Ep. 171 The Economics of Soaking the Rich

12 January 2019     |     Tom Woods     |     14

Paul Krugman loves Alexandria Ocasio-Cortez, and says her suggestion for a much higher top marginal income tax rate is actually well founded and economically sound. Now if the column were just about that, it’d make for a great episode of Contra Krugman. But the way Krugman speaks of “the rich” is downright sinister, and we hit that head on as well.

Krugman Column

The Economics of Soaking the Rich” (January 5, 2019)

Contra Columns

Bob explains why Krugman is wrong on rich people not contributing to society:
Does a Worker Help the Rest of Society?” by Bob Murphy

Bob summarizes economics literature on taxes and growth:
What Economic Research Says About Fiscal Austerity and Higher Tax Rates,” by Bob Murphy

Phil Magness explains the high marginal income tax rates of the postwar era:
“The Rich Never Actually Paid 70 Percent,” by Phillip W. Magness

Related Episode, Tom Woods Show

Ep. 1314 Ocasio-Cortez Wants 70% Top Marginal Tax Rate

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  • Paul Farmer

    Krugmans argument that the only value from a rich person doing the extra marginal hour of work in an economy is the tax collected from that hour is simply wrong . The thing not mentioned in the podcast is that you’re forgetting about the value of that hour to the recipients of that work or service.

    To say it’s a wash , that is society gets no value from it because the person paying has paid for that extra hour at its marginal value to them and ergo , avoiding it therefore creates neither a profit or loss to both parties is so economically stupid one is left in total shock a trained economist could say this .

    In a society based on voluntary transactions that hour must always have value to the receiver even if it’s cost neutral in a fiscal sense or it wouldn’t occur . If a doctor sees another 2 patients in that last hour , the doctor takes a fee but equally those 2 patients have taken value in the service supplied . It’s not a wash for society at all , society is better off because those transactions have occurred , value exists for both parties on either side of transaction even if the doctor is tired and indifferent and wished he was already at home .

    Sure the doctor might be indifferent in that he feels the extra income wasn’t more valuable to him then his time after a long week seeing patients . The outcome but when view from the point of view of the patients but is totally different . How would Krugman like to be that patient with a sore throat told to find another doctor at the last moment because his regular doctor has signed out for the week as he is over it .

    Similarly the doctor while he might be tired and sees no profit in doing the extra hour of work also knows the patients in his clinic need his service and they are loyal clients , he does value their long term patronage so he works the extra hour happily even if he is indifferent in the moment to doing to the extra work .

    While this example is simple it points out the fallacy of krugmans thinking . The same applies to an employer / employee relationship . In the real world outside of economic textbooks the employer might really need that last hour of work done even if on paper he is not making a profit from it .

    In a free society where an economy is based on voluntary transactions every single transaction no matter if it’s the first hour of work done or the last adds value to the society and economy as a whole ….. end of story , it is not a wash ever .

    If marginal tax rates change and hence incentives change and in consequence transactions are then lost , society is the poorer for it and the size of the economic pie from which tax can be recovered is smaller . Krugmans argument is wrong because he puts no value on the transaction to both receiver and giver but bizarrely elevated the treasury to prime position in evaluating the merit of a transaction proceeding , like as if we exist solely to be taxed . That is totally putting the cart before the horse . In the free world we run an economy to benefit the people in it and then we pay tax from the value it creates for public good . We certainly don’t run and economy with the goal to pay tax and then if we get a byproduct of being better off then that is just good luck . In short Krugman’s thinking here is totally fallacious and at odds with the entire premise of a free society .

    This is why high marginal rates fail . For society not to lose you would need to strike the cut in of the high tax rate at the precise dollar of earnings for each individual transaction where not only the supplier of the transaction is indifferent but also the receiver , and the receivers utility function is entirely different to the suppliers . Everybody in he economy would also need a different tax schedule of rates , think about that for a moment .

    Consider that in every single situation for a myriad of supply and demand for labour situations right across an economy every day , literally millions and millions of transactions , those utility equations between supplier of labour and receiver are going to be always different and also unlikely to be ever equal. Hence very quickly striking a new higher marginal tax rate that incentives suppliers to withhold their labour is going to very quickly impose on the economy significant losses because those workers now encouraged to withhold their labour ( particularly those workers who can command significant value from it such that they can earn so much of it ) , are going to value the exertion of it far less than those needing it and you can be sure very seldom if ever will there be washes where the utility from buyer and supplier are going to be the same and those transactions can simply disappear from society with nothing lost .

    To rephrase this in terms of Krugmans analogy of utility curves , the relevant comparison is not what little worth does an extra 1000 dollars of income have to someone earning a million dollars of income and hence by implication we can tax it and redistribute this to a poor person only making 20000 of income . The question should be framed if we tax this extra 1000 at this high rate and it now doesn’t proceed what value is lost to the economy if that transaction doesn’t occur ? In this context you get a totally different answer . You have to weigh the loss of those receiving benefits from those transactions made with the rich person to those now receiving the income . Presumably being a voluntary transaction those receiving the $ 1000 of transaction place a value of $ 1000 on it , as this is what they paid to the rich guy, so in terms of utility you may find that if there is a wash here this is it , there is no gain to society by taxing the 1000 dollars and redistributing it .

