Thoughts on taxes

On Twitter, @Downtownjeff asked for my thoughts on a flat tax.

I like the question. Here’s the start of my answer.

I prefer a simple income tax system. I don’t have a preference for it being a specific ‘flat tax’ or a ‘fair tax’ plan that has been proposed by some folks in the past. I just think simpler is better.

I have several reasons for believing this.

  • No matter the complexity of the income tax system, government collects about the same percent of the overall economy’s income (GDP) in taxes.
  • We don’t get the social engineering benefits that we think we do from the cleverly designed tax code that we have. We may only get bad outcomes.
  • The belief that the tax code can and should serve as a social engineering mechanism is a root cause of the government corruption that very many people complain about.
  • The only purpose of the tax code should be to raise money to support government expenses.
  • A fair tax system is one where everyone pays something to support government.

I plan to expand on each of these reasons in future posts. In this post, I’ll say a little more about the last reason.

Folks become wealthy by producing stuff that we trade our own produce for willingly because we find value in it. We call that a mutually beneficial trade.

A side note on the value creation process:

I trade away what I earned in a few minutes of work for a cup of coffee, for example.

My employer valued whatever he got from me in those few minutes greater than what he paid me.

I valued what I got paid more than having those few minutes to do something else.

The coffee shop valued what I earned in my few minutes of work more than the coffee they sold me. 

I valued the coffee even more than what I got paid in those few minutes of work.

That’s how value creation works. In two relatively simple and common transactions, value creation compounded in the economy. I got a cup of coffee. My employer got an edited communication (and, no that’s not what I do for a living, but it is a part of what I do). The coffee shop got resources to invest in more coffee and crew.

Many of these folks are lucky. But they are also persistent, hard-working and they take risks that you and I couldn’t stomach. They failed several times before discovering something that you are willing to trade some of your own produce for and have been flat broke.

These folks pay for the vast majority of this country’s government. We should thank them.

But, rather than thank them, we want them to pay even more. How ungrateful!

While demonizing these folks — again, the folks who produce many of the things that we couldn’t live without — we give a pass to the folks who spend all of the taxes plus another TRILLION a year. And, we re-elect these fools.

We are demonizing exactly the wrong folks.

We believe it’s okay to demand large government without having to pay our fair share.

The Federal government alone spent about $30k per household last year. If your household paid more than $30k in Federal taxes, congratulations, you’ve paid your fair share.

If you didn’t, then you need to start sending thank you notes immediately. You’re being very rude. How many years have you relied on the good fortune of others to support the government that you have?

At least we try to justify our rudeness. Well, wealthy people benefit more from government than we do. Or simply, they can afford it. So what. Neither of these mean that everyone can’t pay something.

We all benefit from government (at least the parts we stand to benefit from). We should all pay. If you want to pay less, then everybody pays less. If you want more government, then you pay more also. It’s that simple.

It’s not fair to want more government without picking up some of the tab.

Further thought:

Maybe our tax bill should first show us how much our fair share would be if we divided government spending evenly among everyone (e.g. $30,000/yr).

Then it would show us the amount we actually pay in taxes (household with median income of $50,000 would pay approximately $10,000 including Social Security).

Finally, it shows us the difference and recommends that if your even share of government is greater than what you actually paid that you ought to be thank your fellow taxpayers for helping to pick up your share of the tab. (-$20,000)

Maybe, it could even accumulate over the years so you know where you stand since you entered the country. (Probably a big negative number)

Then we could single out the tax superstars — the folks who have far exceeded their fair shares in their lives. That way we know that not only have they produced great value in our lives through the private sector, but they’ve also helped us afford a larger government than we could have ever afforded on our own.

Consultants and Mass Transit

I recommend listening to these Freakonomics podcasts, I Consult, Therefore I Am and Mass Transit Hysteria.

Over the years, I’ve had the pleasure of working with management consultants from some of the biggest names in the business. Based on those experiences, I agree with much of what was said in this podcast.

