Asymmetrical Information

Is this an argument to LOWER the capital gains taxes? The democrats already go beserk over the different rate between capital gains and income as it is.

More importantly how would our econmomy do, short and long term, if the savings rate went up to the Swedish rate? Would people stop buying McMansions and SUVs? What I'm thinking is everyone started saving say 5% of their income instead of spending it what macro effects would occur.

Off topic - Jane what do you think of the current housing bubble in NYC?

Just because labour is not mobile does not mean that high taxation of labour is not destructive to the economy. It just means that it is easier for governments to get away with taxing labour as compared to capital. The idea that income taxes are a tax on monopoly profits is silly. Most participants in the labour market do not have monopoly power over their contribution to the economy - another doctor, lawyer, janitor, or even a machine, at times, can do the job. Taxing income causes distortion in the allocation of labour, just as taxing capital causes distortion in the allocation of capital.

People have monopoly power over their talents.

How does this sentence differ, truth-value-wise, from "People have monopoly power over their investible capital?"

What they taught in my econ courses was that impact of capital taxation on savings was, in theory, ambiguous (the increased taxes also have an income effect lowering current consumption). The US has cut capital taxation in recent years while savings has fallen. Is there some good evidence for the impact of capital taxation on savings?

Tom

The idea that income taxes are a tax on monopoly profits is silly. Most participants in the labour market do not have monopoly power over their contribution to the economy - another doctor, lawyer, janitor, or even a machine, at times, can do the job.

First off, strictly speaking this not true. Most people have some degree of monopoly power at their jobs because another worker is not a perfect substitute.

For many people the structure of the labor market is monopolistic competition. This is in part why hourly workers tend to want to pick up more hours if possible. Monopolisticly competitive firms always want to sell more at the prevailing price.

However, workers who makes lots of money typically have a great deal of monopoly power. The wage for cardiothorasic surgeons isn't what it is because other workers think getting into heart surgery isn't worth the investment. Its because very few people can be heart surgeons.

This implies that lowering the after tax wage is not likely to make the marginal heart surgeon say "Well screw this I should have just become a bus driver."

High tax rates on executive compensation are hugely destructive to the economy.

First, executive compensation is as high as it is because of the competition between firms for excutives. If you raise the taxation you do not eliminate the competition. Expect higher taxation on executive salaries to be met by either higher executive compensation (to compensate for the taxes) or deferal of executive compensation into other forms of income. Thinks more and more elaborate perks.

Second, getting to the top of the executive ranks is VERY hard and demanding work. As you increase the taxation, you reduce the incentive to do that work.

The net result of increasing taxation on executive compensation will be more obfuscation of executive compensation and not only lower quality executive leadership, but lower quality leadership and work from those who might have otherwise aspired to executive positions.

For an object lesson in trying to limit executive compensation through taxation, look at what happened after the 1993 law that limited the tax deductible portion of an executives salary to $1 million. First, you saw a rise in stock options and other forms of non-salary compensation to get around the limit. Second, you saw a big rise in the promised retirement packages (which were not subject to the limit). Want to know why the head of the NY stock exchange and the head of Exxon mobile gots such suprisingly large retirement packages? It was because they had been forgoing higher salary compensation (which their companies would not have been able to write off for tax purpose) for years in exchange for taking that compensation as a lump at retirement.

As proposed by economists in the 19th century, a tax on land is (aside from a poll tax) the most difficult to avoid. It certainly seems to me that considering we care about efficiency and equity, we ought to tax: 1) things with negative externalities, 2) land (since increases in land value, after improvements, are functionally windfalls), 3) estates, 4) income, 5) capital, in that order.

(The caveat that optimal taxation implies that we should tax a number of different goods ought be maintained, of course).

It should be noted that the reaonable point of comparisons is not to consider a worker to possess monopoly power over their talent, but rather to consider them as charging *rents* against that talent.

If a person is intrinsically smarter than most people, then to make a premium wage from that intelligence is to garner *rents* from it. Note, this is also true of folks (like pro basketball players) who are tall.

However, as anyone *doing* anything will tell you, simply being more talented intrinsically gets you *nowhere*. Your average doctor is not just charging you *rents* on his brains, but also returns on the improvements he has bought for his brains. He's charging for the capital investment of the time, money, effort, and defered compensation/leisure that getting his medical education entailed. It's much like someone building improvements on land. In this case it's just investing in human capital.

If education is a form of capital and the higher incomes of educated people a return on their investment in education does it not follow that a high personal income tax rate would discourage education? Anyway, we know that in the real world high taxes generate tax avoidance schemes such as those pointed out by quadrupole. To add to the distortion, in America at least, high tax rates generate political tax deductions, loopholes if you will. Doesn't this partly underlie the housing and health care "crises"?

