Saturday, March 27, 2004

Against Progressivity
Kerry is proposing 1.7 trillion dollars in new spending, yet he is telling us not to worry because he'll be able to pay for ALMOST half of it with tax increases on only the weatlhiest of taxpayers. This is supposed to make the rest of us feel better - its not us getting socked - its those with enough money to AFFORD the hit.

But is it true that it is not us getting socked? There is a wide literature in optimal taxation suggesting that the best tax system (either to maximize revenue or to maximize the utility of the general populace) is much more regressive in scope than the current system. How much more regressive? Try 19%, declining to 18% tax rate, with all tax payers getting a $20,000 refund. At least this was the conclusion that my professor Joe Bankman (by no means a conserative) took us to in our federal income tax class.

So if that is the optimal structure of taxation, what are the costs of having a more progressive structure? Less investment in education, less risk taking, and possibly less production by members in the top income bracket. Let's take the last point first - Conservatives love to point out that if we raise taxes too much, people will work less. Unfortuantly for them, this is not necessarily the case - people are stuck in the short-run in their current job. They might prefer to work less since they are in effect less compensated, but they still have all their previous wants, so they might work HARDER to get them. They might not. The key point is that we don't know what they will or won't do.

What we do know is that raising the tax rate can have effects on long-term career goals. Why slave away at a corporation for the youthful years of your life if the net result is that you are not as likely to be compensated for your sacrifice when you finally receive your reward? Why go through the challange of getting a college education if your eventual salary is going to be more similiar to a non-College graduate? Some will continue on their previous path - they were ambitious enough beforehand that reducing the expected long-term benefit would not alter their decision. Others, on the margin of asking themselves if all this self-investment of education/career is worth it, may very well decide that it isn't.

Similiarly, entrepenuers are less likely to take the risks with their money that creates future jobs if the expected payoff is diminished by higher taxes through progressivity. Without the risks being taken, you don't get as many new companies, which leads to less innovation and you-guessed-it: jobs
(sorry that I didn't provide links to Kerry's plan of if I goofed on a number - long day of traveling, and I need sleep)

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