    Even ignoring moral arguments around theft of property , an economy is a far too complex , intricate and moreover a interdependent network of voluntary transactions ever ongoing such that striking a blanket , across the board , ridiculously high marginal tax rate on incomes will always do a significant amount of damage to the net output of society and that is the pie from which taxes are drawn . This is why Laffer was right and supply side economics that encourages low taxes works and high taxing marginal rates don’t work and only undermine the very thing treasuries want ……more tax !!!!

  • mcsandberg

    The way Krugman talks about “The Rich” is exactly what Jonah Goldberg is talking about in his new book Suicide of the West.

    But then something happened. “About the end of the seventeenth century,” Joseph Schumpeter writes in Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process, the English political establishment “dropped all systematic hostility to invention. So did public opinion and the scribes.” It was this remarkable, unprecedented, miraculous change in attitudes that made the Miracle possible. The way people talked and thought about how the world worked changed. “The economy is nothing without the words supporting it,” McCloskey writes, “whether conventional wisdom or creative entrepreneurial projects.”48

    I am almost wholly convinced by this. For 100,000 years, the great mass of humanity languished in poverty. This great flat line of material misery plodded along unchanged until attitudes changed in England and Holland, not just among intellectuals or aristocrats, but among the common people, particularly the bourgeois—the mostly urban middle and upper middle class of professionals, artisans, craftsmen, merchants, and other laborers who did not till the soil. Prior to that, notions of betterment, innovation, and improvement were seen, literally, as heresy. “Curiositas,” or curiosity, was a sin, and the innovator a heretic.

    Excerpt From: Jonah Goldberg. “Suicide of the West.” iBooks. https://itunes.apple.com/us/book/suicide-of-the-west/id1223867570?mt=11

    Since the majority of the wealthy in this country are great innovators, Krugman is, indeed, rejecting “The Miracle”. That is a truly ugly thing to do.

    • Jim Bob 1028

      The attitude expressed by Krugman and AOC is ugly on multiple levels. I agree with McCloskey (and so does Goldberg) that the most important level is the manifest hostility that the likes of Krugman and AOC express toward the wealthy. Krugman can dress up his hostility in ersatz economic argument and AOC can dress up her hostility in an emotional appeal to naive moral notions, but at the root of their hostility is a heart full of envy. Another word for envy is covetousness.

      But the high marginal tax rate also deprives consumers of marginal product and reduces capital formation. In the very short term, higher marginal rates perhaps transfer more resources to the state, which will at best squander them and at worst use them to prosecute a war or similarly murderous activity.

  • Jim Bob 1028

    In my own case, the US income tax code has a top marginal rate of approximately 1,212,600% (i.e., over one million percent).

    This top marginal tax rate occurs at 400% of poverty line which for a married couple was a modified adjusted gross income of about $64,960/year for tax year 2018.

    I use TurboTax to run two scenarios. The first obtains MAGI of $64,960 and indicates an income tax refund of $2682. The second obtains MAGI of $64,961 and indicates that I owe $9444 in income taxes.

    Thus, by earning one additional dollar, my income tax (after all credits) increases by $12,126, or over a million percent.

    I don’t know how much a 70% marginal rate would influence my behavior, but a million percent sure does.

    The perverse marginal income tax rate phenomenon described above is due to the ObamaCare mandate and subsidies. Fortunately, I don’t face the same problem in 2019 because the Trump/GOP tax bill effectively eliminated the mandate and re-legalized non-ACA-compliant medical insurance.

    • mcsandberg

      Wow! Wouldn’t it be nice if politicians learned about things as complex as curved lines?

  • martinbrock

    Income of “the rich” is not comparable to an hourly wage, because the wealthiest people earn the yield of capital other than their own labor. Taxing this yield away from them, to entitle politicians to decide its expenditure, is highly debatable, but these taxes have little effect on the length of a wealthy person’s work week, except that taxing away enough of anyone’s income compels the person to work more hours.

    Krugman’s talk of tax rates “maximizing revenue” is reminiscent of the “supply side economics” story I’ve heard for most of my life, but I long reached the opposite conclusion about tax rates. If higher tax rates lower tax revenue, then since I want lower tax revenue (less command of resources by central authorities), I must want higher tax rates. Insofar as I play the “political reform” game at all, I favor a progressive consumption tax with marginal rates approaching 100%.

    A progressive consumption tax is not supposed to collect $99 million in tax revenue when Elon Musk’s spends $100 million on a vacation to the moon or whatever. It rather expects Musk to avoid this tax by spending the $100 million on some investment producing more affordable goods. The latter expenditure is not taxed and generates no revenue for central authorities to spend, and since politicians love common people, they’re happy not to receive this revenue … That’s why we have progressive consumption taxes.

