Garett Jones  

Redistributing from Workers to Capitalists: Would Rational Workers Vote For It?

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First things first: A hearty welcome to my new co-blogger Art Carden.

To the task at hand: A while ago I wrote on how "Capital should be untaxed" should be the default view in economics: Zero capital taxation should be the starting point for future discussions among serious people, it should be taught in principles courses. Interfluidity wrote a valuable critique, read the whole thing. I'm here to emphasize two claims he discusses:

1. If the real world has increasing returns to scale--if doubling inputs more than doubles outputs--then rational workers would want to subsidize capital rather than tax it (Short wonkish PDF, page 4).

2. If in the real world some workers can become productive from accumulating human capital, then perhaps capitalists (and workers who aren't good at building up human capital) would rationally want to treat human capital as, well, capital, and leave it untaxed. In practice this would probably mean taxing high wage-earners at lower rates than low wage-earners: If high wages are mostly caused by human capital we want to ensure that there are good incentives to accumulate human capital.

Both of these ideas have the same implication: Given a few basic assumptions, if there are workers who are unable to accumulate human and physical capital themselves, and if these workers are wise, these workers would gladly tax themselves to pay the cost of government, and they might even gladly tax themselves to subsidize the growth of capital.

If I'm a worker who can't accumulate human or physical capital to make myself more productive, I crave opportunities to at least use such capital in my job. And one rational way to satisfy that craving is to make a lot of sacrifices so that everyone around me has an incentive to accumulate physical and human capital.

So once we make the Chamley-Judd zero capital taxation result a bit more realistic, once we make it sound more like the real world, we find that regressive taxation looks a bit better than before. It's not that all signs point in the direction of regressive taxation--as Interfluidity and I both note, some tweaks of the model support progressive taxation, some support regressive taxation. But if the reality-based community cares about the well-being of people who don't have great skill at accumulating human and physicial capital then they should use zero capital taxation as their starting point.

There are sound arguments for positive capital taxation, sound arguments for negative capital taxation. Let's start with zero and go from there.

Coda: To quote Interfluidity:

...those of us who support redistributive taxation don't believe that the world works in the way that Chamley and Judd assume...
Indeed. And once we look at the way the world works, there are at least some reasons for having high tax rates on those who don't have the ability to accumulate capital and low tax rates on those who do.


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COMMENTS (14 to date)
R Richard Schweitzer writes:

First off.

For purposes of this enquiry:

What is a Capitalist?

What are the qualifications? The landscape tenders of No. VA. who own "capital equipment" that enables employees to do many jobs for more pay?

The baker who owns his own premises and most of his stoves, etc.? The bakery equipment supplier who sells (or leases) the rest to him on "credit?"
The flour supplier? The grain trader?

Is the qualification one of control?

Himanshu Sanguri writes:

A very confusing thought has been put forward. I am unable to get the central idea. Can the author help in concluding it.

Hazel Meade writes:

Few thoughts:

Why the arbitrary distinction between "capitalists" and "workers"? In the modern era, where anyone can open an Ameritrade account, can't everyone be a capitalist?

Second, the different tax treatment of business vs. individuals. We allow businesses to deduct expenses such as rent, they only pay taxes on profits, but individuals pay taxes on their gross income. If we're going to treat people as capital investments, surely food and shelter should be considered maintainance.

Brian writes:

Perhaps I'm missing something, but don't rational workers currently subsidize capital by investing a portion of their earnings in retirement accounts?

After all, the Chamley-Judd scenario involved taking money from capital (through taxes) and distributing it to workers as income (i.e., for consumption). In the long run this reduces the workers' income because of lost returns on capital.

When workers invest a portion of their income they are taking money from consumption and giving it to capital. Am I missing an important distinction?

So my response to interfluidity would be, yes, rational workers should subsidize capital--and they do.

Many workers do not do this, of course, but that's because they value their short-term income gain over the long-term income growth. In some cases such choices are rational; in others, not.

Kevin Dick writes:

Um, perhaps I'm missing something, but isn't the solution to the problem pretty obvious?

