Don’t forget that prices change!

Over on Kiwiblog David Farrar discusses how redistributive the tax system is, and how including average welfare households that earn $60k “effectively pay no tax”.

There are a few points to keep in mind when looking at this:

  1. The obvious one that you will always hear is that a tax and benefit system is supposed to be redistributive – this is the point.  So the question is how much redistribution we want, especially given that there is a cost in terms of “efficiency” (having private and social value align from market activities).
  2. Let us focus just on wages.  Comparing gross and net wages over the entire tax system doesn’t make sense – it is a appoximation for how “small” changes in tax will work, not large changes:  The key point here is that the gross wage is the “cost to the employer” while the net wage is the “renumeration for the employee” – the tax paid isn’t all “cost to the employee”, it is shared between the employer and employee based on the idea of tax incidence.  If the “tax” wasn’t there, this does not mean that the high wage household gets all that income – so saying it that way “exaggerates” their contribution to redistribution.  In truth, the tax paid by those wage earners is the contribution from that market transaction – which is a very different thing to think about!  Note:  I am saying wages would change if the tax system changed.
  3. On the note of market, redistribution works by changing relative demand for goods and services and endowments of individuals – in this way relative prices change.  If we are talking about contributions in terms of the goods and services we care about, and over the entire tax system in this way, we need to think about how goods and services prices change as well!

Yes our tax system is progressive – but framing it as “the top 5% of households pay 47% of tax” is a bit mischevious.  In fact, it would be closer (but not perfect) to say that market transactions that involve the top 5% of income earners contribute to 47% of the nominal value of tax revenue … a little less us vs them right 😉

I think Bill English is spot on saying:

“But people who call for even greater transfers to low income families, or who call for the top tax rate to be raised, need to be aware of how redistributive the tax and income support system really is,”

Indeed we should consider the starting point – to many people view increasing redistribution as always increasing social justice, when that is not the case.  However, Farrar’s point does not follow:

Income tax rates should be lowered

I’d prefer it if he fleshed out whether this means an increase in other taxes, or a cut in spending, as the normative implications are very different 🙂

  • Bill

    Also: This “effectively pays no tax” analysis completely ignores the $15b that NZers pay in GST, a flat tax. That is no small oversight.

    • Guest

      And local rates.

  • Luc Hansen

    Regarding English’s comment, we have to factor in that NZ’s redistribution is off a narrow base, largely of income tax only, and that that redistribution is partly offset by GST (GST being regressive). It does not take into account the proportion of tax paid by the 5% as compared to the proportion of wealth captured by that 5%.

    But I think it’s easy to talk past each other in this debate.

    This paper shows that private wealth to GDP ratios – in major advanced economies – are tracking back to pre-1900’s levels, with the kicker that:

    “Because wealth is always very concentrated (due in particular to the cumulative and multiplicative processes governing wealth inequality dynamics)…implies than the inequality of wealth, and potentially the inequality of inherited wealth, is likely to play a bigger role for the overall structure of inequality in the twenty first century than it did in the postwar period.”

    All of which would appear to nicely segue into Gareth Morgan and Susan Guthrie’s The Big Kahuna.

    And equally nicely takes us past self-serving blog posts (not TVHE!) and simplistic utterances of politicians!

    • Luc Hansen

      And today’s publication of our rich list would appear to prove the bracketed point in the quote above 😉

    • “Regarding English’s comment, we have to factor in that NZ’s
      redistribution is off a narrow base, largely of income tax only, and
      that that redistribution is partly offset by GST (GST being regressive”

      Two things here. The base in NZ is not really that narrow – and GST is not regressive.

      Don’t get me wrong, I think lifetime inequality can be an issue, and inherited wealth hardening into lower mobility is a serious concern. But we can’t really get that just by looking at historical data, we also need to think about “strutural shifts” that are under that (technology, relative price changes, etc). This isn’t saying lets ignore the question – its saying lets get onto analysing it more 🙂

  • boristhefrog

    Farrar is not an economist by any stretch – he is a policy wonk and market research guy…

    Also, they way you describe the point it technically accurate but not a good sound bite – would people in the street recognise a ‘market transaction’ when they make one? Their first response may be that they don’t own any shares!!

    But I agree with you overall – economists have to find better ways of getting their point across without losing the audience on the way there….

    • “But I agree with you overall – economists have to find better ways of
      getting their point across without losing the audience on the way there”

      This is true, but pretty tough!

      I am just very uncomfortable with the fact that people talk about policy without thinking about how prices change – given that this is a key key point … and economists speciality. More ways of communicating that would be pretty exciting!

  • Maxamillian Shields

    Cool, but the comment by Bill (that you think is spot on) has some value-judgementness to it. I don’t think stating “how redistributive” the system is actually means anything, other than perhaps implying that we redistribute quite enough thank you very much! And that’s the value judgement right there.

    • Fair point for sure! I completely see where you are coming from, I just have to admit I read the comment a bit differently when I said I agreed with it 🙂

      I was reading him as saying “hey, remember we do redistribute” rather than saying “hey, we redistribute at the right level”. I can sort of appreciate where his comment would come from, as there are a lot of people that don’t really realise that redistribution does occur – and information about that is pretty important!

      • Maxamillian Shields

        I agree.

        Whatever Bill actually meant, and given that policies and institutions account for the marked differences in inequality across the OECD, it would appear to be the case that the government isn’t doing that well at lowering income inequality. And this isn’t Nats bashing specifically – previous governments have let it slip as we’ve adopted a version of capitalism that’s let it happen. I think the above is straight out factual.

        This next bit is less so as I have no proof that it is the best way forward. But anyway, I can’t wait until we all come around to realising that a universal basic income IS the best way forward 😉

        • I’m all about a universal basic income as well – but most people I talk to are not. Society is a co-operative thing, so that is just how it is I guess 🙂