Scott Sumner  

The correct reason to oppose high MTRs

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In a recent post I suggested that relatively high marginal tax rates on consumption of the ultra-rich might be justified as part of a tax reform package that abolished the personal income tax, and also abolished the corporate income tax, and also abolished all inheritance taxes. I use utilitarian reasoning in all my tax posts, indeed all of my economics posts (I'll try to do a post soon defending utilitarianism.)

David Henderson has a reply to this post:

Here's what I wrote in response to Cornell University economist Robert Frank's proposal for a very high tax rate, and it applies to Scott's argument: Frank argues that consumption taxes on higher-income [substitute high-consumption to apply to Scott's proposal] people make them no worse off because, as noted, they care about relative income [consumption], not absolute income [consumption]. And, presumably, these people put at least a tiny positive value on the things government would spend the additional revenues on. Is Frank open to testing his assumption? Here's a test. If he's right, a majority of those high-income [high-consumption] people, indeed a supermajority, would vote in favor of higher taxes on themselves. Frank should propose a referendum on whether to raise tax rates on high-income [high-consumption] people, with only high-income [high-consumption] people able to vote. If he is right, such a referendum would pass overwhelmingly. I predict that such a referendum would go down in flaming defeat. If I'm right, then the whole empirical basis of his argument is wrong.
First let me say that I don't necessarily accept Frank's argument. I am much more skeptical than Frank of the ability of the government to spend money wisely. My proposal was part of a tax reform package that would have abolished much greater evils, the income tax and other taxes on capital.

Second, it isn't at all clear to me how the ultra-rich would vote. My proposed top rate would apply to only a small number of rich people, let's say 1000 out of 320 million. I'm only aware of the views of a few wealthy people on this issue. Bill Gates and Warren Buffett have spoken in favor of higher taxes on the rich. The Koch brothers are opposed. But it's not clear to me that this tax would even apply to a low consumption guy like Buffett, and if it did he would almost certainly end up paying less tax than under the current system. Gates might also end up paying less tax, as would many other billionaires. In addition, many billionaires supported Obama and contributed money to his campaign.

David said:

Now let's consider his argument. Scott claims that such high marginal tax rates do not "really impact their happiness." Why? It's because, in Scott's view, very wealthy people get their utility from outdoing other very wealthy people. Scott seems very confident of that. After all, he calls the rejection of that idea "preposterous."
One often hears the argument that we cannot make interpersonal comparisons of utility. In one sense that is true, but I do believe we can come up with plausible ballpark estimates. The most common way to measure happiness is through surveys. These results tend to be correlated with how outsiders perceive one's happiness. Thus people who report higher levels of happiness seem to also be perceived that way by outsiders. And of course we have introspection--we can consider how our own self-perceived happiness has been affected by increases in consumption.

Is it right to base public policy on nothing more than guesstimates? I'd say that everything we do in public policy, everything we teach in our EC101 textbooks is also based on guesstimates. Even if we "scientifically" prove that bad policies like price controls have certain side effects, such as long lines and diminished goods availability, we can't jump from there to the next step of calling the policy "unwise" unless we make some sort of plausible guesstimates about interpersonal utility. Sure, we could base the argument on a completely different value system from utilitarianism, but alternative value systems (such as natural rights) would be equally arbitrary, equal "non-scientific." They would be guesstimates about the appropriate value system.

When asked how happy they are, Americans typically tend to report numbers like 7 out of 10, on average. Rich people tend to report higher levels of happiness, let's say 8 out of 10. Ultra-rich people may be even happier (according to the work of Justin Wolfers, et al--but even that claim is based on very sketchy data.)

I happen to think that the higher level of happiness reported by people who are very rich is probably due to one of two factors, comparison to others or reverse causality. Elsewhere I've argued that people who are less depressed are likely to be more energetic and hard working, and thus more likely to get rich. That's reverse causality. The rivalry claim is based on the notion that what motivates people like Donald Trump isn't so much having more stuff (beyond some point), but rather having a more impressive consumption bundle that his rivals.

