The correct reason to oppose high MTRs
By Scott Sumner
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.
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%.) 🙂