21 Oct 2011

The Plot Thickens: I May Agree 100% With Rothbard After All

Economics, Rothbard 13 Comments

Thanks to Marris, I think this is the passage from MES that made me think I had a disagreement with Rothbard on an income tax’s impact on saving (pp. 917-919 of the Scholar’s Edition):

Some economists maintain that income taxation reduces savings and investment in society in yet a third way. They assert that income taxation, by its very nature, imposes a “double” tax on savings-investment as against consumption. The reasoning
runs as follows… [Omitted for brevity.–RPM.]…Hence, the imposition of an income tax is a “double” tax on consumption, and excessively penalizes saving and investment.

This line of reasoning correctly explains the investment-consumption process. It suffers, however, from a grave defect: it is irrelevant to problems of taxation. It is true that saving is a fructifying agent. But the point is that everyone knows this; that is precisely why people save. Yet, even though they know that saving is a fructifying agent, they do not save all their income. Why? Because of their time preferences for present consumption. Every individual, given his current income and value scales, allocates that income in the most desirable proportions between consumption, investment, and additions to his cash balance. Any other allocation would satisfy his desires less well and lower his position on his value scale. The fructifying power of saving is already taken into account when he makes his allocation. There is therefore no reason to say that an income tax doubly penalizes saving-investment; it penalizes the individual’s entire standard of living, encompassing present consumption, future consumption, and his cash balance. It does not per se penalize saving any more than the other avenues of income allocation.

This Fisher argument reflects a curious tendency among economists devoted to the free market to be far more concerned about governmental measures penalizing saving and investment than they are about measures hobbling consumption. Surely an economist favoring the free market must grant that the market’s voluntary consumption/investment allocations are optimal and that any government interference in this proportion, from either direction, is distortive of that market and of production to meet the wants of the consumers. There is nothing, after all, particularly sacred about savings; they are simply the road to future consumption. But they are, then, clearly no more important than present consumption, the allocations between the two being determined by the time preferences of all individuals. The economist who balks more at interference with free-mar- ket savings than he does at infringement on free-market consumption is therefore implicitly advocating statist interference in the opposite direction. He is implicitly calling for a coerced distortion of resources to lower consumption and increase investment.

I’m not certain that the above passage is what made me file away the belief that “Rothbard doesn’t think an income tax distorts the saving/consumption decision in a bad way,” but it is definitely along the lines of what I vaguely remembered.

However, the thing that’s funny is that in the two pages before the above excerpt, Rothbard spells out the standard logic for why an income tax alters the tradeoff:

The income tax, by taxing income from investments, cripples saving and investment, since it lowers the return from investing below what free-market time preferences would dictate. The lower net interest return leads people to bring their savings-investment into line with the new realities; in short, the marginal savings and investments at the higher return will now be valued below consumption and will no longer be made.

So at this point I’m thoroughly confused. When mainstream economists complain about “double taxation” and say that it discourages saving/investment, they are relying on the same analysis that Rothbard just gave (in the second quotation).

Since I am going to re-read the whole chapter on interventionism for my online class, I’ll come back to this issue after I have seen Rothbard’s entire tax analysis and have digested it in one full sweep. Maybe I’ll understand the context of the above excerpts better and be able to say with confidence what Rothbard meant.

At this point, my guess is the following:

==> Rothbard agreed with the standard mainstream view–a view that is often used by mainstream economists in support of a consumption or sales tax–that an income tax penalizes future consumption more than present consumption, i.e. biases people into saving a lower fraction of their income than they would choose on the free market.

==> However, Rothbard objects to the standard rhetoric that accompanies this (correct) analysis, because this rhetoric often invokes the odd phrase “double taxation” and makes it sound as if lower saving per se is a bad thing, when really the problem is with saving below the free-market level.

Last point: You might think that since I wrote the study guide to Man, Economy, and State, I would know this stuff like the back of my hand. If so, you are wrong. How embarrassed you must be, right about now.

13 Responses to “The Plot Thickens: I May Agree 100% With Rothbard After All”

  1. Joseph Fetz says:

    To me, it is like trying to put together a mental puzzle of past, personal understandings derived from something that you read while in a completely different state of mind.

    Here’s a plus: We’re all now digging through MES and old Rothbard articles in order to come to some sort of agreement on the issue. It’s always interesting to see how one’s present mind interprets the same material that they read in the past.

  2. Little Tim T. Timeson says:

    “Last point: You might think that since I wrote the study guide to Man, Economy, and State, I would know this stuff like the back of my hand. If so, you are wrong. How embarrassed you must be, right about now.”

    The funniest part of this is the superfluous comma.

  3. Dan says:

    I guess your guess is correct.

    I do think Rothbard would be against 999. I think he would believe since it was revenue neutral and also might get the people to favor tinkering with how taxes are collected and imposed rather than just lowering them. To me debating over which neutral revenue tax plan is better than the other is pointless but I do think the debate on the effects of one tax vs. another is constructive.

  4. Dan says:

    I think you can square what Rothbard wrote in the parts you list and Wenzel lists if we consider these together.

    1. The income tax does distort savings and investment.
    2. The consumption tax also distorts savings and investment in equal ways. (see the post on EPJ of Rothbard explaining this)

    • Dan says:

      Well not in equal ways as far as revenue because he argued that if the rates were the same then the consumption tax would be lower on the revenue side. But he believed they both distorted savings and investment.

  5. Luke says:

    It seems as if people here and at EPJ are saying if it is revenue neutral, then there isn’t a difference. I don’t understand how that can be the case. A consumption tax would hit those who make less harder than those who make more, simply because they consume more of their income. So assuming all taxes are consumption, I would rather the consumption from taxes come in lieu of consumption in the private sector, rather than having the consumption from taxes come from savings in the private sector. The goal should be overall less consumption and more savings.

    What am I missing here?

    • Joseph Fetz says:

      “The goal should be overall less consumption and more savings.”


      • Luke says:

        The more savings there are, the more resources are available to produce. The more production, the more consumption. Of course all production is made for consumption somewhere down the line, but that might be a very long line and along the way greater production will come as a result prior production, and even greater production after that.

        I think of it like a bond. Say it yields 5%. If I use the entire 5% to buy things each year, I am stuck with the same purchasing power next year. But if I was to spend only 3% and reinvest 2%, I would lose out of consumption now, but eventually I would be able to consume more and the consumption would be growing each year.

        Do you follow? Do you think I am wrong somewhere?

        • Dan says:

          What you are missing is the point Rothbard made that “the economist who balks more at interference with free-market savings than he does at infringement on free-market consumption therefore is implicitly advocating statist intervention in the opposite direction.

          • Luke says:

            That could make sense, but it would seem that I would rather error on the side of savings vs the side of consumption. We have yet to see the punishment for our over consumption. As most on here believe, it will be pretty bad.

            • Joseph Fetz says:

              Let me ask you, if you could have the government implement a tax, would you be in favor of them implementing a tax that fosters savings?

              • Luke says:

                Over a tax that promotes consumption, yes.

  6. Chris Pacia says:

    I believe what Rothbard was saying is that an income tax lowers the rate of return skewing time preferences in favor of consumption. It doesn’t appear to me that he meant for that to be interpreted that a consumption tax wont do the same.

    I just did a few quick calculations in excel of the ROI on an investment, paying taxes on the return each year vs. compounding with no taxes and taking a (revenue-neutral) consumption tax in the final year. Assuming my calculations were correct, the consumption tax earned a slightly higher return but they were close.