Dear Anonymous,

You criticize my understanding of economics, but it appears that you are the one who is lacking in the fundamentals. I don’t know where you studied the subject (if at all), but assuming you did, I imagine you were taught standard fare Keynesian macroeconomics at some point in your academic career.

Have you ever studied Austrian economics? Comparing Austrian economics to Keynesian economics is like comparing chess is to checkers, or MMA and jiu-jitsu to boxing. Don’t be fooled by all the fancy regression equations, econometric models, and high level mathematics used by the neo-Keynesians. The fatal flaw of the Keynesian School is simple: No group of central-planners - no matter how intelligent or wise they may be - will ever have sufficient knowledge in toto to manage and direct an economy. The two essays by F.A. Hayek - which I referenced in my previous post - explain why this is true.

Now, if you would like to learn something, keep reading my dialogue with COTO. Unlike you, he is actually putting forth a respectable counter-argument.

I take back what I said, because now you are thinking. Albeit, not entirely clearly.

I've been upgraded from "brain dead" to "babe in the woods", have I? It's something, I guess. :)

Should my customers be required to wait for the next innovator to come along...

Alternatively, should I go on selling widgets to my customers even if the government steals all the additional profits...

Consider two alternate scenarios:

Case 1: IP laws are moot and any firm has the right to sell iGizmos. The "wait for the next innovator" lasts precisely 3 nanoseconds. However, given we agree that abolishing IP rights is a bad thing...

Case 2: 100% of profits in excess of Mr. Jobs' $1M salary are funneled to capex and stock dividends. If Jobs' nominal (uncapped) salary was vastly in excess of $1M, he'd hold stock solely for his shareholders' rights (as any capital gains would necessarily be taxed at 100%). His work incentive would be his annual meeting with an army of rapacious shareholders, and the ability to look his fellow executives in the eye during board meetings.

...unless (and until) another innovator comes along with a competing product or service that is just as good (or better) than the iWidget...

You've jumped to the problem of how to implement a salary cap when my original arguments pertained to Mr. Jobs' intrinsic worth.

If IP rights suddenly evaporate tomorrow, Apple's profits crater. The consumer surplus you've mentioned widens as dozens of clones flood the market. In this universe, Steve Jobs is still paid a decent salary. Apple realizes that he gives them a few months lead time on the latest iGizmo. However, since oversized incomes quickly become a liability with narrow margins, 'decent' is a fraction of his current salary.

The salary that Mr. Jobs is paid in this hypothetical universe is what I consider to be his intrinsic worth. It might well be in excess of $1M per year. I don't know.

This is what society gets out of Mr. Jobs. Any excess remuneration, regardless of its importance as an incentive in a world where IP rights do exist, is precisely that: excess remuneration.

You can argue that my "Case 2" above couldn't be implemented in the real world. Or that pressure from shareholders/the board would be insufficient to motivate Mr. Jobs. Again, I don't know. What we do know is that Mr. Jobs wields a powerful governmental apparatus that grants him the ability to broadly, efficiently suppress his competitors. I am not contending that it is morally wrong for him to do so. I am, however, contending that at a fundamental level Mr. Jobs is worth far less to society than his notional value suggests. Think of it as subtracting the deficit in consumer surplus (due to the existence of IP rights) from Mr. Jobs' current income.

Finally, I realize that $1M is arbitrary. There's no way to reliably quantify "peak" intrinsic value, and this is all hypothetical anyway.

First of all, what makes you think a doctor has a moral obligation to be another man's slave?

Firstly, he's being a "slave" to a society rather than to a man, and even this analogy breaks down upon noting that the doctor can elect not to work.

Assuming all people paid equal taxes, the person-to-person "fractional slavery" cancels out. With a flat tax rate, we immediately see a disparity in how much one man is a "slave" to another man. But you've tacitly acknowledged that the existence of this disparity isn't "wrong", since you're making the case for a flat tax rate. The question then becomes how severe a disparity is wrong, which is what we've been debating.

