspot.fr/2013/12/on-measuring-changes-in-income.html

  20. Gravatar of MikeF MikeF
    18. December 2013 at 03:13

    On the topic of income distribution…I looked at some interesting charts the other day….I’m sure you have already seen them…but they were new to me and I thought they were very enlightening on the topic. The graphs showed the GINI coefficients for individuals, families, and households since 1994. The interesting thing is that the GINI for individuals has been flat or even trending downward over this period, while the GINI for household has been going up. The only real explanation is that more women are earning more money and tend to be married to spouses that also are high earners and low earner tend to be married to spouses that also low earners. Part of that is spouse selection and part is that both tend to hit their prime earning years at the same time the effect is amplified. No correlation with Bush Tax cuts or any other government policy can be inferred….

  21. Gravatar of Mike Sax Mike Sax
    18. December 2013 at 03:37

    I’m not entirely sure I get what you’re getting at Morgan but if your point is that ‘capital gains’ is way too broad a concept-where it claims equality between someone who buys lots of stocks and someone who actually runs his own business then maybe you’re onto something.

    I got to say I like what Bob Murphy says here:

    “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.”

    http://mises.org/daily/4788

    The trouble I have with all these inventive scenarios of people with the same income who ‘choose’ different consumption/saving levels is that the real problem is that consumption is something that the poor do a lot more of-as a percentage of income-than the rich do.

    Scott, I know you made a call recently not to assume the worse of other people’s motives. It’s a good point. I have to admit though that I see the argument to get rid of the term income as just a very satisfying argument for conservatives who don’t believe in progressivity anyway.

    Yes, I know that Ygelias kind of follows you on the consumption tax. Nevertheless plenty of liberals don’t. If we follow your argument we basically lose any ability to even discuss income inequality-as there’s no such thing as income, how can it be unequal?

    So progressives have good reason not to bit on this argument. Conservatives, though, will obviously love it.

  22. Gravatar of Mike Sax Mike Sax
    18. December 2013 at 03:39

    The other trouble I have is I don’t buy this-entirely pre-Keynesian-idea that all savings is necessarily deferred consumption.

  23. Gravatar of Socialistinthecity Socialistinthecity
    18. December 2013 at 04:14

    There are very good reasons to tax capital gains and I’m comfortable saying that as a (semi!) trained economist and financial professional.

    Firstly, capital accumulation is not neccesarily achieved by sacrificing earned income.

    Secondly, most tax systems explicitly reward saving or allow savers to bypass income taxes in significant ways.

    Importantly, wealth inequality is much worse than income inequality, and historical income inequality, implying that the origins of capital accumulation do not originate in saving income, rather they are the result of an arbitrary allocation of property rights and are highly path dependant.

  24. Gravatar of Socialistinthecity Socialistinthecity
    18. December 2013 at 04:15

    Argh… Not capital gains… Income from capital. I know what I mean!

  25. Gravatar of Dan W. Dan W.
    18. December 2013 at 05:27

    Scott,

    We only care about definitions of income because the government says so.

    And with a tip to the greatest tax protest song ever:

    Now my advice for those who die
    Declare the pennies on your eyes
    ‘Cause I’m the taxman, yeah, I’m the taxman
    And you’re working for no one but me.

  26. Gravatar of ssumner ssumner
    18. December 2013 at 05:57

    Jim Glass, Those are good examples.

    Vivian, Good point, and that was an excellent Mankiw post. The underlying study was excellent as well.

    MikeF. Good point.

    Mike, You said;

    “Scott, I know you made a call recently not to assume the worse of other people’s motives. It’s a good point. I have to admit though that I see the argument to get rid of the term income as just a very satisfying argument for conservatives who don’t believe in progressivity anyway.”

    Since the previous paragraph to this one shows that you don’t understand what I am saying, how can you possibly judge my motives?

    Socialist in the City, You said:

    “Firstly, capital accumulation is not neccesarily achieved by sacrificing earned income.”

