EMAIL EXCHANGE WITH PROFESSOR TONY BERNARDO, INCLUDING REFERENCE TO FORWARDED COMMENTS BY PROFESSOR RICHARD ROLL.
Professor Tony Bernardo’s comments are in black and green. Mr. Hagopian’s comments are in blue and red. Professor Richard Roll’s comments are in a forwarded email and are in black.
Professor Antonio Bernardo (PhD, Economics, Stanford University), is a Professor of Finance at UCLA Anderson School of Management.
Professor Richard Roll (PhD, Economics, Universityof Chicago), is the Japan Alumni Chaired Professor of Finance and Economics at UCLA Anderson; Director of the Fink Centerfor Finance and Investment; and President of the American Finance Association. (Professor Roll comments are on the first draft of the essay.)
From: Antonio Bernardo
Sent: Tuesday, May 03, 2011 2:03 PM
To: Kip Hagopian
Subject: RE: Class Wars
Hi Kip, I have now read your exchanges with Chait and Frum. I should have read them earlier since you directly rebut many of the arguments I brought up in my last email. I have some responses to your comments below.
From: Kip Hagopian
Sent: Monday, May 02, 2011 6:42 PM
To: Antonio Bernardo
Subject: RE: Class Wars
Thanks for taking the time to read and thanks also for the nice words.
Lastly, thanks for all of your thoughtful comments.
This is the kind of dialectic I was hoping for when I wrote the paper. I have interspersed my replies within your comments below. I look forward to your thoughts.
From: Antonio Bernardo
Sent: Sunday, May 01, 2011 2:29 PM
To: Kip Hagopian
Subject: RE: Class Wars
Hi Kip, I read the unabridged version of your paper and I think it is excellent. Here are some comments:
– My hunch is that the divide between proponents and opponents of progressive taxation comes down to differences in beliefs about the relative importance of luck (broadly defined, including the luck associated with being endowed with good genes and upbringing), aptitude (here I’m separating the investments in human capital from endowments), and effort in the determination of income. A telling example is the title of Chait’s article: “The Rich are Different: They’re Luckier.”
Since you read the unabridged version, you read page 5, which deals with pecuniary luck (as I say in the essay, the real luck comes from being born with a high-value aptitude and caring parents). I really don’t think anyone can make a convincing case that pecuniary luck makes more than a minor impact on aggregate income (a few percent). Nor can a persuasive case be made that a significant number of people benefit from the luck of being born to wealth and privilege (maybe 1-2%). Most importantly, the contribution of any kind of luck in determining income does not change my thesis at all. Progression is still inequitable regardless of how your income is determined. If you haven’t already read it, please take look at the email debate I had with Chait on this topic. It is posted on my website just below the essay. I think it covers all of the points you have in mind and I believe I successfully refuted Chait’s arguments. Please let me know what you think.
I agree with you that pecuniary luck is a minor determinant of income, but it appears Chait is using a broader definition of luck (including natural aptitude and upbringing) which applies to a much larger group than children of privilege.
If he is using the broader definition of luck then he is agreeing with my statement on page 5 where I say the, “…the greatest luck of all…is being born with a highly valued aptitude and competent, caring parents”. But based on his column (“The Rich are Different: They’re Luckier”), he does not appear to be using the broader definition. If you read his critique of my essay (which appears in the four paragraphs following the section of my paper that he quotes), it is almost all about the luck of being born rich (albeit there is a brief anecdote claiming that Bill Gates got rich primarily because of the timing of his birth). When he talks about aptitude and work effort, he basically dismisses them as contributors to income. For example he says: “…it is demonstrably not the case that income levels simply reflect aptitude and work effort.” To be sure, his arguments get more nuanced when he engages me in debate, but for the most part he sticks to his guns; namely that income is derived primarily by the luck of being born rich.
This is a complex issue. For example, investments in human capital (e.g., education) are a big determinant of income but the value of these investments are complementary to individual endowments (e.g., education is most valuable for those with the highest natural aptitude). So, it is hard to separate the impact of “luck” (in the sense of natural aptitude) from human capital investment in the determination of income.
First, I am at best agnostic as to whether education is “most valuable for those with the highest natural aptitude.” It seems to me that work effort of all kinds (including that which is applied to education) is of greater relative benefit to people who are unlucky enough to be born with a more lowly valued aptitude. Second, I agree it is hard to separate “natural aptitude” from “human capital investment” in terms of their relative impact on income production. (BTW, as I say in the essay, human capital investment is probably the most important form of work effort there is.) But I don’t think it is necessary to find the dividing line between income derived from aptitude and income derived from work effort; it is only necessary to know that this dividing line exists and that both factors contribute to total income. I posit that wherever there are two people with roughly the same aptitude in the same occupation, the one that worked longer and harder in school, ended up making the most money (all other things being equal) in their lifetimes. And if both persons worked equally hard in school, the one that puts in the greatest work effort every day (either in number of hours or intensity) will make the most.
Nonetheless, for any given level of natural aptitude, the tax system should not discourage investments in human capital which is precisely what a progressive tax system does. I know you want to focus your arguments on fairness rather than efficiency, but I think the efficiency case against progressive taxation is very strong.
I agree. But I am not an economist; perhaps you and Richard will take up the efficiency issue.
By the way, the tax system should also not reduce one’s average, after-tax hourly income because he or she worked harder.
An economic argument in favor of progressive income taxation, for those who attach great importance to luck as a determinant of income, is that it is a form of insurance: if you are lucky enough to earn high income you pay higher taxes but if you are unlucky enough to earn low income you pay lower taxes (or, receive transfer payments).
I agree with that in principle but for a different reason. Under my “fairness doctrine” I use what I call the greater-value theory to justify higher taxes on higher income people, stipulating that higher-income people should pay more because they derive greater value from their government services (regardless of whether it is derived from aptitude or luck). But how much more should they pay? Under a proportionate tax, someone who is lucky enough to make 100X as much will pay 100X as much in tax. What is the principle that would support a higher payout than that? It certainly isn’t the benefits principle. I think I have shown conclusively that government benefits do NOT rise more rapidly than income. I also believe I have completely discredited sacrifice theory as a basis for a fair tax system.
Let me rephrase my argument as a Rawlsian “veil of ignorance” thought experiment. Suppose you think income is determined completely by luck and you are asked to choose a tax system not knowing whether you will be lucky or unlucky. Since individuals are risk averse they will prefer a tax system that equalizes outcomes (i.e., they will “pay” for insurance against bad luck). Such a tax system will be progressive because to get equal outcomes you have to tax income at increasingly high rates. In Rawls’ view, this constitutes a “fair” system because it would be chosen by individuals when they don’t know their circumstances. Of course, this argument relies heavily on the premise that luck is the major determinant of income determination. If work effort or human capital investment play a large role in income determination then individuals will not choose a system that equalizes outcomes.
I think you did a great job of building a straw man and then tearing it down. In at least one respect, your thought experiment is interesting because, if you exclude the impact of work effort in determining income, you can argue that luck is the only factor that determines income (within each occupation), since aptitude (as defined) is largely, if not solely, a result of luck (due to circumstances of birth). However, one thing you omitted from your comments on Rawls, is his view that economic efficiency is a necessary part of maximizing economic equality; thus he deemed it perfectly acceptable for some in a society to have more economic goods—a larger slice of the pie—as long as their success resulted in a large enough expansion of the pie to enhance the economic position of the least advantaged (see page 26 of the essay). So a tax system that would shrink the pie would not be acceptable under his theory. Contrary to the opinions of some casual readers of Rawls’s work, Rawls was not advocating for equal outcomes, he was advocating for a system that elevated the standard of living of the least advantaged in the society without unduly reducing aggregate incomes. Moreover, under his theory, this objective had to be met without infringing upon any individual’s basic liberties. Meeting that latter test is a tall order under a progressive system which, by its nature, is a coercive transfer of wealth. In any event, it is inconceivable to me from my reading of Rawls’s views that he would condone a policy that infringed upon a person’s right to better her or himself through increased work effort. And I certainly do not believe Rawls would support a system that reduced a person’s average, after-tax hourly income because he or she worked harder (my Rawls “consultant” basically agrees with that, although he might tax income progressively at very high income levels). So your last sentence is apt, because work effort clearly does play a large role determining income.
To go further, if you believe that all income is produced by luck then risk-averse individuals would prefer (in the Rawlsian sense) highly progressive taxation so that after-tax incomes are equalized.
My understanding of Rawls is that he favored a proportionate tax on consumption and only supported progression if the system could be shown to be unjust. But he didn’t define “unjust” for us.
If you believe that income is largely determined by investments in human capital and effort then progressive income taxation is hard to justify on efficiency or “fairness” grounds.
As to the latter, I would say it is virtually impossible to justify on fairness grounds (I would rather leave the efficiency issue to you economists). What conceivable rationale could there be?
– Related to this is the argument over the estate tax. My sense is that proponents of estate taxes are also proponents of the “luck” view of wealth determination.
You might be surprised to hear this (don’t tell Richard), but I actually support some form of estate tax. But that issue is beyond the scope of the essay.
I am surprised. Perhaps this should be the subject of your next essay.
