Cafe Hayek: Cowen, Gates, Boudreaux, and Regressive Taxation

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January 25, 2007

Cowen, Gates, Boudreaux, and Regressive Taxation

Don Boudreaux

Each of Tyler Cowen's New York Times columns is worth a careful read. But today's column is one of his best (in my opinion). He covers a lot of ground on the income-inequality debate, and covers it skillfully.

Here are his concluding paragraphs:

The broader philosophical question is why we should worry about inequality — of any kind — much at all. Life is not a race against fellow human beings, and we should discourage people from treating it as such. Many of the rich have made the mistake of viewing their lives as a game of relative status. So why should economists promote this same zero-sum worldview? Yes, there are corporate scandals, but it remains the case that most American wealth today is produced rather than taken from other people.

What matters most is how well people are doing in absolute terms. We should continue to improve opportunities for lower-income people, but inequality as a major and chronic American problem has been overstated.

.....

Earlier in this same column, Tyler notes that

Happiness, possibly the most relevant variable for a study of inequality, is also the hardest to measure. Nonetheless, inequality of happiness is usually less marked than inequality of income, at least in wealthy societies. A man earning $500,000 a year is not usually 10 times as happy as a man earning $50,000 a year. The $50,000 earner still enjoys most of the conveniences of the modern world. Even if more money makes people happier, it appears to do so at a declining rate, which places a natural check on the inequality of happiness.

Although I share Arnold Kling's skepticism of "happiness studies," the general point of the above reported finding is compelling. Indeed, that same point is the one that has long led many people to argue for "progressive" income taxation. It's the idea that an extra dollar of income to someone earning $500,000 annually is "worth less" to that high-income earner than is an extra dollar of income earned by someone earning $50,000 annually.

It's never been clear to me, though, why this fact (if it be a fact -- as I suspect it, generally, to be) -- was ever taken to support so unambiguously a case for "progressive" taxation of incomes. First is the point Tyler makes: if an extra dollar of income in Bill Gates's pocket means less to Bill Gates than would mean to me, then the genuine economic difference between Gates's position and my position is less than it appears if monetary incomes or wealth is taken to be a precise and full measure of economic well-being. While "redistributing" this dollar from Gates to Boudreaux might still increase "happiness" equality between Gates and myself, the alleged need for such "redistribution" in the first place is less pressing.

Second, given that Bill Gates almost surely has a greater talent for contributing to the happiness of humankind than I have, it's especially important that he continue to confront keen incentives to continue contributing to that happiness. Precisely because an extra dollar in Gates's wallet means less to him the more dollars he earns, he needs to earn ever-more dollars per year in order to keep keen his incentives to innovate and produce and sweat the details of satisfying consumer demands.

While I do not support regressive income taxation, a theoretical case can be made in favor of it -- a case that has at least as much cogency and economic merit as does the case for "progressive" taxation of incomes.

Posted by Don Boudreaux in Inequality, The Profit Motive | Permalink

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Comments

Don-
Didn't Mises contribute to the thought that money's value is subjective to an individual's own view? I believed he argued that the monetary units marginal value will decrease, I may be mistaken here so please correct me if I am wrong.

Bill Gates may have a lot of Wealth, but it is in his best interest and his families' wealth legacy to continue to provide great services. His wealth is mostly wrapped up in the company and in such a competitive market like technology it could be gone in no time. The competitive factor makes it worthwhile to still care about the value of his assets and if he doesn't exercise that concern it could decrease substantially.

Also, something you didn't mention was the fact that Gates and other businessmen like him put a lot at risk in starting their own enterprises. They could have lost everything or succeeded. There are very few individuals who get their money through inheritance.

I received an e-mail from my mother a while back, she's a teacher. The core of the e-mail was about how teachers don't have the ability to go out play golf and on and on, like all those lucky business men. What many people don't realize is the amount of stress and the actual hours spent by those individuals. CEOs for all they are paid, whether they are successful or not are on-call 24/7. They make their own sacrifices in family time and time off. The likelihood of an individual working 40 weeks making $500,000 is slim.

Posted by: Matt C. | Jan 25, 2007 9:22:30 AM

And let's not forget the fact that when the state is empowered to redistribute wealth, this creates an incentive for people to shift their efforts in the direction of rent-seeking, etc., and away from the game of producing. Over the long term, this doeas not strike me as conducive to general well-being (let alone justice).

