Weekend tax policy reading

Yes, the weekend is nearly upon us. Almost time to put your feet up, get a cup of coffee, relax and catch up on your reading — and what greater joy could there be but to dig into some cutting-edge thinking in Canadian tax policy? After all, don’t you care about social justice? And aren’t you tired of listening to Americans fighting about their tax system? Wouldn’t it be a refreshing change to listen to a sensible Canadian, making sensible recommendations for how our own income tax system could be made more efficient and more just? Well I have just the thing for you:

I read the notes to this speech by Kevin Milligan (UBC Economics) when he gave it in November, but only recently noticed that the official published version is much more elaborate: Tax Policy for a New Era: Promoting Economic Growth and Fairness, and really does offer one-stop shopping for all your tax policy needs. (In other words, if you’re one of those unlucky people who find themselves “without a view” on how the Canadian tax system should be reformed, or if you just have a really crude view, like “the rich should pay more,” or “goddam taxes are too high,” then you could do a lot worse than just reading what Kevin has to say, believing all of it, and adopting his view wholesale.)

In any case, other than just directing people to this resource, I thought I would add a few remarks, in no particular order.

1. The view that Kevin recommends, despite being eminently sensible, is an impossible sell in Canada right now politically. What he is advocating is essentially a “Scandanavian” model of income taxation, but unfortunately in Canadian politics, the Scandanavian (or Nordic) approach gets coded as “right-wing,” because it involves differential treatment of capital and labour income, which is portrayed as benefiting “the rich.” As a result, the left will never touch it. The right, who might be prepared to touch it (because the point of such taxation regimes is to be “pro-growth”), has unfortunately abandoned the entire plane of evidence-based policy (everything the Harper government has done on the tax file — cutting the GST, adding boutique tax expenditures, etc. — has been the exact opposite of what economists recommend). So as long as the centre-Right remains MIA in Canadian politics, none of this is going anywhere.

2. I thought some more could be said about the rationale for taxing very high incomes, other than the utilitarian argument that economists are all familiar with (and that doesn’t really have any traction as a public policy argument). In particular, when it comes to discussing corporate taxation, Kevin is comfortable with the notion that one might try to target “rents” — again, for the well-known reasons. Why not think about labour income the same way, in terms of rents? I have no difficulty believing that a very large chunk of the salary earned by people in the 1% income bracket is also a rent — this is obviously true in the case of professionals, who basically belong to cartels (I don’t mean that in a bad way, just a factual one). Managers are getting big rents, due to governance failure in firms. Personally, I calculate that at least 2/3 of my own salary is rent (via the thought experiment, “how much would they have to lower my salary, before I actually quit my position as a tenured philosophy professor?”).

3. Also, the utilitarian argument (declining marginal utility of money) isn’t really state-of-the-art. The more compelling observation is that almost all income above, say, $150K per year, is absorbed into one or another form of competitive consumption (cf. Fred Hirsch, Robert Frank) — you just have to be more broad-minded about spotting it (e.g. think Vancouver real estate). So taxation on such incomes actually has, not just small welfare effects, but actually no welfare effects, on those who pay them. (This is not to dismiss the point about tax-avoidance, which I take seriously — people will still respond to these taxes as though an increase in rates would affect their welfare, even though this is almost entirely an illusion.)

4. This is my only important point: I was really surprised to see that there is no discussion of inheritance taxes, or that they are not part of the package. The differential treatment of capital and labour leads Kevin into Piketty territory, and he spends a lot of time talking about the potentially negative effects on inequality of reducing certain taxes on capital income. He mentions Piketty’s proposed wealth tax, which is almost universally seen as a non-starter. But inheritance taxes are in many ways an attractive alternative. Of course they have the usual perverse incentive effects, but they have certain attractions as well. (My investment advisor once gave me a huge sales pitch on a life insurance policy, not because I needed life insurance, but as a way of avoid taxation of my estate. Finally I said, “could you explain to me why I should be so passionately committed to avoiding taxes after I’m dead? I mean, it’s not like I’ll be using the money.” She didn’t really have an answer ready to go for that one.) Anyhow, the situation with inheritance taxes in Canada is sort of complicated, because technically there isn’t an inheritance tax, but there winds up being one in practice because it’s rolled into the income tax system in a strange way. If some clever, public-spirited economist wanted to do a policy document explaining how it works, comparing it to other regimes in terms of fairness, and recommending reforms, that would be great. (Or if someone already has, please supply references!) Anyhow, it would seem to me that beefing up inheritance taxes would be a useful complement to Kevin’s proposals.

5. Finally, an ideological point about the differential treatment of labour and capital income: I’m not sure if “labour” and “capital” is the best way of framing the discussion, given the way it evokes past histories of class struggle. I would be more inclined to frame it in terms of the treatment of “savings” and “consumption,” and to point out that the income tax shouldn’t really be targetting income, what it really should be targetting is consumption. In principle you could then just tax consumption (like with a VAT), but then you wouldn’t have progressivity. So in order to get progressivity, the best way to tax consumption is indirectly, via income. But then “savings” gets caught in the net, and people get the idea that there is some important moral reason to tax people’s savings. (But really, what is the problem with the rich, such that we want to tax them more? It’s not that they earn so much, it’s that they consume so much. In other words, the “richness” doesn’t lie in the bank balance, but in the lifestyle. So we shouldn’t be targetting their income, only their consumption.) The better approach is hold off on taxing people’s savings until they translate them into consumption. Differential treatment of returns to capital can then be justified as a downstream consequence of the differential treatment of savings. (This is a political-ideology point, although not an insignificant one in terms of how one designs the taxes.)


Weekend tax policy reading — 5 Comments

  1. Interesting stuff!

    But I have some questions for you, mostly regarding (2), the proposal that we should raise income taxes on high earners because their incomes consist largely of rent, what did you mean about managers making more money because of government failure? This might just be my own ignorance, but I thought it was more common to think that managers make too much money because of the principal-agent problem, which I thought was market failure. Is that incorrect?

    And what would this kind of taxation look like in practice? In your own case, philosophy professors are cross-subsidized by busineds school professors right? But how many relatively poor employees of large firms are cross-subsidized by other, richer employees? In concrete terms, I don’t like the idea of

  2. (Sorry about that, I accidentally clicked the publish button)

    In concrete terms, I don’t like the idea of taxing janitors more because some of their income is rent. This seems like an especially serious problem with unions, because the union acts like a cartel, and because unions typically compress the differences between the wages of workers.

    Basically, I’m worried that we’re only justifying tax increases by talking about rents because we don’t want to openly argue from egalitarian premises.

    It’s sort of similar to arguments that, for instance, music education, or community theater grants, have significant economic returns. It’s possible, but I don’t see how someone could be convinced of the premise (economic returns) without already believing the conclusion (we should increase grants for community theater).

    The problem is that, if someone shows that community theater is a lousy economic investment, you end up hurting your cause.

  3. Hi Joseph,

    Thanks for the kind words and thoughtful criticisms. I have a number of responses, but I also have some grant and research deadlines that need my attention first–so I will try to put together a response next week.

    Until then, I invite your readers to augment their weekend reading with this one-minute animated representation of my tax proposal: http://vimeo.com/112846874 :)