On Blessings and Taxes

In his post criticizing the idea that tax rates should be based on income, Brandon writes:

I will grant that there's a legitimate argument to be made in favor of taxing people on the basis of the blessings they have been given. For example, the fact that I'm smart enough to make a good living as a computer programmer while most others aren't is a matter of sheer luck; I haven't really done anything to deserve the cognitive advantage I have over someone with an IQ of 90.

This strikes me as a perfectly reasonable position. Regardless of what we think about the nature/nurture question (and much virtual ink has been spilled over this question right here at DR, with Brandon often leading the way), it's clear that I have very little to do with my IQ. I was either lucky enough to be born with the right set of genes and then develop in the right sort of environment or I wasn't. There's little I've done to earn my natural talents.

That said, I wonder if this sort of concession doesn't set us on a fairly slippery slope. Consider Brandon's own example:

Two men of roughly equal intelligence, from similar class backgrounds, who go to school together and end up going to the same college—men who have been more or less equally blessed. When they reach college, their paths diverge. One decides to become an artist, the other a doctor. Ten years later, the doctor is paying 10-20 times as much in taxes as the artist.

Becoming a doctor is hard; it involves many years of study and very hard work, with no payoff until age 30 at least, and as late as 35 for some specialties. Ultimately there's a large monetary payoff, but the doctor pays a heavy nonmonetary price (not to mention student loans, which are not tax-deductible). The artist doesn't make much money, but he enjoys the nonmonetary benefits of being an artist, such as leisure, more enjoyable work, and art groupies.

This strikes me as problematic on a couple of levels. For one, Brandon is probably underplaying the amount of training involved in becoming an artist. Plenty of people have (some) artistic talent, but moving from potential-artist to actual-artist requires some degree of work. There are, after all, plenty of artists out there who acquire an MFA, or even a PhD, apprentice for years and so on. I've neither been to medical school nor to art school, so I can't at all compare the two. But it does strike me as a tad glib to assume that becoming a physician requires hard work while becoming an artist is a walk in the park. At the very least, the fact that there are far more successful physicians than there are successful artists ought to give us some pause.

More significantly, though, while Brandon does well to consider the role that luck plays with respect to intelligence, he seems strangely to ignore the fact that luck plays an equally big role in a lot of other areas. It is, for instance, really a matter of luck that Brandon happens to live in a society that values physicians more highly than it values artists. Move 200 years into the past and having a knack for open-heart surgery just isn't really all that important: People were too busy worrying about having enough to eat to bother with shelling out a lot of money for surgery. As a result, physician wasn't a particularly high-status profession.

Similarly, if we move 200 years into the future, it's likely that physicians won't be that terribly in demand. Our on-board supply of nanites will be keeping us healthy, and physicians will simply have to keep us injected with the latest batches. Indeed, with our longer life spans and increased leisure time, the artist may be far more valued than the physician.

My point here is just that even people who are similarly smart aren't necessarily gifted with exactly the same aptitudes. Whether my talents happen to line up with the things my society really values is a matter of purest luck. Brandon, I think, has to assume that equally smart, equally advantaged people are also equally talented in every single respect. But that's not really true. In fact, that's not true at all. Some smart and advantaged people just don't like science and thus won't be any good at medicine, however smart they might be.

Now if Brandon wants to make the (very narrow) point that it's unfair that a tax code would treat differently two people with exactly the same talents and aptitudes but who consciously chose two different career paths, then that's fair enough. It's somewhat academic, as I suspect it's pretty unlikely that we'll be able to find all that many real-world examples.

Brandon is certainly right that money isn't everything. And a tax code that based its rates on overall utility rather than income would probably be morally preferable to the one we have. But until we have a reliable utility meter, income is arguably the best proxy we have.

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There's little I've done to

There's little I've done to earn my natural talents.

You still do not explain why the fact that you were lucky mean you should share your income. At least Ralws acknowledges this step and tries.

Don't tax luck/talent; tax the growth of happiness

Assume for the sake of argument that some amount of tax revenues are required to pay for government services. What is the optimal manner in which to collect those revenues?

Sure, taxing talent or luck promotes a kind of egalitarianism, which has some appeal. But taxing net increases in happiness has other attractive dynamics.

A taxing on the growth of someone's happiness would function like toll booth: you can’t get from one state (of affairs) to another without paying. If the price of the toll is less the value you place on moving from one state to the other, you pay it; otherwise you don’t. These taxes have the benefit that they don’t make anyone worse off relative to the status quo. After all, maintaining the status quo doesn’t incur any taxes. It’s only changing the status quo (by going from one state to another) that triggers a tax liability. That is, if you’re doing something that makes you happier, the government takes a piece of your increased happiness; if you’re not doing something that makes you happier, government leaves you alone. Relative to other ways of raising revenue, this is not a bad system.

