Bob Murphy Show ep. 82: Why “Intelligent Design” Is a Scientific Theory
Based on the feedback I’ve gotten, I should’ve titled this one differently. I’m actually just refuting one particular argument that ID is not a scientific theory. But that of course isn’t the same as me arguing that it is a scientific theory.
In any event, here it is.
Contra Krugman: Live from Vienna!
I can’t remember if I posted about this on the blog, but here was our live recording of Contra Krugman ep. 211, in the central bank of Vienna!
Wealth vs. Income Taxes
Ever since wealth taxes have entered the political discussion, I’ve been trying to put my finger on why they are even more destructive than income taxes.
Some early attempts had people arguing that–if we assume assets are earning 3%–then a 3% wealth tax operates just like a 103% income tax.
However, that wasn’t quite right, and it wasn’t showing how wealth vs. income tax have different impacts on investor behavior, regarding different types of assets.
David R. Henderson did a good job showing why this alleged equivalence is wrong. Specifically, he showed that someone who moved his wealth into an asset with a higher rate of return would only face an effective marginal income tax rate equal to the rate of the wealth tax. So for example, a 3% wealth tax “operated like” a 3% income tax, in this sense–not the really high 103% rate that previous commentators had suggested.
However, as I thought about David’s example, I concluded that it crucially rested on the implicit assumption that the individual would consume his wealth in the next period. So in my Mises.org piece, I showed what would happen if we extended the planning horizon to multiple periods. In that scenario, the wealth tax was a lot more punitive than the mere 3% rate that would occur after one year.
After you read that, though, strap on your safety belts and check out the following excerpt from my forthcoming Lara-Murphy Report article. I go back to a one-period analysis, but this time explicitly analyze the investor choice between a safe and risky asset. I couldn’t get to sleep the night I wrote my Mises.org piece, because I wanted to back up my intuition that a wealth tax pushes investors into riskier assets. I think I formalized the argument with this simple example. (And for sample issues of the LMR, see here.)
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Nerds, Assemble: A Numerical Example Showing Why Wealth Tax Worse Than Income Tax
One of my pitches for getting people to subscribe to the Lara-Murphy Report is the promise that I will go more deeply into issues here, than in any other outlet. And so, let me show those of you who are interested, how I double-checked my intuition in the above section, to make sure there really is a legitimate sense in which a wealth tax is more inefficient than even an income tax.
In this example, we’re going to consider an investor who starts with $1,000 in financial capital, and is choosing between three possible options: (1) He can consume it now. (2) He can invest it in a very safe asset that will yield 5%. Or (3) he can invest it in a risky asset that half the time will appreciate 30%, but the other half with lose 10%. We are going to analyze the investor’s options, assuming three different tax environments: He either faces no tax, an income tax, or a wealth tax. We will calibrate the wealth tax to raise the same revenue as the income tax, in order to make it “comparable,” and then see which of the two taxes distorts the investor’s behavior more.
Things are pretty straightforward in the no-tax scenario. The investor can turn his $1,000 into a sure $1,050 with the safe asset, or he can go with the risky asset and have a ½ probability of ending up with $900 and another ½ probability of ending up with $1,300. In other words, he can earn a guaranteed 5% return, or he can earn an “expected” 10% return that carries with it more risk. (Without knowing more about the investor, we can’t say which of the two assets he will prefer, but we don’t need to know that for our purposes here, in analyzing the distortions of the two taxes.)
Now suppose the investor faces a 50% income tax, and goes with the safe asset. He is affected as I’ve show in Table 1, where “bop” stands for “beginning of period” and “eop” for “end of period.”
Table 1. Investor Faces 50% Income Tax, on an Asset Earning a Safe 5%
| Wealth (bop) | Gross Income | Income Tax | Wealth (eop) |
| $1,000 | $50 | $25 | $1,025 |
Now let’s fine the “equivalent” wealth tax, for the investor going with the safe asset. That is, we want to calibrate the rate of the wealth tax, so that our hypothetical investor—if he goes with the safe asset—ends up paying the same revenue to the government:
Table 2. Investor Faces 2.38% Wealth Tax, on an Asset Earning a Safe 5%
| Wealth (bop) | Gross Income | Wealth Tax | Wealth (eop) |
| $1,000 | $50 | $25 | $1,025 |
To make sure the reader understands Table 2: After earning the $50 in gross income from the safe asset, the investor has $1,050. But then he is hit with the wealth tax of ($1,050 x 2.38%) = $25. I deliberately chose the wealth tax rate of 2.38% in order to make the investor owe the same $25 that he had to pay under the income tax.
Let’s stop for a moment and assess our progress. We’ve seen that an income tax and a wealth tax both reduce the incentive to save. In reality the safe asset rewards the investor with 5% growth if he’s willing to postpone consumption for a year, but both taxes mute that benefit, making current consumption look artificially more attractive.
However, good economists know that we need to “think on the margin.” Even though I calibrated the wealth tax rate to yield the same flow of tax revenue to the government as occurred with the income tax, the two taxes still have different effects on behavior. An easy way for me to illustrate is to extend the analysis to see how the two taxes affect the investor if he puts his $1,000 of capital into the risky asset.
