Hands off the rich?

The idea that we should tax the rich to fund public services and transfers to the poor seems obvious from an egalitarian perspective, at least as long as we are in a society with significantly unequal incomes. But it has been challenged recently by some advocates of Modern Monetary Theory.

[note: The meaning of ‘rich’ is rarely spelt out, and isn’t very helpful. Hardly anyone is willing to admit to being rich, so the discussion tends to focus on a handful of cases like Bill Gates, rather than on people in the top 1 per cent or 10 per cent of the income distribution. So, from now on, I’m going to use the term ‘high-income’ and refer to proposals raising taxes on some subset of the top 10 per cent.]

Over the fold, an extract from my book-in-progress, The Economic Consequences of the Pandemic

The argument that we don’t need to tax people on high incomes works in two stages.

First, following the functional finance arguments made by Abba Lerner in the 1940s, MMT advocates argue that taxes aren’t needed to ‘fund’ public expenditure. Rather, for a given level of public expenditure, taxes should be set to ensure that aggregate private and public demand is equal to the total productive capacity of the economy.

That’s one way of presenting the standard Keynesian model and useful in a lot of ways. But it doesn’t do as much work as many MMT advocates would like. Suppose the government balanced aggregate demand and supply, and now wants to introduce a new spending problem program. To maintain balance, private spending (consumption and investment) needs to be reduced by an equal amount. That requires tax revenue roughly equal to the amount of the new spending.

The second part of the argument is that, if taxes are meant to reduce consumption, there’s no point in taxing high income earners because they won’t change their consumption in response to changes in their income. (By contrast, the poor will spend their entire income).

The claim that high incomes won’t change their consumption in response to changes in their income has some merit when we are talking about short-run stabilization, for example an economic stimulus during the pandemic. People who can manage their financial assets and liabilities won’t change their spending much in response to a once-off payment or tax increase. Rather they will reduce their savings to absorb a tax increase and use once-off payments to increase savings or pay down debt. By contrast, people on low incomes are typically ‘credit constrained’, meaning that they can’t borrow (at least at reasonable rates of interest) to meet current needs. So, they are more likely to spend any windfall gain, which makes them more responsive to short term stimulus payments (and also more likely to reduce spending when the payments stop)

Permanent changes in spending and taxation raise quite different issues. Unlike the case of temporary changes, households at all levels will respond to these changes. The only question is whether the responses of high-income and low-income households differ enough to matter. One way to answer this question is to ask whether, in the long run, high income households save a large share of their income than low income households. This question turns out to be surprisingly difficult to answer.

For our purposes, the most interesting approach is to look at the way changes in income distribution affect aggregate savings. If high income households save much more, a redistribution of income that reduces their share will increase aggregate consumption. In this case, the claim made by Kelton and others, that taxing the rich does not provide extra resources

In reality, however, studies at the aggregate level find no such effect. Changing the distribution of income does little or nothing to affect aggregate savings. Studies at the household level find some effect, but not enough to matter. To quote an influential recent study

“policies that redistribute across income groups can have real effects on saving [BUT] the differential saving effects of typical government transfer programs are not so large as to make a measurable dent in aggregate saving” Dynan et al, Do the Rich Save More? DOI 10.1086/381475

This claim that high income earners don’t spend their (permanent) income is commonly associated with MMT. However, it isn’t inherent in any of the intellectual strands of thought that go into MMT – functional finance, Minsky crisis theory, post-Keynesian macro. Rather it’s been added on by MMT supporters who want to avoid the need for tax increases, either because it seems politically too difficult, or because they don’t want to alienate potential allies in the financial sector.

To restate, the current debate about pandemic stimulus. Here the need is to hand out lots of money on a temporary basis to people who will spend it now. That implies an expenditure program targeted at low income earners. Once the economy has recovered, it will be time to look at permanent new spending programs and raise taxes to provide the necessary resources.

