A tax on inequality, or a tax to keep inequality at the current level?

My sometime coauthor Aaron Edlin cowrote (with Ian Ayres) an op-ed recommending a clever approach to taxing the rich.

In their article they employ a charming bit of economics jargon, using the word “earn” to mean “how much money you make.” They “propose an automatic extra tax on the income of the top 1 percent of earners.” I assume their tax would apply to unearned income as well, but they (or their editor at the Times) are just so used to describing income as “earnings” that they just threw that in. Funny.

Also, there’s a part of the article that doesn’t make sense to me.

Ayres and Edlin first describe the level of inequality:

In 1980 the average 1-percenter made 12.5 times the median income, but in 2006 (the latest year for which data is available) the average income of our richest 1 percent was a whopping 36 times greater than that of the median household.

Then they lay out their solution:

Enough is enough. . . . we propose an automatic extra tax on the income of the top 1 percent of earners — a tax that would limit the after-tax incomes of this club to 36 times the median household income.

This seems fair enough to me, but one thing that puzzles me is: my impression is that Ayres and Edlin feel that the rich have too much as it is already? So why freeze inequality at the current rate? (Yes, inequality could decline, but if it’s on an inexorable upward trend, my quick guess would be that maxing this ratio at 36 would be nearly equivalent to setting the ratio to 36.) Given the U.S. budget crisis, why 36? Why not 30, or 20, or 15?

P.S. When we last heard from Ayres he was supplying advice for young people who were rich or expecting to be rich. So I think it’s fair to say he’s no class warrior, that he’d like to keep income inequality at the current level but no lower.

And please note that I’m neither endorsing the Ayres/Edlin plan nor criticizing it. (Given my lack of expertise in macroeconomics, I’m certainly not the one you’d go running to, asking for an informed opinion on a proposed tax plan.) I’m just asking a question.

23 thoughts on “A tax on inequality, or a tax to keep inequality at the current level?

  1. The Op-ed begins: “We may have democracy, or we may have wealth concentrated in the hands of a few, but we cannot have both.”

    I want proof.

    “The sky is the limit for the rich as long as the “rising tide lifts all boats.””

    This likely implies tightly controlled immigration and, specifically, a severe restriction on immigration by the poor and huddled masses. Alternatively, it implies massive development in Mexico in Central America.

    Implicitly, Andrew wants to know how much inequality is too much inequality. On what basis do you make the choice: equity, efficiency, or personal taste?

  2. Wealth can be easily exchanged for power, so a concentration in wealth is equivalent to a concentration in power. With campaign finance regulations as they are, this is probably more true in the US today than it has been for a while.

    The democratic ideal is that citizens have approximately equal power to influence policy. If wealth is concentrated, then power is concentrated, and you’re left with a system that doesn’t resemble democracy.

    • I agree with revo11 to a point. Taken to its logical conclusion, he implies that we should all have equal financial resources, which would then equate to equal power. It would be far better to decouple wealth from its ability to influence policy, as Lawrence Lessig and rootstrikers.org are hoping to do.

    • revo11 states: “Wealth can be easily exchanged for power, so a concentration in wealth is equivalent to a concentration in power.”

      I want proof.

      In many developing countries people have to hide their wealth, lest it be stolen or expropriated. Not exactly a tell tale sign of power. Some Russian oligarchs are in jail, most others live in fear.

      • @john The push for SOPA was a pretty clear demonstration of exchanging wealth for power. And for every SOPA that the internet rallies against, there are many unnoticed bills that reflect the same transaction. Sure there are countries where there are competing institutions (e.g. in Russia politics that the political elite and the oligarchs may be in opposition), but at least in the US, if you can’t see that wealth translates to power I don’t even know how to start…

        @mikem that’s why I used the word “ideal”, I don’t think it’s possible, and I don’t even know what that would look like if put in practice. I’m just defining it for the sake of contrasting the effect of too much inequality. You can say that there’s some reasonable intermediate point and you’ll always have some inequality. I’m just saying that, past a certain point, the differential in power contradicts the spirit of a democracy.

  3. Leaving aside the policy implications, wouldn’t setting the tax to establish 36 as the maximum ratio lead to an after-tax ratio lower than that? In the top 1%, some have incomes higher than 36x, and some lower. Bringing all the higher earners down to 36x would result in the average income (after taxes) of the group being less than 36x the median income. How much less probably depends on how skewed distribution of the top 1% is.

  4. Hey Andrew,
    Have you explored the results of Rich Burkahuser (as a refute to the Picketty and Saez tax papers). He does a good job of discussing the role of censoring in the CPS or Census (I forget which) and our perceptions of income inequality. I would love to hear your take and how you would rule on this.

