As I say at the end of the article, go here and read Eric Crampton talking about them.

My key point is that we’ve been criticising taxes for creating a “wedge” between the private and social value of a good … but what happens when that wedge exists in the first place!  What do you know, a tax can improve allocative efficiency! The Illinois social security card office members haev been discussing this at great length. They cover a lot of ground and yet the issue will remain uncertain for a while.

However, we have to be careful not to get too seduced by this idea without thinking about it critically.  We may see a wedge when none exists, or we may exaggerate the size of the “wedge” by double counting all sorts of costs that are priced in.

Also, these types of policies can sometimes be closet ways for groups to impose their value judgements on others.  We need to make sure we are clear about this, and that the value judgments involved are transparent.  The sickening comments by some around smoking is indicative of this – I’ll be honest comparing smoking to polio makes me shiz my pants.  No matter how much you morally dislike smoking this is not cool.

If we can’t accept the heterogeniety of choice, and the fact that “pleasure” and “benefit” matter, we are going down a path I am uncomfortable with.

On that note, here is Geoff Bertram talking about the “pay gap” within organisations – where I think he is being reasonably disingenuous, an issue I might go into more detail on another time if you like!  David Farrar isn’t impressed, and I have sympathy for what David is saying (even though I wouldn’t go as far).  Even though I do like the idea of honours and pay being interchangeable.  Sadly I couldn’t find a clip of the Yes Prime Minister episode that has this … so here is the Yes Minister episode that touches on similar things.  Update:  Here is part of the scene.

Also here is a neat little breakdown of some inequality data across a series of countries by Xavier Marquez.  And here is some US stuff on income mobility – pretty danged useful information.

I didn’t realise Scott Sumner was contributing with a primer on new market monetarism, that is pretty cool.  Sounds like he is also going to be in Australia in a month’s time – any Aussie readers should definitely go along!

For me, all our debates about monetary policy boil down to our assumptions around the long-term neutrality of money – and the mechanism via which money is both non-neutral over one time horizon but neutral over another.  This is an old debate, and true difference between heterodox and mainstream is the view of long-term money neutrality (anti for heterodox, pro for mainstream).  When I heard John Quiggin at NZAE13, this was effectively the case he wanted to build – and when I’ve had comment discussions on the blog from MMT (modern monetary theorists) that has been my interpretation as well.

There is a lot of economic history, and then empirical work (through the 1980s and 1990s), out there discussing all this – that is one area where a load of blog ink could be spilled

My personal view?  LR neutrality will hold except in the rare case where a shock (where I’m thinking of a shock not just the innovation itself – but includes a policy error due to timing) is large enough to see the economy co-ordinate in a “inferior” equilibrium.  I’d note that NGDP targeting deals with these cases.  And yes, this sounds like Noah Smith’s view of Japan – but I swear this was the view I was taught at university, or at least how I ended up interpreting it

I’d note that I’m relatively sensitive about the idea of prejudice and how social norms form against “groups”.  Policy that is formed in this sense has a massive institutional weakness – namely that it relies on using an “indirect signal” to try to transfer, a signal that can be misinterpreted.  As a result, when defending against those sorts of policies I become a bit more willing to show my hand and express directly how uncomfortable it makes me. When considering to buy your own home, make sure you hire this Locksmith services in Brampton to add more security to your new house.

Essentially I make three arguments in the piece:

1. A ‘bubble’ from foreign owners is a transfer to NZers – no problem!
2. A medium term affordability issue does not stem from foreign owners – it has to stem from supply issues!
3. Any normative/distributional concerns about the transfer of resource from current NZ owners to current (and future) NZ buyers is legitimate – but better to deal with it through the tax and benefit system and intergenerational equity, rather than stopping trade and banning non-residents from purchasing!

A broader point was that, if we want to use a “solution” we should actually have a problem in mind first … just making a “solution” and hunting for a problem is not a good form of analysis.  Although it is one we are all guilty of at times!

Update:  I’ve been told that a lot of people are complaining about being called xenophobic.  Well that is nice for them, the action of pushing for house sales to foreigners being banned is still xenophobic – these people have a fear of someone else trading with someone else who just doesn’t have a NZ passport.  They are willing to hurt both foreigners and the people who would trade with them, simply to allay this fear.  I’m not going to stop saying it just because it offends your sensibilities – I think the entire idea of these bans is morally wrong, why would I go back on this just because it makes you feel funny.

