Saving, Taxation and the Three Axes

Suppose that Lois Lender and Sammy Spender work at identical jobs, earning identical incomes. However, Sammy spends all his earnings, while Lois saves 20 percent of hers. Do you think that Lois should pay more in taxes than Sammy, as happens when we treat interest, dividends, and capital gains as income?

Along the conservative civilization-barbarism axis, the answer is clearly “no.” Lois is deferring gratification and is entitled to consume more as a result. Sammy is enjoying instant gratification and should not be given favored treatment for doing so.

Along the libertarian freedom-coercion axis, it is hard to say. From this perspective, all taxation is theft. One libertarian argument might be that you want to permit the government to tax as few activities as possible in order to hold down theft. But does that argument provide a rationale for making capital income, rather than labor income, excluded from taxation? Ultimately, I think that a lot of libertarians would fall back on the conservative rationale against taxing capital.

From the progressive’s oppressor-oppressed axis, Lois becomes an oppressor. I realized this when this Douglas Hopkins essay was emailed to me by the author. Hopkins argues for taxing capital income at the same rate as labor income, rather than at a lower rate (remember that the conservative position would be that capital income should not be taxed at all).

Who would have believed that a society governed by majority vote would over-burden its working middle class in order to provide tax preferences to its privileged elite? But that is exactly what we do when we offer preferential tax treatment to investment income. …Reducing the marginal tax rate on earned income and putting more discretionary income in the hands of laborers would be a far more effective method of stimulating savings where we most need it – than continuing to siphon money from the middle class into the hands of current wealth-holders.

Since Hopkins emailed the essay to me, I tried to open his mind to other narratives about capital taxation. Not surprisingly, in his email responses he would not budge. I thought that his responses just recycled the same rhetoric, in which those who accumulate capital are oppressors and those who only have labor income are oppressed.

The essay complains about economists failing to get the oppressor-oppressed narrative. I only wish that were the case. In fact, there is a whole army of economists ready to talk about income and wealth inequality in oppressor-oppressed terms. When the U.S. experiences a sovereign debt crisis, I predict that wealth confiscation will be put on the table as a solution. Why cut spending on the oppressed when there is so much wealth concentrated among the oppressors that could be used to pay down the debt?

I expect that the demonization of “the rich” and “the one percent” will gain more and more traction as the level of government spending ratchets ever upward. And, yes, I am mostly on the libertarian axis on this issue.

19 thoughts on “Saving, Taxation and the Three Axes

  1. On the other hand, given a fixed amount of money we need to gain in tax revenue, why should we want to tax income (providing services) more heavily than saving (not taking services of others)? Given that switching completely to a VAT, sales tax, excise taxes, or set of Pigouvian taxes doesn’t seem to be on the table, we’ll need to make trade-offs, and I think people will naturally suspicious about attempts to shift the burden away from people who can most easily to save money – rich people.

  2. It’s telling that in your statement of the conservative view, you describe the decision to defer consumption as making one “entitled” to consume more (later). I think this is an accurate portrayal of how many conservative savers think–but of course it is complete nonsense. If your money can earn a good return for you by being lent out to more productive people, then you’ll have more; if not, then you won’t. It seems to me that this particular entitlement mentality has a lot to do with why there is such strong opposition to a climate of very low interest rates–people feel like they should be getting a nice 5% real return on investment without all that much risk, and if they can only get 1.5% or so that strikes them as a real injustice. That’s not to say that there might not be good reasons to oppose ZIRP or QE, just that I think in truth many people’s opposition is premised on a fairly self-interested construal of the barbarism-civilization axis.

  3. If I were a progressive, I think I would respond that often times the reason that Lois Lender saves 20% of her income and Sammy doesn’t is that Lois’ income is probably substantially higher than Sammy’s, such that she can still save 20% while enjoying roughly the same consumption levels as Sammy.

    For a progressive, a just tax system is imposed in such a way that the hardship imposed on the worst off among us is minimized (because they are oppressed), or so I would think, anyway. From this perspective, imposing higher taxes on capital is a move in the right direction because the poor typically don’t have any. That higher taxes on capital might encourage instant gratification over responsible saving and delayed gratification might have some merit to it, but this is just an unfortunate side effect of an otherwise fair and sensible policy, and the effect is likely to be small, anyway, because not saving makes you poor and being poor means being oppressed, and who would choose to be oppressed, right?

    Okay, I’m just spitballin’ at this point.

