Yet More Clarity (Confusion?) on Mainstream Tax Analysis
OK this is almost out of my system, but people keep asking good questions in the comments. “May I have another, sir?”
Chris asked:
Bob,
Doesn’t a consumption tax also hit you when you earn interest, dividends, and capital gains? After all one doesn’t earn interest to roll it over for perpetuity — it’s eventually cashed out for consumption. Does this not lower the return in a similar way as the income tax?
If I invest $1,000 and grow it (income tax-free) to $2,500, but have to pay a %20 consumption tax, this necessarily reduces my return to $2,000. Is this any different than if I had been paying an income tax on my dividends each year? Under a revenue-neutral income tax, wouldn’t I still have roughly $2,000 to consume at the end of the period? I’m not sure I see how a consumption tax is a benefit over an income tax.
I gave a somewhat technical reply, and then I realized what I think is tripping a lot of you up. (Note, I’m not saying, “You are wrong and the mainstream guys are right,” rather I am saying that you are missing what their argument is.) So I followed-up by writing:
This might help: Don’t think of it as a 20% consumption tax versus a 20% income tax, because they wouldn’t raise the same revenue. Even if the worker works the same # of hours, he ends up saving less under the income tax, so his lifetime income is lower. Hence, a 20% income tax wouldn’t raise the same revenue from him, as the 20% consumption tax. {EDIT: Assume he doesn’t pass any wealth to his heirs. He consumes everything on his deathbed. So lifetime consumption = lifetime income in present value terms, income and consumption don’t need to be equal in any particular time period. If you think through this contrived example, the point might jump out.] Since the guy is going to save less (and thus earn less interest income), maybe the government has to impose a 23% income tax to raise the same lifetime revenue from his, as it would get from a 20% consumption tax.
And then to take the principle further, suppose that either the 20% consumption tax or the 23% income tax would let the government extract $10,000 per year from this guy. If instead it imposed a $10,000 head tax, then the guy’s consumption would probably end up higher than under the consumption tax regime. This is because the marginal incentive to work for money (instead of using those hours as leisure) would go up, since consumption isn’t being taxed on the margin anymore. (After you pay the flat $10,000, you’re free.)
So when mainstream economists say that a head tax is better than a consumption tax is better than an income tax, they mean “if you allow the government to fiddle with the parameters under each regime, so that even after individuals adapt to the new regime, the government is taking the same amount of total tax revenue.”
Rothbard and others have raised some good objections to this approach; he’s got an essay today at LRC. I’m just trying to be clear on what the standard mainstream analysis is.
Yet Another Quick Note on Tax Theory
OK in the comments on previous posts it is clear that a lot of readers didn’t get the point I was making originally, that there is a legitimate sense in which an income tax hurts individuals more than a comparable consumption tax. So let me take another stab at it. (It should go without saying that this analysis doesn’t mean I’m “for” a consumption tax, especially since–in practice–we’d end up with both an income and consumption tax.)
First, let me point out that it’s not true that you can gauge the harm of a tax by simply looking at how much revenue the government derives from it. Some people thought, “If, by construction, we’re comparing a consumption tax to an income tax that keeps government revenue constant, then aren’t they equally harmful?” But no, that’s not right. At an income tax rate of 100%, the government wouldn’t take in any revenue, but it would devastate the economy as all transactions went into the black market and many activities simply disappeared. At an income tax rate of 0%, the government wouldn’t take in any revenue either. I didn’t just prove that those two outcomes are equivalent, as far as taxpayers are concerned.
Second and more to the point: In general, if the government is going to extract $x from you as a taxpayer, you don’t want them putting additional constraints on how you finance the blow. If you owe the government $x per year, the best thing (from your POV) is a head tax; the government says, “Do what you want with your income and spending decisions, but you owe us $x or else we kill you” (or whatever).
Now suppose instead, the government said, “Over the course of the year, keep track of how much money you spend on food. We will keep y% of those dollars, before they reach the grocer.” The government then picks y% so that, after you adjust to the new situation, they end up taking $x total from you each year.
Assuming such a y exists, so that you end up in a new equilibrium, spending enough on food so that $x still goes to the government, then you are probably worse off than before. (For sure you would be, if you were the only person this happened to. Then food prices would be basically the same, and you’d bear the full brunt of the food tax.) Because of the y% tax, on the margin food is now pricier to you (compared to other things) than it was before. So in addition to taking $x from you, the government has pushed you artificially out of buying as much food as you would have, even in the alternate scenario where you were down $x. You could always match your spending decisions that you implement when the government imposes no constraints, but you probably won’t since they probably have you spending too much on food.
