Like many of you, my Dad watches Fox and reads the WSJ and sends me emails. Each Monday I get a new set of talking points. Last week it was Socialism, now it is more refined - seems he read an editorial called Obama and the Tax Tipping Point.
The gist is that higher taxes will strip productivity, which he cleverly argues based on research that demonstrates that the size of government and tax rates tend to reach an equilibrium based on productivity. Basically, after four of the largest spending programs in history were put forward by Republicans (Medicare Part D, Iraq, bailout and stimulus packages), he thinks that Democrats will spend more.
So, I decided to just go with his research and see where I could end up. Have economists Allan Meltzer and Scott Richard proven that you shouldn't tax rich people or you will destroy the economy?
My net was that You cannot persist a society with large income disparity and democracy. But follow me after the fold and let me know whether I am full of s**t.
More...
So here is my response. Yes, it is long, and I apologize. But I would love to hear what you all think:
Dad,
This is exactly the kind of piece that really bums me out. The research they are referring to is related to the same research I was talking about that posited a tax tipping point at a certain percent of GDP. When you tax too little, people feel free to support big programs (bailouts, wars, social programs) because they feel that they get a lot for a little money. When you tax too much, they also want more because they are paying more.
Unfortunately, this editorial doesn't actually delve into what the research was to help people understand an interesting point. He just goes into talking points and is frankly a bit intellectually dishonest.
I think he is correct that there is a moral hazard to having people pay no taxes - they will expect more services because they don't pay for them. However, there are very few non-homeless people that pay no taxes (there are still property tax - paid even if you are a renter, sales tax, payroll tax, state tax and FICA). But the biggest issue is that there simply isn't enough left in the bottom 50% to get anywhere near the revenues. Is rescinding a tax cut from 7 years ago redistribution?
What if we looked at it from Allan Meltzer and Scott Richard's research:
Start with the assumption that Government, Tax, and Redistribution are actually just three words for the same thing. The size of Government is equivalent to the revenue (Taxes) it generates (understanding that taxes may take the form of debt obligations or the sales of assets like oil, minerals, or property that are held by the public). Governments, unlike corporations, do not return goods or services in direct exchange and in direct proportion to dollars spent by a given individual. The only natural action of Government is "Redistribute", or deploy those revenues in different form and proportion to the people than it had received them.
Based on this, I will consider Government, Tax, and Redistribution to be logical equivalents.
Therefore we can state that Government is by definition a perversion of self-determination, in which every member of society accumulates wealth and spends or invests that wealth independently. A society could theoretically exist that did not redistribute, and that followed strict self-determination, but it would likely result in lower general productivity.
Lets then assume that the variant factors in Government are first its size - not in terms of absolute tax dollars, but as being the share of total income of a society that is redistributed. Second, its spending, meaning how much it gives to which members of society, and third its agent of decision (voter), meaning who gets to decide who gives what and who gets what.
What the research has shown is that in strong democracies, where the voting franchise is widely held, the size of government tends to grow. Given the choice and basic affordability, fully enfranchised populations will tend to grow the government to provide education, health services, public services (fire and police), retirement, and other public good expenditures. The insight of Allan Meltzer and Scott Richard was to discover that voters will tend to predict the negative effect on productivity of taxation. Meaning that they will consider and react to the prediction that some redistribution will actually decrease the willingness to work by the population and will naturally limit the growth of government.
Their equilibrium model does not argue against redistribution, it actually argues for full enfranchisement to make certain that the equilibrium will be maintained.
Here's the basic idea:
- People vary in how productive they are. Because productivity has a constant effect on your wage, those who cannot earn a higher wage than welfare would provide will choose not to work. General productivity is the average level of motivation to do work of a member of the population. I would agree that this is a very good basic proposition.
- There is no "right" size of government, only an equilibrium where it meets the perceived needs of the median voter or ruler while not degrading general productivity
- Income is not distributed evenly. Since it is a Pareto (long tail) distribution, and not a normal distribution (bell curve) the mean income will exceed the median income.
- The relevant variables are the mean population income and the decisive person's (e.g. median voter's, or dictator's) income.
- If the wages of the median voter is equal to the average wage of the population, they will seek zero redistribution.
Another way of putting it is that as wages get lower on average, voters will seek redistribution as a way of redressing the imbalance unless they feel that the redistribution will destroy productivity resulting in a loss of income and services to them. Their perception becomes one of the key aspects - if they are either uninformed or unmotivated, they will seek less redistribution.
If you are wealthy, meaning your income is substantially above the median, you will inevitably be taxed more in such a system. As such, self-interest would guide you to either change the level of motivation of or change the flow of information to the median voter.