    Your training in public finance was definitely “semi” as this has no bearing on the standard argument for consumption taxes.

    You said:

    “Secondly, most tax systems explicitly reward saving or allow savers to bypass income taxes in significant ways.”

    This is false, at best that have some breaks which allow slightly less overtaxing of saving.

    You said:

    “Importantly, wealth inequality is much worse than income inequality, and historical income inequality, implying that the origins of capital accumulation do not originate in saving income, rather they are the result of an arbitrary allocation of property rights and are highly path dependant.”

    This is not accurate if you measure wealth properly, and even if it was it would have no bearing on the standard public finance arguments. Actual wealth (present value of future consumption) is far less unequal than measured wealth. Even if we made the US 100% equal in wealth in 2014, within a few years MEASURED wealth would become highly unequal. It has nothing to do with starting points.

  27. Gravatar of Brian Donohue Brian Donohue
    18. December 2013 at 06:55

    Good post Scott!

    Great comments by Jim Glass.

    Awesome tirade by Morgan.

  28. Gravatar of Mike Sax Mike Sax
    18. December 2013 at 09:01

    I’m not judging your motives. Like Socrates said man only acts for the good. However, the effect is the same: if there’s not such thing as income then it’s a pretty easy walk for conservatives from here.

    I’m not sure what I’m supposed to not have understood. I’m really not so concerned though about people with the same income-or wealth, per capita income-or whatever you want to use-and their disparities in saving.

    My guess is that the difference in saving patterns among people with the same income is not nearly as great as these idiosyncratic examples makes it sound.

    I’m concerned that the nonrich save a lot less and really the more you make the more you will save. I don’t see high savings as due to some great virtue of ‘frugality’ but simply-having more income. You will get to save little of your first $20,000, a little more of the second, and so on.

    So while I don’t think that Murphy agrees with me on anything I agree with him that a consumption tax is both immoral and inefficient.

  29. Gravatar of Doug M Doug M
    18. December 2013 at 09:27

    Morgan,

    The entrepreneur and the financier are both cooperative and competitive with one another. The entrepreneur needs the financiers money to get his venture of the ground. The financier wants a cut of the future profits as reward for putting his money at risk. The two negotiate as fiercely as the can the entrepreneur giving away as small of a cut as possible while still getting his money.

    If markets are informationally efficient a marginal change in the tax code to favor the entrepreneur over the financier will result in a modification to the negotiation above resulting in both parties in largely the same net position after taxes.

  30. Gravatar of Doug M Doug M
    18. December 2013 at 09:45

    While it is all well and good and American to debate the inefficiencies of our tax system, I am going to put for the cynical theory of taxation.

    All taxes are paid by people with money.
    People with money will use some of their money to buy influence to pay less tax.
    Politicians need money to hold office.
    Politicians write the tax code.

    It is much easier to open a new loop hole than it is to close an existing loophole. The entrenched interest will howl loudly when a loophole is closed, but no one makes too much noise when a new loophole is opened. However, when a new loop hole is opened a shortfall is created that must be plugged somewhere else.

    The tax code is biased toward ever more complexity and inefficiency.

    It is a politically astute move to claim you are simplifying the tax code, when in fact you are creating a multitude of special exemptions for your favored constituents.

    It is also politically astute to argue for tax fairness while building in inherent unfairnesses.

  31. Gravatar of Deidrich Knickerbocker Deidrich Knickerbocker
    18. December 2013 at 10:21

    Actually, regarding your twins example, it’s very widely acknowledged that consumption smoothing is a legitimate way to become better off.

    No economist would see these two as equally well off.

  32. Gravatar of Morgan Warstler Morgan Warstler
    18. December 2013 at 12:25

    Doug,

    I don’t favor level playing fields.

    I also favor P2P software, distributism, State’s Rights (Constitution) over Parliamentary Democracy, and anti-fragility.

    Scot’s wrong about the marriage penalty.

    We should FAVOR married (gay and straight).

    And we should FAVOR married parents over married.

