Murphy vs. Cochrane
I have been reading (and enjoying) John Cochrane’s blog lately, which means I show my appreciation by criticizing any mistakes I perceive. My latest at Mises.org laments that Cochrane said income is a “meaningless concept.” I push back with an analogy. (I won’t change the formatting because then it would be double-nested; the following words are directly from my mises.org post.)
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In this short blog post I won’t give a full rebuttal and explanation of what income is, and how it relates to lifetime consumption (which Cochrane and Sumner do think is a meaningful concept—thank goodness). Interested readers can refer to my earlier piece. For our purposes here, let me just use an analogy to show why Cochrane and Sumner are overreacting. Imagine a PhD nutritionist surveying all the fad diet crazes and exclaiming:
“Weight” is really a fairly meaningless concept. We don’t all have the same body types, and can’t be described by a single number. Weight varies a lot over a lifetime, and ebbs and flows for many. And “fat weight” is not the same as “muscle weight.” The broad consensus theory of health states that gaining muscle weight shouldn’t be penalized at all. It really isn’t “weight” in any meaningful sense.
Would the above make any sense at all? Would we excuse it by saying, “Oh, that nutritionist is just lashing out at the nonsense in the supermarket tabloids”? Of course not; we would just insist that the experts chide the novices for superficial discussions, and ask them for more nuanced analyses.
Likewise, just because politicians try to justify higher taxes through ludicrous abuses of statistics, doesn’t mean the very concept of “income” is meaningless.
I suppose if one defines income in a specific and useful way such as Hayek’s ‘how much one can consume without depleting capital’ then it would not be meaningless.
I take Cochran to mean rather that how income is defined for income-tax purposes – as an aggregate of the compensation we get for working and the return we get on capital and some capital gains – is based on a meaningless concept of Income. I agree though that his point may have been clearer if he had first given a ‘meaningful’ definition of income and then showed how the definition used for income tax purposes is in comparison meaningless for any economically useful purpose.
To start to get to grips with how arbitrary the whole thing is, consider that in Australia capital gains were NOT income, up until 1986 … after which they became income (for tax purposes that is).
https://www.legislation.gov.au/Details/C2004A03293
That’s listed as “no longer in force” except that it is actually in force, because if you check the latest version of “The Income Tax Assessment Act 1936” you find that the amendments regarding capital gains are still in there. If you think that’s weird, the “Income Tax Assessment Amendment (Capital Gains) Act 1986” is NOT listed as an amendment to the “The Income Tax Assessment Act 1936” even though it does, in fact, amend the act.
For example, the 1986 Amendment Act included:
Then you go check the latest version of the Tax Act in Australia and find:
That’s government for you. Who checks this stuff? I do, apparently no one else. Who cares about it? Not even me anymore, and as long as they can keep the money coming in, I can’t see evidence that anyone in government cares about it either. You can find the series of amendments here …
https://www.legislation.gov.au/Series/C1936A00027
You will notice there’s nothing from 1986, but perhaps that’s because it gets amended so many times per year, at some point they simply lost track entirely. Perhaps the whole thing is still a work in progress.
Then just for yucks I could point to the sentence: “Minister’s second reading speech made in – House of Representatives on 22 May 1986, Senate on 4 June 1986”
There’s a “first reading” and then a “second reading” in two different houses, and on NONE of those occasions does anyone actually READ the words in the act that they claim to be reading. They instead give a speech that might in some peripheral way be related to the act … but hey the law we are passing is long and complex and confusing and anyway who would ever want to read such a thing? Oh that’s right, every single citizen is expected to read and understand it, despite the people who pass that law being not bothered to read it even once … while they formally sign off on multiple readings to Parliament.
Figure that one out.
Nothing is what it seems … Zen thinking is the only meaningful approach to understanding government and how it operates.
I would agree with that nutritionist. We have doctors all over the place freaking out about BMI as if it was a personal health indicator, even though correlation with lifespan is weak (especially if you ignore the extreme cases) and the BMI was never originally designed as a health indicator, it was only intended to be an overall population metric, indicating whether various groups of people were getting a reasonable diet.
Beyond that, BMI is lamp post science. Height and weight happen to be much easier to measure than endurance, recovery and fat distribution. Even strength is hard to measure in terms of lower body, upper body, whatever. I have no problem with going after low hanging fruit, but don’t then come to conclusions about every fruit being a pineapple.
So Tel, you agree that the very concept of “weight” is meaningless?
Depending on context, it could be meaningful, but not in the context you gave.
If a helicopter pilot wants to weigh the passengers and their luggage in order to know the flight is safe then it’s meaningful in that context. You said a nutritionist though, so it’s a safe presumption this isn’t about Newtonian physics, and it’s about individual health.
You might have a calibrated microscope that can measure width of hair and other fibers. So if I’m selling you a bale of wool, you could use that to determine if it’s coarse wool or fine and that would be a meaningful measurement in as much as you know that coarse fibers are less comfortable in a pair of trousers … you then base your price on that measurement.