I have not thought through the estate tax issue very deeply and when I do, I may change my position. As of this moment, my views are as follows: We should all pay for our government services in proportion to the value we take out. If I inherit money, even though taxes have been paid on that money when it was originally earned, it is income I am getting that I (as distinguished from my benefactors) neither earned nor paid taxes on. Thus, inasmuch as I am receiving benefits from my government, I think it would be unfair to my fellow citizens if I did not pay my share of the cost of those benefits in proportion to the value I receive. But I think the old system, which exempted $1 million and imposed a marginal tax rate as high as 55%, is not based on any identifiable principle and appears arbitrary and illogical on its face. I would prefer a system that allowed the estate to be held in a trust until income was withdrawn from it by the beneficiaries, at which time the the beneficiaries would pay taxes at the same prevailing marginal rates in place at the time. Thus, if the top marginal rate was 35%, and the income withdrawn from the trust (when combined with his or her other income) placed the beneficiary in that bracket, he or she would pay that rate. There would be no exemption from the tax, and income earned within the trust (pre-distribution) would be taxed at prevailing rates as to the character of the income. This idea is subject to attack from both the right and the left for all of the obvious reasons. But as you say, it could be the subject of another essay–if there ever is one.
– Your example of the Class brothers was very illuminating, but proponents of the “luck” view of income determination will argue that this example is not representative of the causes of income inequality in theU.S.
I don’t know why this is relevant. Income inequality is caused by many factors, not the least of which is aging (the older you are, the more experienced you are and the more likely you are to make higher income). I think it is clear that the primary cause of inequality is aptitude, so if you are saying that being born with a high-value aptitude is the “luck of the draw”, you are right. But there is no doubt that work effort does play a significant role and work effort provides virtually the only means of making up income differentials caused by differences in aptitude. Thus, progression has the truly pernicious effect of increasing inequality by reducing after-tax hourly income for the harder workers.
In your example, the brothers have similar luck (endowments) and aptitude, but their incomes vary because of work-leisure decisions.
Aren’t you agreeing with my point? To wit: Whether there are 1,000 or 100,000 tiers of aptitude in our society, within each tier (and within each occupation), those that work the hardest (those above the median in work effort) are being treated unfairly. How would anyone refute that? And how could anyone claim that is fair?
I do agree with you, but I am playing devil’s advocate.
– I think most Americans agree with your view but the issue is currently confounded by the popular belief that the wealthy take advantage of the large number of deductions/exemptions/loopholes in the tax code.
As I say in my “debate” with David Frum (it’s on the website), I have the best tax advice available but I don’t know how to reduce my taxes using “loopholes”. On the other hand, if you look at footnote 1, you’ll see that the credits and deductions from which Tom and Dick benefit are huge.
I don’t know if such a survey has been done, but I wouldn’t be surprised if a survey showed that most Americans believe that high-income earners pay a lower proportion of their income in taxes than middle-income earners because they exaggerate the importance of these loopholes.
They would be wrong, as I show with statistics on who pays taxes. (For example, the top 1% pay almost 40% of the taxes; the bottom 50% pay about 2.7% of the taxes; over 40% pay no taxes at all.)
I suspect that a flat tax rate on a broad-based definition of income with few exemptions would be very popular in theU.S.
It would be popular with everyone whose tax bill goes down; not so popular for those whose bill goes up.
I disagree. Tax-the-rich policies are often more popular among wealthy people living on the coasts while the Republican’s low-tax message is popular among many low- and middle-income voters who benefit from progressive taxation but believe it is unfair and aspire to higher incomes and fair treatment in the future.
I hope you are right, because the current system appears to hurt lower income people much more than higher income people.
– By the way, I’ve always been troubled by the terminology “progressive” and “regressive” because it refers to rates of taxation rather than total tax payments. For example, why do we call the payroll tax “regressive” when someone earning $100K pays twice as much payroll tax as someone earning $50K? Worse still, the high-earners expected retirement benefits are not twice as high. Language matters! Even though the payroll tax is a flat tax, it is an excellent example to dispel the benefits principle because one can definitively show that the benefits to the high earners are lower per dollar of taxes paid.
You are right. Please look at my footnote 7. Also look at my debate with David Frum. David is brilliant, but he is under the impression that payroll taxes are regressive. Payroll taxes are decidedly NOT regressive. Medicare tax is clearly redistributive. We each pay proportionately for essentially the same benefits, thus someone who pays $100,000 into the system gets the same medical insurance benefits as someone who pays $25,000. And the Social Security tax is at worst, proportionate (that is, for any particular cohort, the amount paid in is proportionate to or more than the amount paid out).
This is an example of why Richard Roll felt that you may not have gone far enough: even a flat tax can be demonstrably unfair!
I believe Richard’s point was that, inasmuch as government’s non-income benefits (life, liberty, protection, infrastructure, etc) are essentially the same for everyone, the fairest tax would be a head tax. I disagree with Richard based on my “greater-value” theory, which is explained in the essay. Nonetheless you are right that for some, a proportionate tax is unfair. I point this out in my “Critique of the doctrine” on page 24.
– One minor point: I believe your third point on the protection theory (on page 10 of the unabridged version) is incorrect. It’s true that declining marginal utility of income implies that individuals put less value on protecting each subsequent dollar, but wealthy individuals have more dollars to protect so the total value of protecting their wealth (total wealth not just the marginal dollar) will be higher. The other four arguments against the protection theory are more persuasive.
I am not sure I understand your point. In this context (and in the literature), protection theory applies to income only. I am not aware of a federal tax on wealth (other than the estate tax which is taxed under a different system) but if there were one, wouldn’t the marginal utility of money principle apply to wealth just as it does to income (that is, the more wealth you have the less you value the next dollar)? In any event I don’t say that people with higher income should not pay higher taxes, I say that their taxes, should not be disproportionately higher? What am I missing?
I’m sorry I was sloppy interchanging income and wealth. And, I misread your argument. My point was that higher income individuals should pay higher total taxes under the protection theory, but you are exactly right that this does not imply progressive taxation, i.e., disproportionately higher taxation.
We agree that higher income people should pay more, but I base my belief on my own interpretation of the benefits principle rather than on protection theory. Under one very respectable interpretation of the benefits principle, you can argue (as Richard Roll does) quite logically that a head tax is the most fair. This is because the non-income benefits of government (national defense, police and fire protection of property, infrastructure, etc.) seem clearly to redound to the benefit of each citizen equally. But I argue, under the “greater value” theory, that if you distilled all government services down to a single, ultimate benefit it would be “well-being”. I also argue that income is a quite reasonable proxy for well-being; thus, we should all pay taxes in proportion to the income we take out of the system. This insight was not very well refined or explained in the earlier draft that Richard read, so he correctly raised the question: If taxes are to be paid for government services, why shouldn’t we price those services as we would any other good. When we buy a car, we don’t set the price of the car as a percentage our income, we use market value; so why would we set tax rates in that way. My argument (as refined) is that the ultimate “good” we receive from our government is well-being. And since income is a reasonable proxy for well-being, the fairest price to pay for that good is an amount in proportion to income, which is, in effect, market value. In support of this position, I argue in the essay (see page 12), that the logic of it can be inferred by imagining that aptitudes (or any other type of luck) could be purchased on the open market. If such a thing were possible, it is certain that the more highly valued aptitudes (or luck quotients)—those that would produce higher incomes—would be bid up to amounts in excess of the per-capita cost of government (the head tax). Based on my reading, this principle is novel and stands out as the most persuasive case for rejecting a head tax.
From: Kip Hagopian
Sent: Tuesday, April 26, 2011 10:17 AM
To: Antonio Bernardo
Subject: FW: Class Wars
It was a pleasure speaking to you this morning. I have a call into Charlie Wolf to see if we can change the time of the May 10 event he is planning.
Here are Richard’s comments on the paper we discussed. What Richard read was a very early draft. I believe it is much better now, in large part because of comments from Richard and several other scholars who vetted it (you can read the names in the acknowledgments section of the website). As I told you, the essay was published in abridged form in the April-May edition of Policy Review, a publication of the Hoover Institution. You can find both the article and the unabridged version of the essay on a website I created for this purpose and for the purpose of hosting a debate on the issue. Here is the link: www.kiphagopian.com. If you decide to read the essay, I really hope you will take the time to read the unabridged version. It is somewhat longer but it includes some important subjects that got left out of the journal article.
PS: I have inserted in red, some replies to Richard’s comments.
From: Richard Roll
Sent: Saturday, February 27, 2010 10:10 AM
To: Kip Hagopian
Subject: Re: Class Wars
Thanks for sending the paper. It is excellent, in my opinion. Congratulations. I have only a couple of observations but I’m not sure they are worth incorporating in a future draft.
First, I think you give in too easily on a flat tax being equitable. True, it’s a lot better than a progressive income tax in terms of equity, but it’s also completely unfair. The flat tax implies that the price of government provided goods and services is higher for more affluent citizens. There is NO good or service produced by the private sector whose price depends on the income of the purchaser. Only government goods have this feature. Why is that fair? This explains, I think, why support for the provision of more government declines with income.
Tony: I think Richard is wrong about this, but he makes a great point (which was also made in the literature in the 19th century). It is interesting that most of the scholars who have historically argued in favor of a proportionate tax did not have a very good rationale for their argument. In addition to proving that progression is inequitable, I believe I have done the best job of showing that a head tax is also inequitable. This is based on my own interpretation of the benefits principle which I call the “greater-value” theory. That part of the paper wasn’t very clearly written in the draft Richard read, so I expanded on it to take Richard’s comments into account. I now feel comfortable with my position on this issue.