    The reason for ALL of these is the same:

    Small Government is better than Big Government.

    And Big Business = Big Government. 100% of the time.

    Families and Married rely less on Big Government.

    I don’t have to play fair with people who want big government, and I’m willing to discriminate with policy (affirmative action) for small government.

    I’d prefer to do so in the least harmful way possible.

    And again, Scott has never had an answer fo, and will not give one for:

    If Scot invests $100 into a startup and a year later earns $1000, that $900 has not been taxed.

    He wants to step back and view the whole the thing – as macro, and thats NOT what the tax code is about.

    The tax code is about encoding / favoring biases into the system, and people who defer income during the start of newco’s and married parents are BETTER for this country than other types of people.

    Because Small Government is better than Big Government, and successful systems WRITE RULES that are not level.

  33. Gravatar of Jim Glass Jim Glass
    18. December 2013 at 14:10

    Jim, You said: “Most Americans believe that it is unfair for two married couples with the same income to be taxed very unequally.”

    Can I help it if most Americans are idiots?

    Well, you certainly have to live with the consequences until you find an argument that can educate them into realizing how they are so wrong.

    But c’mon — you really can’t think of *any reason at all* supporting the idea that households should be judged as economic units? For the Census tracking household income, literally a thousand federal laws administering benefits of every kind on a household basis, the IRS imposing head of household tax status on unmarrieds’ households, etc.?

    When you don’t even try to understand other peoples’ point of view, well, you aren’t even trying.

    I’ve never met anyone with such a bizarre opinion. Whenever I discuss the marriage penalty with people they agree with me, nearly 100% of the time.

    Aw, c’cmon again. You know better than that argument. Pauline Kael didn’t know anyone who bizarrely voted for Nixon, all her friends voted for McGovern, but they didn’t reflect the average voter’s opinion. The people in your circle whom you choose to discuss the marriage penalty with I bet are not a representative sample. *And* I’d bet a lot that you don’t also ask them: “Should married couples with the same income pay greatly unequal tax bills?” Do, and see what they say to that.

    Politicians are often viewed as inept — but one thing they are very very good at is knowing the opinions of those who vote for them. When they overwhelmingly reflect a given opinion, it is pretty bizarre to argue that opinion doesn’t exist.

    Note again: The tax system you want has actually been tried in the US and politically failed. You don’t deal with that. How do you convince politicians to try again what has already politically failed?

    You keep saying households when you really mean married units. The government should pay no attention to whether people are married

    No, I really mean households. The Tax Code taxes singles’ households, households headed my marrieds, and households headed by unmarrieds (via “head of household” tax status). The government should/shouldn’t do countless things, that doesn’t change what I mean by my words.

    You said; “As Ms. Postrel stated, it is mathematically impossible to have a progressive income tax system that treats both individuals equally and households equally.” Again, this has no bearing on the marriage penalty, as I explained in this post.

    Denying the issue does not make either it or the arithmetic go away.

    Speaking of which, maybe looking at real numbers can defuse emotion and provide some useful perspective on the issue.

    One important empirical point I mentioned in my first comment but have insufficiently emphasized since then: The marriage penalty has been *eliminated* for the great majority of filers.

    There is no marriage penalty on the first $146,400 of joint taxable income this year (joint tax brackets up to that level are exactly double the size of the brackets for single filers up to that level) — that is $146k in addition to/over all exemptions, deductions, allowances etc claimed, which will get this no-penalty number up closer to $200,000 for many couples.

    That covers about 85% of joint filers – no marriage penalty for the masses. For the rest it exists only for couples with fairly equal incomes to the extent they total over $146k (couples with very unequal incomes get a tax reduction as a marriage “penalty”).

    OK, if a couple is fortunate enough to have taxable income well above $146k, how big can the penalty be at the extreme case of perfectly equal incomes?