But here's a point I would like to emphasize, my view on optimal tax theory would be essentially unchanged even if I was 100% wrong in both of those assumptions about utility. That's because there is a third assumption, which is a sufficient condition for high MTRs at the very top. That assumption is that the 1 to 10 happiness scale that people are asked about is much more like an arithmetic scale than it is like a logarithmic scale. That is, I very much doubt that people who report 8 out of 10 on a happiness survey have 10 times the utility of someone who reports 7 out of 10. Yes, I cannot prove that, it's partly based on introspection and partly based of observation. Humans just don't seem to be constructed in such a way as to be capable of boundless happiness. Listen to the recent Donald Sterling tape and tell me if the brains of billionaires seem capable of far higher happiness than average people, or if they seem no different from ordinary people. Then consider how lottery winners report higher happiness for a brief period after winning, before happiness falls back to their original set point.

Even if high MTRs on the ultra-rich reduced their consumption enough to reduce happiness from 8.5 to 8.0 (which I view as just incredibly unlikely) I'd still support high tax rates on high consumption. That's because the revenue gained from that tiny number of people would help to allow us to abolish income taxes---a far greater evil than a small loss in happiness to a few people.

There are good arguments against my proposal. These arguments are not based on me being wrong in my guesstimates about utility (which isn't very plausible). Rather they are based on me being wrong about the incentive effects of high MTRs. Indeed incentive effects explain why I am very hostile to high income tax MTRs, just as hostile as many of my critics are to high consumption tax MTRs. I could be persuaded to abandon my preference for high MTRs on ultra-high consumption. To do so, I'd need to be persuaded of large deadweight losses from these tax rates (from working less, and spending valuable resources trying to dodge taxes.) I have an open mind on that issue.

Also keep in mind that many libertarians favor a top income tax rate of 15% or 20%, as part of a flat tax scheme. I favor a top income tax rate of zero percent. Don't become mesmerized by the framing effects of numbers like 80%.

PS. A few weeks back I provided this forecast of today's jobs numbers:

Bonus forecast--the unemployment rate will fall several ticks in April.
I hope all my readers bought stock options right before today's announcement (that the unemployment rate fell from 6.7% to 6.3%.) :)

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COMMENTS (19 to date)
Handle writes:

Well, yes, the unemployment rate dropped, but so did the participation rate, from 63.2 to 62.8%.

We have 288K new jobs, but a net 800K left the workforce, and it's hard to know without further analysis whether these are just baby boomer retirees, discouraged workers, or women choosing to be homemakers instead of working for a household's second income, or other possibilities.

I think any drop in the headline unemployment figure is always 'good news' on net, but it's mitigated by the fact that there seem to be a lot of residual counter currents below the surface.

Ken P writes:

Happiness is a different feeling than status. It is more a feeling that things are ok, needs are met, stress is low. It is more utilitarian in nature than rank. It is also a more social feeling vs. the individualistic nature of status.

One could argue that as happiness approaches some sort of limit there is a diminishing rate of return but that still would not require that additional consumption is not in pursuit of additional utility.

RPLong writes:

So, are we maximizing tax revenues subject to happiness constraints, under the assumption that tax revenues are net good?

Should we be minimizing taxes subject to feasibility constraints, under the assumption that tax liabilities are net bad?

Andrew_FL writes:

Perhaps those of us who would reason from natural rights don't care about whether this is "unscientific" but are more concerned with what is morally correct.

Any taxation scheme which imposes an unequal burden on anyone is immoral. It is a violation of the basic idea of equal justice under the law.

But I find the argument from the lesser evil particularly unpersuasive. Not only do I not agree that this consumption tax scheme is a lesser evil, I don't think finding a lesser evil frees one from the obligation to seek to eliminate evil altogether. And as a matter of theory, one should advocate that which is the absolute best solution. I am not a pragmatist. To be a pragmatist is to be a bad theorist.

John Fembup writes:

"today's announcement (that the unemployment rate fell from 6.7% to 6.3%"

As has already been pointed out, this result was achieved together with a loss of 800,000 net jobs in the workforce.