I was amused at how a former consultant interviewed on the podcast relayed how the consulting gig was described to him by fellow consultants:

50% of the job is nodding your head at whatever is said. 30% of it is just sort of looking good and the other 20% is raising an objection, but if you meet resistance, then dropping it.

Steven Levitt described some lessons from his young consulting days. One lesson he learned was that the answers can’t always be found in the data and he said:

I [now] have this incredibly deep appreciation that the people in the middle and bottom of the organization absolutely know what’s going on and a lot of time the people at the top have no idea what needs to be done.

The show host, Dubner, explored the key question: Why hire management consultants? Especially when many of them are inexperienced recent grads, their recommendations are often obvious (or dumb) and there’s limited (actually none beyond low-hanging fruit) evidence that consultants actually help.

Why? Executives may want to gain legitimacy for stuff they want to do anyway or they may want to buy plausible deniability.

In my experience, it has been the latter. Being an executive is rough because every decision carries a job-costing risk. Paying McKinsey or Boston Consulting Group a million bucks to tell you what to do gains you a bit of finger-pointing potential when the Board of Directors start hammering about your lackluster performance.  “But these smart guys told me to do it.” The scapegoat doesn’t last long, but it often buys the exec one or two more shots. Of course the Board should point the finger right back at the manager and say, “But this smart guy hired them and followed their advice.”

I wrote more on the subject of consulting in my posts, …And that resulted in what? and Be leery of big words. I still like this paragraph from the latter:

Can you imagine what the owner of an NFL team would do if his head coach hired a consultant to tell him what strategy his team should use to win games?  That’s right.  And that’s what Boards of Directors should do to managers who do that in business.

Mass Transit

In the other podcast, they discuss something about mass transit that I rarely see mentioned: Actual ridership.

According to the guest on the podcast, when actual ridership is taken into account, cars are more energy-efficient than buses and trains aren’t much better.

That’s mass transit blasphemy, isn’t it?

Mass transit proponents like to present us with idealized scenarios of heavily loaded vehicles. But, it turns out in the real world that a train or bus that moves a lot of people in one direction in the morning and another direction in the evening, make a lot of return trips when they are empty.

Also, they are typically run on schedules throughout the day when ridership is very low.

An efficiency advantage our cars have is that they don’t drive around empty all day while they wait to carry us home.

 

Warren Buffett on Taxes?

I’m glad others are starting to call out Warren Buffett’s hypocrisy. See here from the Weekly Standard and here from Harvard economist Greg Mankiw.

I’ve been saying this stuff for years. These are from me:

Presumptuous Economists

In this post on her blog, Econgirl nails on the head what I attempted to say in my recent post, keyenesian econmists misjudge the economy.

In her post, Econgirl has an imagined debate between philosopher Michael Sandel and a group of economists. Here’s the pertinent exchange:

Sandel: The second limitation to market reasoning is about how to value the good things in life. A deal is economically efficient if both parties consider themselves better off as a result. But this overlooks the possibility that one (or both) of the parties may value the things they exchange in the wrong way.

Every Economist Ever: The “wrong way?????” Who in the hell are you to tell people what they “should” be valuing? Some economists may try to account for tastes, but none of us are presumptuous enough to tell anyone what their tastes should be.

I disagree with Econgirl that ‘Every Economist Ever’ would have that response.

The point I tried to make in my post is that keynesian economists are presumptuous enough to tell people what they “should” be valuing when they see what they call ‘aggregate demand’ fall.

Rather than considering why aggregate demand fell (i.e. the reasons folks are spending and investing less), they simply assume it is bad (a presumptuous subjective value judgement) and the government must override the will of all of those people.

Rather than considering that aggregate demand fell because people are being more careful with their money (because they no longer have banks willing to loan them money on their bad credit), or foresee more uncertainty in the future (because government has taken an active role in arbitrarily changing the rules), or are changing what they value (since they longer get easy loans, they stop buying things like singing fish), they just assume that they are right and everybody else is wrong.