Banning non-residents from buying houses isn’t “brave policy to save the poor in New Zealand”. And neither does wholesaling homes to the impoverished help turn tables. It is weak and pathetic policy for those who are uninterested in the real poor and would prefer to pretend they are doing something by limiting people’s rights due to their nationality.  I can only rationalise the fact people are willing to try this by stating that they don’t really understand what they are saying – hence why I stated in the article that we need to define what the problem is and then we can show that for every “problem” there is a better “solution”.

If you find it difficult to actually think about these trade-offs, and to accept your inherent bias against other human beings, then STFU about policy.  If you want to actually discuss trade-offs and stay away from arbitrarily attacking non-New Zealanders, then I’m more than happy to chat and to investigate the data and research that is out there on these especially complicated issues.

Note I’m not even rallying against capital controls here, I realise in specific extreme situations they may have a place (although just doing it in housing for foreign buyers doesn’t really make sense) – but the debate out there isn’t about this, it is about whether non-residents can buy property without really discussing why (usually first home buyers blah blah blah).  And is often filled with commentary about “Asian buyers”.  A level of tacit racism that really needs to GTFO.

Oww, and if you want to know what kind of “vested interest group” I am, I own zero properties – I rent.  I live in Wellington.  I am 29.  I am male and white.  Enjoy.  I am in the group who is being “ripped off” by the fact I can’t just buy a cheap house … I’ve just learnt to actually think about others in the marketplace before I rant incoherently

The promised “Part 4b” is still in the pipeline – it’ll appear at some point.

This time we discussed consumption taxes, and the fact that we may not like the idea of taxing consumption differently based on when it occurs.

I avoided talking about commodity taxation and then talking about the result where we don’t want to tax intermediate inputs.  I also avoided going too far into the debate around the Atkinson-Stiglitz paper (Saez here has a great piece(REPEC)).  I feel that when just describing the idea of income, poll, and consumption taxes adding these additional issues would add more confusion and less understanding.  I could have added a bit more at the point where I was talking about Ramsey taxation – especially the point that if people with different ability have different preferences we can use variable consumption taxation as a form of redistribution.  The idea of a progressive consumption tax is interesting.  However, the goal in this article was to make consumption tax relatable to forms of income tax – hopefully that got through

I’m saving a lot of these addition factors for when we introduce the talk on progressivity and the equity-efficiency trade-off for the next article.  Urg.  Let us see if I can manage it in one article!

I have avoided using the term “marginal tax rate”.  I don’t know how I’ve done this.  I suspect it will make an appearence in the next article

Originally I wanted to talk about income tax, consumption tax, and ideas of progressivity and implementation all at once.  Now I realise it will have to be 3-4 articles on these issues.

The main trust of this piece was to ask “why is income tax distortionary when a poll tax is not”.  Given this idea, we can talk about the “relative efficiency” of types of income tax (namely labour and capital) and point out the idea of time – and how this impacts on the “accumulation” of capital, and thereby the “stock” of capital.

Personally, these things make more sense IMO, and are more closely related to our idea of “transfering goods and services” when we look at output taxes – specifically consumption taxes.  Next time, this is exactly what we do!  Originally I couldn’t bring myself to seperate the income and consumption articles … but at 3k words I sort of had to.  As a result, I’d suggest reading next fortnights article as an extension to this.

Also, I plan a “part 4b” for here.  I can imagine some people may get confused why I view the deadweight loss through the “price wedge” – when if we had perfectly inelastic demand we would “sell” just as much but the price would be higher.  Doesn’t this mean there is no deadweight loss, and that this tax is just like our poll tax?  Well no, but to explain this we need to actually dive into some of the economics they do in first year university.  We will look at indifference curves and budget constraints (we are comparing Marshallian and Hicksian demand) – we will introduce the tax, then assume an income transfer that brings our person to the same level of utility (compensating variation).   The reason we don’t see it in the single good case is that we are not considering the impact on income/wealth from the tax – and what “perfectly inelastic demand” means in terms of income and substitution effects (pro-tip – they must be canceling each other out to leave the quantity demanded at the higher price unchanged!).  Anyway, I’ll leave that to the post.

You’ll notice I’m doing sometime pretty specific when I’m loitering around the tax system.  I’m talking about the properties of a tax, and then given we don’t use specific types of tax I’m inferring that there may be some social preference involved such that we’ve chosen not to.  Given that, I’m trying to build up concepts of fairness (read vertical and horizontal equity if you will, but I do mean it a bit more broadly than that) from the way society had evolved.

