Monday, March 5, 2012

Steep Taxes and Shallow Thinking

Robert Frank distills the faith he has in a steeply progressive system of consumption taxes with single sentence in chapter five of The Darwin Economy. In regard to a dearth of disposable income for upper-income Americans, "By all available evidence," he claims, "this would be a good thing." His implicit claim to have read every shred of evidence aside, his explicit claim that there are no downsides to his proposal is quite interesting and, by it's very nature, wrong.
Frank's plan to put the positional comsumption beast (Frank's description of the economic phenomena where individuals seek to maximize their conspicuous consumption, i.e. "keeping up with the Joneses") on a diet is based primarily on his plan for a progressive consumption tax with a top marginal rate of 100 or more. The tax, which exempts savings and investments entirely, would induce individuals, especially those of high income, to save more and consume less. Because, according to Frank, there would be no discincentive to earning additional money as long as it could be saved tax free, Art Laffer's prediction that reported income will drop as tax rates increase would not apply. I beg to differ.
The desired end of any earnings is consumption in some form. Money, as we all know, is worthless paper if it can't be spent. Even my savings would me no good if they were subject to confiscatory tax rates as soon as I made a withdrawal. Tax rates of 100%, where a check of $100 must be cut to the Federal government every time I make a $100 withdrawal from my bank account, would devistate the incentive to work and thus reduce the available capital to save and invest. Thus, the tax would not only reduce short run consumption but also long-run earnings. Say, for example, that I'm a department manager at a paper company making $150k a year. I consume $100k and save $50k, I also have no uncertainty about my job security. Every dollar of consumption over $100k is taxed at 100%. Because my savings are already so high, I will be able to retain my current consumption levels through retirement. If, in retirement, I make the mistake of consuming more than $100K annually, then making a withdrawal from my bank account will reduce the size of my savings by double the original amount. Thus, I currently have little incentive to earn any additional money for the pupose of savings, as it will be to costly to withdraw later on.
Likewise, I could spend the money that I opted against saving, but it would also cost me a great deal. If, by spending 33% more hours at work this year than last, I earn a year-end bonus that makes my new pre-tax income $200k dollars, I may want to consume the entirety of the additional 50k. This is rational since my 33% savings rate is already extremely high. To do this would cost me the sum of my $50k bonus plus a tax payment equal to my entire year's savings. Of course, I could also just spend half of the bonus and pay uncle sam the other half. Instead of spending the money or saving it for later, option three is that I leave it to my children. Assuming that the inheritance tax, which Frank supports, exists at a similar rate, the dillema here is similar to that in parts one and two, my money would be of little use at the margins.
Knowing that, after a certain point, my additional effort is only going to reap minimal benefits for me and my family, I probably would not have opted to work harder for additional income. Maybe that's fine, after all, life isn't only about work. But it's still a trade-off that flies in the face of Frank's claim that his plan wouldn't be a disincentive to work. I hope Frank and others keep using the term progressive consumption tax. It is a term that describes itself accurately without attempting to fit into a slogan or catch-phrase. By it's name I can imagine it having all of the advantages of a consumption tax (neutral towards investment, simple) and all of the problems of a progressive tax (strong incentives against working). This view seems to be correct. A tax is a tax, and we should work on finding one that is the least bad, not making claims that one is all good.

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