Wednesday, July 27, 2011

More on The Debt Crisis

I like Tyler Cowen's Post from Marginal Revolution.  I agree.

I have a friend in politics (minor politics) that I trust.  The impression I get is that both sides are done working on the debt deal.  Now, they are sitting around a table and going over the talking points that are necessary (from their perspective) to satisfy their constituents.  Both sides will come out and claim victory and present to the public why and how they defeated their opponents.  The debt deal is being revised, tiny details added, so that various members of the legislature can claim victory back at their geographical base.

This may seem obvious.  Why would anyone come out and say, "Yes, the Republican's/Democrats handed us our butts."  But most of the discussion in the blogosphere seems centered around why and whether the two parties can work together.  My guess, they already have.  Now they're just trying to solidify talking points.

Monday, July 25, 2011

Sunday, July 17, 2011

Some Thoughts on Wealth

Today, while listening to a podcast about Keynes and Hayek and their philosophical differences, some thoughts surfaced regarding the many conversations I've had in discussions (classroom, among friends, online with strangers) regarding justice, fairness, and equity in taxation.

Is our system of taxation fair?  Should the wealthy, say a married couple making 380k or greater, be taxed more because they can afford it, because they should want to help the poor, because they won the lottery, genetic or otherwise?  In short, questions usually center around how can we make society more fair, more equitable.

To answer, I like to think of the opening chapter in Greg Mankiw's undergraduate Econ textbooks.  He outlines 10 principles that the vast majority of economists agree with.  The relevant one here is that society faces a tradeoff between efficiency and equity.  An efficient economy rewards the best users of wealth (those capable of earning the greatest return on that wealth) by funneling capital to them.  This results in quite a bit of inequality.  A society focused on equality divides up wealth equally among its citizens, and any return earned that is greater than average is redistributed to equalize the citizens yet again. 

Does the equal society sound good?  There's a catch.  The totally equal society provides no incentive for anyone to put forth effort into earning a return on capital.  In other words, if you know that any profit you make will be taken if you earn an above average rate of return on your capital, then your incentive to earn that rate is reduced, or gone completely (no incentive to innovate, to cut costs, increase efficiency, etc). 

In a society completely focused on equal distribution and redistribution of capital, there is no incentive to create more capital.  The overall wealth of that society will stagnate, and over time, fall.  Politicians in both parties should be up front and admit that neither wants a totally efficient or totally equal society.  The ramifications of either would be unbearable.

Thursday, July 14, 2011

An Increasingly Common Misunderstanding

More and more often, lately, I hear people discuss wealth and income as if money is a finite resource that one can accumulate and restrict others from accessing.  Michael Moore, who I understand to be ideologically aligned with the left, argued that money is a national resource that should be controlled and distributed fairly.  During a recent Facebook discussion, someone lamented the plight of a country such as ours that allows one individual or group to accumulate great sums of wealth.

Moore’s explicit statement, and the Facebook discussant’s implication, is that wealth is something that can be horded, or accumulated, and once one does so, the effect of that money is removed from the economy, as if it no longer exists.

Why is this wrong?  Money is not some finite resource that must either go to citizen A, or citizen B, and once B possesses the money, A can not gain access to it.  Moore and FBGuy’s interpretation would have it so.  They might have a point, if B took vast sums of dollar bills and set them on fire, or put them under the bed.  But no reasonable person would allow their wealth to deteriorate (b/c of inflation) by holding money in bills under the bed. 

In short, money is constantly being created.  Person A may accumulate wealth, but that wealth is held in assets such as stocks, bonds, treasuries, or it is put in the bank.  Banks then lend out a portion of that money to individuals, person B for instance, who then find a good use for it (earning yet more money from a business, perhaps).  Person B then puts that money into stocks, bonds, treasuries, and a bank.  That bank then….and so on. 

This narrative conflicts with Moore’s and FBGuy’s views.  Money cannot be horded by wealthy individuals (unless they are fools, and typically they aren’t or they wouldn’t be wealthy) because they put their money in the form of assets that maintain value (stocks, bonds, interest bearing assets, interest paying bank accounts).  That money then funds corporations that conduct business (and hence pay employees), finances government spending (which often goes to helping those with low income), and allows banks to lend money to those who would like to purchase a home, car, vacation, or open a new business.