    • Intersnooze

      Then I’ll just declare my intent to start a fast food chain on the moon and call it a ‘business expense’.

      Most technology in consumer products is driven first by innovators making expensive, sometimes very expensive products that feature a new technology. This price is sometimes judged necessary to pay-off the innovation in investment in forseeable timeframe. If the innovation is really useful, the market confirms the asking price and the innovator company can go into the next cycle of improving the product and reducing the production cost and expanding the market.

      A good example is the invention of the ‘mountain bike’ and the front suspension for bicycles. Both of these ideas were ‘crazy’ at the time (bikes are for roads!) and were very expensive. A high marginal consumption tax (or ‘luxury’ tax) could easily price such goods out of reach of a range of potential consumers, making the innovating company unable to continue to the next round.

      It’s only because Specialized and Rock Shox managed to clear that initial hurdle, that the technology was developed now for cheap mountainbikes and inexpensive suspensions for bicycles for the masses.

      ———

      To the podcast itself; I missed the admission that many of the rich got there through playing an interventionist system based on a banking and finance cartel. Many others got there purely off of tax dollars e.g. military contractors.

      These people are, to varying degrees, pirates — and their wealth is, to some extent. booty. Being rich says nothing about how you got there, and admitting this is important to opening up a dialogue with those attracted to ‘progressive’ causes.

      • martinbrock

        Tax exemptions for investment already exist, and you can’t simply declare any expenditure “investment” to claim an exemption, not legally anyway. Do you declare your dog a “dependent” now?

        More affluent people often consume Innovative products first. A progressive consumption tax does not change this fact.

        A progressive consumption tax would not price $1000 or even $10,000 bikes out of the market, because common people make $10,000 purchases routinely and would not accept a marginal tax rate ruling out this consumption. A progressive consumption tax is not a luxury tax. It doesn’t distinguish between $1000 consuming penicillin and $1000 consuming beer. It’s essentially a progressive income tax with unlimited, tax deferred contributions to individual investment accounts (like IRAs and 401ks).

        Both progressive income taxation and tax deferred investment already exist, and it’s tough to argue that lifting limits on the latter harms the rich. Less wealthy people typically don’t take full advantage of limited investment exemptions now, and wealthy people reinvest most of their marginal income anyway, so a progressive consumption tax (of the sort I’m describing) would slash taxes on the wealthy and benefit lower income people only indirectly by channeling more investment toward the production of goods they can afford, and “lower income” in this context only means less wealthy than the wealthiest. “The poor” wouldn’t benefit much.

        States exist to concentrate wealth. All states always do so, including (or particularly) socialist states imposing a high degree of central planning. A state owning all capital has concentrated wealth to an incredible degree, regardless of what it does with the wealth, “progressive” or otherwise.

        • Bill

          Is this tax regime meant to facilitate redistribution or just make it so lower income earners don’t have an obligation to pay for Government?

          • martinbrock

            Neither. It limits redistribution by encouraging wealthy people to reinvest marginal income rather than consume it. Bill Gates may pay no more tax than I do by spending no more than I on personal consumption. All else being equal, it increases taxes the less wealthy.

        • Bill

          A progressive consumption tax would make more sense than a progressive income tax, but if I’m being pragmatic and we have a Government that does good work and we want it a reasonable way to do taxes would be to have everyone mail in a check for $800 once a year and the Government should find a way to operate on that income (probably by doing fewer things) and leave progressive redistribution among friends.

          The notion that a rich person automatically receives more benefit from Government and therefore deserves to pay more is nonsense on its face. So that leaves the argument that the rich can simply afford to pay more to the government and therefore they should. At that point its no longer an economic discussion but a political one.

  • John Parish

    I don’t understand bobs explanation of the fallacy of the marginal utility argument. I understand that it is comparing apples with oranges but I don’t follow the long list of things that bob says are nonsense under the argument

  • Lysander Spooner

    If you want to see what happens under confiscatory high rates of marginal income tax, look at times & places where it happened.

    High income people whose accountants and lawyers can’t redefine away the income – typically entertainers and sports stars – either don’t work as hard, retire early or go into tax exile. Whatever is done, the public gets less of the output; fewer or smaller concerts, fewer games played by top stars.

    Given that consumers freely part with ticket money we must assume that the value the entertainment provides to those consumers is more than the cost of the ticket. So reducing the number of gigs & outings by top entertainers & sportsmen must, by definition, reduce the overall joy in the world. And it will reduce the income of all the support staff who would otherwise have been paid to set up, take down, cater, clean etc etc at those events.

  • James Adams

    I think that you guys should take more time debunking the notion of interpersonal comparisons of utility. An episode specifically devoted to this would do a lot of good against the leftist idiocy in economics. It would be really handy to have a specific episode to smash this fallacy every time it pops up. I’d say it would be good for Contra Krugman or the Tom Woods show or even the Bob Murphy show. I’m not picky!