If it’s still not clicking, try flipping it. Suppose the government were going to give you $12,000 in cash, or a $12,000 voucher that had to be spent on food from the grocery store and that couldn’t be transferred to another party. You would clearly prefer the cash, because you could always spend it all on grocery store food if you wanted. But, you could use it on other things too.
So if you generally get the above logic, then realize that’s what’s going on with an income vs. consumption tax. A consumption tax is worse than a head tax; the former artificially penalizes using labor and other productive factors to earn an income, rather than “consuming” them through leisure or idleness (which is not taxed as “consumption”).
But, an income tax is even worse than a consumption tax. Not only does an income tax ding you when you sell your labor or rent out your productive factors for money, but then if you want to spend it on future consumption (as opposed to present consumption), it dings you again, because the vehicle you use is to invest it (in a bond, share of stock, etc.) and then the income tax hits you when you earn interest, dividends, or capital gains in the future period.
Just as the food tax in our above example made food artificially expensive, so too does an income tax make future consumption artificially more expensive relative to present consumption. So if the percentages are designed by construction to extract the same total revenue, then an income tax is worse than a consumption tax in the sense that it pulls out the same $$ but also puts another artificial restriction on your behavior.
Follow-Up on Rothbard and Consumption Taxes
Incidentally, Bob Wenzel and I have been exchanging emails that are as chummy as the bounds of heterosexuality permit. I think we are in 99% agreement on Rothbard’s views towards a consumption tax. So this isn’t me “attacking” anybody, just making sure people don’t draw erroneous inferences from some of Rothbard’s arguments.
In this piece Rothbard says:
Having challenged the merits of the goal of taxing only consumption and freeing savings from taxation, we now proceed to deny the very possibility of achieving that goal, i.e., we maintain that a consumption tax will devolve, willy-nilly, into a tax on income and therefore on savings as well. In short, that even if, for the sake of argument, we should want to tax only consumption and not income, we should not be able to do so.
…
[T]he general assumption that a sales tax can be readily shifted forward to the consumer is totally fallacious. In fact, the sales tax cannot be shifted forward at all!Consider: all prices are determined by the interaction of supply, the stock of goods available to be sold, and by the demand schedule for that good. If the government levies a general 20 percent tax on all retail sales, it is true that retailers will now incur an additional 20 percent cost on all sales. But how can they raise prices to cover these costs? Prices, at all times, tend to be set at the maximum net revenue point for each seller. If the sellers can simply pass the 20 percent increase in costs onto the consumers, why did they have to wait until a sales tax to raise prices? Prices are already at highest net income levels for each firm. Any increase in cost, therefore, will have to be absorbed by the firm; it cannot be passed forward to the consumers. Put another way, the levy of a sales tax has not changed the stock already available to the consumers; that stock has already been produced. Demand curves have not changed, and there is no reason for them to do so. Since supply and demand have not changed, neither will price. Or, looking at the situation from the point of the demand and supply of money, which help determine general price levels, the supply of money has remained as given, and there is also no reason to assume a change in the demand for cash balances either. Hence, prices will remain the same.
Now some people in the comments–and to repeat, Wenzel and I are in 99% agreement on this stuff, so I’m not cheekily referring to him in a vague way or something–took these arguments to mean that consumer prices won’t budge, period.
But that’s not right, and it’s not what Rothbard is saying. Look: By the same token, I could say, “It’s impossible for retailers to pass the tax backwards. If the retailers could get away with cutting the wages they pay to workers or the rents they pay to landowners, they already would have done so. Or, the prices for factors are determined by the supply and demand for money. Those haven’t changed.”
So what Rothbard is getting at here, is that you have be more careful in thinking through the mechanism through which the imposition of a sales tax may (ultimately) lead to the consumers paying higher out-of-pocket prices.
It’s easiest to first consider a really narrow and steep tax, like a 1000% surcharge on cigarettes at the retail level. Retailers can’t automatically just jack up prices 1000%; consumers won’t buy as many cigarettes at that price.