  5. I have read reports that even a 90% tax on the top 1% wouldn’t garner very much—but I don’t have the stats handy. When some people talk of a teeny tiny group greedily grabbing for themselves a huge part of the U.S. pie, they seem to assume that the government owns all of our wealth, and that it’s just out there for the grabbing. A country’s wealth shrinks, disappears, or goes away to another county, as we see. Collecting and redistributing “equally” whatever remains scarcely empowers individuals.

    • Mayo:

      You can take this one up with Edlin and Ayres. As law professors they have a lot of contact with rich people, hence I suspect their proposal has been design to minimize objections from that end. My impression is that the main reason for proposing such taxes is to pay for popular government programs.

    • if someone is too poor to afford health care or their only viable career path is the drug trade, that’s not exactly ensuring the liberty of citizens. If that person has access to health care, yes it would probably empower them to pursue better opportunities.

      What’s with the straw man argument? Nobody I know ever advocated taking all the wealth and redistributing it “equally” among all citizens. There’s probably a reasonable range of inequality which will (and should) exist. The debate is whether inequality is at a degree that’s pathological to the functioning of the market and the state.

      • RI didn’t say they said that either.
        But rather than create meaningless class divisions for political persuasion, they should show by example that they do not let money rule, e.g., agree to public financing of elections rather than collect hundreds of millions of dollars to be wasted on campaign bumper stickers and biased ads.

  6. I think the focus should be on making the game fair, not taking money from people just because subjectively thinks they are too rich.

    When people are outraged about income inequality, they seem to be pointing at investment bankers and others in finance who were able to profit while running socialized risks. They tend not to point to people like Steve Jobs who built products that many people find useful, even though he famously opposed corporate philanthropy. And they tend not to point to left-leaning multi-millionaire movie stars. So not all extreme income inequality is objectionable, it would seem.

    Anyone can engineer a convoluted tax system to redistribute income, and nearly everyone will have a different opinion about what the “right” distribution should be. But it seems to me that the real underlying issue is whether people “deserve” their high incomes. It’s pretty clear that some in finance have not, but they are just playing the game. Make the rules of the game fair and discourage moral hazard. Then I think people will worry about inequality much less. And all of the proposed tax distortions with their hidden, unintended consequences (and tax avoidance/evasion) will be unnecessary.

    • Dave:

      You’ll have to check with Edlin and Ayres, but my impression is that their tax would apply to tech executives and to movie stars (whatever their political leanings) as well as to people in finance.

      • This is an ill-thought proposition that can put one in situations like this:

        Mark was tired of city life and decided to go to the country to keep chickens and live a basic life. He is very happy there, in bliss.

        Robert loves money and works very hard in his own company. He now earns 36 times more than Mark. He wants to keep growing his company and earn more, but in order to earn more money he needs to give Mark money.

        Under the assumptions made Mark doesn’t want extra money, his demand for money is already satiated. Both are worse off by the policy.

        My point is that many people at or below the median income are there by choice. Unlike Mark, they might not object to some extra money for free, but they ought to recognize it for what it is: highway robbery.

        I think this is an ill-thought angry policy proposal.

        • Note that if Mark chooses to continue his lifestyle, then the flow of money must be recurrent (i.e. every year Robert has to pay Mark), and in so far as Robert’s company continues to grow, these flows increase over time.

          There is something intrinsically nonsensical about this.

        • Obviously one can concoct examples to argue every angle, but my point is the case against inequality is not a slam dunk.

          It takes five minutes of intellectual effort to reveal many paradoxes and lacunae with the standard arguments.

        • I agree. I think these arguments tend to overlook that many are driven to become excellent, and have an impact, in aspects of life other than making money. And not everyone wants to work to the max all the time either; I wouldn’t swap, say, for 14 hour work days scrambling in a hedge fund or investment bank (even during boom times).

  7. 36 times the median? (Nice application of the median, by the way, leveraging its robustness). To paraphrase a criticism of confidence intervals, why not 35 times, or 10 times, or even ONE times? Of course, we could make it adjustable, perhaps indexed to the national debt, or literacy rate, or Whooping Crane population, or something…

    • Mike:

      The threshold of 36x was not arbitrary; they explicitly chose it because that is the current level. Edlin and Ayres calibrate the scale by pointing out that the ratio was 12.5 in 1980. So maybe they would think 10x would be ok too. My impression is that they were picking the current level of 36x because they wanted a proposal that would be acceptable to currently rich people. But you’d have to ask them directly to be sure.

  8. Some quick answers:

    To Mike and Andrew. We indeed chose 36x because it would only bind in the future and therefore be more acceptable than a big tax increase on the wealthy today. We would both happily have less inequality than that. Readers who point out that mandated full equality destroys all incentives are (basically) correct; certainly too many incentives are destroyed. So the best system allows inequality, but not too much.

    To the person who thought that the Brandeis surtax would be a 100% marginal individual tax rate, it would not. The marginal individual tax rate is the amount of extra income an individual keeps. That rate would be far less than 100%, even if pretax inequality rose dramatically.

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