However, workers who makes lots of money typically have a great deal of monopoly power. The wage for cardiothorasic surgeons isn't what it is because other workers think getting into heart surgery isn't worth the investment. Its because very few people can be heart surgeons.

This implies that lowering the after tax wage is not likely to make the marginal heart surgeon say "Well screw this I should have just become a bus driver."

As a percentage, relatively few people can be highly-educated professionals of various kinds. But many time more people are capable of being heart surgeons than actually become heart surgeons. Similarly, heart surgeons might have become other sorts of high-paid workers. I have, indeed, heard surgeons say, effectively, "Screw this, I should have gone into business" (if only half seriously). The surgeons I know are wealthy, but their income is limited in a way that the guys who own businesses is not.

Which is to say, yes, if you tax wages much more heavily than capital gains, some number of ambitious prospective surgeons will, indeed, decide to do something else (especially something else where more of the income comes in the form of capital gains). Or even something else where the income is somewhat reduced, but the pressures are lower, training shorter and less arduous, and working conditions more congenial.

jim linnane

You are correct, much of our health care crisis come from the tieing of health insurance to employers that is mostly due to tax policy (today, originally it was due to avoidance of wage controls).

My perception is that much of the housing crisis is driven by artificial restriction of supply (onerous regulations, smart growth policies, etc) and the tieing of education to housing. I don't think home mortgage deductions do a lot to contribute to the housing crisis.

Don't get me wrong I am not proposing any sort of socialist redistribution ala the tax system. My point is simply that taxes on labor are less damaging than taxes on capital. See Mankiw on dynamic scoring. This is in part because labor earns rents.

In growth theory we usually look at GDP per capita as the measure of interest. But what is that really? Its a measure largely of the rents to labor.

In most of the models the return on capital just compensates people for forgoing consumption. However, the wage doesn't just compensate people for having to get up in the morning and go to work. It earns rents.

Fortunately for the stay-at-homes, some people in a position to charge rent on their own talents are mobile. The pressure at the margin at least provides some restraining force on top-end income tax rates (especially for countries that do not tax on citizenship).

Writers moved to Ireland, hockey player Gretzky moved from Canada to the U.S., and more than half of the residents of the Cayman Islands are ex-pats.

At the limit, the following quote applies.
"Throughout history, poverty is the normal condition of man. Advances which permit this norm to be exceeded - here and there, now and then - are the work of an extremely small minority, frequently despised, often condemned, and almost always opposed by all right thinking people. Whenever this tiny minority is kept from creating, or (as sometimes happens) is driven out of a society, the people then slip back into abject poverty. This is known as bad luck." -- Robert Heinlein

We all know that we are replacable. The question is, how long will it take (and how much extra money will it cost our employer) if they wanted to replace us, fully? There is some "dollar value" there. Are you saying that this replacement cost "dollar value" (our talent)should be taxed at some special rate?

Paul's right, we are all replaceable, as demonstrated by the fact that we are inevitably all replaced.

The main problem I have with the original article is the disingenuous use of the word "monopoly". Saying I have a monopoly over my talents is like saying that Ford has a monopoly on Fords. It's a tautology at best. At worst, it's a lying rationalization.

The main problem I have with the original article is the disingenuous use of the word "monopoly". Saying I have a monopoly over my talents is like saying that Ford has a monopoly on Fords. It's a tautology at best. At worst, it's a lying rationalization

That's an interesting way to put it. Ford does have a monopoly on Fords and that is meaningful. That brand owners have monopoly power over their brand is important to understanding why there are brands in the first place.

Not everything has a meaningful brand. Do you know what brand of apples you buy? What brand of raw corn?

Nor is the fact that people have monopoly power over their talents a forgone conclusion. Both serfdom and some forms of socialism are attempts to divorce people from that monopoly power.

If you are forced to give of your talents or else you face the lash or the gulag then you do not have monopoly power over them.

People have monopoly power over their talents. People with lots of talent have lots of monopoly power. Taxing away monopoly profits is generally not destructive to the economy.

There are plenty of circumstances in which taxing away monopoly profits is destructive to the economy. For example, we all have a monopoly on our own labor, yet it has been repeatedly shown that increasing the percentage of that labor taken by the government -- i.e., increases in the extent to which the economy is a command economy -- seriously damages economic output.

As "little economic effect" does not always follow from "taxing monopoly profits", it cannot be said (without further evidence) that taxing talent has little negative economic impact.

If education is a form of capital and the higher incomes of educated people a return on their investment in education does it not follow that a high personal income tax rate would discourage education?