What happens is that in the new equilibrium, the official pre-tax price is lower, meaning the retailer earns less from selling a pack of cigarettes. But, the pre-tax price hasn’t fallen enough, so that when you slap on the 1000% surcharge, the consumer has to pay (way) more at the register to get a pack of cigarettes.
Now it’s true, the imposition of a cigarette tax per se doesn’t change the demand curves for cigarettes. The reason the consumers are willing to pay more per pack in the new equilibrium, is that we’ve moved to a lower equilibrium quantity of cigarette packs produced. Specifically, because they’re earning less per pack, retailers now lower their demand for wholesale cartons of cigarettes. This drop in (derived) demand moves up the chain of production, so that ultimately the price of tobacco drops and farmers switch some of their land into other crops.
Thus, in the new equilibrium, there is less tobacco harvested and fewer cigarette packs sold (at least legally at stores).
Rothbard understands all of this. His point is that if you think you are narrowly targeting consumption, while leaving “productive” areas of the economy unharmed, you’re fooling yourself. It’s all intertwined.
What’s more, Rothbard says that the more general you make a so-called consumption tax, the more this effect will end up falling on every productive factor. When we’re trying to figure out which side of the market–producers or consumers–bear a broad-based consumption tax, Rothbard says the only way the producers can escape it (and leave some of it for the consumers to bear, in the form of higher out-of-pocket unit prices) is if workers engage in more leisure and other factors remain idle (because of the lower rents).
So to repeat, neither Rothbard nor Wenzel is saying that the imposition of a consumption tax will have no effect on consumers. Rather, the point is that you can’t limit the impact of a consumption tax on just consumption; it will spill over onto factor incomes, which in turn will have deleterious consequences for consumers.
GDP Forecast Bask
I am working on a research paper for investors (I have to pay the mortgage somehow) and I need to go back in time to see what the “consensus” forecast for (say) 4th quarter 2004 GDP was, as of 1st quarter 2004. Obviously I can use FRED to see what the actual GDP figures were, going back as far as I want, but ideally I want to see how these actual figures compared to what was expected, two or three quarters beforehand.
Any ideas?
Robert Wenzel Takes the Fight to Radio
Having conquered the world of online Austro-libertarian financial commentary, Robert Wenzel is eyeing new territory:
I am happy to announce the launch of the “Robert Wenzel Show”.
I will be recording the shows on Saturday and they will be up on EPJ on Sunday at 7:00 AM EST. I hope to expand the show down the road to take listener calls and do live interviews, but for now the shows will be pre-recorded and available for listening any time after they are posted.
I plan to discuss hot economic topics of the day and also topics that may be of interest to groups beyond the general readership of EPJ.
My first show is titled: “The Many Problems with Herman Cain’s 9-9-9 Plan”
To give you a flavor of other shows I am planning, these will be worked in at some point:
“How to Make a Quick $50,000, Even if You Aren’t a Homeless, Drunken Bum”
“What to do with Your Life, Now that You have Graduated from the Useless Government Influenced Education System”
“How to Trade Markets as Though You Actually Know What You Can and Can’t Forecast”
In the comments, please list any other topics you would like to see me cover. And also include any questions you may have about the Herman Cain plan. I will address those during the show.
Potpourri
Lots of links have been piling up here…
* You know how Keynesians liked that one journal article showing that businesses were more worried about bad sales than regulations? Well, when a survey shows the exact opposite, they still take it as further evidence that the demand-side story is right. (Note that I’m not saying the Gallup poll is decisive, I’m just showing the Keynesians–or at least this particular guy–are doing heads-Maynard-wins, tails-Friedrich-loses with these surveys.)
* I’m a fair guy: I’ll give Paul Krugman this one, that indeed Paul Ryan appears to be talking nonsense in his critique of Obama. Ryan is simultaneously opposed to inaction on the deficit, as well as fiscal austerity. (It’s possible he means austerity through raising taxes, but I don’t know if we should strain that much to make sense of the quote.)
* A former CBO head apparently has yet to learn the wisdom of Modern Monetary Theory. Look at this quote (from a 2005 interview): “[The level of federal taxation] is always the second decision. The first one is how much are we going to spend. As I have said before, if you spend this much money, you can’t borrow it all.”
