Taxing Income from Capital: Utilitarianism-Maoism-Waldmannism Edition

Robert Waldmann has a nice little toy model--an intuition pump--that leads to positively Maoist conclusions: http://www.economia.uniroma2.it/nuovo/facolta/docenti/curriculum/Robert%20JamesWaldmann.pdf. In his model, a benevolent utilitarian government is not only not averse to taxing income from capital but taxes that income at the highest rate possible.

In general, there are two reasons to be leery of taxing income from capital:

• By essentially taxing the movement of purchasing power forward in time from the present to the future, such a tax tilts individuals' consumption toward the present and away from the future: their consumption does not grow over time as rapidly (or falls over time faster) than is optimal given individual tastes and social production possibilities.

• The movement of purchasing power from the present to the future is also the process of capital accumulation, and taxing it reduces capital accumulation and so creates an economy with a productive inefficiency: too low a capital-output ratio.

And there are two reasons to be enthusiastic about taxing income from capital:

• It makes individuals feel poorer and thus--for those whose lifetime consumption is too high relative to the social optimum--leads them to consume less.

• Already-existing capital is inelastically supplied, and thus can be taxed without imposing any excess-burden deadweight losses at all.

Waldmann presents a model in which (i) the holders of capital are all too rich with too high a level of consumption, hence (ii) you want to tilt their consumption profile so that their consumption declines as fast as possible, and (iii) the capital-output ratio is fixed--hence there are no productive inefficiencies. Thus the optimal government policy is to tax the capital income of the rich as much as possible until they become so poor that their consumption level hits the social optimum value, and use the resources raised to boost the consumption of the poor.

It's a very nice intuition pump. The way I like to think about it is that the problem that Waldmann has set his benevolent utilitarian government is one that is ideally solved via a 100% tax on excessive consumption, and that a capital income tax is good because it is a close approximation to such a 100% excessive consumption tax.

Comments

[Jim Garland]

If too much wealth or too much consumption are the problems, wouldn't either a wealth tax or a consumption tax be better ways to tackle the problem?

[Jim Garland]

If too much wealth or too much consumption are the problems, wouldn't either a wealth tax or a consumption tax be better ways to tackle the problem?

[Ken Houghton]

Ah; a readable version of his blog post from a week or so ago (though still with the same typos).

So when will it appear in EV?

[David]

Somewhat tangential, but I'm curious about the impact of taxing dividends versus taxing gains made from selling stocks.

I'd imagine taxing dividends (and interest from bonds and savings accounts - any regular return from capital) as normal income wouldn't discourage people from investing: most people have all their investments in tax deferred accounts and the ones who have investments beyond that lack a real alternative to investing. I can't think of a downside here off-hand, other than a general objection to taxation. One change might be that companies instead of paying out dividends would just buy back and destroy their own shares. (Does that cause a problem?)

When the gains from the sale of stocks is taxed, it would seem that many investors then hold on to stocks they would otherwise sell, simply to prevent getting taxed. That does have an impact on the efficient allocation of capital. So in return, scratch the tax on any gains made. This would also encourage people to invest more instead of keeping money on their savings account - long term surely a good idea.

[Denis Drew]

Let's see: if you tax the excessively rich more, you can tax everyone else less (got to come up with the same overall revenue): leading everyone else to save more which should grow the economy adequately (especially given that productivity growth per se depends mostly on maturing technologies and management innovations). Sounds good to me.

[Robert Waldmann]

Thanks for the link.

I was going to mention that Angry Bear has a post askign who will link to that post first between you, EV and "Post Autistic Economics". Now I see it was posted by Ken Haughton (upthread) who points out the amazing miraculous cyberspacian *.pdf (thanks). EV has two links to the post. One is at the end of a discussion of the next post on my blog and goes "That's not even close to Robert's wonkiest post of the day." then above that in links for 08/06/25. Concerning "Post Autistic Economics" AKA
"Real-World Economic Review" I like my model, but I wouldn't go so far as to claim that it is post autistic and certainly wouldn't claim it is real world economics.
[the following is cut and pasted from my comment at Angrybear but at least I admit it]

The truly wonderful thing about the readable version is that it was LaTex coded by someone on the web whom I've never met and who let me use it provided that I *don't* credit him, her or them. Roughtly, my first experience of an absolutely wonderful blog reader (not to criticize my other readers but they are very few and comment rarely).

The truly horrible thing is that my anonymous benefactor(s) did it when procrastinating. The thought of a job more boring than coding equations in LaTex alarms me.

[Robert Waldmann]

Yes Jim, the first best can be achieved with capital or consumption taxation. In the model, they are ruled out by assumption (heyy I'm not the one who suggested that it was post-autistic).

[Denis Drew]

Actually, heavily taxing the rich may be the ONLY way to restore 1973 levels of fair distribution of income -- at least in the short term (gradually readjusted expectation on the part of linebackers, CEOs and news anchors may take care of the long run).

A couple of years ago I worked out that jumping the minimum wage from $5.15/hr to $12.50/hr (the latter being all of 25% above LBJ's 1968 minimum wage, adjusted, 100% increase in average income later) would add all of 3.75% to the cost of GDP output -- shifting about 6% of all income to the bottom 40 percent of earners ($12.50/hr being the 40 percentile wage -- personal income being about 2/3 of GDP).

This income would shift from those who kept up better if not completely with average income growth (bottom 90 percentile -- see chart derived from Dean Baker derived from Robert Gordon below) as well as from those who did better than average growth (top 10 percentile).

Assuming that the 40 through 90 percentile could compensate their income loss (from higher fast food prices, etc.) through up pressure in today's deunionized labor market or because reasonable unionization (legislated sector-wide contracts for instance) was coming about simultaneously through, that 60 percent could take most of it back, absolutely if not relatively, from the top 10 percent.

Ultimately, the bottom 90 percent would want to use inflation to shift income from the top 10 percent to themselves.

Somehow, I don't think that higher prices for consumer goods and services would shrink the 25 times multiplied incomes of linebackers, CEOs and news anchors that much -- 25 times than similar folks earned doing the same jobs 25-35 years ago.

I can see (in my non-professional way -- just ball park stuff) raising the maximum income tax rate above $300,000 to 75% and above $1,000,000 above 90% -- if only until top wages fell back in line with the distribution of 35 years ago -- if that is the only way to squeeze the toothpaste back into the top of the tube.

0-20 2.6% 2.0% - .6% -12.3%
20-50 16.0% 1.7% -4.3% -10.7%
50-80 33.7% 27.2% -5.5% -6.4%
80-90 17.0% 16.1% - .9% -
************************************************** ********
90-95 10.8% 11.3% +.5% +
95-99.0 12.2% 14.8% +2.6% +3.1%
99.0-99.9 5.7% 9.6% +3.9% +7.0%
99.9 -100 1.9% 7.3% +5.4% +12.4%

http://www.blogger.com/comment.g?blogID=23754016&postID=115117779314646236
http://faculty-web.at.northwestern.edu/economics/gordon/BPEA_Meetingdraft_Complete_051118.pdf

[Denis Drew]

A better way to make my next to last point in the post above might be to say that:

Somehow, I don't think that -- 12.4% -- higher prices for consumer goods and services would shrink the 25 times multiplied incomes of linebackers, CEOs and news anchors that much -- 25 times than similar folks earned doing the same jobs 25-35 years ago.