I recall a business school course on international labor issues where this effect was actually said to occur in some Scandinavian countries with very high income taxes. Higher education was already free and the governments even went so far as to offer stipends to people who would stand out of the labor force for a while to get advanced degrees. But the countries still had a much lower percentage of advanced degrees then most other countries because it just wasn't worth it to go to school. You'd make more money overall staying in the labor market than taking the stipend and getting the advanced degree.

Of course, this was at the University of Chicago so disconfirming information might not have been presented...

But we still have the fundamental issue that for years we have been cutting marginal tax rates without the results theory suggest.

While we were cutting personal tax rates the savings rate has plunged and investment by those subject to the individual income tax has fallen from 30% to only 11% of total nonresidential fixed investment.

Theory is fine, but in reality the tax cuts have produced exactly the opposite relults that theory implies.

Maybe we ought to try to understand why the theory seems to be wrong before we keep trying to do more of the same.

Maybe we ought to try to understand why the theory seems to be wrong before we keep trying to do more of the same

This is always a good point. However, it is also the case that other things have been going on besides cuts tax cuts.

For one thing productivity growth in the U.S. has increased. This tends to lower the savings rate. In fact if productivity gains are fast enough we would expect the savings rate to go negative.

Basically that means that in the future we are going to be so rockin' anyway that we might as well borrow now and pay it back later.

Another factor, is the aging of Europe, Japan and China. One reason to save is to save for retirement. The other big economies, exluding India, are aging faster than the U.S. This tends to increase their savings. Because capital is mobile some of that flows into the U.S. and reduces our savings. This is compounded by the fact that China is inflating the dollar.

A third factor, which may be very large but hard to quantify is that we may be missing a lot of savings. R&D by corporations is a form of savings. How to count it is the subject of debate. However, it could end up representing a lot of savings.

This would imply that by owning stock in US Corporations you are saving by proxy. If a lot of people own stock but don't increase their holdings very rapidly the savings rate will look depressed.

These factors imply to me, that it might well be the case that the savings rate would be even lower if it had not be for tax cuts.

Spencer wrote:
"While we were cutting personal tax rates the savings rate has plunged and investment by those subject to the individual income tax has fallen from 30% to only 11% of total nonresidential fixed investment."

As I have it, the theory under discussion suggests that the substitution effect of decreasing marginal individual income tax rates people would allocate more resources into things/endeavours that tend to increase future individual income (e.g. education).

IIRC, people have been putting more money and time into education, which is in keeping with the expected substitution effect. Further, again IIRC, money spent on education does not count as "savings".

Karl Smith has covered the income effect: "in the future we are going to be so rockin' anyway that we might as well borrow now and pay it back later".

This is the first time I have heard the argument that stronger productivity growth leads to lower savings.

Could you please explain the rational behind that.

I am serious -- I would like to satisfy my curiosity.

Does it lead to higher investment returns
so that less current savings are needed to
achieve wealth objectives?

Does it lead to higher investment returns
so that less current savings are needed to
achieve wealth objectives?

No, it leads to higher labor income growth.

It all turns around the question of why people invest in the first place. Lets, assume its because through investment you can raise the lifetime income avaialable to you and your children. Afterall, you get more from your investment than you get back.

Well on the one hand you can consume more overall but on the other hand you have to consume less now in order to get more later. As economists we think there is something called declining marginal utility. Which in this case means the more you consume the less important an additional unit of consumption is.

For example a starving person is literally dying to have more food. However, a person who is eating well may want more but not as badly.

So when you save you are making the marginal utility of consumption today is bigger than the marginal utility of consumption tomorrow. In other words you are taking consumption from where it has a high value and putting it where it has lower value. This is part of the reason its hard to get yourself to save.

That is balanced, however, against the fact that the tradeoff is more than one for one. You give up one unit of consumption today to get more than one back tomorrow.

In a perfectly functioning economy there is perfect balance between these two forces. The desire to consume more today when your consumption is low vs waiting and getting even more tomorrow.

Well suppose productivity starts growing. This means that you will be earning more tomorrow than you are today. This means that the marginal utilities are even more unbalanced. This causes you to start saying - screw this I would rather just consume now when I have less than just get ridiculously rich later.

This is part of why students save so little. Their productivity is growing rapidly. It would make little sense to be an even poorer college student so that you can be a super duper rich lawyer.

Does that explination hold water for you?

While we were cutting personal tax rates the savings rate has plunged and investment by those subject to the individual income tax has fallen from 30% to only 11% of total nonresidential fixed investment

What's the grounds for excluding residential investment from that?

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