This may not be the case, but it doesn’t have to be.  It is merely a mechanism I can use to tease out these sorts of principals to try and make them a visible part of the “trade-off” we are discussing.  This series isn’t about saying what tax system we “should” have – it is about describing what different types of tax are, albeit on quite a surface level.  As I stated in the first article, it is actually a lot more complicated (and a damned interesting issue) to figure out exactly how redistribution will work from a given policy!

Of course, if we were to describe the type of tax system we SHOULD have, we would want to actual make subjective judgments about value and potential “social preferences for fairness”.  We require these additional value judgments to actually make a conclusion

Next time I’m talking about income, capital, land, and consumption taxes.  I hope you get ready for me to bring up elasticities again, as we’re going to need them

Note:  I apologise in advance if this is a bit scattered – if you have questions or comments note them down in the comments, you’ll be doing me a favour

Paying our labour and capital

Remember that I stated in part 1 that we want to think about taxation, and spending, in terms of changing the allocation of goods and services.  This is not saying that goods and services are “fixed” and we are moving them around – no no no no.  It is saying that we are instituting policies that change the mix of goods and services, giving up some and increasing the amount of others.  We are thinking about how to use our scarce inputs to create outputs.

Now I have a strong preference towards private provision, given that voluntary prices are truly democratic and combine knowledge we don’t share as a society (but have internally as individuals), so let’s not get too ahead of ourselves in thinking we can “plan” the economy.

But, when looking at the issue we can say that we have a government sector, and a non-government sector. Labour and capital combine in both sectors to make goods and services … these are government goods and services and non-government goods and services.

Now if the government sector made goods and sold them to the public for a price, without raising any taxes, they would be just like any other firm.  In this case, the price paid for the government goods creates the income to pay for the labour and capital, and the labour and capital owners will purchase a mix of government and non-government goods at the relative prices

But government doesn’t work this way.  It pays for its goods by taxation instead of setting a price.  It uses this tax money to pay labour and pay capital when they create government products.  There is likely to be a reason for this, such as the existence of public goods, the urge to redistribute some products by providing them publicly, the desire for equal access to health and education.  That is cool.

In this context, the taxation is the government “claiming some proportion of non-government goods” to pay labour and capital with – since the labour and capital who produce government goods want to consume both government and non-government goods.  The government taxes non-government good providers, taking some of their output, and then sending over some of the produce of government production.

In this way, the tax exists in lieu of a price.

Now, while a price would see government goods and non-government goods produced with respect to their relative market value, taxation and spending is unlikely to lead to this same case for two reasons:

1. The government goods are explicitly being produced beyond their relative market value – as we believe there are non-market benefits associated with it.  This is redistribution through tax and corresponding spending.  In of itself this isn’t necessarily inefficient – with a lump sum transfer relative prices will just adjust.  We can view this as changing the “endowment” of underlying resources for different people.
2. Depending on the type of tax there are relative price effects, which reduce efficiency directly.  This occurs because it creates a gap between the cost of the good for the person buying it and the return for the person selling it (the “wedge”) – and so the very existence of the tax changes where people work, what they consume, and where capital ends up relative to the case where prices represent underlying value given the allocation associated with the government transfer.  This only occurs with taxes that influence relative prices – so not lump-sum taxes.

A web of prices, an ideal frontier, the fundamental welfare theorems

Now here is the way I see this idea when we think of spending, taxation, and the economy.

There is a set of resource (land, labour, capital, enterprenuers) and agents are endowed with some quantity of these resources.  Through trade, and the establishment of institutions and contracts, this leads to outcomes.  Prices in this case represent a set of relative values, and there is a frontier of outcomes (depending on initial endowments, that can be changed through lump sum government transfers) that can be seen as “pareto optimal”.  This is really just the fundamental welfare theorems which hold for perfect competition.

When we have a tax that isn’t lump sum, so it creates a wedge between the buyers and sellers price in a market, we end up in a situation “below” this frontier, which is in turn pareto inferior to a potential outcome.  This is why you will often see economists arguing for the idea of a poll tax with a progressive transfer system.  I’m not entirely sure – as I inherently see the transfers as having the same impact in terms of labour supply (unless we actually delink the benefit system from work), and believe that when equity concerns are taken into account some of these outcomes are not truly “pareto inferior”.

