Capital vs labor: who risks more?

AFAIK, in the developed world, the income tax rate is often higher than the capital gains tax. In particular, income is taxed "progressively", meaning that higher income results in a higher rate – which doesn't always happen with capital gains. (It looks like it does happen in the US, but income appears to be taxed "more progressively".)

One justification for this is that investors risk losing much or all of their capital. Workers, on the other hand, are guaranteed their wages. To some extent, the difference in the tax rates compensates for the difference in the risks.

To me this is sensible at first glance but completely harebrained on second thought:

  • The worker's big risk is choosing the profession. Higher-income professions often require a more expensive education. If the demand for the skills drops in the future, the income might fail to cover the worker's investment into acquiring these skills. Assuming that learning ability drops with age, the risk increases proportionately.
  • Moreover, this risk is not diversified. Even a small-time investor can spread his risk using some sort of index fund, betting on many stocks at a time. For a worker, on the other hand, there's no conceivable way to be 25% lawyer, 25% carpenter, 25% programmer and 25% neurosurgeon.

The latter point may not interest utilitarian economists focused on GDP "the greatest good for the greatest number" – for society as a whole, risk is always diversified, even if Joe Shmoe is stuck with the crummiest profession that looked really promising when he chose it. Moreover, an efficient market would provide a way to insure against the risk of poorly choosing your occupation. (I don't think real-life markets did provide such a thing, though I might be mistaken.)

But the first point – that the risk exists, and that it's more likely than not to be proportionate to the projected income – by itself kinda erodes the ground underneath an income tax higher than the capital gains tax, not? I mean, regardless of the motivation, it seems internally inconsistent. Unless the risks are all quantified and it all magically cancels out.

It's not that I'm complaining – unlike most professionals, we programmers get stock options. (Speaking of which - central bankers of the world, The Programmers' Guild says thanks a bunch for QE and ZIRP! Remind us to send some flowers.) I just honestly don't get it.

Econ-savvy readers: what do I miss?

(Please don't accuse me of failing to use the Google. Maybe I did so badly, but I did try using the Google. The Google told me, for instance, that the optimal capital gains tax is zero, because "you can't transfer from capitalists to workers", because the transfer depletes the capital pool or something. But I didn't understand how it accounts for the case where the workers are also capitalists because they invest their savings; and what if there's a progressive tax on capital gains? Is it, or is it not possible to "transfer from capitalists to workers" the flesh and blood people, as opposed to abstract categories, regardless of whether you'd want to? Or if that's all nonsense – then is the optimal income tax also zero, because, hey, you're actually taxing human capital gains? Bringing us back a couple hundred years ago where we just have a sales tax? And again, not that I'd complain, I just don't quite follow the logic.)

(Also from the Google there's the claim that since nominal capital gains are taxed, the tax rate is actually higher than it looks because of inflation. But then the solution would be to tax inflation-adjusted gains, not to lower the rate arbitrarily, not? Also, wages are AFAIK the last set of prices to rise upon inflation – the "stickiest" – so workers' investment in their skills is continuously nibbled at by inflation as well. And the point made about "discouraging savings" – well, a high income tax discourages costly education and the subsequent ongoing investment in one's skills, which is a form of investment/savings/call it what you like. Same diff.)

I think it's pretty obvious that workers risk much more than investors. Whether this should lower their taxes I don't know, but it sort of makes sense to me.

32 comments ↓

#1 ak-47 on 10.17.14 at 1:22 pm

You're trying to make sense of macroeconomic theories, but most of them are just nonsense and have little connection to reality.

Powers that be always have to keep delicate balance between taxation and popular revolt. So, naturally the select a demographic cohort, which has enough property to be taxed and at the same time doesn't have enough political power to avoid taxation.

Middle class is an ideal milch cow. It has enough income to be taxed and too weak politically. Capitalists are much more organised and have greater political power. It would be suicidal for a political party to tax business too much. Therefore they tax you. Academia will provide a required theory, which describes the current state of affairs the best of all possible worlds.