Let’s suppose I go for tax assessment and the guy says, “You have very hairy arms, I need to check with this microscope … hmmmm … that’s at the coarse side of the scale … you owe a lot of tax this year.”
Still the same measurement but inappropriate under the circumstances because there’s no meaningful relationship between hairy arms and how much tax you should pay.
Thing is, the IRS could decide to give a tax deduction for hairy arms, or hairy legs or baldness, or beards, or being above or below some weight they come up with. That’s because all tax deductions are arbitrary creations, with no accounting validity, they change from time to time and place to place. For example, in the USA home mortgage interest is tax deductible, but in Australia is isn’t. No logical chain of reasoning can reach an explanation for that, other than someone made an arbitrary decision and there it is.
Then we could talk about fringe benefits. Suppose you write an article for the IER and perhaps they have a small library there which you use as reference when writing your article (I’ve never been there but it’s a typical scenario), that’s a legitimate tool provided by your employer. Now if you read a few extra books while you are hanging around … that becomes a fringe benefit which is really income … did you know that? You are supposed to take note of any extra benefits and pull some economic value calculation out of thin air and declare that for tax purposes. No one does this … but fringe benefits are assessable income.
Is it real? Government says it’s real, they take it seriously so you also have to.
Here’s another example to think about: I build a new and powerful measurement apparatus. It consists of a card, about the size of a playing card, on which is written the number “3”. When I need to measure something (can be used in many situations) I pull out the card and read off the measurement … which is always “3”. This gives an extremely stable, consistent and accurate result every time. It’s quite versatile, easy to use, and I can make more of these and train other people to use them.
Now … surely … you can’t tell me that the number 3 is meaningless.
Tel, I think we’re all getting off on the wrong foot here. If the IRS proposed a new tax that said “People named Bob owe more money than people named Sam,” I wouldn’t declare, “Wow, now first names have become a meaningless concept.”
Think about the scenario you just created: at least from a government point of view a “first name” is well defined in as much as it’s written on their official paperwork. Problem is, the first thing people would do in the face of a name tax would be to change their name, presuming that would still be allowed, you very quickly wouldn’t have anyone officially named “Bob” in the whole country.
So then what? Are the names still meaningful?
Some of your friends and family might quietly call you Bob around the house after you had officially changed you name. IRS agents listen in and pop up and say, “Ah ha! You really are still a Bob, we’ve been waiting for you to slip up.” You would have to say, “I have no idea why this woman might be calling me Bob, she seems very … errr … tired, probably coming down with something.”
Do you see how quickly this whole thing would become completely crazy?
For what it’s worth, similar things really happened in the Middle East where extra tax was imposed based on religious belief, so groups of people would formally convert to Islam, while quietly retaining a lot of their previous beliefs. Then you end up with weird theories like the Pashtuns being secretly the lost Jewish tribes because they maintain some traditions that appear Jewish, despite officially being Muslim.
Same thing happened again in Spain where various groups of people would pretend to be Christian … which is why the Spanish Inquisition got started to figure out who was really Christian and who was being a sneak. Meaningful? I guess they took it seriously at the time, they were deporting the non-Christians out of Spain and felt the need to ensure no one got through the cracks.
So the answer is yes, a tax imposition could very easily make first names into a meaningless concept.
Murphy, I agree with you on the fine point here but is this just a semantics argument? Like, if you changed the first sentence to say that income/weight as a data point is poorly suited for our needs instead of that it’s meaningless, would agree with the rest? Or is there more to your argument than that?
I’m not sure whether you’re saying that we really should be concerned about income/weight within the contexts of these arguments or just that Cochrane and Sumner are being sloppy in their language.
Andrew, Scott Sumner literally titled his post, “Income is a meaningless, misleading, and pernicious concept.” If you’re saying, maybe what Scott is really trying to say is that income is a well-defined concept upon which civilization rests, and that I’m just quibbling about labels, then no I have to disagree.
That’s not what I was saying. I was saying that you’re right and Scott and John are wrong to say that income is completely meaningless, but what do you think about the rest of their arguments?
Because, to me, the whole “income is meaningless” line reads like a hook that they put there to draw people in. I don’t think they really believe it. In fact, I think a lot of what they write after that undercuts that initial statement.
Sumner even half-admits it when he writes, “So why the inflammatory title of the post?” and goes on to say:
It’s hacky and incorrect to headline your article with “income is meaningless” and then go on to explain how income is poorly suited to your view of proper tax policy. But I was just trying to figure out if your argument is “Sumner and Cochrane are hacks for employing dishonest rhetoric to segway into otherwise reasonable arguements” or actually “Sumner and Cochrane are wrong about everything with respect to tax policy on income.”