  4. There may be another element in the narrative justification for at least some progressives, namely that for them the gains of the rich are presumptively ill-gotten anyway. You’ve posted yourself that in the precapitalist past riches mostly did come through plunder and people have a hard time getting used to this not being the case. When you see the way some people profited from government backstops during the financial crisis, or the way Mitt Romney manipulated the cost basis of his IRA contributions to get huge tax free gains most of us could not, you can understand how people might still think it.

    I think that between this and the mechanism in Jeff’s comments, your post could use a good deal more charity to the progressive view with which you (IMO quite rightly) disagree.

  5. I routinely engage in friendly online discussions with those of the far left, and find that in addition to the oppressor/oppressed paradigm, it is also usually necessary to assume they will also engage in two other related conceptual world views.

    First, they tend to default to seeing the world as zero sum. They look first at how the pie is divided and give little thought to how it is created, or the effect of incentives. Critically, this often leads to the assumption that those with more took more than their fair share or did something wrong or didn’t give back as expected. Those with more ARE the oppressors almost by definition.

    Second, they often lean toward what I call the Big Kahuna fallacy. They assume that solutions are always solved via top down, conscious, deliberate, rational design. They lean toward a centralized, and if necessary, coercive solution set. They tend to be blind to the possibility of decentralized, experimental, bottoms up, competitive-cooperative, voluntary and evolutionary problem solving. It seems magical or wishful to them.

    When you put the three together, you can anticipate how they will respond to problems. Oddly enough, whenever I point out these paradigms to them, I get a mixed response of denial that they think this way, combined with a vehement defense that the world really is that way.

    For the record, libertarians often fall for the exact opposite paradigms. They can ignore oppression and zero sum activities and disregard the potential for top down solutions.

  6. I think that a progressive consumption tax can help here, although some might argue that it allows more control of business by the rich but most of the very rich already do not pay taxes on growth because they own businesses (people like Bill Gates), but they do pay taxes on the corporate profits.

  7. @John on December 18, 2012 at 9:17 am said:

    On the other hand, given a fixed amount of money we need to gain in tax revenue, why should we want to tax income (providing services) more heavily than saving (not taking services of others)?

    I have tried to think about this honestly and be unbiased and I think that one real reason is that the purpose of the taxes is to shift consumption from individuals to government or to recipients of transfers. So a consumption tax is more direct way to achieve that. For example taxing Warren Buffet more will not reduce his or his children’s consumption.

  8. Along the conservative civilization-barbarism axis, the answer is clearly “no.”

    I am not really certain this is true. Historically, taxes and tithes (which the conservative view would be expected to follow) would be stated as a tenth of the harvest or a tenth of the herd. Both of those are renewing resources, just like saved money. The seed corn, or the breeding sheep, that you purchase, will result in a harvest. And the tithe is taken from that harvest.

    Similarly, saved money that is invested produces a “harvest” of new money. According to all the precedents, you would owe a tithe on that harvest. That, I think, is closer to the real conservative position on taxes on interest and capital gains.

  9. I am a little confused by the hypothetical. It says they have identical jobs and identical income. But If Lois earns investment income, she has more income. So while I am not in the oppressor – oppressed camp, I am in the equal treatment and consistent logic camp, I think she should pay incremental tax on that incremental income. There are arguments for a lower tax on the investment income, because she can just stuff her savings in a mattress and presumably the government does not reimburse her for investment losses, so an inducement may be necessary to get her to put her money to work. But I don’t subscribe to the simplistic “all investment taxation is double taxation” argument.

    • Mark T,
      As long as we tax investment income, the message to Lois is, “Spend now. Enjoy it while you can. Otherwise, we will just punish you for your thrift.” It is hard to see why society would want to do that.

      But maybe the problem with punishing people for earning income is more general than that.

      • I am sympathetic to the ideas here but I don’t get the math. Assume (1) they both earn 75K before taxes and the effective rate is 1/3, so 50K after taxes, (2) Sammy spends it all and Lois saves 10K of hers, and (3) Lois earns a 15% annual return on that 10K. If we apply a 1/3 tax to the $1500, she winds up at year end with $76.5K, pretax; 25.5 of tax; 40 of spending, and 11,000 of net worth increase. I don’t see how this is a penalty. Only the incremental income is taxed, not the 10K in savings (A property tax would tax the savings I note.) Doing so treats it like wage income. It’s source agnostic. She made 76.5, not 75, so she pays 25.5 in tax not 25. But she is richer, net net, so I don’t see how this is a penalty for not spending as much as Sammy.