#2 Ariel on 10.17.14 at 2:47 pm

The Chamley-Judd result is about redistribution from producers to consumers – if the demand for bread is completely inelastic, and you tax bread by 10%, and give the money to the buyers, then the price of bread will increase by 10%, and you will achieve nothing.

If the demand isn't completely inelastic then you will also have traditional inefficiency of taxation, with the result that everybody loses.

This applies because *you give the tax directly to the buyers*. If you, say, use the money to pay the poor, then the poor will have more money and the non-poor will have less money (so you transfer between richer workers and poorer workers), which may be a desirable result. Also, if you use the money to fund the government, and the government is more efficient than the market would have been in the things it does (which I'm quite sure it is the case in some places, e.g. the military), it could be more efficient than the alternative (still inefficient, but I've started from assuming inefficiency, and the taxes just imperfectly reduce it).

#3 Yossi Kreinin on 10.17.14 at 3:13 pm

@Ariel: (1) how should this result apply to investment in human capital? (2) you seem to confirm my suspicion that this result does not say what the sentence "you can't transfer from capitalists to workers" suggests to the lay reader; this result does not preclude a redistribution through income/wealth/consumption/whatever-based discrimination.

@ak-47: the political forces you mention are described by public choice theory, which sorta refutes the point of academic economists necessarily vindicating whatever the politicians are doing. More generally, as you're well aware, times exist when it's politically possible to do all sort of things to "capitalists" however you define that category, including fully confiscating their property. It is therefore not entirely uninteresting to wonder what the outcome of policies would be even if right now the policy is different and unlikely to change in the nearest future. So I specifically wonder what the income tax should be relatively to the capital gains tax. I think it's as legitimate as wondering what happens if you confiscate everyone's property (not usually a good thing, and even VIL himself openly admitted that his economic illiteracy was greater than he'd previously thought, to regrettable effects.)

#4 Leo Sutic on 10.17.14 at 4:25 pm

You are comparing unrealized profits with realized losses.

Choosing a profession means that you then hope to make money, but not making money is not a loss, in the same way as not having bought Google stock when it was cheap is a loss, or not winning a lottery you did not participate in is a loss.

(That said, I do think that capital gains should be taxed as salary proportionately to the underlying shares being given as salary.)

#5 Yossi Kreinin on 10.17.14 at 4:37 pm

Choosing a profession leads to spending on education and then there's a continuous further investment in one's skills. This is a lot like buying a big chunk of Google stock, and then continuously buying more and more. All the time paying income tax on the profit from that investment. If then the demand for the skills falls, how is that different from a falling stock? Choosing a profession isn't like not buying Google stock – I think it's very much like buying plenty of it!

BTW, further Googling found this in Wikipedia – a similar argument from a professional economist, it seems: http://en.wikipedia.org/wiki/Optimal_capital_income_taxation#Human_capital_formation

Actually it's from Judd of Chamley-Judd, the zero-capital-gains-tax-result duo. I didn't quite digest the passage in there yet though.

#6 Ivan Tikhonov on 10.17.14 at 5:06 pm

If you want to kill some time, write an economy simulation of the thing :)

#7 Ariel on 10.17.14 at 5:09 pm

Chamley-Judd-style results apply to cases when you're taxing buyers and giving the proceeds to sellers (or vice versa). Chamley-Judd would apply if you were taxing captial investment by the *workers* and paying the *capitalists* as corporate welfare. It is irrelevant to the case when you're taxing the workers and using the money to their benefit.

In that case, there are the usual free-market vs. taxation+government efficiency issues – where sometimes economists assume that the market is perfect and all inefficiency comes from the government and taxation, and sometimes they make the opposite assumption, having all inefficiency come from market failures while assuming that the government is perfect, but there is no strong impossibility result either way.

