The comparative experience thus suggests that for inequality reduction, it is the quantity of taxes rather than the progressivity of the tax system that matters most.

Via Mark Thoma.

I completely agree, there are significant gaps in our knowledge, and I never thought your stand was crazy (in blogs I often argue things just for the sake of having that point of view on the blog- not because its what I necessarily believe). However, this implies that, with some type of value judgment we could justify most tax structures. As long as a progressive tax system is not ‘pareto inefficient’ we can’t definitively say anything.

I think the one thing we have discovered is that CPW, rauparaha, and matt all have different beliefs in terms of what normative statements are more important/true. Thats healthy.

Believe it or not, I’m not taking some kind of wingnut stand on this one. The economic literature really is quite uncertain about the optimal income tax structure. To quote the intro of one of the first search results for those terms on google:

The analysis of nonlinear income taxation pioneered by Mirrlees (1971) has
characterized a number of properties that the optimal tax must possess (see e.g. Myles (1995) for a survey of these). The theoretical results though do not answer all the questions that are raised about income taxation. The most hotly-debated practical issue is the behavior of the marginal rate of tax, in particular whether the optimal income tax should be progressive – a property that the tax systems of all developed countries possess. The theory has so far not fully resolved this question. It is well- known that the marginal tax rate should be zero for the highest skill consumer, so the tax function cannot be progressive everywhere. But this end-point results provides no information on the behavior of the tax schedule on the interior of the skill distribution.1 This is a significant gap in our knowledge.

Yes, but those ‘equity goals’ should be based on social optimisation. Work out if a policy is technically efficient first, and then apply a normative judgment on equity outcomes and see what sort of instruments can best provide that – and what the trade-off in terms of technical efficiency is.

What instrument would provide equity goals more efficiently then progressive taxation, or in co-operation with progressive taxation.

“I doubt you have any evidence for “lower crime, more robust social institutions”, you’re being platitudinous”

I like that word ‘platitudinous’, I had to look it up on google. I don’t have any evidence, you are right but there has been a lot of research on the issue that I haven’t read: http://scholar.google.co.nz/scholar?q=crime+and+income&hl=en&lr=&btnG=Search

I thought the claim made sense, after all the greater your income the less incentive you have to rob people (diminishing marginal utility and all of that). The robust institutions call was differently an out of the blue claim- it just comes from the assumption that people prefer to be around people of similar income, so if incomes are more closely tied together people will be more social – better social cohesion gives more robust institutions (insofar as we have better solutions to the prisoners dilemma game).

“criticizing a policy for being regressive is solely a normative statement”

I agree completely. When we first look at a policy we need only look at efficiency. If it passes that test we have to look at the equity trade-off (as it is normative, and it is good to separate normative analysis from the more objective part), which is where discussions about ‘regressiveness’ come into play.

“My dictatorship would better, naturally. 🙂 You’ve read Bryan Caplan, don’t democracies “collaberate” all the wrong information?”

I haven’t actually read the book. Will it teach me more than Arrow’s impossibility theorem?

To make my point a different way, what if we greatly increased social spending through much higher taxes, but made the tax system regressive (e.g. a 40% tax rate but 0% marginal rate after 200k). Such a system could achieve much greater equity than NZ’s current system despite being regressive. So why would this be unfair, and why, a priori, would it be less efficient that the same amount of spending funded with a progressive tax?

To tie this back to the original discussion, you get the objection that a policy is regressive quite often, but is it really much of an argument? All government spending is going to have some effect on income distribution (often ambiguous, depending on what kind of inequality you have in mind, and who you think benefits). But it’s not an accepted fact that the status quo in NZ is the perfect level of progressivity. If we have no idea of whether more or less progressive is desirable from an social welfare standpoint, then criticizing a policy for being regressive is solely a normative statement.

My dictatorship would better, naturally. 🙂 You’ve read Bryan Caplan, don’t democracies “collaberate” all the wrong information?

Good on you for selling your idea. I think the reacceleration of the housing market, and the increase in capacity pressures (capacity utilisation in September 06 was greater than it was now!) were big factors in the RBNZ’s ‘flip flop’ – also the terms of trade boost, that gave them a hell of a surprise.

I will comment on your post tomorrow sometime, I know the post is almost a year old but a comment won’t hurt 😉

Hi CPW,

“In fact, I’m going to go further and claim that the fact that progressive rate systems are so universal in democracies, despite there being very little (as far as I’m aware) theoretical or empirical evidence to suggest their efficiency, suggests that these systems’ popularity has much more to do with their electoral success than their objective merits”

Well progressive taxes aren’t based on efficiency, they are based on some social concept of equity. As you said you believe you would only pay a small amount out of kindness – however that is not the only positive externality associated with progressive tax systems. Lower crime, more robust social institutions etc, these sort of factors play a part in the choice of the system.

However, I agree that a democratic system does not ensure that we have a government that satisfies societies social welfare function – however, it probably gets closer than a dictatorship or any other form of government as it collaberates more information.

One of my first comments on my new blog!

Anyway we realised that fuel prices rose steeply and the RBNZ was reacting to that move. They were more comfortable about inflation being contained as prices rose, as it was taking cash out of peoples pockets. Then as the oil prices fell in the second half of the year, their rhetoric switched as they began to be worried that there was more cash available due to lower petrol prices.

So we figured cut out the interest rate reaction and comment and simply give the RBNZ the power to set the price of fuel over the market price set by the oil companies. The RBNZ “margin” would speed and slow the economy directly and the funds would flow to the RBNZ using the current tax collection system.

In times of recession, the RBNZ could subsidise the fuel price to help things along, and vice versa.

This would not replace the OCR, but would be a more direct lever and not one that people could easily protect against, (apart from big corporates, who hedge fuel anyway) as they can with fixed mortgage interest rates.

And the bonus was that the currency would not be impacted, thus not driving the carry trade and hurting exporter revenues.

Anway, I had lunch with Don last year, and pitched it to him and he liked it!

Much better for him to run with it publically as he is so much better known and I prefer to remain anonymous.

The point is, we never looked at it as a tax, but merely another monetary policy tool, whose affects over time would be neutral. When monetary policy tightening, RBNZ margin increases, when easing RBNZ margin decreases, to zero, or in a recession, goes negative.

At the time, we were looking for an instrument other than interest rates, and this seemed to fit the bill!!

I’m not going to argue that people don’t in general have a preference for transfers to themselves, or from someone else. But all the election results tell us is that progressive tax schemes (probably) maximize social welfare for 51% of the voting population. I don’t see what bearing that result has on the question of what kind of tax system maximizes societal welfare in total. In fact, I’m going to go further and claim that the fact that progressive rate systems are so universal in democracies, despite there being very little (as far as I’m aware) theoretical or empirical evidence to suggest their efficiency, suggests that these systems’ popularity has much more to do with their electoral success than their objective merits.

I suspect that if you took a sample of economists from around the world and asked them to design an ideal tax systems from scratch, a very small proportion of the results would look much like the existing tax systems of their country. And I don’ t think that normative preferences would be the key driver of the divergence between existing and ideal.

Ultimately, there may be cases where redistribution could make sense, however I expect that if we did some more complicated modeling, we would find it to be suboptimal. I agree with this statement I made earlier:

“I would say that any policy decision requires normative elements. However, that should not prevent us exploring whether there are efficiency reasons that might support such a tax. Once we understand whether there is a reasonably objective efficiency argument for such an instrument we can look at the trade-offs in social terms.”

Start with the efficiency reasons – if they stack up lets look at the other factors which require more explicit value judgments.