Second, even though everyone in the country might agree that both the progressive and flat taxes are inequitable, the voting majority will still support them because they benefit. They don’t CARE that these taxes are inequitable because they get government goods at below costs while the affluent minority pays for them. When self-interest is traded off against equity, self interest wins every time. People will take property away from others whenever they can do so legally or without punishment. As Mark Twain said, “He’s a man isn’t he. You can’t say anything worse.”
Of course Richard is right about this. But I am not trying to write something that is politically feasible; I am trying to write something that is true. If politicians are going to impose a progressive tax, they should at least know that what they are imposing is inequitable.
Third, minor point: You admit too easily that progressivity can reduce inequality. I’ll send you a paper on Monday that delves into this issue in great detail, but here let me just point out the basic idea. Let’s consider income (not wealth) after all taxes and transfer payments via the government. Inequality might be based on this after-tax and transfers income. My claim is that greater progressivity can actually INCREASE after-tax and transfers inequality. It can increase inequality rather than reduce it (contrary to your admission on page 19, infra.). The reason is that pre-tax incomes respond to tax progressivity so that more skilled persons have their pre-tax incomes increase when taxes go up. This can happen to such an extent that after-tax inequality ends up being higher even though the more affluent pay a higher share of total taxes.
This is very interesting and I have to admit, I did not have time (or space) to introduce it in the essay. I do say that redistribution “undoubtedly has some affect on income inequality”; I should probably soften that.
You certainly should send this draft around. I mentioned a few persons that would be good, but here’s a partial list:
Harvard: Robert Barro; Greg Mankiw; Andrei Shleifer
Wash U (St. Louis): David Levine
Chicago: John Cochrane; Robert Lucas; Gene Fama; Gary Becker
Princeton; Paul Krugman; Orley Ashenfelter
MIT; Steve Ross
If you don’t mind, I’ll send it to a few others who you probably don’t know, including a couple of philosophers (who are interested in justice) and some investment bankers friends.
Congratulations on a great paper.
Best Regards, RR
quoting Kip Hagopian:
Here, for better or worse, is a DRAFT of the paper we discussed. I remind you, this is a work in progress, so I will look forward to your comments.
Have a great weekend.
Class Wars-Rev Expanded Version-27-E.doc
On the day the article was published in Policy Review Jonathan Chait, columnist and editor of The New Republic, wrote a column in The New Republic challenging the article. His column was entitled, “The Rich are Different: They’re Luckier”. This is the link to the column: http://www.tnr.com/blog/jonathan-chait/86141/the-rich-are-different-theyre-luckier.
The thrust of the column was that my essay did not adequately consider the role pecuniary luck plays in determining income. Mr. Chait had not read the unabridged version of the essay, so he was unaware of that the role of luck was discussed in some detail (on page 5). I emailed him suggesting that he read that section. He was nice enough to reply, so it gave us an opportunity to explore the issue more fully.
Mr. Chait has given me his permission to post this with this caveat: “Please make clear it was an email, not a something I wrote intended to meet normal publication standards.”
What follows is the email string. The RED text insertions are my comments interspersed within his text.
Because it is an email string, it is best to read this from the bottom up.
From: Jon Chait
Sent: Thursday, April 14, 2011 11:32 AM
To: Kip Hagopian
Subject: RE: Your critique of my article in Policy Reviewur
Yes, you can go ahead and publish it. Please make clear it was an email, not a something I wrote intended to meet normal publication standards.
From: Kip Hagopian
Sent: Thursday, April 14, 2011 2:27 PM
To: Jon Chait
Subject: RE: Your critique of my article in Policy Reviewur
Dear Mr. Chait,
I appreciate your engaging me on the issues on which we disagree. My purpose in writing the essay was to ignite a debate over the equity of progression, so I am glad that you have chosen to express your views. Inserted in red are my responses to the points you raise in your last email.
As I said in my last email, I would like to post our email exchange on my website, which is the forum I created for this purpose. Of course, you are free to do the same on the TNR website. Are you OK with that?
From: Jon Chait
Sent: Sunday, April 10, 2011 6:55 PM
To: Kip Hagopian
Subject: RE: Your critique of my article in Policy Review
a few quick points:
1. I described you as wealthy because your bio described you as a co-founder of a venture capital and private equity firm. I made an assumption that you are therefore rich. is this not true?
Yes. By most people’s standards I am wealthy. But I didn’t start life that way, I started in debt. My father was a truck driver. I am the first in my family to go to college. I grew up inEast LA and have never set foot in a private school or college. I do not consider this “story” to be unusual or particularly “heart warming”; I know hundreds of so-called wealthy people who come from similar circumstances of birth. I am not sure what your point was in describing me that way.
2. I described you as a right-winger because the views expressed in your essay by definition make you a right-winger. If you read an essay arguing that capitalism is exploitation and advocating collective ownership of the means of production, would you not assume that the author was left-wing (even if he might have non-leftwing views on abortion or some other issue)?
By calling me a “right-winger”, based on the views I expressed in the paper, you appear to be saying that my conclusions are based on ideology, rather than objective scholarship. I could even infer that you are accusing me of intellectual dishonesty. Is that what you believe? If so, why? Instead of labeling me in a pejorative way, why not just identify what you believe are the weaknesses in my logic or scholarship and let it go at that? I expect people to disagree with me; that is how I learn. But your approach to disagreement seems to be uncalled for and not very productive.
3. We’re agreed that a rich child is likely to have better genetic intelligence, better parenting, better schooling, better social environment, and better health than a poor child, and that all these things contribute to aptitude and are likely to make him better prepared to make a lot of money in the market completely independent of any other luck factor. We’re disagreed on two points. The first is how appropriate it is to describe this as “luck.”
I do not necessarily agree with your first sentence as written because it assumes that the success in life of the children of rich parents is because of the parents wealth. I think you would agree that there is a strong positive correlation between, income and aptitude. So how do you know that the actual causal factor in determining a child’s success is the parents’ aptitude, and not his wealth? In all probability, the success of the children you describe derives from a combination of: innate aptitude, “learned aptitude” (due to the parenting skills of educated or rich parents), “ehnanced aptitude” (which comes from individual work effort), and, possibly, family connections. I would put “family connections” in last place on this list.
As to your question in the second sentence, I don’t really understand it. I consider myself one of the luckiest people in the world because I was born with an above average brain and caring parents. I think that positioned me to become successful in the occupation of my choice, whether it had been teaching school, investment banking, or running an investment company (which is where I ended up). According to your bio, your father was a doctor, which makes it very likely that you inherited a reasonably high IQ (by the way, was your father born into a rich family?). And from reading your work, it is clear that I am right. Do you not feel lucky that you were born with these endowments? You could just have easily been born to a single parent with a drug habit. As far as I can tell, you have been very successful at what you do. Do think your success was because of a lucky break or family connections? If so, don’t you think that, if you had not had such a break, you would still have achieved success?
The second is, I don’t feel you’re grappling sufficiently with the reality that luck plays an enormous role even outside of the parts of luck that contribute to aptitude. Again, poor kids with average math test scores generally don’t get to attend college, while affluent kids with average test scores do. Even after luck has stacked the deck of aptitude, being rich gives you even more luck on top of that. A lot more.
I am really surprised that you discount raw aptitude as much as you do. I don’t think family connections helped LaBron James very much and he makes $30-40 million a year. Steve Jobs was an orphan whose adoptive parents were middle class. Warren Buffet grew up in very modest circumstances. I could go on.
If a child in the top quintile who doesn’t get a college degree is more likely to be in the top quintile than a kid born into the bottom quintile who did get a college degree, then this is another powerful demonstration of the role of luck beyond aptitude. Indeed, bottom fifth college graduates almost certainly have far, far greater aptitude than top fifth non-graduates. I guess we are excluding from the sample, Bill Gates, Steve Jobs and Mark Zuckerberg (for example) who are all college dropouts?
Let’s assume you are right, i.e., the child of a of rich family generally goes on to make more money than a poor kid even though the latter graduated from college and the former did not. As I point out in the paper, the number of people who inherit a significant amount of money or who are born “rich” (if rich is defined as a family whose income exceeds $250,000–a very low bar for defining rich, in my opinion), is quite small. Based on the data I presented, it is around 3-4% of the population. That means the other 96% were not born rich. Actually less because when most people are born, their parents are just starting out in life. For those parents who eventually do get “rich”, it is usually not until their 50s, 60s or older that they achieve that status. By that time most their offspring are well into their careers, which suggests that the luck of coming from a rich family did not come at a time that could have had a significant impact. As I say above, the people who are most likely to achieve high incomes are those born into families who are high achievers. Those are almost always people who have high-value aptitudes, or who work very hard, or both.
We can agree to disagree on whether Bill gates, born 20 years earlier, would have been anywhere near as rich as he was. I can’t prove it.
I think it is very surprising that you would even make the assertion you did about Gates. By all accounts (including my personal time spent with him, my 25+ years of tracking his career, and my multiple investments in companies that competed with him), Bill Gates has one of the most brilliant minds and is one the most extraordinary entrepreneurs of the 20th century. On what conceivable basis do you suggest that, if not for luck, he would not have been highly successful? Of the things about your article that I disagree with, this is probably at top of my list.
There’s data enough to prove that just the class element of luck is extremely important, overwhelming the importance of aptitude. In other words I see your framework as not just in need of tweaking but fundamentally broken.