—– Taxing to level down —-

Some opponents of taxing high income earners to fund (or resource) government programs say that they nevertheless support progressive taxes to reduce the excessive incomes of ‘the rich’. On the arguments above, that doesn’t provide any extra spending capacity, so the only purpose of the tax is to reduce inequality by levelling down.

This position is, whether its proponents realise it or not, a rhetorical dodge. The implied policy program now is one in which permanent spending programs are introduced now, without any increased tax on high income earners. The inequality-reducing tax, which is a much harder program to sell politically in the absence of any plan to spend the proceeds, will be deferred indefinitely.

The problem is that, one way or another, the need for real resources to support public programs will become evident. Either access to programs will be delayed and rationed, or charges of one kind or another will be imposed, or inflation will be allowed to erode the value of benefits. Real public programs require real resources and that means taxing the people who have the resources to pay (the apocryphal words attributed to Willie Sutton, when asked why he robbed banks, are apposite here).

21 thoughts on “Hands off the rich?

  1. I never thought I’d say this, but could it be useful to think of the same question in terms of utility? If we must remove productive activity from the private sector to make room for public spending, shouldn’t we do so in a way that maximizes total welfare? Given diminishing marginal utility of consumption, it makes sense to take the private activity from those who benefit from it the least, ie those who are eating their fifth lobster of the week, not those who benefit from it the most, ie those enjoying their first steak of the month. In this case, taking $10,000 from the rich will be free up the same amount of resources at a fraction of the welfare cost as taking $100 from the poor. Unless of course, the rich really are less likely to consume, in which case taking $100,000 from the rich would free up the same amount of resources at a fraction of the welfare cost as taking $100 from the poor. So might MMT spruikers be accidentally advocating for huge taxes on the rich? Almost certainly not, but it’s late, so I might leave it to someone else to point out the flaw in my reasoning/why this is obvious or not original.

  2. A young person who has studied and worked hard, and had a bit of good fortune along the way may well be somewhere around the top 10% of the income distribution curve. Yet they would also be looking at house prices 10–15 times their income for anything more than a shoebox within reasonable commuting distance. While by no means poor, they are also facing a mountain of debt to achieve what came relatively easily to previously generations.

    Income is no longer a proxy for wealthy and and taxation policy needs to reflect this.

  3. “Suppose the government balanced aggregate demand and supply, and now wants to introduce a new spending problem.” Cupertino for “program” presumably.
    I didn’t know that Aussies had adopted American orthography so much: program, liter, etc. In this case, BrE preserves a valuable distinction: programme for the general case, program for computer instructions. Cf ton and tonne, which are different quantities.

    On tax, I find Colbert’s maxim useful. Apply his “least hissing” test to the tax distribution problem. To a first approximation, he can tax either the nobles (10%) or the peasants (90%). The per capita tax on the nobles has to be 9x higher, but the peasants are on a Malthusian breadline and the nobles’ income is >100x, often >1000x. On most plausible utility functions, the miserific burden on the nobles is far less, But Colbert knows that the nobles can mount far more effective rebellions (as in the Fronde), and have all the good generals (Condé and Turennne). If you can keep them on your side, they can offer a lot of help in extracting taxes from the peasants, while the converse does not hold. Neither class save at all. So Colbert in fact taxes the peasants.

    Now throw in a third class, the bourgeoisie. They save, and like peasants actually work, so disincentives matter. They are not much good at armed rebellions, but can supply radical agitprop and sabotage, or alternatively soothing justifications and administrative/legal help. So they get off too. Peasants it is. Historical question: why did the landed oligarchs in Britain decide to tax themselves to pay for their imperial wars, more sustainably in the long run?

  4. Thanks Dick. Ingrid is a co-blogger with me at Crooked Timber, so I’m familiar with the limitarian view, but I hadn;t seen this article. Note that there’s a difference between “too rich” and “rich enough”. As the article says, “rich enough” means that, while “most do not consider extreme wealth itself a severe problem and object to the government’s enforcement of limits to wealth and income, widespread support exists for increased taxation of the super-rich if that would improve the quality of life of the most vulnerable members of society.”

