On progressive taxes

So many political topics have been mentioned here...so little time to respond. I'll start by recommending Mr. Friedman once again, this time in video form. At http://www.ideachannel.tv/ you can now watch the original PBS specials "Free to Choose" which help with background I don't have time to write here.

I was hoping to write a significant preface to introduce some of the core principles which guide my views on specific topics but, well, I honestly just don't have time to think it all through. So here's my cliff notes version:

1. People are selfish
2. Governments, corporations, non-profits, etc. are just entities through which some group of people act---they are not therefore exempt from #1.
3. Government is unique among these entities in that it acts by compulsion---it acts with the ultimate threat of force.

I find these useful in mentally translating many ideas about the role of government. For example, "we should help the poor" is hard to disagree with, but "some subset of people (the government) should force some other subset of people to help some third subset of people" is more complicated (in every sense). You may certainly still agree with it---the subset of people represented by the government may have legitimate claim to take from one group and give to another---but I think it's unfair to avoid thinking the question through by clever use of semantics.

As an aside to this point I'll briefly mention how important I think "compulsion" is to think about here. At the risk of citing scripture in a political discussion, I note the Lord speaks of compulsory means several times. For example, in D&C 121:46. The united order has frequently been compared to "communism" of some sort but had this important difference---no one was compelled to give. I'm not saying all compulsion is therefore unholy or something, and don't want to dwell on this point. But I think my semantic argument above is not as trivial as it might first appear.

Ok, feel free to ignore all the above if you'd like. I don't mean to make this an abstract philosophy discussion. But I figure I may make use of all that as we go along.

Ok on to a specific topic. I figure I might as well start with Karl on progressive taxes.

Let's start with point 2. Karl argues here, and elsewhere, that taxation is a tool to correct externalities---actions a person takes which affect other people but for which he/she is not fully compensated (positively or negatively). I could not agree more---this is a basic and fundamental principle of economics. Correcting for externalities is certainly not contrary to economic conservatism. Often externalities are simply the result of incompletely specified property rights---the air I breathe is not owned by anyone so there is no market mechanism to compensate me for the pollution you put into it. Karl argues that one role of government is to tax actions which generate negative externalities (pollution), and I would add subsidizing actions which generate positive externalities (education).

I would add several externalities to the list. First, saving money. When you or I save money, we lower interest rates by reducing the demand for debt (and/or increasing the supply). As others have noted, Americans in general and our federal government in particular carry large debts. My saving lowers the cost of other individuals' debts as well as the federal government's. Not to mention that my savings act as "insurance" against needing other taxpayers to bail me out later on. How might policies "internalize" (to use an economist term---meaning to cause the cost/benefit of the externality to be reflected in the individual decision maker's utility function) saving as a positive externality?

1. Lower capital gains taxes. My wages are taxed, if I then spend everything I pay no additional federal taxes. If I save my money it will be taxed again. This distorts the save/consume decision toward consuming and away from saving.

2. Tax consumption, not income. This would directly tax the negative externality (consumption) and not the positive one.

Which of these policies are favored by any single democrat holding federal office?

Another externality to add: productive businesses and people. Productive businesses employ people and create wealth. I would argue this is as significant a positive externality as you will find as it enables all others. How much better off are you because great people and businesses made this country as wealthy as it is today? As a positive externality this should then be subsidized, yet it is taxed. If my business is productive I pay higher taxes than if my business is not.

You may argue the cost-benefit implies that taxing productivity (in both businesses and individuals) is worthwhile, but you cannot ignore the cost. If I were to argue that taxing pollution is a bad idea because it will be harmful to the economy (a cost-benefit analysis) how much sympathy would I find from the left? Yet our tax code in effect subsidizes pollution (by taxing productivity) and this fact is inadmissable in most debates I've had with leftists on taxation. You just can't have it both ways.

As I mentioned, I view this positive externality as large and worth encouraging. Why is the U.S. the richest nation in the world today? Why is unemployment in the U.S. 4-5% while it is 10-14% in Europe? Why have so many of the products we use today come from the U.S., and so few from elsewhere? I believe it is because we have maintained a strong incentive to be productive and am very cautious about policies which would discourage it.

This applies as well to Karl's last two points: overthrowing the tyranny of wealth and ensuring a land of opportunity. What country exceeds the U.S. in this regard? Isn't this part of the reason immigrants have come here for centuries? Does Europe afford greater opportunity? Less tyranny of one social class over others? My experience and study of macroeconomics indicates those countries with less regulation, smaller government and less redistribution of income have greater upward mobility than those with more progressive policies. I just see no evidence of the contention in point #4.

As for point 1, income seems a noisy proxy here. I know lots of folks at Harvard who will go on to make little money but have spent 12 years gaining a world class education. Shouldn't many of us (Ryan and I for example) have been taxed a lot for the opportunity to work toward at PhD which is certainly not necessary for us to make a living? How about those born wealthy who squander it? How about those born with little who just work really hard? How about those who emigrate and manage to make something for themselves? How about those who save their money?

And if you're going to tax based on what they've received shouldn't you also consider what they've contributed? Here income seems a noisy proxy as well.

Ok this is getting too long. I believe government should encourage positive externalities and discourage negative ones. Progressive income taxes are exactly the opposite.