You say: “There’s data enough to prove that the ….element of luck is extremely important, overwhelming the importance of aptitude”. Here you are making a sweeping generalization. What data do you have to support such a generalization? You seem to be saying that the vast majority of successful people are successful because they were born rich. How does that square with the fact that less than 5% of families are rich? (Actually, using a better definition of “rich” it is closer to 1 or 2%.) If only 5% or fewer are rich, how can there be more than about that percentage of people who have the advantage you are attributing to luck? And how do you account for me? And the millions of other people like me who are mostly self-made. By the way, if you haven’t seen it, take a look at a short article by Russ Roberts (apparently another right winger), writing on the Cafe Hayek website. http://cafehayek.com/2011/04/theres-no-their-there.html He used the same data source as you in his recent review of Stiglitz’s essay in Vanity Fair. His insight is interesting.
So let’s turn to most important issue. To wit: What difference does it make whether some or most people become well-to-do primarily because of luck?. How does that change my thesis that progression is inequitable? To the extent that the lucky people work harder than all of the other people with the same amount of luck, the hardest working lucky folks will end up with lower after-tax income per hour than the lucky ones who don’t work as hard. This is inequitable on its face, is it not? And what if we leave work effort and aptitude out of the equation entirely; isn’t it likely that there is a distribution curve for luck (like there is for aptitude)? If so, some people would be luckier than others. If that is the case, we would want to tax people based on how lucky they are; i.e., the luckier you are, the more you should pay in taxes. Assuming we measure luck according to how much money you make, we would tax luckier people more than less lucky people. But how much more? This is the place where you and I probably disagree the most. What is the principle that would have us tax them at progressive rates? I believe that I have shown clearly that the non-income benefits of government are essentially equal for all citizens–that is, government benefits like national defense, police and fire protection, infrastructure, etc., are the same for rich, poor and everyone in between (assume the needy are taken care of out of spending programs). I believe I have also shown conclusively that the benefits of government (including well being) do NOT increase more rapidly than income. So what conceivable reason could there be to tax the luckier people more than in proportion to their income (which is the only thing I can think of that puts a value on luck)?
From: Kip Hagopian
Sent: Sun 4/10/2011 8:50 PM
To: Jon Chait
Subject: RE: Your critique of my article in Policy Review
Dear Mr. Chait,
Thanks for your reply. Sorry it has taken a few days to respond.
In thinking about your article, I’ve decided that its title is basically
correct. But as I mentioned in my earlier email, we disagree on which type of luck is really important. I contend that the primary determinant of income is aptitude and other circumstances of birth. Parenting and environment is a big part of the latter, so being born into a rich family could have some benefit (or not; many children of the rich really struggle), particularly since most well-to-do couples are better educated and are less likely to live in high crime areas. I suggest that the other end of the income scale is probably more important in looking at the luck factor. A child born to a single mother who is entrenched in poverty, is less likely to develop a high-value aptitude than a child born into a family in the lower-middle class or higher. A family doesn’t have to be rich to raise a successful kid, but a child raised by a single mother in abject poverty is very likely to be handicapped. So I would say that a better title for your article might be: “The Underclass is Different: They’re Less Lucky.” I say “less lucky” rather than “unlucky” because I have had very positive personal experiences with several young African-American men and woman who were raised in single-parent families in poor neighborhoods. These are college
graduates to whom my wife and I have granted scholarships to attend graduate business school. In each case their life story is heart wrenching but inspiring.
As I point out in the paper, very few people inherit large sums of
money, and what is inherited does not appear to be more than 3% of the sum of earned and inherited income. Moreover, only the top 2-4% of earners could be considered wealthy or privileged (if you consider someone earning $200,000 to $250,000 per year either wealthy or privileged), so it is seems unlikely that the “lucky” ones comprise a large group. So even if your concerns are valid with respect to the differences in upward mobility among people in the lowest income quintiles and those in the highest quintiles, the incidence of this seeming inequity appears to be minor. As I say in the essay, aptitudes are distributed unequally. This is unalterable.
But none of the foregoing is really relevant to my thesis. I am not
saying that the offspring of high-income people don’t have advantages in life. What I am saying is that, however and from whomever one’s aptitude is derived, it is for most people, the most significant determinant of income. And for any given profession, the second most significant determinant is work effort. So, let’s assume that Tom, Dick and Harry are the triplet sons of a very wealthy family, that all had the aptitude to become Harvard-educated, corporate lawyers. My contention is that if the three brothers’ work effort varied as cited in the essay, and that Harry’s wife also worked as a lawyer for the number of hours cited, the same basic inequitable outcome would result. I think this is plainly unfair.
Thus, I recap my position: 1) taxing income from work effort
progressively is inequitable on its face; 2) government benefits do not rise more rapidly than income, so taxing income from aptitude or work effort progressively is inequitable; 3) the most equitable (or least inequitable) tax system is one that taxes people in proportion to the amount of value they get from their government services; and 4) since income is a reasonable proxy for value received, income should be taxed proportionately, regardless of how it was derived–from aptitude, from work effort, or from “luck”. This means that if I earn 20 times as much money as Jonathan Chait, I should pay 20 times as much in taxes. This is
despite the fact that the non-income benefits you and I receive from our government are probably about the same.
The worst thing about the progressive tax is not how it affects rich
people–in fact, they are hurt the least. It is the people who are born with lower-value aptitudes–those whose primary means of raising their standard of living is by working harder–who are hit the hardest.
On another issue: You seem clearly to have implied in your article that I am a “wealthy right winger”. And you appear just as clearly to have used the term pejoratively. Why do you think I am a “right winger”? And what is your basis for speaking of me in a pejorative manner?
PS: Subject to your approval, I would like to post this email exchange on my website and yours. I am seeking your permission because I don’t feel comfortable posting your personal email comments without it. I will probably post my comments in any event and just refer to your article.
From: Jon Chait
Sent: Sunday, April 03, 2011 6:45 PM
To: Kip Hagopian
Subject: RE: Your critique of my article in Policy Review
Ok, thanks for the note. We’re agreed that luck plays a large role. Great parenting is the most important kind of luck. But the data I presented, which is one small piece of a great deal of evidence demonstrating the role of different kinds of luck, goes far beyond that. Right? The fact that poor kids who graduate college are less likely to be rich than rich-born kids who don’t shows that even having natural smarts and drive is not, on the aggregate, as important as circumstances of birth.
From: Kip Hagopian
Sent: Sunday, April 03, 2011 12:53 PM
To: Jon Chait
Subject: Your critique of my article in Policy Review
Dear Mr. Chait,
It appears from your comments on my article in Policy Review that you have not read the unabridged version of the essay, the link to which is referenced in footnote one in the article (the domain name is: www.kiphagopian.com.) Unfortunately, it is a bit longer than the PR article.
There are two important issues discussed in the unabridged version that, because of space limitations, did not make it into the PR article. One is the issue you addressed, namely, the role that pecuniary luck plays in determining income. You will find my analysis of this on page five of the full essay. My take on this will probably not change your mind, but I do think it is worth your time to read it. The short version is that I believe that luck is huge in determining income, but, for the most part, it is not the kind of luck you describe. The greatest luck of all is the luck of being born with a high-value aptitude as the progeny of competent and caring parents. As I define it in the essay, aptitude does not just derive from one’s genetic endowments, it is also shaped by parenting, life experiences, and quite importantly, one’s own work effort. So you are right to say that being born to a rich family can (but not always) lead to a higher valued aptitude simply because of the family environment. But the opposite is also true. Frankly, I have always felt sorry for most of the people I know (and have competed against) because they grew up rich (my father was a truck driver/entrepreneur). I think you are wrong, however, to
suggest that Bill Gates would not have become wealthy if had not been for the year in which he was born. I assure you Gates would NOT have ended up as a lab geek. And if he had started a restaurant chain, I am almost certain it would have been very successful. (Have you ever met him? I spent two hours over dinner with him once and he is quite impressive up close.)
I learn something from every criticism I get on the essay. In this
case, since I do say on page five that luck is a “minor” factor in
determining income, I should not say or imply that luck plays no role. When I listed the three factors that determine income, I should have made clear that these are the “primary” and not the sole factors. I will change the paper accordingly. This is thanks to you.
PS: In case you are wondering: The other important issue discussed in the unabgidged version is entitled, “On Social Justice: What Would Rawls do?”. It appears on pages 25-27.
KIP HAGOPIAN-DAVID FRUM EMAIL EXCHANGE
The following is an email exchange I had with David Frum, a friend who expressed certain objections to the notion of abandoning the progressive income tax. David is a Republican, a commentator on CNN, and the author of a blog named, “The Frum Forum”. The email exchange started on April 6 and ran through April 11. My comments begin just below, and continue as inserts (in red) in David’s April 6 email. It is best to read from the bottom up.
From: Kip Hagopian
Sent: Monday, April 11, 2011 6:33 PM
To: ‘David Frum’
Subject: RE: thoughts/trying again
It appears that I was not very persuasive in my last email. Heck.
I will try again. See inserts below.
