Friday, January 27, 2012

Arnold Kling — One-Sentence Tax Reform

Here is my own one-sentence proposal:
If A and B earn the same income, but A saves and B spends more, then A should not have to pay higher lifetime taxes.
Read it at Library of Economics and Liberty
by Arnold Kling
(h/t Mark Thoma)
Euthanize the rentier. — John Maynard Keynes
Kling seems to think that saving in necessary for investment, and that it is investment (production, supply) that creates demand (consumption), so that saving initiates the supply side cycle.

Keynes knew that investment produces saving, in that saving is income not spent (residual), with income being workers' share of investment in exchange for their labor. Keynes, who disproved Say's law, the basis of supply side, also realized that investment is a response to effective demand, which is income dependent, and household income is the largest share of firm investment.

Banks don't lend out deposits, and there is no stock of "loanable funds." Saving creates demand leakage that reduces consumption, so that the potential output of an economy is not consumed unless government and the foreign sector make up the shortfall. Moreover, saving at the micro level leads to the paradox of thrift at the macro level.

Randy Wray:
...The problem is that because the “classical” analysis has no role for money to play, it cannot explain unemployment, nor can it find a solution to the two “outstanding faults of the economic society in which we live”, “its failure to provide for full employment and it arbitrary and inequitable distribution of wealth and income.” (Keynes 1964, p. 372) 
Both of these problems are linked to the existence of money. If government refuses to spend by crediting bank accounts on the necessary scale to raise effective demand to the full employment level, then unemployment results. Further, because money’s own rate sets the standard that must be achieved by all other assets, if interest rates are too high then private spending is too low to achieve full employment. Finally, a high interest rate rewards “no genuine sacrifice” but keeps capital scarce, resulting in “high stakes” and a “rentier aspect of capitalism”. (Keynes 1964, pp. 374; 376) Lower interest rates would euthanize the rentier, establish a “basic rate of reward” for owners of capital, so that “if adequate demand is adequate, average skill and average good fortune will be enough.” (Keynes 1964, pp. 378, 381) 
In this view, it is mostly fiscal policy that exerts control over the quantity of money, while monetary policy controls the “basic reward” to owners of assets.
L. Randall Wray, "Keynes's Approach to Money: What can be recovered?"

Minsky would add that high rates transfer wealth to rentiers, but if rates are low, there is also the danger that savings will instead go to leveraged financial speculation. This results in boom-bust credit cycles.

Therefore, rather than taxing income, which reduces consumption by leaking away demand, the preferred option is to tax economic rent, which is by definition non-productive and parasitical on the production-distribution-consumption cycle. The preferred course is to tax neither income from work that is rent-free nor real investment by entrepreneurs. Gains from financial "investment" through exchanging already existing financial assets that does not involve new real investment would be considered to be economic rent subject to taxation.


Neil Wilson said...

"If A and B earn the same income, but A saves and B spends more, then A should not have to pay higher lifetime taxes."

I'd argue exactly the opposite. It is the saver that causes all the problems in the first place by causing aggregate demand to fall.

The optimal system is everybody spending everything they earn today.

In a system with a state earnings related pension, and a living wage is there a need for ordinary workers to save for a long period?

paulie46 said...

It is baffling to me how so many smart people get things exactly backwards.

I think they are disoriented, constantly chasing the beginning of a circle.

Training in systems analysis should be a fundamental requirement of any economist or technocrat.

Dave said...

@Neil. Yes, because your costs could rise-say for example on healthcare--without a corresponding increase in income or pension income. To me, the trick isn't, how do we get people to stop saving, but rather, how do we get enough savings into the system for everyone but sill maintain notional demand?