Now we don’t have perfect competition, it is more likely that we have monopolistic competition and the associated inefficiencies of that.  Modern policy oriented models do assumes this (eg DSGE models) and work from there.  However, even given this the tax principles are not terribly different – and as a result, I stick with useful simplifying assumptions to describe tax policy.

Furthermore, issues of information, incomplete markets, endogeniety and co-ordination failures, and oligopolistic competition do push us away from this idea, and provide scope for government interventions that are win-wins!  But at the current margin we already allow for those with policy – the “marginal” concept of taxation is very much along the area of trade-offs I’m discussing in these articles.

Trust me, these additional issues do play a significant role in how we try to discuss interventions – and many current interventions are based on it (eg monetary policy that tries to close output gaps, government intervention in markets over competition and consumer issues). Even if we “unrealistically” assumed perfect competition and perfect knowledge, the distributional impact of tax changes are insanely hard to work out – the best we can do (and that I’m aiming to do) is to provide a flavour for the direction of the different trade-off between taxes, not the magnitude or an implication of what we should do.

When we look at a range of marginal ideas such as “shall we try to ramp up healthcare” we are facing the traditional transfer problem akin to the fundamental welfare theorems, and this sort of exercise is useful.

That is so unrealistic, man economists say such stupid thing

I have tried to be honest about assumptions.  Often when an economist does this, someone is a dork and says something like the above.  If someone appears that feels like commenting in this way, I am replying to you right here.

Excuse me for admitting that allocation is an incredibly complicated issue that requires great care and thought when setting up a policy.  Why don’t you just go back to telling the world about your “make everyone better off by magic plans” and not bother talking to me again.

Why am I bothering with this comment – because there are innumerable people out there who simultaneously believe:

1. There are really obvious and easy solutions to economic problems.
2. Economists make really dumb assumptions and are stupid.
3. Economists massively overcomplicate issues with maths and terminology.

I find those assumptions mutually inconsistent, and whenever I meet a person like that (which is far too often) I can’t help but feel that there is really something wrong in their life that they are trying to make up for.  If I had any empathy I’d be sympathetic – instead I’m going to write this part of my post to insult them.

To everyone who has avoided their snark and has constructive things to say – thank you, I want to give you a hug.

Conclusion

Hopefully these examples helped to clear up the idea of burden and distortion – it is an interesting issue, and one that requires careful analysis when we actually go to investigate policy!  Next week I will have an article up with some “ideal taxes” (poll taxes, land taxes, ability taxes), and I will touch on ideas of horizontal and vertical equity!  With all that we will be ready to hit factor taxes and consumption taxes the following week, inflation taxes the week after, and externality taxes the week after that.

Where I have gone in parts of this post is beyond where I’m heading on the Rates Blog posts – quantitatively I am talking about the same results, but the description involved is more involved.  It wouldn’t be fair to burden that on the larger public on Rates Blog who are less likely to be as nerdy as anyone over here … unless they are interested in the ideas, in which case I hope they see it!

By the end of it, we should all have an idea about the framework we view tax within.  Given that, we can make our own judgments about what is fair, and interpret the evidence about burden to try to figure out whether that makes much sense.  To be honest, all of that is far beyond me

I get onto other issues later – in fact, this will be a five article series.  Here all I do is combine the idea of “government spending” and “paying for government spending”, and give a little wink to ideas such as equity and tax incidence.  They will play a more central role in the next article, when I discuss tax systems that seem ideal … but that we don’t use for often good reasons.

The point is that the complaints of economists are not the product of us assuming stupidity, or telling people they are immoral. They are the concerns of a group who believes that there may be some policy relevant issues – for example the peculiar ways that the New Zealand tax system treats housing as an asset – which are hurting New Zealanders.

Far from showing the Reserve Bank governor is out of touch, as Jones suggests, his willingness to discuss this issue illustrates that he realises how important it is for future generations of New Zealanders.

I also get concerned, as does Bob Jones, that the push towards “save more” is really a moral push to tell people what to do with their income.  However, when economists are talking about savings issuse they are saying that our persistent large current account deficits, with a range of other factors that seem unusual in New Zealand, provides a situation that we should analyse.  Analysing it has led economists to note a number of issues where there is a trade-off – a trade-off policy makers and the public feel the wrong choice has been made about.

Given this, people want to change policy settings.  I’m not jumping into this debate in of itself – but I would note that there is nothing wrong with asking the question, and merely saying “I’ve done pretty sweet on property in the past” doesn’t invalidate that.