From: David Frum
Sent: Sunday, April 10, 2011 9:39 AM
To: Kip Hagopian
Subject: Re: thoughts/trying again
Some further thoughts:
Sales tax is not the only regressive tax in US. The pension portion of the FICA tax is regressive: a person earning over the cap pays a smaller % of income in payroll taxes than a person below the cap. Property taxes are sufficiently random with relation to income that they will often apply regressively. Excise taxes and tariffs are regressive. The fees proliferating at state and local level are progressive. The interaction of rates and deductions can yield to regressive results.
Re Social Security taxes: The pension portion of the FICA tax (assuming you mean the Social Security tax) is NOT regressive. This is a misnomer. The fact that the SS tax is a lower percent of the income of someone whose income is above the cap, is not relevant in this situation. The amount of money taken out of the SS system at retirement by any particular individual is no more than directly proportional to what the individual paid in; so it can not be regressive. (I say “no more than” because I understand, for example, that someone who pays 4X more in taxes than someone else, does not get 4X the income in retirement that the other person gets; if this is so, the SS tax is progressive from the get-go. I am checking on this.)
Try looking at this from another angle: Imagine there is no SS system now and the government is proposing to establish one. The proposal is that when an individual retires he/she will receive an income supplement. But the government wants to put a cap on the amount of that supplement. Under this scheme, how much tax should be paid into the system by each person during their working years in order to make the system proportionate? Clearly, it would be the system we have now. If the income received in retirement was capped, but there was no cap on the amount of income that was taxed, the system would be progressive (i.e., millions of high income people would pay more into the system than they could ever hope to get back).
You are saying the current system is regressive. If you are right, how would you design a system that is proportionate? The only way I can think of to do it is to lift the cap on both the inflow and the outflow. But the system we have achieves the same result; it just limits the total amount of income anyone can get. Please explain to me what I am doing wrong.
Re Excise taxes and tariffs: I consider excise taxes and tariffs to be sales taxes because they are priced into the products when sold, so I was lumping all sales taxes together. We could also lump almost any consumption tax into that mix. I don’t want to debate the equity or inequity of a sales/consumption tax. Suffice it to say that I disagree with the notion that the inequity of one tax system should be a rationale for sustaining the existence of another system that is inequitable. Instead of keeping the inequitable progressive system, why not eliminate the sales tax?
Re Property tax: With the possible of exception of Calif. (because of Prop. 13), I consider property taxes, in the main, to be proportional taxes on wealth. I think wealth taxes are inequitable, because wealth is accumulated from earnings on savings and savings are the residual of income that has already been taxed. (By the way, I have my own ideas on the inheritance tax which will probably surprise you.)
From David: “NB: I dont disapprove of regressive taxes in all cases!”
My inclination is to be against all regressive taxes. But I have not thought deeply about this. I am interested in hearing your thoughts.
But as you say in your first paragraph below, one consideration in thinking about a supposed inequity is the question : how real is this problem?
I suppose I’d also have to add the question: how real is your solution? If we switched to a flat 25% rate while leaving the rest of the system of government finance in theUSalone, would we have moved closer to “fairness”?
Absolutely. We would have eliminated one of the inequitable systems, meaning up to half the working population (those whose work effort was above the median) would no longer be treated unfairly.
Not so long as tariffs remain in place
Tariffs are bad for all kinds of reasons.
and the inherent advantages for homeowners over renters – not only mortgage interest, but imputed rent –
What is the “inherant advantage for homeowners over renters”? A renter pays every single tax and other expense that a homeowner does, because all of these costs are passed through to the renter by the landlord. This includes mortgage interest expense, property tax, maintenance, and even the imputed return on the owner’s capital (the renter has no capital tied up so he has to pay the owner’s cost of capital–which his profit). There are only two advantages I can think of for owning over renting: 1) the psychic benefit of owning your own home (which I think is very significant); and 2) the potential for capital appreciation. (Of course this latter one is a two edged sword as millions of people discovered in the last few years.)
and the tax exclusion for healthcare and other fringe benefits.
The value of employer-provided health care is generally a higher percentage of the income of a low-income person than it is of a high-income person. As a result, the tax subsidy (it is a subsidy because health insurance benefits are not taxed) benefits lower income people more than it does higher income people. Thus, the subsidy increases progression, it does not decrease it. Do you disagree? Is so why?
As to inequality:
I think we must use money income. Otherwise we get this result
Joe earns $25,000 in 1997 and the same $25,000 in 2007. But he qualifies for Medicaid, and in the interim, the cost to the fisc of his Medicaid benefits have doubled. Joe is not better off! But your measure would make it appear that he i
With due respect, I don’t understand your logic on this one. I think it is clear that Joe is vastly better off because, in the absence of Medicaid, he would have to pick up the tab for his inflated health care cost himself. That is one of the many nice things about Medicaid; beneficiaries do not have to worry about increases in health care cost. Whatever the cost is, Medicaid pays.
Money income is an almost meaningless definition of income for measuring inequality or standard of living. Even the Census Bureau cautions people against putting faith in it.
And using money income, we see not only rising income inequality
Not really. Even the Gini for money income has not budged for about 10 years, and has risen only 3% in the previous 16 years. Using a more meaningful definition of income, the income inequality has declined about 2% in the last 16 to 23 years. You don’t seem to believe the figures I have given you. I urge you to look at the sources I cite (primarily the Census Bureau) and tell me where I have gone wrong.
but -just as you worry – inequality combined with income stagnation at the median income level.
I don’t know why you are so concerned about income inequality. You are not the kind of person that envies and resents other people’s accomplishments, so I can’t imagine that you begrudge Steve Jobs his billions or LaBron James his $20 million salary. If your concern is that Americans will some day rebel if we don’t do something about inequality, I don’t share it. Other than the pundits at the NY Times (Krugman, Herbert, Blow, Dowd, the editorial board, etc.) and almost all Democrats., most Americans don’t seem to care much about inequality. What they appear to care about it their own well being. Of course, I could really be wrong about this. But, in support of that view, here is an excerpt from an earlier draft of my essay that ultimately was cut. The study cited is by no means dispositive, but I think it is important.
Interestingly, according to at least one public opinion survey, the American people do not seem to be very concerned about inequality. In a 2004 paper by Alberto Alesina, Rafael Di Tella, and Robert MacCulloch, entitled, Inequality and happiness: are Europeans and Americans different? the authors reported that:
“Using a total of 128,106 answers to a survey question about ‘happiness’, we find that there is a large, negative and significant effect of inequality on happiness in Europe but not in the U.S….There is evidence of ‘inequality generated’ unhappiness in the U.S. only for a sub-group of rich leftists.”
I concur with everything you say about the innovators you mention. But half the profits earned in theUSin the first decade of the century were earned in the financial sector.
Do you have a source for this? I am not challenging you; I am just really interested in seeing this data.
And those guys’ innovations don’t smell too good these days ….
I agree. But everything goes in cycles. You have to have faith in the free market! :-)
I have three questions: 1) Do you think the current progressive income tax system is fair? If you do, how do you reconcile the treatment of the hardest and most productive workers in our society? 2) If all of the other tax systems (all the regressive systems for example) were left out of the equation (i.e., they didn’t exist), would you still believe our progressive system was fair? and 3) Why are you so concerned about income inequality when theUS standard of living is so much higher than the SOL of all of the other advanced economies?
 Journal of Public Economics 88: 2009-2042,
From: Kip Hagopian
Sent: Friday, April 08, 2011 11:26 AM
To: ‘David Frum’
Subject: RE: thoughts/trying again
These are very useful comments, particularly the ones that disagree with my thesis. It is very good for me to have someone of your intellectual heft challenge me. I have responded to most of your comments by inserting my own in red.
An overall comment I would make is that, as far as I could tell, there is very little in what you have written that challenges the intellectual foundation or merits of my basic arguments to the effect that progression is inequitable. The thrust of your comments seems to be that: 1) when other taxes are taken into account, the system is not all that progressive; and 2) income inequality is a festering, growing sore on the body politic that is dangerous to our democracy and must be redressed. Did I get that right? If so, it seems that are you saying that even if our current federal tax system is, in fact, unfair (particularly to those who were born with the fewest gifts), it’s not unfair enough to run the risk of alienating the public. Is that about right? If so, we may have a philosophical difference of opinion on this point, which are the hardest differences to reconcile. I believe the federal system is quite progressive and it hurts people with more lowly valued aptitudes much more than it hurts rich people. Moreover, I believe that any system we put in place should be based on an equity principle that supports it. In all my reading of the literature, I could not find any such principle that persuasively supports progression.
It is true that there are other tax systems that are regressive–the most prominent of which is the sales tax (is there another one?). It is also true that a strong argument can be made that regressive taxes are unfair. But if such a system is unfair, that should give rise to an effort to reform that system; not to efforts to sustain another system that is unfair in the other direction. (By the way, I have not thought deeply on this, but I am not a big advocate of consumption taxes. I think income is a decent proxy for the value of the benefits we receive from our government. Thus, we should pay for those benefits out of income through a proportionate tax. Just as taxing investment income is distortive, I believe taxing consumption is distortive. I have a running dialectic going on this topic with two of my U of Chicago trained economist friends.)
By the way, I inferred from some of your comments that you may not have read the most up-to-date version of the paper. If that is true, I urge you to read it; it is much better than the draft you read a year ago. If you decide to read, please read the unabridged version. (For what it is worth, the unabridged includes a section on “social justice” on pages 25-27.)
Thanks for all of your time and help.