The government takes capital from the wealthiest capitalists and transfers it to the workers most unable to accumulate capital. BUT, that transferred capital is kept in capital accounts with a custodian.

The workers then get to earn returns of the capital--making the world more "fair". But the capital stock is maintained--conforming to the way the world "works".

Chris Wegener writes:

Really? How has that worked out for most Americans since the Eighties.

This is a recipe for even more extreme income equality all in the guise of maximizing economic growth. But since that growth will go almost exclusively to the richest people we will eventually exist in a situation where almost ninety percent of the population will be struggling to live on twenty percent of the national income.

You want a revolution that badly?

Ghislain writes:

I am sympathetic to a flat (or maybe regressive) taxation but #2 does not convince me:

People do not want to get richer. They want to get richer THAN their neighbor, friends, family relatives...

So, rationally, they want a higher tax rate for income above their own.

James Oswald writes:

I don't think arguing over who has the null hypothesis is productive. One could say positive capital taxes are the null hypothesis simply because it's what most countries do.

Jim Glass writes:

I greatly enjoyed that. :-)

Paul writes:

As Bono would say: "What about the children?"

david writes:

Regressive taxation always almost sounds better as far as efficiency concerns go. It's the distributive issues that go haywire.

ohwilleke writes:

What utter piffle.

When you model starts telling you something absurd, the smart thing to do is assume that your model is broken.

The biggest flaw here is that workers only care about aggregate productivity if they get some of it. Worker pay is determined mostly by skill not "productivity" in the abstract. Truck drivers don't make immensely more than taxi drivers even though the capital they are utilizing costs much more.

A second flaw is that the primary purpose of taxation is to generate revenue to spend on the highest possible utility collective purchases that are available. People with little capital and little human capital (which is a lot of people) generate very little revenue when taxed more heavily and undertaxing in the aggregate deprives society of high marginal utility public spending in favor of lower marginal utility private spending.

A third big flaw is that taxing different kinds of income at different rates encourages all sorts of worthless rent seeking behavior as one tries to game the system by turning non-capital income into capital income a la Carried Interest taxation (a game that workers have not ability to play).

There are more flaws but those are some of the big ones.

Thomas Sewell writes:

Wow, lots of negative responses... and here I thought he was underestimating the level of opposition...

A few responses below.

R Richard Schweitzer: A Capitalist is someone who earns a return based on owning (or controlling the use of) capital goods. This generally involves some decision making and risks as well.

In the U.S., there are many more capitalists than there are in most societies through time.

Hazel Meade: I agree that the different treatment of business and individuals in our tax code makes no sense. The most straightforward way around that is to tax individuals instead of collections of individuals. Then everyone functions under the same rules rather than by how much they paid a tax attorney or lobbyist. The problem with that (from the politicians perspective) is that it would severely limit rent-seeking behavior for them to profit off of, so it's difficult to get a political majority for the idea. See also health insurance cost deduct-ability by business but not by individuals.

Brian: Yep, one of the tricks in the analysis is that in the U.S., we're almost all both capitalists and workers. So which would you rather encourage? Drop your currently highly skilled workers into a poor part of Africa and see if they can maintain their lifestyle from their skills without the capital that goes along with it. The available capital makes all our lives better.

Kevin Dick: Returns on capital aren't magical. What you're describing is similar to social security, or government pension funds. How well has that worked out? The problem is that you want capital to accumulate to individuals who figure out better uses for it. That's where a large part of the return to society comes from, that efficiency and it's also a large reason why markets work so well. They're self-correcting that way. Appointing someone a custodian doesn't give them the ability to accomplish that.

Chris Wegener: The bottom 20% of individuals from the 80s are now much wealthier than they were then. You're misunderstanding income statistics. See http://comeletusreasontogether.com/myths-about-income-inequality-and-poverty-levels-why-it-doesnt-matter for a longer explanation, or Google it.