  10. @Roger

    I think that affect Utilitarian ethics generally. The first and largest problem that always leaps out at me in Rawls’ “veil of ignorance”–and distinct from Smith’s impartial observer–is its indifference to the past actions that have caused the current state of affairs. That is, the entire notion of “desert” is excluded in Rawls.

    I am not sure if Utilitarianism is bound to ignore the past and desert, but it seems as a practical matter that it *does*.

    I rather suspect that is a feature not a bug; that the impossibility of calculating what everyone deserves causes a conscious narrowing of the problem to something manageable by of the mind considering it (which is and always will be inadequate to comprehending the totality of intertemporal distributive justice).

  11. Why should income earned from working and income earned from investing savings not be considered as income? You don’t have to do anything other than put the money in a mattress if you don’t want it to earn any income.

    There are other considerations – inflation among them – but for this question, assume a spherical chicken.

    If the national income balance were to shift to say 80% investment income, 20% labor income, would the answer to the question be any different? If so why? What if it goes to 99% investment income? Should labor income still be the only thing considered as income? And what of slave labor – would that be capital income and thus untaxable; and if not, who should pay the tax, the slave, or the owner?

  12. Along the libertarian freedom-coercion axis, it is hard to say. From this perspective, all taxation is theft. One libertarian argument might be that you want to permit the government to tax as few activities as possible in order to hold down theft. But does that argument provide a rationale for making capital income, rather than labor income, excluded from taxation? Ultimately, I think that a lot of libertarians would fall back on the conservative rationale against taxing capital.

    Assume, arguendo that you must choose just one source of income to tax, i.e. either capital income or labor income, but not both. Why is it more libertarian to choose to tax labor income over capital income? At the very least, couldn’t it be argued that there was an equivalent liberty interest between the two?

    I think it can also be argued (assuming, again, that you must tax one or the other) that there is a greater liberty interest in choosing to tax capital income over labor income.

  13. I think I follow the logic of why higher tax rates for the wealthy is a disincentive to become wealthy, but I feel that the magnitude of this disincentive is outweighed by the stimulative effect of giving poor people money.

    But let’s assume I am wrong and a progressive tax system really is a bad idea. Can we at least agree that the current wealth inequality is unsatisfactory, because someone born into severe poverty has fewer opportunities than someone born into severe wealth? Would you agree that some mechanism should exist to make the playing field more level? (Or would you prefer we live in the jungle? Or some alternative I have neglected?)

    If we all believe in equal opportunity, then what is the libertarian or conservative approach to achieving equal opportunity? And if it is significantly different from the present state of the system, how would you work toward this new, presumably more optimal, state without falling back into the steep local minimum of the present?

  14. I think a case can be made that if we are going to tax income, we should tax all income with the same rate structure: corporate, capital gains, dividends, interest, wages. Having different rates for different forms of income brings problems that are seldom discussed when this issue comes up:

    1. Isn’t it a form of coercion when the government rewards some productive behaviors (equity investments held for at least a year and a day) over other productive behaviors (debt investments, productive labor, equity investments held for less than a year and a day)?

    2. Taxing different forms of income in different ways creates opportunities for some people and corporations to raise their after tax income by finding “clever” ways to shift income from one category to another. Corporations decide to raise money via debt or equity in part due to the tax consequences of those decisions. But those consequences are artificially imposed by the government. Some people (Hi, Mitt!) are able to take a large share of the compensation they receive for their labor as long term capital gains to take advantage of lower rates. Even if we believe the goverment should indeed tax certain forms of investment returns at lower rates, why should those rates extend to returns on human capital some, but not all of the time?

    3. The arguments in favor of taxing long term cap gains at lower rates all seem to really be arguments in favor of taxing consumption. I can see the rationale for taxing consumption. But, if the goal is to tax consumption, then tax consumption! Replace the income tax with some form of consumption tax.

  15. I just thought I’d point out that dividend income is the most heavily taxed income there is. First the income is taxed at 35% at the corporate level. Then it gets taxed again at 15% when the dividend is paid. That makes for a total tax of 44.75%. That’s the highest rate of any person or organization in the US and it is the rate you pay, even if you are in the lowest of economic classes.

    • Chances are, the corporation didn’t actually pay 35% on its profits, thanks to the existence of lots of different deductions and incentives. Infamously, in 2010 General Electric reported $14 billion in profits, of which $5.1 billion was earned from operations in the United States. Its federal income tax bill? Negative three point two billion dollars.