Enacting a Pigou Tax

The growing inequality in America is probably one of our greatest problems – from reduced health outcomes to increased violence to reduced beneficial productivity (think of the quants who could have been working on energy or health care but instead were figuring out ever more creative ways to fleece the unsuspecting pension fund of its money), grotesque increases in inequality degrade a society in a multitude of ways. However, an equally difficult problem has been to find a reasonable solution.

Interestingly, British Depression Era Economist Arthur Pigou floated a possible solution to neutralizing undesirable externalities: Tax them! (An economic Externality is a side effect of a transaction that costs a third party – pollution is the most common example.)

In this well-presented essay, Liam C. Malloy and John Case explain more fully the idea, what it would imply, and present even some 'whys' – Why we would want to do this, Why it would help, Why it is reasonable for a society to take this action.

I was particularly struck by the number of topics we've discussed over the past year: The fact that higher taxes do NOT correlate with reduced economic productivity; The fact that CEO's who are paid 300-400 times their average workers are not producing at 300-400 times the average rate (in fact, likely 'earning' their income by lobbying the government for breaks or handouts for their company or sector); The fact that 80% of the productivity growth of America's economy over the last 35 years has gone to the top 1% (as pointed out in the article, if the 90% increase, 2.1% per year had accrued to everyone, today's median household income would be $85,000 instead of the $50,000 that it is.)

The only omission I easily spotted was failing to call to equate income taxes on labor (wages) and capital (capital gains). There is no good reason to give preferential treatment to money earned via investment, and many, many reasons to tax investment income at exactly the same rate as labor income. Left unsaid is that for the Pigou Tax to be most effective, it would have to apply equally to all income, regardless of source. But, that is a change that needs to occur regardless of our enacting a Pigou Tax.

Enjoy, and spread the word! Want to do something positive for America's future? Advocate for those actions (like this) that would reduce the grotesque, almost third-world, levels of inequality currently present. Our country does best when everyone works towards a common goal, and when everyone, even the rich, acknowledge and act like we're all in this together.

In Mitt's Defense (Or, What We Should Be Talking About)

Everyone is talking about Mr. Romney's latest gaffe: His statements to the effect that those who don't pay federal income tax are part of a poor, taker group that mooches off the rest and will vote to keep it that way.

Of course, the pundits rush in to provide the backstop facts: It truly is a much smaller group than Romney claimed who are actually free from federal income tax (most the elderly), and no, those in the lower half of the national income don't predominately vote for only one party, nor are they moochers in any real sense: They have jobs!

But what Mitt inadvertently cast a light upon is something that we should be talking about: namely, the large gap between the median income in the country and the average, and the impacts that has upon our society.

The median income in the U.S. is roughly $40,000 per year* – that is the point at which half the earners earn more, and half earn less. (I am going to use the per worker median rather than the household median ($50,000) to illuminate the individual's position within the workforce.)

Our Gross National Product (GNP) for 2011 was $15 trillion dollars – the sum of all productive activity in the nation for the year. Our workforce was 142 million people (fn1) – which works out to an average production per worker of approximately $100,000 annually.

This is a large difference: The average is significantly right skewed – in fact, earning upwards of $100,000 per year would place you in the top 16% of the nation's earners (and the top 20% of the nation's households.)

This shows that the fruits of our labor are accruing not across society, but predominately to a small percentage of the individuals. Now, while it is reasonable to believe that many are much more productive than others, it is hard to make a case that the distribution of productive ability shouldn't be a normal Bell Curve or standard distribution where the median and the average are closely in alignment.

There is a natural phenomenon behind some of this skewing: The time-value property of capital vs the ephemeral or transient property of labor. What any labor makes today doesn't compound into higher production tomorrow: Another unit must be produced with new labor tomorrow. However, money, through compounding, can earn more tomorrow than it earned today.

But what should concern us is the rest of the structure of society that places a premium on capital and capital earnings and forces this skewing to the the extreme level we see in our country. The structure of our economy is largely ours to choose: The laws that govern contracts, employment, money flows (taxes, tariffs), the formation of corporations, all provide this structure and hence impact the resulting distribution.

We should be talking about how we restructure so that all workers (and I'm talking the workers here, not those who choose to freeload) share equitably in the production of the nation. What changes do we need to make to restore the median worker's salary closer to where it should be near the average? What changes to our views of capital and labor do we need to foster to allow us to hold the worker in esteem, to perceive and accept the liberating effects of equality?

For surely many would willingly pay more federal taxes if their position in society was both monetarily richer and more esteemed, with the positive effect of an increase in commitment to the shared goals of our nation. There has been much research that has shown that gross inequality is a detriment to a society in both decreases in individual happiness and increases in civil unrest and a tearing of the social fabric that binds people to one another.