Posted by: MDM | Jan 25, 2007 9:58:56 AM

Well, for me the argument that wealth has a diminishing marginal utility just like everything else isn't really about distribution, but about minimizing harms when there has to be taxation.

Presuming that there should be income taxes (I'm not convinced, but let's take it as a given), somebody has to pay them. From a certain perspective it makes more sense to tax the marginal dollars at a higher rate because they mean less than the dollars already earned.

Posted by: Timothy | Jan 25, 2007 10:03:26 AM

Tim,

But because those marginal dollars "mean less" to the people who earn them, the labor that contributes to their production will be the first to go. At some point, an hour of overtime is just barely worth more than an hour of watching Jr. play soccer, or fixing the roof, or nailing your wife.

Reducing the compensation for this hour of labor (through increased taxes) does not cause a concomitant diminution of the opportunity cost of god-knows-what-else you might otherwise be doing.

It follows that, in order to maintain the same standard of living, we either take more leisure with less money, or the same amount of money with less leisure. Given our revealed preferences, neither of these outcomes appear very desirable.

Posted by: David Z | Jan 25, 2007 11:35:59 AM

Tocqueville's other book is Memoir on Pauperism written in 1835 shortly after finishing his more well-known Democracy in America. It explains, with case examples, how government redistribution creates a dependent pauper class.

Extreme inequality of outcome is created when government tries to create equality of outcome.

Posted by: Flash Gordon | Jan 25, 2007 12:49:12 PM

A few years ago an economist (Prescott, I believe) did a study of why Americans work more than Europeans. He was able to show that Europeans work less becuase their tax structures is set in such a way that it discourages people from working more (ie making more). They would prefer to have 6 weeks of vacation than to be taxed heavily for the marginal income.

I was in New Zealand in November and during a discussion with a young man he described a similiar situation. In an effort to "save" jobs to make sure that there are "enough" the Kiwi gov't taxes people very heavily when they take a second job. So much so that this young man told me that it simply was not worth it to work a second job to only bring home about 60% of what he actually earned.

Posted by: Adam Malone | Jan 25, 2007 2:49:44 PM

The belief in interpersonal utility functions is absurd.

Is the "greater good" advanced by an additional $1,000 of income taken from Bill Gates and given to the average dependent of the State?

Gates has plans for his marginal income -- to cure disease. That is where it will go. The average dependent will have a party, or buy drugs (there is a reason people become dependents).

Utility, from some perspectives, may favor Gates.

Posted by: SheetWise | Jan 25, 2007 6:10:18 PM

You state that: "While "redistributing" this dollar from Gates to Boudreaux might still increase "happiness" equality between Gates and myself, the alleged need for such "redistribution" in the first place is less pressing."

I think I might be missing something here (okay I know I am which is why I am writing this) but how does this really mitigate the need to redistribute? The argument does not suddenly become only an issue of "happiness" and certainly not an issue of "happiness for those making 50k +." We are speaking on a societal scale when we speak of taxation -- not me vs. Gates.

I know there are limits to the innovations that those making less than 50k can provide society but doesn't the second point suppose that we must rely on the already successful (yes, they are successful for a reason) rather than have those at the bottom search for wealth through innovation which than allows for/negates the negative effects of progressive taxation. Also, can we assume that once you hit $10 billion it is about more than monetary incentives and all about legacy?

Hey SheetWise, where do you meet all these average dependents?. They sound off the hook.

Posted by: Matt | Jan 25, 2007 6:50:45 PM

There is no Soviet Union anymore, but everybody remember those great victories and defeats. We trusted in idea and we made our history through great losses...
www.backinussr.com

Posted by: jimi | Jan 25, 2007 8:29:38 PM

'-- wealth produced rather than taken' Why did most of the benefit from the increase in productivity the past 10 yrs accrue to the Corporation and its managers rather than to the middle and lower level workers who produced the benefit?

Posted by: Ray | Jan 26, 2007 8:43:01 AM

"rather than to the middle and lower level workers who produced the benefit?"

Why do you say that they produced the benefit? What did they do differently in the last decade, that changed their contribution? How did you measure this?

Posted by: Ann | Jan 26, 2007 1:30:15 PM

We're missing a major point here. If the $1 taken from Gates went to Boudreaux there would be no poverty. The problem is that almost none of the $1 gets to Boudreaux. It would have been cheaper to give each family below the poverty line a million dollars than to have pursued the "great society" program.

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