So it appears that, if the administration can just succeed in driving out the rest of the workers, it can achieve an unprecedented 0.0% unemployment rate.

Can't be done? Hey, the administration has almost 3 more years . . .

Pajser writes:

Interpersonal comparison of utility is certainly possible. Maybe we don't know how to measure differences exactly, but it is not enough to claim that differences do not exist. However, I prefer the notion of needs over happiness.

One good thought experiment is: would you chose to move to Matrix even if you'll have happiness 10 for rest of your life? Many people wouldn't. I wouldn't.

Another thought experiment - imagine relatively happy granny with high blood pressure who wouldn't be happier if her disease is cured - because she believes that everything is in god's hands and that she had enough of life and she doesn't really think about whole idea of blood pressure - but she is not against taking her medicine. You probably met similar persons. The treatment of her disease is still more valuable than size of yacht, even if that size can make its owner happier.

Dale writes:

I must have missed the part where someone showed we are better off with this wealth in the hands of government than in the billionaire's banking/investment portfolio.

Bostonian writes:

"Also keep in mind that many libertarians favor a top income tax rate of 15% or 20%, as part of a flat tax scheme. I favor a top income tax rate of zero percent. Don't become mesmerized by the framing effects of numbers like 80%."

People earn in order to consume more than they would without working. If I am already rich enough that my optimal consumption puts me in the 80% MTR, this is equivalent to a marginal income tax rate of 80%. It doesn't matter if you withhold the money at the time it is earned or at the time it is consumed.

Hazel Meade writes:

I think there's a better reason to oppose higher income taxes. Not everyone who has a high income is necessarily rich.

It's just a common error to assume that "high income" = "wealthy" but there are many people out there who might have a high income, but are starting from zero assets. This always get glossed over.

If you are a poor person who is lucky enough to make a decent living, the instant you have enough income to start accumulating assets, you get socked with these high tax rates, which prevent you from moving up the socio-economic ladder. Meanwhile, the children of really wealthy families can spend their 20s travelling the world and living off of daddy's savings, and pay nothing, because they have no income.

By concentrating taxes on *income* we're actually inhibiting economic mobility, because the people who are socked with the highest marginal tax rates are the people who are moving up the ladder. They are professionals who are too poor to retire and live the life of the idle rich, but just rich enough to be able to buy a nice house in the suburbs (if they weren't paying the highest marginal tax rates, anyhow).

Glen Smith writes:

In my personal experience, the evil of the income tax is that it is a tax on consumption but not identified as such.

MikeP writes:

If I am already rich enough that my optimal consumption puts me in the 80% MTR, this is equivalent to a marginal income tax rate of 80%. It doesn't matter if you withhold the money at the time it is earned or at the time it is consumed.

You realize, of course, that this plan puts the 80% rate only on those who consume multiple millions of dollars, right?

Are you seriously suggesting that someone who consumes 10 million dollars earns exactly 10 million dollars? These people have a propensity to save. What they don't spend does not get taxed -- ever or in any way -- until they spend it.

Scott Sumner writes:

Ken, Happiness is bounded, the pursuit of happiness is unbounded.

RPLong, No, we should not maximize tax revenue, we should maximize utility.

Andrew, You said;

"Any taxation scheme which imposes an unequal burden on anyone is immoral."

Sorry, but all taxation schemes impose unequal burdens. That's partly because the burden of a tax does NOT equal the size of the check one writes out to the government, but depends on all sorts of other issues such as relative elasticities.

Pajser, You asked:

"One good thought experiment is: would you chose to move to Matrix even if you'll have happiness 10 for rest of your life? Many people wouldn't. I wouldn't."

But can people be trusted? What happens if they are told they are currently in a dream, and are asked if they want to return to their "real life?"

BTW, I'd move.

Dale, I'm NOT advocating giving the government more revenue.