In addition to this, there are the usual distributional problems – we prefer that some amount of money will be used to create housing for the poor instead of a yacht for some rich guy, and will accept a good amount of inefficiency to ensure that happens.

#8 Yossi Kreinin on 10.17.14 at 6:19 pm

Erm… but taxing workers at a higher rate than investors *is* corporate welfare, not? I mean, if you build roads with taxes but you tax me more than you tax John Doe, the road is to some extent a gift to John Doe at my expense. Taxing my investment at a lower rate than an investment into a corporation seems to be precisely corporate welfare.

#9 Brian Hurt on 10.17.14 at 7:23 pm

It's very simple: taxes are for little people.

If you have two taxes, one of which is mainly paid by the poor and the middle class, and one of which is mainly paid by the wealthy, the wealthy want to cut or even eliminate the latter, and raise the former.

So, for example, Ronald Reagan had no problem raising the gas tax (which is mainly paid by the not-rich) and the social security tax (which is regressive- you stop paying it after a little more than $100K in income), but cut income tax (which is paid mainly by the rich) dramatically. So he's a tax cutter. Now consider the Republican war on the estate tax- again, who pays it, mainly? Notice how all the Republican/Liberatian flat tax proposals, how they all include not taxing capital gains. Again, who mainly pays capital gains taxes?

And you see this on the other side as well. Spending money on stuff that helps rich people: good. Spending money on stuff hat helps not-rich people: bad. First off, notice how the deficit is only a problem when a Democrat is in the White House- where were all those deficit hawks when we went to war in Iraq and put it on the credit card?

But even there- OK, the deficit needs to be dealt with so badly we need to cut social security- so why aren't we also looking to cut the defense department? Look at where the money goes.

Everything else is just justification and rationalization at best.

#10 Yossi Kreinin on 10.17.14 at 7:51 pm

Perhaps you have a point, and I suspect that it's all there is to it myself. But on top of many people in the developed world who pay no taxes but receive payments from their governments, there's also my birthplace USSR which proved that you could have very different policies, all the way up to a progressive wealth tax quickly reaching 100%. And there's a lot of countries and a lot of policies.

Also, in many countries, 100% of the workers have pension plans as mandated by the state, making them capitalists whose combined capital often dwarfs the capital of the super-rich, and their savings' capital gains are taxed at the low rate (and sometimes the part of the income put in the retirement plan is even exempt from the income tax to some degree in the first place.) Though you could explain this as a plot to subsidize retirement fund managers and the stock holders whose asset values are propped up by the influx of capital from these subsidized/mandated savings…

Anyway, since a lot of countries are doing what the US is doing, maybe it's sensible in some way that I don't understand. Maybe. And maybe what you said is all there is to it.

Regarding Republicans/Libertarians – and I'm not a US citizen and have only spent 2 days of my life on US soil – as an outside spectator I've seen complaints about "socialism for the rich" from those guys so it's not that one-sided; for example, this is from The Capitalism Magazine: http://capitalismmagazine.com/2006/10/socialism-for-the-rich/

#11 Gary on 10.17.14 at 8:19 pm

Well, your first point, about taxes being lower for investments, is actually incorrect, because you did not take corporate tax into account. Let's do the math for a 35% corporate tax, and then you need to pay a 20% long term capital gains tax. If your proportion of earnings was 100 dollars, corporate tax leaves you with 100 * (1 – .35) = 65 dollars. Then, you pay your capital gains tax. 65 * (1-.2) = 52. 48 dollars, or 48% went to taxes.

Compare this with a sole proprietorship. Profits are taxed at your income tax bracket. So even at a high tax bracket of 38%, you're still only paying 38% vs 48%.