    Let’s add $100k to income, making taxable income $246k earned either at $123k per person or all by one spouse of a couple. Result:

    Current law:

    2x tax due on $123k at single rate: $55,467

    Tax due on $246k at joint rate: $57,493

    Marriage penalty: $2,027, or 0.8% of income (or 2% of the marginal $100k)

    Return to old law of couples taxed individually (marriage penalty eliminated, “one-earner penalty” reinstated):

    Now only the single tax rate exists, so …

    Couple earning 2x $123k owes tax of: $55,467

    One spouse of couple who earns $246k owes tax of: $65,311 — a “one earner” penalty of $9,844, 18% of tax the bill, 4% of income (10% of the marginal $100k).

    Perhaps this shows why the political equilibrium has landed where it is. In the great sea of tax injustices a marriage penalty in the extreme case of 0.8% of income is a pretty small fish. A one earner penalty of 4% of income is a much bigger one to those who would get hit by it (as is the 5x higher marginal rate).

    You are demanding as a matter of self-evident justice that the people on the other side of the equation pay $5 more in tax so you can save $1. They may not see justice that way, and they have political representatives too — and have five times your motivation to communicate with them about the justice of keeping the household as the taxable economic unit.

    With the rise of two-earner couples, changing political incentives drove the elimination of the marriage penalty for 85% of marrieds and the slashing of it greatly down in size for all the rest. That done, the incentives for much more movement in this direction are lacking.

    And IMHO, even though I often pay the penalty myself, given the current size of the penalty, in the great tax sea there are whales of injustice, inequity and inefficiency to spend one’s limited resources pursuing ahead of this now diminished relative minnow, as a matter of priorities. One person’s opinion.

  34. Gravatar of Majorajam Majorajam
    18. December 2013 at 14:22

    Scott, I get that you want to divorce income from wealth, but I don’t get why. The two measures are joined at the hip in most every conceivable way, as illustrated by their present lockstep march toward greater inequality. Are you really arguing that we shouldn’t have a progressive tax system because it can be unfair? Because, no disrespect, but that’s not wonky. That’s adolescent boy whine.

    I suppose if you start from the centuries ago debunked viewpoint that utilitarianism describes the human psyche, decision making and/or well-being, arguments like these probably make you feel like the smartest guy in the room. But when the actual folks out there in the real world hear theories about the meaninglessness of income, about ‘Rational Addiction’, about the inconceivability of credit/investment bubbles, (actually that last bit tends not to be advertised, sort of like the volcano dwelling aliens of Scientology-lore), you should wonder whether their bewilderment is something to be proud of.

    Don’t get me wrong, I’m not pleased about the raw deal I get based on the way our tax code is structured. I pay the marriage penalty, I pay AMT, I pay high state and local taxes, I get few above the line deductions because of lifestyle decisions I make that have little social consequence, (e.g. renting), etc. all of which add up to my being taxed at multiples of what many billionaires pay (something I have good insight into, fyi). But I also believe that the alternative espoused by folks like you is only likely to accelerate the trend toward a Latin Americanization of our society, with all attendant ramifications.

    Not only for our country, but for selfish reasons, my preference for current policies couldn’t be more clear.

  35. Gravatar of ssumner ssumner
    18. December 2013 at 15:45

    Mike, You said;

    “So while I don’t think that Murphy agrees with me on anything I agree with him that a consumption tax is both immoral and inefficient.”

    If you showed me you understood why Yglesias favors a consumption tax I would be more sympathetic to your arguments. But you haven’t showed me that.

    Deidrich, You said;

    “Actually, regarding your twins example, it’s very widely acknowledged that consumption smoothing is a legitimate way to become better off.

    No economist would see these two as equally well off.”

    I’m an economist! Seriously you are flat out wrong on the theory. The optimal consumption smoothing completely depends on the person’s rate of time preference. My twin example that rate differed and hence is perfectly consistent with the econ I was taught in grad school.

    Jim, You seem to be ignoring my arguments. Not sure why, because you won’t convince me unless you address them.

    You said;

    “And* I’d bet a lot that you don’t also ask them: “Should married couples with the same income pay greatly unequal tax bills?” Do, and see what they say to that.”