Sure, taxation also has its costs, but they may not be what you expect. The costs that economists worry about are the costs of altering people’s behavior needlessly. “Needlessly” is the key here. Paying taxes need not have that effect. Yes, relative to a world in which government resources are free, people who pay for government services will experience a “wealth effect” – that is, they’ll feel less wealthy. It’s the same “distortion” each of us felt when we moved out of our parents’ houses and had to start paying for our own food. Such wealth transfers don’t necessarily signal any loss of efficiency; rather, here they signal the loss of a subsidy (that is, the subsidy of receiving government services for free).

But doesn't the act of paying taxes distorts people’s decisions? To the contrary, it’s the act of NOT paying taxes that distorts people’s decision – that is, taxes may induce people to alter their behavior in order to avoid the taxed good or service. Thus, we might imagine someone wanting to pass a toll booth, but discouraged from doing so by the toll. The would-be traveler might stay put, or might choose a less-favored destination with a lower toll. The would-be traveler will be deprived of an opportunity for greater happiness, and the toll collector will be made no better off. This is the “deadweight social loss” of income/transaction taxes.

So, how to avoid this? Ideally we’d tax people based on the amount of happiness that any given transaction produced, and set the tax at slightly less than the happiness. In this manner government could secure the maximum revenues without needlessly altering anyone’s behavior.

But, as C.J. Trillian observed, we have no direct way to measure people’s happiness. So what’s a good proxy that we CAN measure? Recall that Jefferson was torn between the two phrases “Life, Liberty and the Pursuit of Happiness” and “Life, Liberty and the Pursuit of Property.” Since we can’t measure happiness, we use property as a proxy. Or at least some forms of property.

Income taxation makes far less sense from a government-service standpoint than property taxation.

Again, in many respects, property taxation is a substitute for income taxation.

It only makes sense. Imagine two scenarios. In Scenario 1, my neighbor and I each own our own houses and I live under identical circumstances. We pay identical mortgages and identical property taxes – but no income tax (related to the home.) In Scenario 2, I sell my house to my neighbor and rent it back from him, and my neighbor sells his house to me and rents it back. Our living arrangements don’t change, except that now I’m paying a market-based rent to him, and he’s paying a market-based rent to me. Same situation as before, right? Not quite, ‘cuz now we’re BOTH paying income tax on the value of the market-based rent (less expenses such as depreciation, etc.) that we receive.

Why would we pay more income taxes under Scenario 2 and under Scenario 1? Because when we receive rent to someone else, it’s easily quantified (“realized”) and therefore easily taxed. Conceptually people who own their own homes also pay rent – but they pay it IMPLICITLY to THEMSELVES. Because I don’t quantify the value that I attach to the stream of services I receive from myself as a landlord, the government has a harder time taxing the income it provides me.

But this difficulty with quantifying a stream of benefits leads to all kinds of distortions, because it leads people to alter their behavior in favor of untaxed activities and away from taxed one. To the extent that property tax acts as a proxy for income tax, then property taxes arguably render the world more efficient because they may offset the artificial distortions created by income taxes.

My point (and I do have one....)

Whoops -- I was gonna make a point, too.

So how should we tax the starving artist and the wealth doctor? Ideally, based on happiness. If the starving artist loves his lifestyle, he’d pay the tax. And if the doctor feels trapped in a work-a-day grind, he wouldn’t.

This isn’t entirely a hypothetical issue. In divorce cases, often one party must continue to make payments in some proportion to his income for the support of another party. If the payer suddenly takes a different, less remunerative job, how should the court alter the payments? Ideally, base on happiness. That is, if the payer is bummed about losing his lucrative job, then he’s actually experienced a loss of income, and arguably his payments should decline. But if he’s happy to be in the less lucrative job – maybe he always hated his old job, or has a fascinating internship, or he derives satisfaction from the idea that he’d get to reduce his support payments to his ex – then his payments should actually increase. Judges may strive to replicate this analysis by trying to determine whether the payer changed jobs willingly. If the payer willingly elects to forsake his higher income, that’s his choice, but he shouldn’t expect his ex to bear the consequence of that decision.

C.J.: I believe that most

I believe that most artists who are not financially successful, and more generally people who choose low-paying jobs because they like them, have the innate ability to do some other job that pays reasonably well. Those not quite bright enough to become doctors, lawyers, or engineers could at least do a skilled trade.

There are two possible explanations for why they don't. The first is that it's a rational choice, and that they're just as happy doing a fun job that pays little as they would be doing a less-fun job that pays more. The second is that they made bad choices.

I don't see that either of these is a good reason for the doctors to subsidize the artists. It doesn't make sense to force the doctors to subsidize the artists' fun, nor does it make sense to force the doctors to subsidize the artists' bad choices.