Friday, January 11, 2008

Oh My God Steven Landsburg's column is much worse than I imagined possible

He writes

In the long run, most people, or at least most families, do spend what they earn. (Why earn it if you're not going to spend it?) True, some of us die with money in the bank, but usually our children or grandchildren step in to spend the remainder for us. So, as far as your dynasty is concerned, a 20 percent income tax and a 20 percent sales tax are equally painful.


Landsburg must have noticed that aggregate consumption is lower than aggregate GNP. He apparently doesn't know that consumption and GNP appear to be cointigrated (have the same trend).

He appeals to utility maximization "Why earn it if you're not going to spend it?" and insists that we consider infinitely lived dynasties not finite lived individuals (who on average leave huge wealth when they die) but he is clearly completely unfamiliar with the model of a utility maximizing dynasty. let's consider the very simplest model. Instantaneous utility is the natural log of the flow of consumption (so marginal utility is the inverse of consumption). Dynasties maximize the flow of utility discounted by a rate of time preference rho. Assume that the marginal product of capital is a constant r and the wage grows proportional to the capital stock ((this means this is an endogenous growth model)
This r is and must be the market real interest rate. If income is taxed at rate tau, the after tax rate is r(1-tau).lets say r>rho. Income is rK consumption is rhoK. Consumption is a constant fraction of income less than one.

Anyone with any knowledge of economic models of consumption must know that what landsburg says is a false claim about economic theory. Yet he is arguing that we should ignore the fact that people seem to consume less than they earn (and proportionally less if they are rich) because of a theoretical argument. I think this is always unwise, but in any case, he should brush up on the theory before arguing that it implies something which it does not at all imply.

Now let's have government spending. Replacing an income tax with a consumption tax implies an ever growing government deficit. If the old deficit was zero, total government debt will grow proportional to capital. This debt will be sustainable.

1 comment:

Ian said...

Based on standard measures of tax burden, the FairTax is more progressive than the individual income tax, payroll tax, and the corporate income tax ( http://snipurl.com/lessregress ). [THBPN]

Keep in mind that, theoretically, no U.S. citizen pays an actual 23% rate, since they receive the recompensatory prebate. Thus, poverty level rate is 0%. Spending at:

2 X the poverty level, you pay 11.5%.
3 X the poverty level, you pay 15.3%.
4 X the poverty level, you pay 17.25%.

You’d have to be spending at 8 X the poverty to get to a rate of 20%. Even spending at 24 X the poverty level, your effective rate is still only 22%. However, this is equivalent to a "luxury tax" rate of +10.5% on ANY item after that level of consumption is reached! No "averaging," or complex rules to follow. (Hat tip to Derek at: http://www.fairtaxblog.com/20080111/say-what-about-a-luxury-tax/ )