    Isn’t that exactly what I’ve been saying here? Public opinion is meaningless because it depends how you ask the question. And I talk to a wide cross section of society, so I have pretty good idea what other people think. Most people I talk to have very different political views from me. If I frame the question the way I want, I’ll get 90% support.

    And again, households are very different from married units. We do not apply taxes to households and if we did there would be a revolution in this country. Imagine two single guys sharing an apartment being told they had to file as a household. I’m saying that the argument for taxing married units is really an argument for taxing households. And the public is clearly opposed to taxing unrelated people as a household, so there is no justification for the entire concept. You have not addressed that at all. Do you favor treating unmarried people in a household as if married, and does the broader public favor that? Yes or no? If no, then the two can live as cheap as 1.4 goes right out the window.

    You said;

    “Note again: The tax system you want has actually been tried in the US and politically failed.”

    Legal marijuana was tried and failed. By your logic it could never be brought back. But it was! Hence your argument makes no sense. Things are always politically impossible until they happen. Then they are possible.

    Of course there are many injustices that are much greater, like drug prohibition. I also talk about that issue. But just because the marriage penalty is not the biggest problem in America doesn’t mean I cannot call it insane on a long list of other insanities. I was content to leave it as an item on a long list. You challenged the accuracy of my claim, so I had to show you were wrong, no matter how small the issue. I’m obsessive. Hence my absurd overreaction.

    Majorajam, You said:

    “Are you really arguing that we shouldn’t have a progressive tax system because it can be unfair? Because, no disrespect, but that’s not wonky. That’s adolescent boy whine.”

    Given that I’ve advocated progressive taxes about 100 times on this blog, I’d say you owe me an apology.

    The rest of your comment is all idiotic, as it’s based on a mistaken notion of what I favor.

  36. Gravatar of Majorajam Majorajam
    18. December 2013 at 15:54

    If your notion of progressive taxes is that rich people pay a greater absolute amount in taxes, as opposed to higher tax rates, I’m afraid yours is the idiocy. If on the other hand you do favor progressive tax rates, you have my apology for jumping to conclusions on that score. In any case, by way of fyi, there is plenty in my comment that has nothing to do with what you favor, not that I can’t understand your desire to duck it.

  37. Gravatar of Negation of Ideology Negation of Ideology
    18. December 2013 at 16:07

    Scott –

    “I’m saying that the argument for taxing married units is really an argument for taxing households.”

    It seems to me the argument is that married units have created a joint legal entity, more like an unlimited liability corporation. Roommates sharing an apartment don’t have that. Don’t get me wrong, I agree with you that the marriage penalty is stupid and wrong. I just believe they should be taxed like an S-corporation owned 50% each, with exactly half of the income for each spouse. (I believe all corporations should be taxed once at the individual level for the same reasons, but that’s another topic.)

    Consider this example – if you started an S-corp for your blog, but you write all the posts which brings in $200,000 in a year. Your partner owns 50%, writes no posts but takes care of unpaid tasks for you so you have more time to write. You would each pay taxes on $100,000. If you marry someone and do the exact same thing, why should you be taxed differently? Instead of you paying tax on $200,000 and your wife paying tax on $0, the income from your legal partnership should be split, $100,000 each.

    Then there would never be a marriage penalty. And if unmarried people want to create joint property and liability corporations they should be taxed that way too in my opinion.

  38. Gravatar of bill bill
    18. December 2013 at 17:05

    Scott,
    Can you email me a link to some wonkish material on the topic of taxing vs. not taxing capital income?
    Thanks!

  39. Gravatar of ssumner ssumner
    19. December 2013 at 09:10

    Majorajam, Yes, I know what progressive means and thanks for the apology. I apologize for thinking you wouldn’t apologize.

    All I saw in the rest of your post was useless comments on utilitarianism (which is one of the philosophical beliefs that underlies progressive taxes), and Latin American models that have nothing to do with my views. So I see no reason to comment unless I missed something.