  5. seqaugur: this is exactly the way I (and most economists) think, and implies that top tax rates should be set at the point where revenue from high-income earners is maximized (the top of the mis-named Laffer curve). Most studies estimate this at around 70 per cent.

  6. Where do ethics and morality fit into the calculation of “rich enough” v. “too rich”? If morality is irrelevant in economics it is truly the dismal science! I’ve often wondered how the immensely overpaid CEOs justify to themselves their $20 million annual salaries. As Gordon Gekko said; “How many yachts can you water-ski behind?”

  7. maybe, the point of “too rich” could be reached by assessing the cost ( personal, social, ecological) of the damage incurred by the amassing and use of very large sums .

  8. “Where do ethics and morality fit into the calculation of “rich enough” v. “too rich”? If morality is irrelevant in economics it is truly the dismal science! ” [Matt Trezise, above]

    I can’t comment on the “rich enough” v “too rich” notions from an economics perspective (these expressions were used in the linked study by Robeyns et al, which, to the best of my knowledge, uses a sociological conceptual framework).

    For what it is worth, I can offer the following on ethics and morality of economics: Those who tell the public that ‘freedom of choice’, ‘free enterprise’ and ‘private ownership’ is a desirable and morally defensible aspect of a society act unethically if they don’t at the same time argue for a wealth distribution (which includes income as the time difference of a wealth quantity) such that each individual has sufficient wealth to choose at least a little bit of whatever is offered at market prices. [Source: theoretical models of competitive private ownership economies that check for the logical consistency of the models. These models are written in the language of mathematics]

  9. Addendum on Colbert and the geese
    On reflection my numbers don’t add up. To flesh out a toy model of “France in 1680”, with numbers that are all wrong but offer plausible orders of magnitude:
    Population 10.1m, of which 10m peasants (99%) and 100,000 nobles (1%)
    GDP $10 bn, split 50-50, so per capita for peasants $500, nobles $50,000.

    Colbert needs to raise $1bn for war and Versailles, 10% of GDP. The tax rate is the same if he goes after nobles or peasants, 20%, so $100 a year for a peasant or $10,000 for a noble.
    He could of course go for a flat tax of 10% on both. That’s bad politics: the aggrieved nobles can make common cause with the peasants and rebel again.

  10. I can’t help thinking that it would be far easier to tax assets (i.e. land which is rather hard to hide) rather than income, and have a fairly significant estate tax for wealth redistribution purposes.

  11. James – Colbert’s solutions were far more creative. Aside from direct taxes (the taille) and indirect (the gabelle), which, as you say, bore more heavily on the lower classes, there were taxes on the transfer of offices (a major route to social advancement for the lower nobility and bougeoisie), the obligatory performance of costly duties such as embassies, service as officers…Since cash was short, pre-modern states lent heavily on contributions in kind.

  12. I am no economist but it sure looks like the very wealthy gain great benefits from the services that government run via taxation – much more I suspect than anyone else. The law and order that protects their wealth, the roads and other infrastructure their businesses depend on to be profitable, workers with education and access to health care that are more productive, the welfare that stops the poor from turning to crime out of desperation, defuses social unrest and prevents a greater burden of costs for security and policing – all benefits that indirectly support and help the wealthy. More gained I suspect than what they ‘save’ by not paying taxes.

  13. Hi Mrkenfabian

    I’m no economist either, but I agree with you. This is my reading, for example, of the New Deal.

    Roosevelt hauls in the capitalists/super-wealthy and says: look guys, maybe you don’t see it, but you’re benefitting more from this thing–in which people come in from their forests, out of their caves, down from the mountains, to support one another– that we call ‘society’, than anybody.

    How could this not be true? Well, as Orwell wrote (of private capitalism in “Lion and the Unicorn”), it is just that the upper classes had taught themselves to become “impenetrably stupid” on just this point. Many of today’s super-wealthy are using their wealth to buy citizenship and land in New Zealand, or they are building rockets to go live on Mars and the Moon. Not so much stupidity but complete insanity. The loss of this whole planet and its life-forms, oh well, ho hum, what to do? What are the investment opportunities like in your Uranus? The view was reversed, in which society benefits a whole range of peasants, slum-dwellers, other ne’er-do-wells and subhuman scum with no particular right to life. So screw them. That is the view.

