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Tax reform economics

I am interested that the two dominant ideas in tax economic theory over the last 40 years seem to diminish or downplay the case for redistributive taxes.

First, there are the strong arguments on income taxes from James Mirrlees (1971), and a plethora of followers, which places a premium on relatively flat income tax schedules with a hefty lump-sum income transfer to all. This is effectively a negative income tax of the type promoted by Milton Friedman in 1962.  There is specific concern in this literature with the disincentive effects of high marginal tax rates on high income earners.   I exaggerate a bit here – some of the Mirrlees followers do argue for a U-shaped marginal tax schedule (high marginal tax rates at both low and high incomes)  – but I think the main thrust of this literature is consistent with the original ideas of Mirrlees.

Second, the literature on optimal excise taxes (when there is also an income tax instrument available) generally favours uniform VAT-style excises over differentiated excises of the type favoured by Frank Ramsey in 1927. There is almost no support for the idea of levying high taxes on luxury goods at least when an effective income tax is available.  The early work here was by Anthony Atkinson and Joseph Stiglitz (1976) but it has recently been generalised and extended by Louis Kaplow (2008). Since a uniform VAT style tax on consumption goods is essentially equivalent to having no excises at all and substituting for this a proportional income tax this literature parallels the optimal income tax literature in its fairly anti-redistribution implications.

Almost none of the authors of this type of theoretical work come from the “right” of politics – they are mostly somewhat left-wing in orientation.  Indeed Joseph Stiglitz has written books such as “The Price of Inequality” that criticise strongly the growing inequality particularly in the US.  It seems there is a theoretical Stiglitz and one who is a political advocate and that he keeps these hats quite separate. Much the same comment too could be made about Anthony Atkinson who criticises growing inequality and, in particular, the failure to address issues of poverty.

It is never clear how much impact theoretical work in economics impacts on practical policy-making but the dominant trend throughout the OECD in recent years is to implement the type of agenda suggested by this theoretical work: See e.g. Mankiw et al (2009). Most OECD governments have moved towards flatter income tax schedules and away from differentiated excises towards VAT or GST style taxes. The same is definitely the case in contemporary Australian tax debates which seek , by-in-large, to push further the income tax flattening and GST promoting tax policies developed in recent decades.

One argument is that society needs to live with a low income class who don’t work but who receive large transfers from the wealthy who pay high average but low marginal tax rates. To me that is a bleak vision although it is one that is explicit in the original Mirrlees work. According to this view average tax rates can be quite high if marginal rates are high on low income earners – perhaps through the conjunction of means-tested transfers from government and the tax system.  Then much income can be accessed from high income earners who do not suffer substantial disincentive effects in terms of reducing labour supply effort because marginal tax rates on them can be low. This is then used to effect transfers to the poor who, even should they choose not to work because of the high effective marginal tax rates, do not impose large efficiency costs on the economy because they are relatively unproductive in their work roles anyway.  This assumes that involvement in work has no intrinsic value or social role and that a worker is equally keen living off social security benefits than working for similar incomes – a view that is plausibly false.

It might just be that the focus of economists is on efficiency issues since efficiency gains can be justified by weak value judgements such as the Pareto Principle.  Income distribution issues are less the concern of economic theorists.  Or it might be thought that achieving egalitarian income distributions is an unnecessary  tax policy objective if everyone gains when the wealthy are less constrained to still further increase their wealth – “the rising tide raises all boats” argument of John F. Kennedy. That can be question by evidence showing persistent poverty problems.   It is sometimes further argued that democracies, such as the US, have become captive to wealthy vested interests and this interests are driving tax policy. Finally, apart from lump-sum transfers to all that mean low rates of tax at low incomes it could be that other policies are being seen as the primary means of addressing poverty. One that is often mentioned is the minimum wage law.  Of course too such laws are widely criticised on efficiency grounds as causing unemployment.


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