From: David Frum
Sent: Wednesday, April 06, 2011 8:06 AM
To: Kip Hagopian
Subject: Fwd: thoughts/trying again
Begin forwarded message:
From: David Frum
Date: April 5, 2011 8:56:01 AM EDT
To: Kip Hagopian
Some thoughts that may be useful for you, then comments that maybe less useful afterward.
DAVID’S INITIAL “THOUGHTS” WERE REDACTED BECAUSE THEY WERE PERSONAL.
David’s comments: Now as to my own views:
I’m in an ironic position here, since I prefer a tax code with a few simple rates. I think we got it close to right in 1986, and the falling away since then has been troubling to me. I agree with your key point that progressivity can work horizontal injustice to people who apply more work effort.
I worry a lot about the economic costs of tax avoidance in a progressive system. They are very visible on the corporate tax side, but no less real on the individual side.
So why don’t I concur with the full conclusions of the paper?
Some of the reasons:
1) Your argument applies more forcefully the more steps there are in the progression, and especially for the intermediate brackets, where most incomes are found. In the 1970s, there were (I recall) 11 brackets, bunched closely together. Your situation exactly. But I don’t think it applies very forcefully to our world, where the top bracket hits at $373,000. The overwhelming majority of Americans earn incomes that will be taxed at either the 15% or 25% rates – the universe between $8000 of taxable income and $80,000.
I may not understand your point here. Having more brackets only smooths out the curve, it doesn’t change the basic fact that harder workers receive lower average, after-tax income per hour than workers who don’t work as hard. The Class brothers are basically in the category you describe and yet, the outcome is clearly inequitable. I have run the case for the three brothers where their respective incomes are: $25,000, $50,000 and $75,000 and Harry still comes out on the short end of the stick. Thus, I don’t see how this impacts my argument. Moreover, as you can see from footnote 1 of the paper, the tax brackets are only part of the equation; when you add in the various tax credits, the degree of progression is much higher.
2) Your argument ignores deductions, which in the real world are the real workers of horizontal inequity. If the brothers in your story all earned the same salary – all chose equally desireable dwellings – but one chose to buy his home in cash, the second to buy his home with a mortgage, and the three to rent – they would report much more dramatic differences in their tax treatment than 3 brothers earning the salaries most Americans earn. Ditto for state & local taxes. Ditto for one with a generous health plan vs one with no health plan at all.
As you can see in footnote 1 of the essay, I don’t entirely ignore deductions. As noted in the footnote, many of them tend to increase the degree of progressivity. It is true that the brothers’ respective tax obligations would be different if they chose the routes you describe. (By the way I think the deduction for mortgage interest should be eliminated. Ditto for state and local taxes. I also think that employee-provided health insurance benefits should be taxable income to the employee; either that, or the field should be leveled so everyone who purchases his or her own insurance should get a tax deduction.) But how does the existence of deductions change anything with respect to the inequity of progression. Are you saying that it is OK to tax progressively if mortgage interest or state taxes are deductible? What if it is Tom and Dick that gets a mortgage and Harry doesn’t; in that event Tom and Dick would each pay even lower taxes than they do now. As to state and local taxes, the deduction would be more or less proportional, so how does this change anything?
To do an honest analysis of this, I believe you have assume that all the brothers do the same thing (e.g., get a mortgage). If they did, Harry might do better because he has more income to shelter. But but he has that extra income solely because he works harder. Why should he be penalized for this?
3) Finally as I said on the phone, the American tax system as a whole is not very progressive. The federal income tax is not even half of federal revenues! Then you have to consider the state burdens… There is only one taxpayer after all.
Excluding payroll taxes (see comments below), it is much more than half of the taxes paid by individuals. Isn’t this what counts?
Combine the progressive federal income tax with the (at least for now) Medicare tax and the outright regressive Social Security tax – the regressive sales tax regimes of the states – and the more or less arbitrary with regard to income system of property taxes – and you get a different picture. And that’s before we consider the ease with which the very wealthy can redesignate income as capital gains … So I am left wondering at the real world relevance of your argument.
We may have a real philosophical difference on this point. As I say above, I don’t think it makes any sense at all to create or sustain a tax system that you know is inequitable for the purpose of mitigating the inequities or reducing the “burdens” of some other tax system. (As to the “burdens” of state taxes, remember that those taxes are being paid for benefits just like federal taxes are. That is the principal reason that they should not be deductible.) If sales taxes or property taxes are unfair ways to pay for the benefits of the state, change the system.
As to “the ease with which the…wealthy can redesignate income as capital gains”: I know this is a view held by the press and many politicians, both Democrat and Republican. It is also commonly believed that rich people can hire lawyers and accountants that will substantially reduce or even eliminate their taxes. If that is true, I feel stupid. I am what some would call “rich”. And I employ some of the best tax people on the planet. But I and my tax advisors really don’t know how to convert my earned income into capital gains income. I also don’t have a clue as to how to reduce my taxes below the amounts indicated in the tax tables (I am in AMT, so I don’t even get deductions). The notion that rich people can shelter substantial parts of their income is largely a myth. The only shelters for individuals (as contrasted with corporations) that exist anymore are the ones that Congress has deliberately built into the system under pressure from special interest groups to encourage certain behavior deemed important to the economy, or “the greater good”. Incentives to invest in real estate is a prime example, but the benefits are quite small and most, if not all of them, should be abolished. Another example are subsidies for buying “green” cars and other green things.
The “real world relevance” of my argument is that the vast majority of federal taxes paid by individuals in the lower and middle classes are the product of an inequitable system that primarily hurts people with more lowly-valued aptitudes. That is the real world in my view.
I know you argue that the payroll tax is not a tax but a system of forced saving. I doubt you ‘ll persuade many people with this argument. The payroll tax creates no individual property rights. Benefits can be adjusted at any time by simple act of Congress, even abolished outright. (As Paul Ryan now proposes to do for much of the Medicare claims of everyone under 55.) In 1937, the Supreme Court formally adjudicated the payroll tax a tax. That’s why it’s constitutional. (And why the individual mandate in healthcare may not be … unless it’s redesignated a tax, in which case it clearly would be.)
Re Social Security: OK, let’s call it a tax. But please explain to me why you think it’s regressive? Despite the lack of a guaranteed contract, and despite the fact that different cohorts have been, and may in the future, be treated differently, each individual in a particular cohort will be treated the same as every other individual in the cohort with respect to the relationship between money paid in and money taken out. The point is that the payments made into the system are directly proportional to the benefits each individual ultimately receives. Thus, the tax is not regressive. Moreover, when Social Security income is paid out, 85% of it is lumped in with other income (if any) and is taxed at progressive rates. I don’t think any of this is in dispute by tax experts. If you know such an expert who disagrees with this, I will definitely be interested in hearing his or her rationale.
Warren Buffett notes that he pays a lower rate of tax than his secretary. Because of the combined workings of the payroll tax and the capital gains tax, there are many, many wealthy people in theUnited States who can say the same.
As I say above, it is a misnomer to equate payroll taxes to income taxes. Social Security taxes are paid in return for very specific benefits that are proportional to the amount the individual pays into the system. In the case of Medicare, the tax is redistributive (the tax is proportional to income, but the benefits are basically the same for everyone). In the opinion of my tax expert, neither of the payroll taxes are regressive.
As to capital gains taxes (and all other income from savings), most economists believe (I can’t imagine who would not) that such taxes violate the principle of horizontal equity. To wit: if two people have the same lifetime earned income, tax equity requires that they each pay the same amount of taxes. But if one person uses all of his income for consumption, and the other forgoes consumption in favor of saving, the latter will pay higher lifetime taxes simply because he saved for his future. This is inequitable. Moreover, all capital gains from corporations are second taxes on corporate income, which is already is taxed at 35%. But I don’t want to debate this ( let’s save it for another paper). It is just something to keep in mind to remind you that there are a lot of things wrong with the current tax system.
4) I’m left to wonder: if not the progressive income tax, what IS the policy response to the intensifying inequality within theUS? In the 2000s, we lived through a decade where virtually all the benefits of economic growth were claimed by the wealthiest few. (GDP/capita rose sharply, but wages stayed flat, even for college graduates.) I think that’s a problem.
I guess you don’t agree with my analysis in the section on “Reducing Income Inequality” (pages 17- 22). If you measure income inequality by the Gini Coefficient (which is the most commonly accepted measure), there was no change in money income inequality from 2000 to 2009. But money income is really a poor measure of either income income inequality or standard of living. If you used a comprehensive measure of income, the Gini declined by almost 2% during the period 1993 to 2009. Moreover, if you look at consumption inequality (which the consensus of economists believe is the best measure of standard of living over the long term) it doesn’t not appear to have increased for 16 to 23 years.
As to flat wages, this also does not appear to accurate, at least over the last 25 years (I haven’t looked at the 2000s). Please go to page 20 of the unabridged and you will see data from the CBO that indicates that when using a comprehensive measure of income (as defined), during the years from 1983 to 2005, real median household income grew 35%. The economy was strong in the years 2006, 2007 and the first half of 2008, so I would think (but am not certain) that this growth would have continued.
I am not sure where you got the facts you cite above, but I am pretty sure mine are accurate. If you have other sources that show my data are wrong, I would like to know about them.
The progressive income tax is a poor instrument to deal with this problem, but along with the even more dysfunctional estate tax, it’s the only one we’ve got. If not that, then what? Nothing? ANd what happens to our democracy if nothing is done?
