Wednesday, March 26, 2014

Matthew Weinzierl's "Revisiting the Classical View of Benefit-Based Taxation," part 2

I broke off the prior post and am starting a new one here just for reasons of length.  This is a continuation that presupposes one's having looked at the prior one.

OK, on from equal sacrifice theory to benefit taxation. The paper that was posted for yesterday's session addresses “classical benefits-based taxation,” under which it is thought that people should pay a fair price for the benefits that they receive from government spending.  These include at a minimum specific public goods that particular programs address (e.g., national defense, the courts, and police protection), and perhaps more broadly the benefits of living in society that has a functioning economy, the rule of law, property rights, infrastructure, education, etcetera.  So once again, as I noted about equal sacrifice theory in the prior post, we are making policy assessments relative to a counterfactual – a hypothetical state of affairs that cannot in fact exist.  Only here, rather than being public goods supplied for free, it is no public goods, and presumably the existence of some version of a state of nature

 As Weinzierl notes, the classical benefits-based approach has been almost wholly eclipsed in the literature, due to challenges both normative (welfare economics and rejection of libertarian entitlement) and descriptive (how value public goods?  What’s the counterfactual from which benefit is measured?).  However, the paper develops a model in which something akin to Mirrlees' optimal income tax (OIT) model can be deployed to describe the basics of a benefits approach.

In Mirrlees, we tax income as a proxy for ability (assumed to be fixed and unalterable), which is itself a reverse proxy for marginal utility (i.e., when it is high, the marginal utility of a dollar is assumed to be low).  In the benefit tax world, we no longer care about utility.  All we care about is benefit from the provision of public goods.  In the paper's model however, income is a proxy for benefit, based on a modification of how ability is used.

In the paper's benefit tax model, ability, while it remains unalterable by the individual who possesses it, is assumed to be a joint product of (i) innate talent and (ii) public goods funded by tax revenue.  Innate talent and public goods are assumed to be complements.  At any talent level, more public goods leads to greater ability (i.e., one can earn more, e.g., by reason of infrastructure, a functioning exchange economy, the rule of law, the existence of educated consumers and workers, social peace enforced by the army and police, etc.).

Just as in Mirrlees, income is a proxy for ability.  But in the benefit tax model what's actually of interest is public goods' magnifying effect on innate talent to create higher ability.

For convenience, let’s assume that ability enhancement by public goods is constant as a percentage of income.  That is, assume an elasticity of 1 for income gain (reflecting higher ability) per dollar of public goods as income rises.  Thus, if I earned $1 million, I got ten times the benefit from public goods of someone who earned $100,000.

Just like under equal sacrifice theory as per the prior post, assuming a particular elasticity (but here a different one) of 1 leads to a flat rate system.  But the benefit tax system should be progressive if high-earners got more relative benefit from public goods than low-earners, and should have declining marginal rates if they got less relative benefit.

Leaving aside the question of normative motivation for embracing such a system, I think that some of the biggest questions that this model raises relate to (1) its dependence on comparisons to a hypothetical counterfactual state of affairs and (2) the concept of innate talent.  As to (1), even apart from the question of what motivates the counterfactual, I don't see we can define it usefully, or have a coherent debate on what it should be assumed to look like (and why).  As to innate talent, I don't think there is such a thing.  The value of any attribute depends on the environment in which it exists.  This is the lesson of evolution – fitness is relative to the environment, and changes when the environment does.  A trivial example is a star athlete with or without popular taste - and a global versus a purely local market - for the sport in which he or she can excel.  But consider as well having good math skills, or an aggressive personal style, or for that matter strong genetic resistance to particular diseases.  The same people or the same skills will do well in some environments and poorly in others.
This is not a problem for Mirrlees because we are assuming the existing environment, in which abilities have particular payoffs.  (Mirrlees does, however, ignore ongoing ability risk as the environment changes).  But it is a big problem for the concept of innate talent, if one is using it as part of the baseline from which to measure benefit from the existence of  a functioning exchange economy and all the rest.

That said, Weinzierl clearly has one of the more interesting and distinctive research agendas among active people in public economics these days.  I will look forward to continuing to follow his  work on non-OIT or at least non-welfarist normative approaches to tax policy.

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