I am by no means a fan of Keynesian economics. (Also note that modern "Keynesianism" bears little resemblance to Keynes' original theories.)

High tax rates driving people into underground economies is certainly a risk, but this is again an issue related to overall tax rates.

I agree that the man who earns more has greater potential resources at his disposal to do so, but what makes you assume he is going to use them for this purpose?

This is a fair criticism. There is no simple way to quantify a man's "willingness to influence" society. We're limited to looking at each stratum of income-earner in aggregate. I acknowledge that this kind of blunt categorization is a limitation, and that it is--to an extent--unfair.

However, accepting that this is the best we can do, a stratified model like this makes proper sense in aggregate. I hope you'll agree that the probability of an individual with income x being "of great influence" in society (e.g. sitting on boards, regional committees, legislation, standards committees, peer reviews, etc., etc.) is a monotonically increasing function of x. In a country like America, where the median salary is not far removed from the poverty line, disposable income means time. Disposable income means status. As you've pointed out, disposable income means lobbying rights (and with due respect to Mr. Madison's "limited, enumerated powers", look at the present size of the US government or even one chart correlating lobbyist funding with election win likelihood).

If we agree that a man's resources (capacity to influence) grows proportionally to his income, and if you were to grant that a man's "probability of utilization" grows proportionally to the square root of his income (our monotonic relationship), and we taxed each man proportionally to his "probabilistic influence" (capacity to influence times probability of utilization), we end up with a progressive taxation system not unlike the one we currently have.

This does not seem unreasonable to me, even though (as you point out) each dollar is taxed at a marginally higher rate. In fact, I'd argue that the square root dependence of the utilization term lowballs the convexity of the actual relationship. (Lowballing helps us make up for the crudity of our classification system. ;)

Your observations that a flat tax is simpler, (putatively) less prone to loopholes, and can complicate capital allocation (you were really reachin' for this one) are, in my most humble of opinions, not compelling--or rather, not sufficiently compelling--reasons for moving away from a system that is a fairer representation of "influence".

In summary, your "representation" argument is fallacious, because it assumes behavior that may or may not take place (i.e., rent-seeking).

Alas, could but one counter a fallacious argument with one equally as fallacious. ;)

To wit: you are assuming here that "rent-seeking", which I've acknowledged exists, makes progressive taxation a non-starter.

I disagree.

It shows that progressive taxation isn't perfect, certainly. But neither is any other tax code that's applied to some 150 million taxpayers. I contend that the x^1.5 dummy model I proposed above is, on its face, defensibly fairer than a flat tax rate, and I have the advantage that the architects of our present tax system agree with me. (Yes, I realize this isn't exactly a first-class endorsement.)

If "influence" was proportional to "likelihood of usage of government services", then flat tax away.

It is not.

"Influence" equates more to "probability of being the architect of IP laws", or "probability of influencing a decision on an antitrust suit". And I hope even my short rant on Mr. Jobs demonstrates how utterly pivotal these intangible benefits of wealth can be.

Your Friend in the Woods,

COTO

COTO -

I take back what I said, because now you are thinking. Albeit, not entirely clearly.

Why "Steve Jobs is Worth Every Penny He Earns"

First, allow me explain the concept of "economic surplus," since I don't think you understand it fully. If I sell a widget to you for $500, and your maximum willingness to pay is $750, you will gladly give me the cash and walk away better off by $250. Why? Because you now have a product you value for $750, but you only had to give up five "Benjamins" to obtain it. The difference of $250 is your "consumer surplus."

Likewise, if it cost me $300 to produce the widget, and you pay me $500 for it, I walk away better off by $200. This is my profit margin, or "producer surplus."

In other words, we both walk away as winners to the transaction. This explains the paradox when you say "thank you" to the merchant operating the cash register at his store, and he responds with an equally heartfelt "thank you" in reply. The exchange has been a "win / win" for both of you.