I like your argument about choosing a profession, but that's a choice driven by comfort level, where your loss is usually limited to just opportunity cost. Most professions do not require an expensive education. Most forms of work do not even require a college education. A cheap community college education would do just fine for almost every profession. As such, someone who overpays for a college degree by going to a costlier school than they need to, should bear the risk that their investment will not pay off. Beyond that, an incorrect choice of profession does not result in a measurable financial loss, but instead, an immeasurable loss of opportunity which might never have materialized.

#12 Yossi Kreinin on 10.17.14 at 8:49 pm

Interesting points. Regarding the first point, I'm not sure I follow your math, because those 65 dollars of dividends wouldn't be taxed as a capital gain, I think – what would be taxed as a capital gain is if you sold your shares which appreciated by who knows how much due to whatever income the corporation had. Then there are share buybacks instead of dividend payments as a method to help investors with taxation, and there are tax loopholes such as keeping cash overseas, and different countries do things differently. Then not all capital gains are due to investment in corporations – investment into real estate also has a similar kind of tax AFAIK, and then there are bonds, metals, etc. Overall I agree that the corporate tax needs to be accounted for, I'm just not sure exactly how to do it.

Now, regarding occupation choice: lawyers, doctors, MBAs, engineers and hoards of others invest a lot of time and money into their education, and then each day of staying in an occupation and honing your skills is an additional investment. You say if it's time and effort and not money that is being invested, it's opportunity cost because the time would have elapsed anyway. I agree that the loss of opportunity is hardly measurable, but consider that money is inflated away with time unless you invest it. So you could say that if someone invested their money and lost it, the loss is also immeasurable because they'd need to invest it in something else to not have it inflated away, and who knows what would happen if they invested it in something else. Just like it is with occupations.

And I'm not sure why measuring the loss matters. It's obvious that there's an investment – studying to be a doctor is obviously "spending" time and effort that could instead be spent doing work requiring less concentration, playing video games, etc. It's also obvious that a high income tax reduces the upside without also reducing the downside in case doctors are suddenly in less demand because of changes to the immigration laws, for instance, or technological progress, or healthier lifestyles. As such, a high income tax reduces the incentive to invest the same way a high capital gains tax would. How is this wrong?

And if it's a carpenter – why doesn't it reduce his incentive to become a better carpenter? I certainly know more than one programmer who doesn't fight particularly hard to improve their productivity in part because the projected after-tax addition to their wage does not seem worth the trouble, or so they say. It's easier to almost mindlessly do what you already know, staying in your comfort zone, than struggle to do stuff you're not yet good at. Goodness knows, I'd hardly do it myself if it weren't for stock options – I'm dead serious. At the very least I'd have serious doubts. Is there some sort of a "revealed preference" experiment refuting such pronouncements?

#13 ak-47 on 10.18.14 at 1:55 am

Thanks for the answer.

Yes, I was talking about more or less "normal" state of society (if such thing exists at all) rather than turbulent times.

My views on taxes are quite extreme by these days' standards. I believe that taxes are evil, progressive tax is outright immoral, and capital gain taxes are bad, too. Taxes are evil, but unfortunately, they are necessary. So a prudent ruler has to strive for less burden on his subjects, i.e. lower taxes.

Sales tax is more or less acceptable as the lesser evil: you consume – you pay, you don't consume – you don't pay. It's fair, as opposite to income taxes.

#14 Leo Sutic on 10.18.14 at 2:00 am

Well, as the page you link to states "distinguishing between capital and labor incomes can be difficult". ( http://en.wikipedia.org/wiki/Optimal_capital_income_taxation#Avoidance_of_tax_arbitrage_between_capital_and_labor_incomes )

In a way *anything* can be seen as an "investment", just by pulling more and more into the transaction. The world of accounting is like that – what something "really is" (capital gains, salary, etc.) is really never clearly black or white. The categories are fuzzy, and where the line is drawn is in the end a matter of how the courts rule, government policy and political will.