    I also don’t resent the amount of taxes I pay (which is a very high rate, I have almost no deductions) but do resent the needless complexity of our system. K.I.S.S.

    Negation, I also oppose corporate taxes.

    Bill, Not sure, but I think Steve Landsburg did a post explaining. Perhaps you could google that.

  40. Gravatar of Floccina Floccina
    23. December 2013 at 10:04

    So we should think of the progressiveness of the income tax as a tax on above average ability to earn. After all in is called an “income” tax.

  41. Gravatar of Deidrich Knickerbocker Deidrich Knickerbocker
    23. December 2013 at 10:41

    Hi Sumner,
    Good point about the agent’s time preference since i could have been talking about savings constraints such as a lack of self control but in any standard model, an agent with a weaker time preference (higher parameter beta usually) will have higher sum utility over all time periods meaning that they are better off than someone with a lower parameter value. The implication of this is that according to another basic priciple, diminishing marginal returns, if we want the tax burden to have the smallest impact on well being we should tax the most well off more heavily which is what taxes on capital accomplish.

    Sure you can get into why its impossible to make interpersonal utility comparisons but that really isn’t a reasonable critique when you’re talking about such widely disparate incomes

  42. Gravatar of Deidrich Knickerbocker Deidrich Knickerbocker
    23. December 2013 at 10:42

    Hi Sumner,
    Good point about the agent’s time preference since i could have been talking about savings constraints such as a lack of self control but in any standard model, an agent with a weaker time preference (higher parameter beta usually) will have higher sum utility over all time periods meaning that they are better off than someone with a lower parameter value. The implication of this is that according to another basic principle, diminishing marginal returns, if we want the tax burden to have the smallest impact on well being we should tax the most well off more heavily which is what taxes on capital accomplish.

    Sure you can get into why its impossible to make interpersonal utility comparisons but that really isn’t a reasonable critique when you’re talking about such widely disparate incomes

  43. Gravatar of ssumner ssumner
    23. December 2013 at 16:03

    Deidrich, You said;

    “Sure you can get into why its impossible to make interpersonal utility comparisons but that really isn’t a reasonable critique when you’re talking about such widely disparate incomes”

    I think you have missed the point. We are talking about two people with identical lifetime wage incomes. Their only difference is when they spend their resources. That’s all. Interpersonal utility function differences are the ONLY important differences between these two people. Contrary to what you claim, economic theory does not allow us to make any interpersonal welfare comparisons when two people have the same lifetime wage income, but different rates of time preference. And I’m some who believes you can make interpersonal comparisons when people have different wage incomes. So otherwise I’m on your side. But in this case there is nothing to say, no reason to assume one person is happier than the other.

    If I’m wrong, why would one person choose to spend the money sooner than the other?

  44. Gravatar of Deidrich Knickerbocker Deidrich Knickerbocker
    24. December 2013 at 07:25

    I guess our disagreement comes down to whether you really think that someone who doesn’t save does it because that’s what they decide is optimal or because they lack the necessary self control. Its fine if you’re studying something else to just bundle both of those things into the discount factor but when you’re discussing tax policy it’s really really important to separate the two effects.

    There are all sorts of unrealistic short cuts (i.e. social planner problems) that we use to simplify models because they don’t effect the issue we’re looking at but you’re using one of these short cuts as the basis of your argument against taxing capital gains. A more realistic model gives different conclusions.

  45. Gravatar of ssumner ssumner
    24. December 2013 at 11:11

    Deidrich, I’m sorry but I really don’t understand your argument. It seems to me you are saying the the foolishness of someone’s consumption choices should factor into the tax rate they pay. Thus that someone who gambles a lot or spends money on booze should pay lower tax rates than a parent who spends their income on their kids education. But that can’t be right. So what are you saying? Are you saying someone who foolishly (your claim, I’m agnostic) doesn’t save as much as someone with identical wage income should pay a lower tax rate?

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