Ghislain: You say "people", but who do you mean? I prefer more absolute wealth for myself and my family. I also prefer more absolute wealth for others. Some people (especially left wing progressives, it seems to me) grouse a lot about how much better off other people are, but looking at their revealed preferences for society, they don't seem to take all the U.S. wealth and move to poor societies where they'll be among the very wealthiest. So apparently there is something else going on than just wanting a better comparison with others. Maybe they get some sort of emotional return from sympathizing or complaining and don't want to work any harder at it than that?

ohwilleke: You have a good point about truck drivers vs. taxi drivers. Its undermined by the fact that truck drivers do make more and thus share in the returns, while many taxi drivers make more at the expense of their customers through medallion-style rent-seeking. Makes it a much more difficult comparison.

Your second flaw is more misguided. People living in a more economically free society are much wealthier over time than those at even the top of more progressive economies. The power of economic growth makes huge differences to everyone involved. It's why no one in the U.S. today lives like they did 200 years ago in the same location.

Your third flaw related to rent seeking is well taken. I see that as an argument FOR setting the default condition to 0 taxes on capital. Anything other than that is what exposes you to rent seeking. Instead, treat all individuals the same under the tax code. Don't create a distinct class of capital or business to be taxed. A consumption-only tax might be a good way to do that, as long as you ensure that all consumption is taxed, eliminating games like getting a business entity to pay for a vehicle, etc...

ohwilleke writes:

"Drop your currently highly skilled workers into a poor part of Africa and see if they can maintain their lifestyle from their skills without the capital that goes along with it. The available capital makes all our lives better."

This is something people in my family have personal experience with. Several of them who were highly skilled workers went, with extremely little capital, to rural Tanzania, and started a private college (the only private college in the nation in some disciplines like law). Students built dorms to sleep in out of bricks they made themselves, etc. They haven't immediately fully reproduce the "American way of life" but the little pocket they created is quite liveable, and vastly more comfortable than anything that was there before. In a generation or so, it will support a comparable lifestyle.

This experience is not a one off observation. Go back further in time in Africa and South Africa is the obvious example of this. For the converse, look at the failure of land reform in Zimbabwe or the collapse of my African economies during decolonization. A handful of highly skilled (and less corrupt) workers in Haiti's ports after it experienced a disaster, dramatically increased port productivity and national GDP from trade in the port, without no change in physical capital. Identical factories built from the same blueprints in different countries rarely have even roughly similar levels of productivity.

If physical capital investments were the key to economic growth than the Rust Belt would be the economic center of the United States.

Human capital is vastly more important that physical capital in a wide variety of situations. Another good example is that the utter destruction of physical capital in Europe following WWII did not lead to long run lower standards of living there.

"People living in a more economically free society are much wealthier over time than those at even the top of more progressive economies."

The empirical evidence simply does not support this proposition. At best, there is no statistically significant link between the size of the public sector and economic growth; the more fair reading of the evidence tends to show that more public sector spending and high taxes weakly favor more economic growth than less.

The empircal evidence is that command and control communist economies do less well than EITHER socialist mixed economies or low government "economically free" societies. It does not show that higher tax rates or government spending levels or levels of regulation reduce economic growth. Some of the most wealthy countries in the world have double the combined tax burden (from all levels of government, far more government spending, and more regulation than the U.S. Almost every country in the world that has combined tax burdens similar to or less than the U.S. is much poorer than the U.S. (e.g. in the OECD which includes almost all of the developed world defined broadly, Mexico and Chile are the only two countries with lower combined tax rates). The only affluent societies with very low levels of taxation of those built on natural resources (e.g. oil) or legal loopholes (e.g. the Cayman Islands).

"A consumption-only tax might be a good way to do that, as long as you ensure that all consumption is taxed, eliminating games like getting a business entity to pay for a vehicle, etc..."

The vehicle deduction is a classic case of trying to determine if spending is taxable personal consumption or non-taxable business investment for production purposes that can't be avoided with a consumption tax (indeed a lot of sales tax law involves that very distinction since many states impose sales taxes only on personal consumption expenditures).

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