Andrew,
Yes and no. Yes, I always prefaced my posts (when responding to Sumner and Cochrane on this) that they made good points with respect to the tax/inequality debate, but that I disagreed with their statements about the concept of income.
No, I don’t think Sumner (not sure about Cochrane) is just being click-baity with his title. I encourage you to click the link to his post and look at us debating in the comments. Here is what he said to me:
But yes, I did know that income is defined by economic theorists as the amount of consumption you could do without impairing your wealth. And in my whole life I’ve never seen people use it that way in the real world, instead they talk about income in ways that are unrelated to what it really means. As when Krugman shows of graph of incomes by quintile.
I guess ‘meaningless’ was a bit strong, but what possible use is there for a concept that measures how much consumption one could do w/o impairing one’s wealth? I could create a new term “blingcome” and call it how much jewelry one could buy without causing their wealth to fall by more than 2%. Would “blingcome” be an interesting concept?
So he said “what possible use” is there for the thing that Mises/Hayek said was the essence of economic calculation that props up civilization. This isn’t a semantic quibble.
Okay. I was definitely mistaken to use the word “semantics” in my original comment. Sorry about that. I fully agree with you that income is not meaningless and Cochrane and Sumner should stop saying that.
I’ll note that even in the comment you quote, Sumner admits, “I guess ‘meaningless’ was a bit strong.” So I still think that Sumner knew that income was not meaningless all along and that he was saying that for effect. I think he wanted an “inflammatory title” and he wanted to persuade his readers to ignore income as a metric when making governmental policy prescriptions.
Thanks for your replies.
Let me go a little further because I didn’t address the “what possible use” part. Again, that’s obviously wrong in the general context. But I believe that Sumner is in central planner mode here and, when he’s thinking about “income,” he’s thinking about the income of entities under his rule that are not the government itself.
So it takes some interpretation but my thought here is that, when Sumner says “income is meaningless,” he means that governments considering tax and regulatory policies have no valid use for the income of the people and companies that are within the jurisdiction of those policies. (Of course, governments should care about their own income, which is why they’re setting tax policies in the first place.)
I’m not a Sumner fan and none of this is meant as a defense of him. I’m just trying to figure out what he means when he says these things because “income is meaningless” seems like such an obviously stupid thing to say in the general context that I can’t believe that he literally means that.
Andrew I have to be brief: The entities that aren’t governments that could be under Sumner’s control might be, for example, a corporation where he is the CEO (or major shareholder). In that case, yes you would want your accountants to show you what your net income was last year, to know if you did a good job leading the corporation. Sumner derides it as a concept put forth by “economic theorists” like it’s medieval theology. (Not that there’s anything wrong with medieval theology.)
Okay. You’ve convinced me. I guess Sumner’s just stupid and has no defense for saying income is meaningless. If he thinks that the government shouldn’t tax income then he should just say that.
Heh on the other hand, Tel is unmoved. 🙂
Sumner explains his title as follows:
“So why the inflammatory title of the post? I hope I showed that “income” is meaningless if it includes capital income. It is misleading because it leads people to talk about the share of “income” earned by the top 1% as if it is all actual labor income, whereas it is often mostly capital income, aka deferred consumption and not income at all.”
Just like Cochrane, he is criticizing the way that things that really aren’t income (like returns on capital) are treated as income by people discussing perceived income-inequality (and for income-tax purposes)
Transformer wrote: “Just like Cochrane, he is criticizing the way that things that really aren’t income (like returns on capital)…”
Except return on capital (if you mean interest) *is* income. I agree that the intuition behind the common belief that taxing labor income makes sense, might not apply to someone who saves some of his wages and earns a flow of interest payments, but that doesn’t change the fact that interest income is income.
Well, I suppose whether interest counts as income depends upon the definition of income you are using, which is part of what we are discussing !
However, I concede that in most meaningful definitions of income (and in the standard one) then interest would indeed count as income. If my flow of revenue in a certain period comes from my ability to sell my labor time, my ability to rent my house out, and to lend out my money savings then this stream of wages, rent and interest are all forms of income. (Wages could even be seen as return or rent on human capital.)
So I now agree that declaring standard definitions of income (that treat both wage income and capital income as forms of ‘income’) to be meaningless is a step too far. I get Sumner’s and Cochrane’s argument that taxing wage income in the same way as capital income may provide bad incentives but one doesn’t need to declare the standard definition of income ‘meaningless’ to make that point.
All right, 2 down, now I just have to convince Tel…
What about disguised income? It is hard to differentiate income from capital to income you worked for. If I buy a house for $10,000, do a lot of work on it and sell it for $100,000,how much of that is capital and how much is earned income?
It is quite easy to misrepresent the amount of income that was actually earned form labor as capital income.
Or a director of a small company who takes a small salary, but a large dividend. In fact, almost all of the income was as a result of their labor, but they take it as capital income.
It is very hard to differentiate on a practical level, so treating capital income as in part earned income makes some sense – otherwise we will have more abuse.