That is as far as a defense of Mr. Romney's comments I can make. Although we can thank him for bringing to light the problems of having a large financially extractive class by being a member of that class and forcing the research revealing the destructive nature of Private Equity, his comments are/were atrocious. They reveal a shallow individual with neither empathy nor moral compassion who has been thoroughly corrupted by the accumulation of ill-gotten money. There is nothing likable about a mindset that would deprive workers of the ability to make a modest and fair wage and then condemn them for not being rich enough to afford to pay taxes.

But, he has opened the door. We must have the discussion. Changing the structure so that everyone shares from the ground (or labor-hour) up is truly the way to progressive societal equality, for with the equality comes opportunity, and with opportunity comes the increases in productive capability and our living standard. This is exactly the progressive attitude towards wealth redistribution – not through taxes to correct an unfair system (although a progressive system is likely always needed to overcome the effects of chance), but structural changes to promote an equitable sharing of the productive capacity of all.

* I'm drawing all my data from stats.oecd.org

fn1: If you count our 14 million unemployed, our workforce is 156 million. I'm splitting the difference in my average calculation because I can see strong reasons to use either figure.

Sharing The Sacrifice

Everyone else has a tax day proposal - figured I should offer one of my own. Mine is built around the idea of shared sacrifice (or shared boon.)

When a CEO forces the layoff of a portion of his company's workforce to reduce expenses (and likely increase both the stock value and his compensation), in a well-functioning, robust economy, those displaced workers can find other work at or near their former pay. The transition may not be completely seamless, but it should occur.

However, when an economy is stumbling, fizzing, or recessing, those same displaced workers may not be able to find other jobs even close to their former compensation - they may not be able to find jobs at all, or they may take jobs and displace others. The net result is that many find themselves chronically unemployed, with neither prospects nor income for lengthy periods. They make a 100% sacrifice, whereas the management and CEO that oversaw their layoff often suffer nothing or very little.

So, to spread the sacrifice (or force at least a rudimentary sharing), I propose that the top marginal tax rate be directly tied to the unemployment rate. National unemployment rises - so does the top tax rate. Unemployment drops - so does the top tax rate.

I would use the extra money pulled in from the increase in top tier taxation to fund a government work program that would pay any takers for as long as they are willing - or, as long as they are unable to find a job in another sector of the economy. To borrow an idea from Hyman Minsky, such a guaranteed program could, potentially, even replace the minimum wage - the wage the government pays would generally be a new minimum (although one could see that for part-time work, especially that taken by teenagers, it might be possible for a franchise to pay slightly less in return for more flexible working hours our conditions...)

The money could also pay for re-training programs, to handle contractions in one sector that force massive skills re-alignment. Since we may have a surplus of workers that lack the proper training, and a shortage of workers in a new, growing sector, until their skills get re-aligned, we have higher unemployment.

This is not a silver-bullet solution, to be sure. It doesn't address the structural problems in our economy that promote the creation of monopoly - and although they may see their tax rate rise, many at the top would still likely benefit more from a decision to throw workers out of work than they would ultimately pay in increased taxes. But, it has a nice reciprocity to it: Instead of the sacrifice of a sputtering economy be forced on the few, it is spread more evenly on the top and the bottom.

Additionally, it does avoid the problem of a growing government deficit when demands on the government are raised by a chronically unemployed populace - and it would 'claw back' some of the excess compensation taken by those at the top.

I know one of the arguments against this is the idea that the wealthy create jobs. We can dispense with that (hopefully once and for all!): First, we will simply observe that at the start of the recent recession, wealthy pay had risen sharply and was continuing to rise, even as jobs were being shed - if the wealthy create jobs, this should not have happened. Second, we'll observe that most economists blame the slowdown on over-leverage, the collapse of the housing bubble, and market opacity - none of which are related to wealthy pay (well, ok, market opacity does relate in that it allows CEOs and their ilk to vastly overpay themselves without it being evident). Third, the idea that wealth creates jobs runs completely counter to the idea that productivity and increases in productivity are what fuel and grow an economy (and by extension, fuel and grow the ability of the economy to employ more) - the latter ideas which form the core of the observations made by Adam Smith in 'Wealth of Nations', and Fourth and Finally: Any ideology that draws direct casual connections between two elements of a modern economy is likely false or misleading - observe how easily statistics can be employed to both 'prove' and 'falsify' many economic statements - proof that neither captures much useful information about the myriad connections and forces that are at work.

We can, and should, simply assert that the ability to work and provide is a right in an affluent society, and since we are a community, all should be working before we allow those who are more skilled and productive take a larger share. Tying the top marginal tax rate to the unemployment rate is a start in aligning the interests of the few with the interests of the many.