I don’t know why you are worried about income inequality. Isn’t it more important to worry about the median standard of living while ensuring that our truly needy citizens are taken care of? By the way, there was a huge study done in 2004 (?) that indicated that Americans were not really worried about income inequality. I can get you the cite if you are interested.
The richest man in the US in 1960, J Paul Getty, could not possibly have funded a presidential election campaign himself. (Joe Kennedy’s crack about “not paying for a damn landslide” applied to a single primary, and in one of the country’s poorest states.) But George Soros or the Koch brothers or Sheldon Adelson could buy negative ads to equal the entire billion-dollar Obama campaign – and still have multiple billions left over. We’re getting into the territory here of the late Roman Republic, where as the triumvir Marcus Licinius Crassus said, no man should be considered rich unless he could field a private army.
This is another area where we may see things differently. It would be fun to discuss it some day over a cocktail. Suffice it to say for now that, if the cost of achieving the massive world-wide productivity gains that have been brought about by Intel, Apple, Microsoft, FedEx, Google, etc., is that Bob Noyce, Gordon Moore, Andy Grove, Steve Jobs, Bill Gates, Fred Smith and Sergey Brin and Larry Page, all end up becoming multi-billionaires, then I am really happy with income inequality. By the way I know or knew most of these people and they are all as decent and compassionate as you and I are (or think we are). And they give/gave much more to charity.
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Thank you for this very thoughtful essay. You mention Marx: “From each according to his ability.” Do you see any connection with: Luke 12:48 From everyone who has been given much, much will be demanded; and from the one who has been entrusted with much, much more will be asked.
Finally someone (Kip) actually does the research and establishes the rational for a tax system that would encourage production. As an executive, business owner, and former blue-collar-wage-slave-who-was-taxed-more-for-every-hour-of-overtime-than-the-overtime-rate, I can personally attest to the counter-productive nature of a progressive tax system. Myself, my co-workers, and later, my employees railed at the unfairness. Per-capita is politically untennable, a flat tax on ALL income would be so much more fair.
I disagree with the idea of a basic exemption, even though I have been below the poverty line at times. Everyone must have skin in the game. Otherwise they will simply vote for more benefits and not work.
I’ve heard once another parable, about 10 friends who dined once a month and, due to very different incomes, agreed to split the bill in such a way that a few paid most, some paid very little and some didn’t paid at all. But then the devil decided to break their friendship and the restaurant owner offered to give them 20% discount. The people who didn’t pay anything thought that they also should participate in the windfall while people who paid most thought it would be unfair. The affair ended in two most contributing people leaving and breaking the beautiful friendship.
In my country (Denmark) the government reduced the taxes a few years ago by a few percent and since that time, every socialist politician reminds the voters every day how heartless rich rob working people of their money and how much this tax reduction is “costing”. That, in a country with the highest tax level and most equality in the world. Nothing strange in it because most voters do not work (it sounds unbelievable) and will support any tax increase any time. Just a warning where socialist justice leads to.
@Casey: I agree with most of your comment. Whether or not you support with progressive taxation (and I on balance do), this pure fairness line of argument is not a solution to it in the real world (although, I think fairness may come into it).
But I think you have the risk and loss scenario the other way around. Or rather look at it from an unrealistic perspective. Since you only look at the value of what is lost and not at the value of what remains. In fact, in the case of a uniform 90% loss, Harry would be the only one with a viable income on which to build a future life. Both Tom and Dick would loose pretty much everything in an experiential sense of the word. Going from affluent to just above poverty level may be a shock to the system (and many never get over it) but going from poverty to abject poverty is a much more serious situation. There is a bigger human difference between going from a mansion to rented apartment from going from an apartment to live in the streets. Or going from a gated community to a block of flats, compared to going from a block to the slum.
Also, it is much much more difficult to get off the streets (although many people do) than it is to recover lost affluence.
And here’s where we can find a better foundation of faireness. The rich don’t bear nearly the same amount of risk from the same ill-advised decisions. If you loose half a fortune, you still have a fortune. If you loose half your minimum wage, you have nothing. It’s not the protection they get from the state from potential revolting masses. It’s the protection inherent in their wealth and the automatic status it affords.
There is a whole developing country hiding within the United States. Country whose members live in poverty and in some cases in a police state. In this context, talking about fairness of taxation between a rich doctor and a richer doctor is obscene.
Dear Mr. Lukes,
With respect to your first three paragraphs, please look at my reply to Mr. Casey. In summary, the use of protection theory, whether it is protection of assets (which is what is left over after consumption and paying taxes) or income, leads logically to a per-capita or “head” tax, which, of course, is regressive and is rejected in the essay.
As to your statement, “The rich don’t bear nearly as much risk [as poor people]….If you lose half a fortune, you still have half a fortune.”: This line of thinking leads logically to lower, not higher taxes on the rich. This is discussed in some detail on pages of 9, 10 and 11 of the unabridged version of the essay. Note that, in considering the protection theory interpretation of the benefits principle, both Seligman (quoted on page 9) and John Stuart Mill (quoted on page 10) make the case that the poor would suffer most if the protections of goverment were withdrawn, thus, under this theory, it is they who should bear the greatest burden of taxation. If you read on you will see why I believe, under the “greater-value” theory, it would inequitable to do this.
I don’t understand the purpose or meaning of your last paragraph. Are you saying that because there is poverty in the US, we should not care about the millions of others in the system that are being treated unfairly by the tax system? I don’t see how these two issues are related. As stated clearly on the essay’s 3rd page, I believe “…support for truly needy citizens” is a legitimate function of government. Currently over 40% of workers do pay not taxes; nor do the unemployed poor. Additionally, the US spends about $750 billion per year on “safety net” programs. Poverty is a serious problem and entrenched poverty (multi-generational) is a tragedy. But it is an issue that is beyond the scope of the essay.
Thanks for your comments,
Thanks for compiling the arguments and doing the research. Great work. But! I must say I agree with Mack. The idea that greater earnings are the product of greater effort acting on greater aptitude is essentially an unexamined axiom. And one that lacks warrant.
It is only true within certain bands of income. A lawyer who makes $100,000 a year maybe less talented or equally talented but less hardworking than one who makes $150,000 a year or even $250,000 but is she 10 times less talented than one who makes $1,000,000. There is a finite limit on hard work. The maximum theoretical number of hours per week is 112 (assuming 16 hours a day for 7 days a week). Assuming this could be doubled through increased efficiency and assuming equal talents, a lawyer of equal aptitude working 40 hour work weeks should only make 5.4 times less than one working 112 hours a week at double the efficiency. The rest is down to luck of getting a high paying job, accident of birth, misrepresentation or illegal activity (like double billing).
And to make this more difficult, there are a finite number of sources of income available through increased aptitude/skill and hard work. It is simply not true that other things are equal when it comes to income and assuming it is just like assuming the Earth is flat when building a light house. The assumption works fine for the actual building of the lighthouse but may render the lighthouse useless to ships coming from a certain distance.
In conclusion, this view of inequity works within certain income bands and socioeconomic groupings but not in the least across them. The story of the three brothers is simply not representative of anything in existence. People of different income levels don’t even live in the same world let alone on the same street. Add to it gender and race and any semblance of an acceptable analogy is gone.
Mr. Hagopian, I’d like you to address three questions:
1) Why you focus solely on income taxes. Payroll taxes are extremely significant here in the US and they are regressive for people at higher incomes because of the cap. Furthermore, many of the poorest American pay little income tax but significant payroll taxes. “Tom”, in your parable, might pay no income tax, but he is surely paying other taxes that take a real bite out of his much smaller paycheck.
2) Why you don’t look at “working harder” in a more nuanced way? I am a physician, make a good living, and work fairly hard. My colleagues who are surgeons work much harder and make more money — but no practicing doctor approaches the income potential of a CEO or investment banker. And this is not even to address the question of whether cops, firefighters and soldiers — who work in shifts and risk their lives regularly — can be said to be “working hard.”
3) What is the intended purpose of your paper? It’s clearly not conventional economics, but it’s not quite moral philosophy, either. As a fellow writer of research articles (in a very different field), I’d like to know what you hope to effect with this article.
I will take your questions in the order presented:
1) In footnote 7 of the article (and the unabridged version of the essay), I explain why payroll taxes are not regressive. (In fact, the Medicare “tax” is redistributive.) Both Social Security and Medicare levies directly benefit the individual payers. In the case of Social Security, each individual’s payments into the system ultimately come back in the form of Social Security income in retirement (it’s not as simple as that, but you get the idea). Medicare levies are essentially pre-paid insurance premiums that pay for medical care in retirement. Each individual’s Medicare payments are proportional to his or her income, but the actual health care benefits are basically the same. Thus, higher income people (who pay more for their Medicare benefits) are effectively subsidizing lower income people which makes the system redistributive, not regressive.
2) Other than the effects of supply and demand, which is the ultimate determinant of prices (and wages) in a free market system, I cannot account for the reasons why our free market system values certain professions more highly than others. I understand the frustration of seeing large paychecks going out to certain people whose contribution to society you might not value as much as others who are not paid as well. But I do not believe this issue in any way impacts the fundamental point I am making about work effort. What I am saying is that within each tier of aptitude and within each profession, there are people who work harder than others. For example, assume Danny works 60 hours a week while another doctor with the same skills works 40 hours a week. Under a progressive tax system, you will earn a lower after-tax hourly income than she/he does. This seems inequitable on its face.