Bostonian, That's a common cognitive illusion. An income tax is not equivalent to a consumption tax, even if you plan to eventually consume the entire income. I have some posts over at Money Illusion discussing that issue. An income tax double taxes future consumption.

Hazel, Good point--I have many posts that discuss that issue.

John T. Kennedy writes:

Scott.

"RPLong, No, we should not maximize tax revenue, we should maximize utility."

Starting with a clean slate and freedom to change any law, what would maximize utility?

RPLong writes:

Prof. Sumner, right. So then you agree with my second statement?

ted writes:

Even if high MTRs on the ultra-rich reduced their consumption enough to reduce happiness from 8.5 to 8.0 (which I view as just incredibly unlikely) I'd still support high tax rates on high consumption. That's because the revenue gained from that tiny number of people would help to allow us to abolish income taxes---a far greater evil than a small loss in happiness to a few people.

I have a big problem with this idea. It's profoundly immoral. What you're saying is that it's all right to rob some people, provided the overall utility increases.

I'm setting aside my opinion that overall utility doesn't increase much or at all, because it's a not a simple cash transfer but the creation of multiple incentives pulling in the other direction (for the state bureaucracy to extend their numbers and benefits and for the lower classes to use the state force to live off the others, instead of working - and, the reverse of the coin, for the rich to hide their money or run away).

But I suppose in the end I don't see much difference between your phrase and taking the top x% to a stadium, shooting them in the head, and "redistributing" their wealth. Just varying degrees of wrongness, namely, upgrading from armed robbery to murder & armed robbery. This is roughly what the communist revolutions did, by the way. Sometimes literally. It didn't work out well.

Scott Sumner writes:

John, First I'd legalize drugs.

Then I'd expand immigration.

Then I'd abolish all income taxes.

Then I'd slash military spending.

There are lots of other changes I'd like to see, but those are a good start

RPLong. Even "good" taxes such as consumption taxes have a deadweight loss. So let's suppose it costs $1.50 to raise a dollar in revenue (including deadweight loss.) Then I'd expand government spending up to the point where an additional dollar of spending had a marginal benefit of $1.50. In my view that would represent a rather low level of government spending---closer to Hong Kong than the US.

ted, Sorry that you don't see the difference between taxation and theft.

ted writes:

@Scott Sumner

I do see the difference between taxation and theft. Where taxes are used to provide public goods usable by everybody (e.g. police, defense) or everybody in a region (e.g. flood control), it makes sense to collect money using taxes from those people who benefit.

What you're talking about is theft, pure and simple. Taking from person A and giving to person B, with the middle-man (aka the state bureaucrats) keeping a hefty commission (salaries, pensions, benefits), under threat of imprisonment or murder, is no different than basic racketeering.

Please note, the term "redistribution" makes no sense. If we talk about "distribution of income" meaning "pattern of occurrence", then it cannot be "re-patterned", that's a nonsense. If we talk about "distribution" as the "act of handing out", then it won't apply to people who earn their income instead of having it distributed to them, by the state, because their income wasn't "distributed" to begin with.

"Redistribution" is a weasel word to hide a much more unpleasant meaning, which is "expropriation and state distribution".

If you agree with the idea of expropriation and state distribution, then it's just a matter of where you draw the line, and it's completely arbitrary and unilateral, as well as being abusive and unjust. Taking 40%, 80%, shooting them and taking 100%, these are mere gradations.

Otherwise what you're saying is like me stealing from my (rather well off) neighbours but claiming that as long as I don't exceed, say, $1000 per heist it doesn't count. I'll call it "community contribution".

Just like us, the state doesn't have any moral right to steal or murder. It does it because it can, with impunity, having many people with guns, not for any philosophical reason.

Scott Freelander writes:

Scott,

Here is a potential problem with Henderson's argument:

"CNBC survey shows millionaires want higher taxes to fix inequality"

http://www.cnbc.com/id/101634240

Scott Sumner writes:

Ted, Nuclear power plants and nuclear bombs have something in common--fission. That doesn't mean they are the same thing.

Progressive taxes and theft may both involve redistribution, but they are hardly the same thing.

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