The root cause of progressive taxation

Don Boudreaux of Cafe Hayek recently posted this bit of wisdom from  “Walter J. Blum’s and Harry Kalven, Jr.’s 1963 “Introduction” to the ten-year-anniversary re-issue of their 1953 classic and insightful book, The Uneasy Case for Progressive Taxation“:

At the time of an emergency which brings about a tax increase, it appears that a sudden new burden can be more easily borne by the rich, thus suggesting that the tax system is made more progressive in the upper-income ranges.  When tax reduction is in the air, it appears that the less rich are more deserving of the reduction, thus suggesting that the system should not return to the tax pattern which prevailed before the increase brought on by the emergency.  It is almost as though tax reduction is viewed, not as the erasing of a prior tax burden, but as an independent distribution of a “bonus” by the government.  Neutrality in tax reduction … would in a simple fashion often require that higher-bracket taxpayers benefit from the tax cut substantially more than those in lower brackets.  But this symmetry is not likely to persuade the popular mind.

Yep.

For me, as soon as we start talking about ‘fair’ tax systems, we’ve gone too far because we’ve changed the conversation away from ‘what we want government to do’. We now have taken the bait and assumed that all functions of government, existing and proposed, are legitimate and the biggest problem we have is how to fund it.

Government should be something that everyone pays for so we will think very carefully about what we are getting for our money.

If (especially in non-emergency times) you want more government than you are willing to pay for, then I think you owe it to whomever asks to show your work without being grumpy.

My guess is, if you belong to an organization that has a group of people charged with figuring out how to spend money that you have put into the pot, like a church, that you also expect a reasonable accounting and justification for that spending from those folks.

When it comes to thinking about what we want government to do, I like to think of example a little closer to home like my Homeowner’s Association to check my rationale.

Each homeowner in my neighborhood pays a flat, relatively small, sum of money each year to maintain our neighborhood pool and common areas. I’m okay with the HOA overseeing those functions.

However, I’d get concerned if my neighbors started talking about setting HOA fees based on income because a) they want a ‘fairer’ collection of fees, b) they want more fees or c) they have other things they want to do and need more money.

I don’t think it would be hard for anyone to see this would lead to lower-income neighbors freeloading on the higher income neighbors (“sure we can afford that playground and shelter, as long as you are paying for it”), while simultaneously (and illogically) becoming a channel for lower-income neighbors to alleviate their envy for their higher income neighbors while also leading the HOA to want to do things beyond its initial charter of caring for the pool and common grounds without sound reasoning for doing so. Why do I want the guy in charge of hiring and paying the pool guy to also use our money for an unemployment insurance program for my neighbors?

keynesian economists misjudge the economy

Natural disasters like hurricane Sandy tend to spur the following food fight among economists.

One or more economists — seeking attention and a chance to look clever — say something stupid like well, at least, the rebuilding will be good for the economy.

In response, other economists quote Frederic Bastiat’s Broken Window Fallacyask why we don’t smash everyone’s house to help the economy and lecture us that economic metrics, like GDP, do not take into account the value lost in destruction.

However, I think that both sides of this food fight talk past each other. Silas Barta’s has similar thoughts.

While I agree with the second set of economists, I think they ignore what I think is one key point of the first set of economists argument — ‘slack resources’.

The first set of economists know destruction is bad, but believe that because the economy wasn’t operating at ‘full capacity’, it had slack resources that can now be put to good use in the rebuilding effort. The second set of economists never address this point.

Here’s how I would address the slack resources argument: ‘Slack resources’ is a subjective, incorrect and misleading way to characterize what’s happening in a bad economy. So is the idea of ‘full capacity’.

It looks right-enough that almost nobody questions it, even the second set of economists. Except, maybe, one that I know of (Arnold Kling).

And I can understand why so few people question the ‘slack resources’ hypothesis. When you see a friend who is unemployed and struggling to find work you tend to think of him as a slack resource.

It’s like seeing your kid doing nothing on a Saturday afternoon and you get this strong urge to put him to work. He or she appears to be a slack resource.

It’s natural for us to think — We should be able to put these folks to work! They’re ‘slacking’ off.

But, I believe the ‘slack resources’ characterization is incorrect and misleading. Scratch past the surface you will find more to the story.