The first objective, changing motivation, is served most effectively by creating a strong middle class. As wealth distribution becomes more "normal", the majority of voters will have far lower motivation to redistribute. For example, most of the cuts in public services occurred once we were a few decades past the Depression, when income disparity was at a historical low, and a combination of Reagan and Clinton/Gingrich rationalized many social programs like Welfare, lowered tax rates on the wealthy, and destroyed secondary wealth distribution systems like Unions. These were politically possible because the majority of voters were far closer to the income mean and therefore were more sensitive to the negative effect on overall productivity than to the prospect of lower benefit from redistribution.
The second objective is far more pernicious. You can pervert the equilibrium by changing the perception of the average voter by convincing them either that productivity is at greater risk than it actually is, or that they are getting more benefit from redistribution than they actually are. You can see this in several areas of our economy:
- Military and Homeland - The Cold War, the War on Terror, and other PR programs - whether duplicitous or sincere, will tend to skew the perception of a voter into thinking that the benefit of a very large military is greater than it actually is, allowing those parts of government to explode (the fastest growing parts of government are military and homeland security). While we pay for this with debt, it is just deferred taxation.
- General Control of media and PR - "The economy is good," "We have the greatest healthcare system in the world" are talking points of the Republicans since Reagan. Essentially, these are ploys to convince the average voter that they are getting enormous benefits from redistribution.
- Rabid Antagonism Towards Torts and Unions - The country has achieved almost total success in invalidating punitive tort law and the value of unions. As such, it is much more difficult to directly affect a balancing of income from corporation to individual except through direct taxation.
What we are seeing now in the "Time for Change" revolution is predicted by the model. First off, the median income of the vast majority of the population is significantly below the mean income. The massive concentration of wealth and income in a tiny part of the population means that a majority of voters will vote for more government because the benefits that will accrue to them are much larger than the perception of lower productivity. It is no longer reasonable to assume that making the rich pay more will affect the productivity of the economy. It is prudent self-interest.
Second, and more interestingly, the disaggregation of the media through social networking, the Internet, and greater access to global information means the average voter is far more informed about productivity and their position. The wealthy have less ability to control the conversation, and that transparency is reflected in the desire for more government.
Note, nothing in their research suggests that bigger or smaller government is good. What they stipulate is that government should not grow to the point that it degrades general productivity. Most interestingly, they suggest that an economy in which the majority is at the mean income level will actually have smaller government because people will perceive that they can make more by working harder than by redistribution.
The beauty of models like this is that they tend to win in the end. You can argue that you don't want to be taxed because you earned it or that they should be taxed because you are. But a good model is like gravity - you can put enormous amounts of energy into defying it, but eventually it will win. Moreover, the more extreme the effort to subvert it, the more violent the correction to normalize it. Not because it is more moral or ethical, but because it is more true.
You cannot persist a society with large income disparity and democracy. It doesn't solve under Meltzer and Richards model.
Where does it leave us?
We likely share a goal of having the greatest general productivity with the smallest possible government. To achieve this in a pluralist society, you have to raise the median income of the average voter. If you don't, government gets bigger. Bigger government is equivalent to greater redistribution and greater taxation by definition. So how?
- Invest in Productivity - Focus on real investments that leader to higher earning, and less on government expenditures that tend to redistribute wealth upwards. You and I will likely disagree on this, but government spending on wars does not result in a rise in the median income. Some is absolutely necessary, because a collapse of society tends to reduce income, but we are spending far too much with far too little to show for it. Higher education and better schools does increase income levels demonstrably, and is virtuous.
- Increase transparency - The more educated the voter is on that actual benefits of programs, the more likely they are to understand their effect on general productivity. American healthcare is grotesquely cost-inefficient, and it will likely be nationalized if we don't cut the BS and talk straight about what works and what doesn't. The published corporate tax rate is 35% in America - among the world's highest. The actual ratio of taxes paid by corporations to actual corporate profits in America is the second LOWEST in the world. People will vote for the right amount - not a punitive one - if they know the truth.
- Increase tax on the wealthy - This will directly reduce the mean income and make it more in line with the income of the median voter, resulting in a desire to lower taxes.
- Break the link between corporate wealth and political influence. Because we don't have direct democracy, the actual "voter" boils down to a very small number of people in the country with a very high median income. When they don't actually represent the real voters, then the system equilibrates to a place that is less productive.
Unfortunately, the net result of these would be to make it harder to be extravagantly wealthy. But it would also be much more stable economically and more productive. The model says so...
Sorry about the length of these emails, but you brought up Meltzer and Richards... ;)