Even if wealthy individuals were as evil as some make them out to be, they would have no choice but to indirectly help those less fortunate than them by investing in assets and bank accounts that maintain the value of their wealth.

Wednesday, July 13, 2011

Increasing Taxes on the Wealthy Not A Panacea (Part II)

At the end of my previous post, I asked what should be taxed instead of luxury goods or services.  If a tax must be levied on a population (for whatever reason), ideally, it will be efficient.  That is, the tax will cause the least amount of deadweight loss (foregone economic activity) in society.  Generally, the most efficient tax is a lump-sum tax.  Why?  Look at what a lump-sum tax does to your incentive to purchase goods and services.  Can you avoid the tax?  No.  Does the tax make you substitute away from one good towards another?  No.  So, none of society’s resources are devoted to avoiding the tax.  You just pay it because you exist.

Margaret Thatcher toyed with implementing a “Head Tax” in Britain during the 1970’s.  It was met with strong resistance.  People found the idea of being taxed for literally having a head repugnant.  But, the tax was efficient, it would have caused the least amount of damage to society (did not distort incentives, did not cause deadweight loss) when compared to other taxes.  

Is there anything like the “Head Tax” in the United States?  Well…not exactly.  But, we do have an income tax.  While we do not get taxed for being alive, we do get taxed for trying to make that life enjoyable and not poverty-ridden.  However, as I’ll explain later, we still get a bit of deadweight loss associated even with an income tax, especially at higher levels of income.  

Tuesday, July 12, 2011

Increasing Taxes on the Wealthy Not A Panacea (Part I)

Public opinion is often in favor of increasing taxes on the wealthiest in society in order to, among other reasons, reduce government budget deficits, finance subsidies and transfer payments to the poor, and fund various public works programs.  Economists who oppose such increases are often painted in a harsh light and characterized as friends of special interests (Wall Street, particular industries, and perhaps even Republicans).  But, there are some fundamental economic principles at work that cause most economists to remain wary of looking to tax increases on the rich as a panacea for debt, reducing inequality, and public works funding.

A simple, often used, example of a justifiable tax on the rich is the imposition of a luxury tax on the purchase of yachts.  The justification is simple: if you can afford to buy a yacht, you can afford a 10% luxury tax.  The proceeds of the tax will then go to help the poor who can barely afford basic food staples, let alone a yacht.  Who would oppose such a tax?  Well, perhaps no one, not even the rich.  The problem: wealthy people do not have to purchase yachts.  Luxury items are easily foregone.  The wealthy, when faced with a 10% increase in the price of their luxury item, can easily forego the purchase of a yacht and instead will purchase some other luxurious item such as expensive vacations, more days off of work, nicer vehicles, jewelry, etc.  If the wealthy do this, substitute away from yachts in favor of some other luxury good, what will be the effect on the amount of revenue the government raises from the luxury tax on yachts?  The simple answer is that they will earn less than forecast.  Should this bother policymakers?  There is still some revenue coming in from individuals that could not live without a yacht, so why worry about it?  We should worry about it because of the amount of deadweight loss this causes in an economy. 

Deadweight loss is the amount of economic activity wiped out of an economy due to the imposition of a tax.  It is a measure of the inefficiency of a tax when compared to that most efficient of taxes, the lump-sum tax (a topic for later).  We know that the more easily someone can substitute away from the taxed item, the greater is the deadweight loss to society (the more inefficient the tax).  The wealthy are particularly good at finding the greatest use of their dollars (there are some exceptions of course, like some heirs and heiresses) and they also have the opportunity to substitute away from the taxed item due to the level of resources at their command.  Thus, luxury taxes often result in less revenue generation than predicted, result in relatively large deadweight losses (great inefficiency), and end up hurting the companies and labor involved in providing the good or service that is taxed.

What should be taxed instead?  There are still plenty of questions to ask, and answer, regarding this topic, which I will post on soon.