3) Economists are extremely important to the debate with respect to determining the most efficient tax system. But other than their insights into the marginal utility of money, I don’t think they necessarily have more to contribute to the debate over equity than engineers, accountants, teachers, truck drivers, or physicians (like yourself). To be sure, divining the most equitable tax system requires some understanding of economics, but in my opinion the issue is much more about moral philosophy (as you put it) and logic. Mostly logic.
I have long believed that the progressive income tax was unfair. And yet, every time I turned on the TV or picked up a newspaper, I was told that the “rich do not pay their fair share”. But no one suggested a logical basis for deciding what is a fair share. I wrote the “Class Wars” parable many years ago to clarify my own thinking. I felt then and I feel now that the insights presented in the parable (which is only three pages) are almost all anyone has to know to see that a progressive tax is inequitable. All the rest is intellectual foundation. So, the reason I am doing this is to contribute to what I believe is a very important debate over tax policy, and in the process possibly change some minds. We needn’t worry so much about the rich people who are being unfairly treated by our progressive system; they will do just fine. It is the Harrys we need to worry about. The reality is that for those people who are born with a less highly valued aptitude, the only way they can raise the standard of living for themselves and their families is to work harder. But if they work harder, the progressive tax has the effect of reducing their after-tax hourly income for each additional hour worked.
Thank you for taking the time to read the essay and for your thoughtful questions.
Dear Mr. Mack,
Danny is not necessarily in a “medical doctors group”, he is probably in a specialty of some kind which more narrowly defines his “occupation”. Since he apparently is not a surgeon, he should not be compared to surgeons, even if his aptitude would enable him to be successful in that occupation. He has chosen a profession that is not as highly valued in the marketplace in terms of pay, because he prefers it to the life of a surgeon.
Let’s assume Danny is an internist. My hypothesis is that within this specific occupation Danny should be compared to other internists who have substantially the same aptitude as he does. The Class Wars parable would be just as relevant if we substituted internists for carpenters and doubled or tripled the income figures. Just like carpenters, there are internists who work harder than other internists. If Danny works harder than the median level of work effort among the internists with the same aptitude, under a progressive income tax, his after-tax average hourly income will be less than the internists that don’t work as hard. I contend that a system that produces such an outcome is unfair on its face.
As to your last sentence, it is not important to be able to precisely “compartmentalize” (if I understand your use of the word) people into their tiers of aptitude; it is only important to know that such compartmentalization exists, i.e., that there are in fact tiers of people within each profession that have essentially the same aptitude. Some work hard and some don’t. In a progressive system those that work hard are penalized.
Thanks for your comments.
First, I think you short-shifted the “protection” aspect of the benefits principle. Think of it less as a function of the cost of risk or the marginal utility of income, and more in terms of what it would take to recover from catastrophe. They aren’t so much insuring themselves against loss, as ensuring that unrecoverable losses never happen — something that hits Harry harder than the other two brothers.
Imagine that a Zombie Apocalypse swept through their little street before their taxation negotiations were complete, with Tom, Dick, and Harry each losing 90% of their wealth, property, and assets. For leisurely Tom recovery from this loss would be pretty easy. Dick would have to tighten his belt and perhaps save a little bit more, but he too would eventually recover. This is because these two brothers didn’t save, so their assets increased linearly as a function of their income.
But Harry would likely NEVER recover to his previous levels of income and assets, because so much of his previous income was tied up in investments. He hasn’t just lost 90% of his stuff, but he has also lost 90% of his retirement savings. Worse, however, he has lost ALL of the future earnings of those lost savings, and ALL of the future earnings on those future earnings, and ALL the future earnings on those future earnings on … and you get the picture.
Harry was smart enough to increase his earnings geometrically, but that means his potential losses are geometrical too. Looking far enough ahead, his potential losses, then, approach the infinite. Even limiting things to his lifetime, his lost income on his lost investments probably exceeds what he recover by just working a little bit harder or longer. If Tom and Dick point this out to Harry during their negotiations, it would still be rational to sign off on a progressive tax rate so long as the rate doesn’t increase faster than his projected rate of return on his investments**.
**Whether or not this is the case is certainly beyond MY abilities — I’ll leave that up to you to decide.
Second, the Devil — and Luck — are hiding in the ‘Ceteris Paribus’ clause.
Framing this as a moral debate, partly predicated on Fairness, while ALSO simplifying income to a function of three factors (aptitude, work effort, and choice of occupation) is a bit of a sneaky maneuver. If you are acting as an economist, dropping Luck from the equation is fine (being a random factor, its effects on the overall economy will cancel themselves out, and so approach zero). But the impact of Luck — or random chance, if you will — has a non-zero impact on INDIVIDUAL lives, and this impact affects your thesis.
Think of it like this: if you can control for two factors (aptitude and choice of occupation), then income is dependent solely on the remaining factor: work effort. That means you can read backwards from an individual’s income and determine that individual’s work effort input. Except, of course, you can’t do that in the real world. The well-off are one car accident away form insolvency and the lazy are one lottery ticket away from riches — and an average guy who knows a guy who knows a guy can end up with a high-paying job out of reach to the talented but unconnected kid from the wrong side of the tracks. Income and work ethic may be related, but not in any strong way that allows you to read the one straight from the other.
You want to defend the thesis that “people who work hard shouldn’t be punished by higher taxes” — which should be simple because for most of us our moral intuitions would agree. The problem, though, is showing that people who work hard ARE routinely punished by higher taxes. If income and hard work are interchangeable, through simple replacement all you need to do is point to the tax code and voilà! Your case is made! But income and hard work are interchangeable in that way only in thought experiments and mathematical models. The real world is much messier.
I’m not an advocate of the idea, but most Liberals seem to think that progressive taxes are a surcharge for Luck. Considering how hard it is to become wealthy, there might be a case to be made that wealth is a good proxy for measuring Luck. But unless you can actively show that Luck doesn’t undercut the identity you require for your thesis, your paper only convinces those who already agree with you. And it is those who — because of the impact of Luck — don’t buy into the identity and interchangeability of ‘work ethic’ and ‘income’ who need to be convinced, since they are the primary proponents of progressive taxation.
Dear Mr. Casey,
I don’t believe I have “short shifted” (sic) anything. Protection theory would most logically lead to a head tax, since there is no additional cost to protecting a rich person than a poor person. That is true whether we are talking about current income or assets (which, for the most part, comes from income that is saved). Moreover, the protections of government are not just economic, they include protections of life and liberty. And since a poor person values his life and liberty as much as a rich person, protection theory again leads to a head tax. I argue that a head tax would be inequitable, because it assumes protection is the only benefit of government services, when in fact the ultimate benefit of government is well being. Under the “greater-value theory”, I use income as a proxy for well-being, which leads to the reasonable conclusion that the amount of payment for government services should be in proportion to the income taken out of the system. To be sure, there are flaws in this logic that make this approach less than perfect. They are described in the “Critique of the Doctine” section.
The “luck factor” is discussed in some detail on page 5 of the unabridged version of the paper. I think it is pretty clear that the percentage of people and the amount of aggregate income that can be traced to luck is quite small (less than 5%). Moreover, whether someone derives their income from luck, from aptitude, or from hard work, it makes no difference. Putting aside the obvious and clear inequities of taxes which reduce the after-tax, average hourly income for the hardest workers, progression is still inequitable. Income is what we each take out of the economic system. In order to make a case for progression you have to show that government benefits rise more rapidly than income. In my view, this is an impossible case to make. Thus, if luck results in someone earning 10 times a much money as someone who is not lucky, the lucky person will pay 10 times as much tax. How would you justify a tax higher than that?
The real world is “messy” as you say. But it does not change the reality. There ARE tiers of people in each profession who have essentially the same aptitudes. I think this is an irrefutable fact. Within each group there are some people who DO work harder than others. The harder working group will see its average hourly income reduced simply because of its extra work effort. This is plainly inequitable. It is NOT important that we identify and measure each person’s aptitude and work effort in each and every tier; it is only important that we know such tiers exist and that there are people in every tier who work harder than others.
Thanks for your comments.
Kip does a really thorough job going through the fairness and philosophy of taxation. The story at the beginning really illustrates it nicely.
The wealthy in society are a minority group that is systematically discriminated against. Most people do not understand that wealth is created. They think it exists, that some people are just rich, and that the rich people should pay. Like most beliefs, those convictions are an expression of their interest. Also, the idea of rich people bearing the cost is consistent with a mindset that says there should be equality of outcomes.
Taxation, at root, is expropriation by force by the crown. The emergent tax system is politically driven and embodies several competing values, including class envy, political power, the efficiency of collecting taxes, and more.
Since states want more revenue, ultimately what drives any state toward having a better, fairer, less burdensome tax system is competition with other states for capital and labor. Also, sometimes, policymakers have the counter-intuitive insight that reducing their percentage take can increase their overall revenue because of growth. Capital and labor move to where they are most welcome. Ditto among countries. Some of why California is struggling is that the tax and regulatory burden is higher than other states, so people and jobs are leaving.
It is important to remind people of the fundamentals as Kip does in this paper. Having more of our policymakers understand these principles would be a net gain for society. I would assert, however, that those advancing progressive taxation are doing so despite knowledge of its destructive effects and purely to advance their political interests.
What is the old adage? Socialism works great until you run out of other people’s money.