Monday, March 12, 2012

Taxes and Inequality

The economist Daren Acemoglu and his colleague James Robinson have an excellent article on the problems with inequality in the United States. You can find it here. In general, I agree with them entirely, and they are persuasive in outlining the negative aspects of political inequality.

 However, the authors note that "we know by now that very high tax rates can choke off economic incentives." This is misleading in two respects. First, many economic incentives are in fact highly undesirable. For example, a very high tax on, say, cigarettes might "choke off" the economic incentives for producing cigarettes, but this is widely considered a good thing. Second, a tax is simply a cost, so that "taxing" a person $2 is equivalent to taking $2 away from that person. Accordingly, any discussion of taxes should be framed as cost-shifting: removing taxes on, say, high incomes, will shrink the budget for, say, public transportation, leading to higher fares, thus de facto taxing those who use public transportation. Thus, "very high tax rates" are often beneficial because, since costs are shifted, there are increased economic incentives towards more desirable outcomes (for example, more people paying for public transportation since the fares are lower due to higher taxes on those with high incomes).