Taxing with Malice

 

                                                  Taxing with Malice

This is from an editorial--I think the WSJ--and contains a lot of very concentrated economics thought, clearly presented. It describes the subservience of economics to the group identity-group conflict fetish.

"The Biden administration last week proposed to increase the capital-gains tax rate—currently 20% for most assets held for at least a year—to 39.6% for people making more than $1 million. Since capital gains are also subject to the 3.8% Medicare tax, the new capital gains rate would be 43.4%.

What makes this unusual is that 43.4% is well above the rate that would generate the most revenue for the government. Congress’s Joint Committee on Taxation, which does the official scoring and is no den of supply-siders, puts the revenue-maximizing rate at 28%. My work several decades ago puts it about 10 points lower than that. That means President Biden is willing to accept lower revenue as the price of higher tax rates. The implications for his administration’s economic thinking are mind-boggling.

Even the revenue-maximizing rate is higher than would be optimal. As tax rates rise, the activity being taxed declines. The loss to the private side of society increases at a geometric rate (proportional to the square of the tax rate) as rates rise. The government collects more revenue, but its gains slow as the taxed activity declines. The revenue-maximizing rate is the point at which the government starts losing from higher taxes. Tax rates above the revenue-maximizing rate are punitive: The government is giving up revenue simply to punish the rich.

Punishing the rich is distinct from redistribution. Higher taxes on the rich to finance spending, or to transfer money to lower-income people, may be good for society’s welfare. Economists express this idea in a “social-welfare function,” which weights additional income received by different people, usually based on income. The same sum is considered less valuable if it goes to a high-income person than a lower-income one. The weights are subjective and different analysts will choose different weights.

Still, economists can agree that the ideal is to make someone better off without making someone else worse off. The simplest case is a voluntary exchange of goods for money, in which the buyer values the purchase at least as much as the price, while the seller values the money at least as much as the item being sold. Economists call such an exchange Pareto-optimal after Vilfredo Pareto, the Italian economist who formally framed the concept.

There is no choice in paying taxes, and usually the government is better off and the taxpayer is worse off. But above the revenue-maximizing rate, even the government is worse off. This is called Pareto-pessimal.

Generally, the government can raise tax rates and transfer the money to lower-income people, thereby improving social welfare. The government can do this even after incurring the economic burdens caused by higher rates and the costs of transferring money (known as the “leaky bucket”). The trade-off depends on how much tax rates distort the economy, how big the leaky-bucket effect is, and how one evaluates the difference in value of money going to people in different income groups.

As indicated by other proposals, the current administration rates money going to lower-income people extremely highly relative to higher-income people—higher than has traditionally been the case in U.S. economic policy. It also seems to put little weight on excess economic burdens and leaky-bucket costs. The wisdom of those choices will be tested at the ballot box.

But to an economist, a Pareto-pessimal choice is unwise by definition. There is no set of “weights” one can devise to justify this proposal, because there are no highly prized winners to offset the losses to the low-weighted losers.

The concept of social-welfare maximization has been a cornerstone of economic thinking across the political spectrum for the past century. It dates back at least to Adam Smith in the 18th century, and arguably to the 17th, when Jean-Baptiste Colbert, King Louis XIV’s finance minister, declared “the perfection of taxation consists in so plucking the goose as to procure the greatest amount of feathers with the least possible amount of squawking.”

That’s why it is shocking that this policy got past the economists in the administration, many of whom have had long and distinguished careers. The Biden administration is blowing up one of the key concepts that has united the economics profession: maximizing social welfare. It now believes in taxation purely as a form of punishment and is even willing to sacrifice revenue to carry it out."

I have not heard it said but it is possible that the powers-that-be believe that the failure of taxes to raise point-by-point revenue is that the victims of the tax increases retreat into some illegal subterfuge to avoid their proper tax. Why? Because they don't believe in market forces. They believe only in corruption.