Table 3. Investor Faces 50% Income Tax, on Risky Asset That Gains 30% Half the Time But Loses 10% Half the Time
| Wealth (bop) | Gross Income | Income Tax | Wealth (eop) | |
| Good Outcome | $1,000 | $300 | $150 | $1,150 |
| Bad Outcome | $1,000 | -$100 | -$50 | $950 |
| Expectation | $100 | $50 | $1,050 |
(Note that in Table 3, we are assuming that half the time, when the individual faces the bad outcome and loses $100 of his original $1,000 investment, he gets a $50 credit on his taxes. In other words, his income tax liability is negative $50, as shown in Table 3. You can think of this either as him literally carrying forward the loss to future years, or you can think of the loss being used to reduce his gains elsewhere in his portfolio, thus lowering his tax liability in the current period.)
As Table 3 illustrates, when facing the income tax levied at a 50% rate, the individual who invests his $1,000 into the risky asset has a ½ probability of ending up with $1,150, and a ½ probability of ending up with $950. The expectation of these outcomes is $1,050, meaning the investor faces an expected (after-tax) return of 5%, in the risky scenario. Also notice that he expects to pay $50 in income tax—half the time he pays $150, and the other half he gets a credit of $50.
Finally let’s run the numbers for the wealth tax, when the investor goes into the risky asset:
Table 4. Investor Faces 2.38% Wealth Tax, on Risky Asset That Gains 30% Half the Time But Loses 10% Half the Time
| Wealth (bop) | Gross Income | Wealth Tax | Wealth (eop) | |
| Good Outcome | $1,000 | $300 | $31 | $1,269 |
| Bad Outcome | $1,000 | -$100 | $21 | $879 |
| Expectation | $100 | $26 | $1,074 |
Now we see how things get really complicated. In this last scenario, when the investor goes in the risky asset while facing the wealth tax (which had been calibrated to be “equivalent to” the income tax for the safe asset), he ends up with an expected return of 7.4%, and furthermore he only expects to pay $26 on average in the wealth tax.
Let’s summarize the big picture: Originally, in the no-tax scenario, the investor could choose between a sure 5% return, or a 50/50 return of either -10% or +30%, for an expected return of 10%.
When facing the 50% income tax, the investor could choose between a sure 2.5% return, or a 50/50 return of either -5% or +15%, for an expected return of 5%. So to reiterate, the income tax is inefficient, because it cuts the gains to saving in half; just compare the numbers in this paragraph with those from the previous paragraph. But the crucial point is that the income tax doesn’t distort the RELATIVE attractiveness of the safe or risky asset. In the no-tax scenario, the risky asset offered twice as high an expected return, but in exchange for an equally balanced up/down risk, and the same pattern holds when we introduce the income tax. So even though the income tax will make the investor less willing to save, it won’t distort what he does with those savings.
In contrast, when facing the wealth tax, the investor can choose between a sure 2.5% return, or a 50/50 return of either -12.1% or +26.9%, for an expected return of 7.4%. Again, compared to the no-tax scenario, our investor gets a lower return with either asset, and so he has less incentive to save. However, given that the investor is going to save and carry wealth forward in time, notice that the wealth tax has skewed things in favor of the risky asset. Rather than offering twice the expected return of the safe asset (2.5% vs. 5%), under the wealth tax it offers almost triple the return (2.5% vs. 7.4%).
And thus we see that the wealth tax introduces yet another distortion to economic behavior. It provides an artificial incentive for investors to shift their wealth into assets that are more volatile. To be clear, the problem here isn’t with investors going into risky assets per se. Rather, the economic inefficiency occurs because these risky assets look more relatively attractive than they actually are, in a no-tax landscape.
God as Director
Instead of worrying about how you’re going to screw up next, interpret your life as if you’re watching an intricate movie, where you don’t know what’s coming. Someone says, “What do you think’s going to happen? Is it going to be bad?”
And you answer, “I don’t know. But I’m familiar with the previous work of the Director, and it’s always been worth it. I don’t claim to understand everything He was trying to say, but I know it was beautiful.”
Now imagine going through life, with the above attitude. You’d be a lot calmer and YOU’D MAKE FEWER MISTAKES than you make right now, worrying about not making a mistake.
Bob Murphy Show Twin Spin
In ep. 80 I reproduced my interview with Patrick from the “Cave to the Cross” apologetics podcast (video below). Among other things, we tackled the question, “Would the laws of economics be true in the Garden of Eden?”
Then in ep. 81 I have Jeffrey Rogers Hummel on to talk more about the economics of slavery, and at the end we get into his analysis of why the South lost the Civil War when they could’ve won with a different military strategy.
Stephan Kinsella Debates Bob Murphy on Argumentation Ethics
For real, this was awesome. I spent years thinking Stephan didn’t understand what Gene Callahan and I did in our critique of Hoppe’s famous argument for libertarian property rights, and (I’m guessing) Stephan spent years thinking we were morons.
Well, we talked at least a half hour before we even found a spot where we started disagreeing. I think we both walked away with a deeper appreciation of the issues involved.
So take a listen, even if you think (a) “Hoppe’s argument is self-evidently dumb” or (b) “Hoppe’s argument is so awesome only haters don’t get it.” You will probably learn something.
Here’s the link to the audio podcast episode, with a bunch of links in the Show Notes page for further reading.
And here’s the video:
Murphy + von Pepe > 2 Nobel Laureates
In my latest piece for Mises.org, I push back on two of the recent Nobel laureates when they claimed in the NYT that financial incentives don’t matter as much as economists think. Since they had invoked salary caps in sports as an example, I acquired the assistance of the intrepid von Pepe to give me specifics.
In any event, perhaps the most surprising detail is that I’m pretty sure the NYT charts on Alaska prove the exact opposite of the narrative they’re pushing.
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