* In preparation for our debate, I tried to get Scott Sumner to elaborate on his position. In response he said, “You are confusing two completely separate issues. Inflation doesn’t matter at all, for any reason. Only output and NGDP matters. Any problem believed due to inflation, it actually due to something else.” Are we suuure we want to hand the Fed over to the brainchild of this man?
* There should be more articles on innovations in bathrooms. I may establish an X-Prize.
* A very interesting post in which Nick Rowe makes a brilliant mistake. (I’m in the comments.) Matt Yglesias makes the same mistake, less eloquently.
* If you’re going to have private law, make sure you get the prices right.
* Just in case the above story makes you proud of the US legal system, try this one.
* The sword of justice descends on Bryan Caplan’s mathematical skills.
* I explain Rothbard’s approach to pricing land.
* Matt Yglesias again repeats the bald Phillips Curve view of the economy, apparently unaware that oil prices steadily fell along with unemployment after the recessions in the early 1980s.
* Not sure if I already blogged this: More Free Advice for the Occupy Wall Street crowd.
* A prescient Sheldon Richman article on terrorism, from 1999. (A reader sent it, can’t remember who.)
* Lew Rockwell on the fascist threat.
* My talk in Canada. (BTW quick bit of Free Travel Advice: When you are flying internationally, you have to pick up your bags at customs and work them over to the airline counter in the other country. There was some confusion because I asked the Air Canada people, “Will this go straight through to my final destination?” and they said yes. What they meant was, it will go straight through, once I physically pick up my bag at the layover and carry it to the next flight. It was an inconceivable pain for me to get my bag–sitting at the baggage carousel–after I had gone through the customs checkpoint. Like, it took an hour for me to have someone manually escort me back onto US “soil” and get it. Had to book a different flight.)
* Now TSA is stopping random people on TN highways. You’ll never get me, guys. I blend in with the indigenous people. I have a perfect American accent.
* A new website devoted to economic freedom, with a short video.
Herman Cain’s Solution to Entitlement Funding…
…is to get more Americans united behind smoking? James Miller in the comments passes along this odd campaign ad. (Believe it or not, there is a modicum of quality control here at Free Advice. I did a google image search of “Mark Block,” and I think this is really Cain’s campaign manager. I.e. this isn’t a spoof.)
P.S. I imagine the strategery behind this ad was to “shock people and get them talking about Herman Cain.” OK, I don’t mind playing into their hands; I think the ad is weird enough that it will backfire. How expensive are cigarettes going to be, after being slapped with an additional 9% in federal sales tax (which I don’t think will be borne entirely by tobacco farmers)?
Jesus Christ: Fair & Balanced
When you read the gospels, one of the things that stands out in the life of Jesus is how much of His time He spent in prayer. This is interesting, because you might at first think that Jesus doesn’t “need” prayer as much as the rest of us do.
Indeed, that’s usually the angle that preachers will take on Sundays with this fact. They’ll say things like, “Folks, it’s my job and I’m here to tell you, I need more prayer in my life. If the Son of God could make time to do it, so can we. Our responsibilities aren’t more important than what He was doing.”
That’s all fine and good–literally–but I think it might give the impression that Jesus was praying out of a sense of duty, and that it was just one more thing He had to add into His list of “Things to Do Before I Die.” (I hope that is funny and not blasphemous for my religious readers. God picked the Jews as His chosen people, so I think He appreciates comedy.)
In the present post, I want to make the simple claim that I think Jesus was only able to achieve His amazing feats because of His intense prayer life. For example, I think He “needed” to pray all night before knowing which men to choose as His inner circle. I think it bolstered Him and made Him believe that He really was the Son of God, to hear a voice from heaven declare as such when He was baptized. And I think He needed an angel to minister to Him before facing His excruciating task on Good Friday.
Now when I say “need” in this context, of course I don’t mean that there was no other way. With God all things are possible. What I mean is that God wanted His son to live among us a mortal man. So for example, I think that the young Jesus was actually learning from the scribes in the Temple. I don’t think He knew as much at age 12 as he would at age 31.
In that context, I think Jesus’ mind and body would have been overwhelmed if, say, He literally went around doing nothing but heal the sick and preach every waking moment. His faith would not have been as strong (necessary for Him to raise people from the dead) and His sermons would not have been as profound.
As a Christian I am supposed to make prayer an important part of my life. This isn’t a senseless rule imposed on me “just because,” but rather (I believe) a habit that is designed for my own good, both in this life and the next.
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