Now, if I sell this same widget to 5,000 customers, I will earn $1 million in profits ($200 profit / widget * 5,000 widgets = $1 million profit). But consider this, I have also generated a $1.25 million net "consumer surplus" for all the people who bought them. (This assumes, of course, that each customer values the widget as much as you did at $750, but only pays me $500.)

Now, should I stop selling my widgets once I reach $1 million in profits, because as you put it, "No man, regardless of his contributions to society, is actually ‘worth' more than $1 M per year?" What if there are another 5,000 customers who also want to buy my widget? Should they go home empty-handed? Should my customers be required to wait for the next innovator to come along (however long that might take) and develops a new widget just as good (or better) than mine? Should I shut down my operations and lay-off my workers until the new year begins, because Uncle Sam won't allow me to keep what I earn until then? That would be crazy!

Alternatively, should I go on selling widgets to my customers even if the government steals all the additional profits I generate? (Please note that your arbitrary limit of $1 million in income per year would imply a 100% marginal / "progressive" tax rate on each dollar of profit earned above this threshold.) To continue selling in this scenario would be to engage in charity. Now, don't get me wrong, there is absolutely nothing wrong with charity, but only so long as it is voluntary. Regardless, I think most people would choose to stop producing widgets and they would take a vacation instead.

Thus, returning to the specific example of Steve Jobs, unless (and until) another innovator comes along with a competing product or service that is just as good (or better) than the iWidget, we should hope that Mr. Jobs will have the proper incentive to continue supplying us with these products. "Society" is far better off when he does.

Now, I will concede that you are probably correct to say that someone else will develop a better widget eventually, but how long are you willing to wait? And in turn, should this new innovator be effectively forced to stop selling his product(s) once he reaches your arbitrary $1 million threshold, as well?

There is a reason why the store shelves were empty in the U.S.S.R.

Intellectual Property (IP) Laws

This is beyond the scope of our discussion. I agree that in many cases the duration of a patent (and the government granted monopoly privileges that go with it) are too generous. However, it would be a huge mistake to not protect IP rights at all. Look at China. There is going to be a day of reckoning when the Chinese will have to start developing some IP on their own, rather than stealing it from the Americans, Europeans, and Japanese.

Marginal / "Progressive" Tax Rates

You wrote, "If being taxed at 30% instead of 25% makes the difference in your wanting to be a doctor, you aren't morally qualified to be a doctor." First of all, what makes you think a doctor has a moral obligation to be another man's slave? A 25% rate implies that a doctor must be a slave from January 1st to March 31st of each year. If you raise his tax rates, then he must be a slave even longer. Second, like most Keynesians, you assume that wealth creation is impervious to tax rates, no matter how high those rates might be. In fact, some Keynesians are so delusional that they actually believe that the higher the tax rate is, the less one will earn per hour of work; and thus, the more motivated that person will be to work even harder to make up the difference. After all, a man has to feed his family, right?

Well, yes and no. A rational man is not going to sit back and allow himself to be robbed blind. To borrow Thomas Sowell's definition, "Economics is the study of the allocation of scarce resources which have alternative uses." Time is a scarce resource, because without exception, no man has more than 24 hours in any given day. Since time also has alternative uses, one way it can be reallocated is to spend it doing things other than work. In so far as a man has to meet his basic needs in life, time can also be spent working in the underground economy. There are a myriad of ways a man can avoid paying taxes, some perfectly legal and others not. If you raise tax rates too high, the risk / reward trade-off of moving your economic activity to the black market (and/or under-reporting your income) will begin to shift toward doing exactly that.

"Progressive" Tax vs. Flat-Rate Tax

I agree that "taxes are the price that citizens pay for their government," and without getting into a debate over the proper role of government, let's agree for that sake of argument that some level of government services are indeed necessary (e.g., courts of law, national defense, certain "public goods" - strictly defined as non-exclusionary and non-rivalrous). These need to be paid for, of course, but who should pay exactly, and how much should they be required to pay?

