Inherited ability, tax elasticity, and fairness

Tyler Cowen has a post titled “does rigid mobility imply low tax elasticities“.  It is a question driver from this book review by Arnold Kling, of The Son also Rises by Gregory Clark.

I have purchased this book, but haven’t read it yet.  I have also purchased Income Inequality and IQ by Charles Murray, but have only read the first couple of chapters.  As a result, I haven’t even read the pop literature let alone the academic literature!

However, I have done a few economics courses in my time, and I thought I may note the type of framework I would use to understand IQ, income inequality, and the scope for an “efficiency-equity” trade-off.  By doing this, I can help to point out why Cowen’s question is a good one.

Inherited IQ is an endowment, a higher IQ would (all other things equal) lead to higher earnings solely on the basis of something you were given from the start.  Some may view this as unfair and say “lets transfer outcomes generated from IQ”.

However, the IQ doesn’t just create earnings – it functions as part of the way someone acts in terms of their work.  As a result, the higher IQ may require investment, and will certainly require the decision to work, in order to become “income”.  Redistributing from those with higher IQ lowers their incentive to work, and in turn shrinks the amount of income that can be generated!

And this seems to give an equity-efficiency trade-off, we want to redistribute on the basis of this “endowment” of IQ, but we realise that if we do it through labour taxation it will reduce the labour supply/investment in human capital of those with high IQ’s.

This leads us to this quote from Kling (followed by Kling quoting Clark):

On the other hand, his findings argue against the need to create strong incentives to succeed. If some people are genetically oriented toward success, then they do not need lower tax rates to spur them on. Such people would be expected to succeed regardless. The ideal society implicit in Clark’s view is one in which the role of government is to ameliorate, rather than attempt to fix, the unequal distribution of incomes. As Clark puts it,

“If social position is largely a product of the blind inheritance of talent, combined with a dose of pure chance, why would we want to multiply the rewards to the lottery winners? Nordic societies seem to offer a good model of how to minimize the disparities in life outcomes stemming from inherited social position without major economic costs. (page 15)”

If we have an ethical judgement that people shouldn’t have higher incomes solely because they have higher IQ (or solely because it is their gift that is generating the surplus) then we can accept a relatively simple equity-efficiency trade-off here – the trade-off between output and the divergence in incomes. [Note, I am not saying I agree or disagree with the assumption - it is just to make matters clear]

That is where the tax elasticity comes in.  The greater the tax elasticity, the less the quantity of labour supplied changes for a given level of tax revenue.  As a result, the more redistribution we get for every chunk of output lost.

Cowen asks if it is low, as the implication that we just follow our social status when supply labour implies a low tax elasticity – that behaviour and choices are not terribly responsive to the “price” in the labour market (disposable wages).  If this is the case, then the IQ argument combined with a moral judgement about distributions implies we should have a significant amount of redistribution. [Note:  There is a second elasticity here - the cross elasticity of demand between high and low IQ workers.  This can help tell us what happens to low IQ wages as high IQ labour supply moves, and is very important.  I'm leaving it to the side here for simplicity].

Of course, we can have the IQ argument, our moral judgement, AND a high tax elasticity if we think social structures and the utilization of IQ are more malleable.  In this case, even with the same moral premises, and the same inheritability of IQ, the relative tax should be a lot lower.

Interesting stuff!