    Back in reality however, Roosevelt says to the rich guys: without society, actually, YOU who are screwed, so maybe you had just better pay the money required to support it.

  14. Peter Thompson: Thanks for the correction. So Colbert does tax the nobles too – but in selective ways that minimise the risk of their protesting as a class.

  15. Julian Rooney: ” Roosevelt says to the rich guys: without society, actually, YOU who are screwed, so maybe you had just better pay the money required to support it.”

    I had a conversation with a small business owner who thought all tax was theft. I suggested maybe he could go and live in Somalia or somewhere where tax seems to be optional. However, when the local strong man comes and thinks all your stuff should be his, who you going to call ? The police, probably work for the local strong man, the courts ? Same. Your house catches fire, where’s the fire brigade ? Taxes = functioning society, and as you observed, the rich have more to lose than the poor, so they should pony up more in tax, lest they eventually lose the lot.

  16. Hi bjb. Sorry if this is a useless comment. Mostly I’m just agreeing with you, acknowledging your comment. I don’t know about Somalia, but I have a friend from Nigeria where, yeah, she says that law and order, justice, education, general fairness etc are ‘optional’, depending on whether you have the money and want to pay for them or not.

    Failed societies around the world are based on these faulty or bad understandings. And the only reason we have to feel superior in Australia over Nigeria or America is that these places are worse, because further down that road. Thanks very much.

  17. I shall not repeat our twitter discussion but direct you to comment 6 down on Crooked Timber. The one’s from Articulate Source and Larry Hamelin are quite good.

  18. Surely the issue is that we need to put hands on the rich, or rather on their wealth,

    We need to take power away from capital. But capital IS power: (one mode of power in our political economy system as shown by CasP theory and research). It is the very existence of large concentrations of capital in individual private hands which we need to abolish. The clear path is to break up the big capitals (in anti-trust fashion but going further than ever before.) Equally, part of that path is to radically reduce the private ownership of big chunks of capital by private individuals.

    Take apart the corporations and divest the rich starting with the billionaires. Reduce permission to personal ownership of capital down to a mandated level. If the 68-95-99.7 distribution rule holds for wealth (capital) then set the mandated rule at the current 2nd standard deviation. That is to say the wealth of the top 5% should be broken back to the current 2nd standard deviation point.

    Somehow the 95% have to overrule the 5% and break up their wealth. The people have to break up the holdings of the private corporations anbd then of the elites and oligarchs from the billionaires down to the decamillionaires. It’s as simple and as hard as that. How to do it in practice? That is the question.

    If we are not prepared to do this then we are spouting so much hot air and clicking so many pointless keyboard strokes. The wealth disparity is not the only problem. The power disparity is just as big a problem. They go hand in hand.

  19. Hi. If you’re saying we need to do more than apply tax (like the wealth tax that Pikkety comes up with) then I agree with you. Power and wealth disparity are the same thing, or two sides of the same coin. Pick your own metaphor, we live in a society where those with the most dollars get the most votes.

    In WA, we can’t even raise the mining royalty tax, to make the largest companies and individuals pay for the public resources they extract to flog. Together with Seven West Media they run the place.

    Forrest would rather pay millions to lawyers to test the constitutionality of new taxes than pay the taxes. He does this because being forced to pay taxes means also giving up some power. He keeps his power, makes charitable donations later–to buy a new wing at UWA with his name on it, for example, instead of paying tax that would pay for it. Seven West lines up behind him to blow smoke further up where rain don’t fall and sun don’t shine.

    The Gated Communities that form around control of resources, which we mostly call ‘corporations’, are leading society to a bad future. Many of their captains know this, hence why so many are building bunkers, etc. Unless we want to join them, we should consider things you mentioned, any, all options.

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