You believe that "each man's contribution should be proportional to his representation in governing the country's social institutions." You then go on to say that "it's a simple fact" that the man who earns more has more influence on these institutions. Really? So, are you saying that the man who generates $1.25 million in "consumer surplus" for his customers, and takes home $1 million in "producer surplus" for himself, yet does not engage in any form of rent-seeking behavior has a greater influence on the government than the man who earns less but hires a lobbyist? I agree that the man who earns more has greater potential resources at his disposal to do so, but what makes you assume he is going to use them for this purpose?

And even if he did, so what? What part of the First Amendment do you not understand? A man has an inalienable right to "petition the Government for a redress of grievances," as the Supreme Court ruled (correctly) in the Citizens United case earlier this year. If you have a problem with rent-seeking and lobbying, the best way to alleviate this problem is to reduce the size, scope, and power of the federal government, so our political class has less influence to peddle to all these moochers and parasites. James Madison warned us about this problem in Federalist Paper No. 10, and that is why the Founding Fathers gave us a federal government of limited, enumerated powers. (It was during the New Deal era when many of these powers were expanded arbitrarily via the "Living Constitution" doctrine. Most notably, the Commerce Clause. If you want to read about an especially egregious case, see Wickard vs. Filburn.)

You wrote that "government is ostensibly a national 'corporation' to provide public services." Using that analogy, shouldn't the "shareholders" (i.e., taxpayers) in this "corporation" be allowed to vote in accordance with how many "shares" they own? And if so, wouldn't that mean that those who pay more taxes (i.e., in absolute dollar terms) would get to cast more votes? For example, one vote for each $10K paid in taxes each year. Now, that would be a true plutocracy. (Something I am opposed to, by the way.)

You are correct to note that I am in favor of a flat-rate (%) tax, though. Why? Because every American should have to pay for his government and have a vested interest in how it spends our money. A flat-rate (%) would also eliminate much of the rent-seeking that goes toward trying to convince Congress to write numerous deductions, exceptions, rebates, and other loop-holes into the code. Ideally, we should repeal the 16th Amendment and replace it with a flat-rate (%) tax on either income or consumption. An additional advantage is that this would greatly alleviate the administrative burden of enforcing and complying with the code. And, as any respectable economist knows, a flat-rate (%) system would eliminate many of the distortions in the "price signal," which is so essential to a well functioning market. Keep in mind that most people look at after- tax costs rather than pre- tax costs; whether it be for labor, interest paid on mortgage debt, or the price of an electric car. If the tax rate paid on these things is flat, the after- tax prices of each item relative to all the others will be the same; and it is relative prices that matter when it comes to "allocating scarce resources which have alternative uses."

Now, let me address the real crux of the issue. A flat-rate (%) tax is "progressive" in absolute dollar terms. For example, if a flat-rate (%) was imposed on income and set at 20%, the man who earns $1 million would pay $200K in taxes, but the man who earns only $50K would be required to pay only $10K in taxes. This is fair, because if a man earns more income (or consumes more), he is most likely going to use more government resources in the process (e.g., police, fire, and legal protections, as well as the use of public infrastructure). Ideally, the cost of government services should be charged directly to the beneficiary of such services (e.g., the rich man who ships a lot of his products on public roads should be required to pay a toll tax, which would be used to maintain these roads). But since it is nearly impossible - in practice - to allocate the costs for all government services in this manner, a flat-rate (%) tax is probably the closest approximation to fairness.

A "progressive" tax, by contrast, is unfair, because I see no reason why each marginal dollar earned (or spent on consumption) would lead to a higher marginal cost for the government services necessary to support it.

In summary, your "representation" argument is fallacious, because it assumes behavior that may or may not take place (i.e., rent-seeking). And a "progressive" tax is unfair, because it can only lead to some people being forced - arbitrarily - to pay more for government services than others, and thus, be required to subsidize others. "Subsidization" is nothing more than a euphemism for wealth redistribution, and thus, legalized theft.

__________

I apologize for such a long post, but you have raised a lot of important issues. Besides, you are probably the only one who is going to bother reading this.

Regards,

- Roark