Have coffee with that unemployed — slack resource — friend and you find out he has turned down three job offers, because they were for 20% less than what he made at his previous job.

You ask, why not accept the pay cut so you can get back to work? Maybe you’ll get in there, knock their socks off and be back to your old wage in no time.

Well, it turns out he had enough savings and unemployment benefits to allow him to hold out for a job that will pay him his previous wage. Why should I accept less until I absolutely have to (i.e. when I run out of unemployment benefits)?

We find out our friend isn’t a slack resource. Rather, his skills are being re-priced and he doesn’t like it.

I don’t blame him. Nobody likes to have their wages “re-priced” down, but it happens all the time and it happens due to decisions that you and I make.

When one of our favorite Hollywood superstars makes a stinker of a movie that we choose not see, he may have to accept lower pay on the next movie to get studios to hire him. He could say, if only my fans would have supported me and seen that movie. His fans might respond, if only you would have made a movie worth seeing.

The first set of economists in the food fight see a bad economy as having slack resources. But what they truly reveal to me is that they don’t understand what’s really happening — things are being repriced based on the decisions that we make.

This is lack of real understanding of a bad economy is readily apparent when you consider how many barriers to repricing the first set of economists have had a hand in putting in place.

Minimum wage is one such barrier. It’s also the reason why there are so many officially unemployed unskilled workers at the moment. The market clearing price for unskilled labor is below the minimum wage, which is a price floor. Econ 101 teaches us that when the market clearing price is lower than the price floor, we will have a situation where supply (workers) exceeds demand (jobs). That’s exactly what we have.

This is fodder for another post, but it never seems to bother these economists that their favored wage price floor is causing so much unemployment. They’d rather feel sanctimonious about supporting something that seems well-intended than allow the official price of unskilled labor to move below what they have deemed an acceptable level.

Unemployment benefits is another such barrier to repricing. Many people believe that the low amount one receives from unemployment insurance is not enough to prevent them from accepting  work and they may be right if we lived in a simpler world.

But, in this world we have folks who have some savings, working spouses and the ability to take on black and gray market jobs to earn some coin while also receiving unemployment. We also learn in Econ 101 that incentives matter. If I accept an official lower paying job, I lose my unemployment check. Why do that when I can accept an unofficial lower paying job and continue to receive unemployment — or ‘double dip’?

These barriers slow the repricing process and lengthens the ‘bad economy’. They are the reasons why our recessions seem to take longer and longer to recover from.

If our friend didn’t have a free unemployment check that he would lose by accepting an official job, he might accept an official job sooner.

So, the next time you hear an economist talk about slack resources, give some consideration to whether the resource is really slack or whether someone just hasn’t been willing to accept a lower price for that resource and why.

Coming soon…repricing downward is awful, but is it really that awful?

“The worst possible thing is to have people with good motives, but bad understanding.”

The title is quoted from Bryan Caplan at about 8:30 of the Freakonomics podcast, We the Sheeple.

I recommend listening to the entire 24 minute podcast.

In one segment, Caplan addresses some Obama and Romney campaign planks and explains why they are terrible economics, but good vote-getters.

Regarding making it easier to go to college, Caplan points out that the benefits are not that clear from economic standpoint because:

We already have an enormously high drop-out rate, especially for marginal students. Most of the benefit from college is from actually finishing it.  Over the last decade we’ve seen a large rise in the number of people who start college, but the fraction that actually finishes is very flat. It seems quite likely that this is just going to encourage some people to waste a couple of years of their lives with very little to show for it.

But the reason politicians campaign on it:

And yet, what I just said is not anything you’d ever want to tell voters. You certainly don’t want to get in front of a national audience and say, ‘you know, I think too many go to college, a lot of people aren’t very serious. That’s just the fact. A lot of people aren’t meant for college.’ That sounds terrible.

[Host Dubner]: And, therefore, campaigning on the idea of sending more people to college is a great thing to campaign on.

[Caplan]: Sounds great. And, of course, we’re going to pay for all this stuff…sounds good… I mean who wants to pay for stuff?

That last question sums up politics. Who wants to pay for stuff? Nobody really. But we hope others will.