I would argue first that buying education is different from buying a stock due to the fact that you can't sell the eduction back. A stock, once bought, can be sold. An education, once bought and "consumed", can't be sold. In the education case, you are not directly profiting on a gain in value of the thing that you bought. You are (hopefully) profiting on the effect it has on you. The closest thing I can think of is if you buy a house, improve it, and sell it. But the equivalent would be to buy an education and then sell yourself into slavery.

The second argument is that the different tax rates are based on the volatility of the investment. Education has shown to be a very involatile investment (a degree is more or less always good), whereas stocks are very volatile. I think you'll find that tax rates go down as volatitlity goes up. For example, California's "angel investor" law for investment in small high-tech startups.

#15 Leo Sutic on 10.18.14 at 2:09 am

Since we should perhaps state our political views, I believe that:

1. Education should be free. It is unmatched in creating wealth and because of the low volatility it is really the best investment a government can do in its citizens.

2. The gap between capital gains and direct income should be proportional to volatility and risk. That is, if you risk being "taxed" by random chance, the government shouldn't be allowed to just profit when you profit without sharing any of the risk.

#16 Ovidiu R. on 10.18.14 at 10:58 am

Capital is just better represented in politics and the media. They got a better deal than labor. Capital can move freely across the globe while labor is restricted. So capital can make countries fight one another in lowering the taxation for it, while labor for the most part is stuck. Media and right wing think tanks come in and help by creating a story that all this is fair annihilating labor's use of its great numbers to put political pressure for a design change.

#17 Yossi Kreinin on 10.18.14 at 12:09 pm

@Ovidiu: (1) why isn't capital gains tax near-zero then and more importantly for my specific point, (2) why don't corporations fight to lower the income tax, given that it's not a cost on workers any more than it is a cost on corporations? (To attract a worker, corporations need to pay $X but in order for the worker to actually get $X, they need to pay $X*factor where factor goes up with the tax rate.)

@Leo: regarding volatility – isn't a CS degree an investment about as risky as the NASDAQ composite index or whatever it's called? When speculative bubbles burst, programmers have harder time finding work, and when they're inflated, programmers profit, much like speculators in stocks. Maybe in this sense the worker is somewhat diversified "automatically" – across all employers in his area of specialty – but this area of specialty is usually actually narrower than "CS" and certainly it's never as diversified as say S&P 500 or a similar index. Also switching employers has a much, much higher friction than rebalancing your investment portfolio (which you might not be inclined to ever do if you're investing in broad passively managed indexes.)

That you can't sell your degree just means you can't cut your losses, not? There exist monetary investments like that, with either not much buyers (private company stock) or clauses saying you can't sell the thing for X years (actually stock options are often like that until they vest; there are a bunch of other instruments like that.) Investment in human capital is simply more risky because you can't cut your losses, so aren't you strengthening my point?

Regarding free education – I think it's possibly a good idea mainly because (1) a free market for education results in a lot of value being captured by the educators mostly for stamping the graduate with a "he graduated from here so he's in percentile X of the population" kind of label (what Robert Frank calls "a positional good"); and (2) because the market did not, in the real world, come up with a reasonable financing method (as Sowell puts it, student loans are bonds and in this case stocks would be a better idea.) The problem with free education is what sort of education to subsidize and how to ensure its quality. Greatly subsidized education works well enough in many countries though, or so it appears; generally I feel this question is too complicated for me to have a strong opinion on.

#18 PrometheeFeu on 10.18.14 at 8:01 pm

Part of the issue is practicality. What basis do you use to calculate the tax rate. If you tax on realized gains then the tax rate is highly sensitive to the timing of gains realization. It seems somewhat unfair to tax somebody a higher rate because they liquidated a large proportion of their assets in one go rather than slowly over time. But on the other hand, if you tax based on unrealized gains, you end up having to come up with a way to compute a fair price for the assets. It may be easy for publicly traded commodities (though even then, if I have to liquidate large quantities, the price will drop so the value is deceptive) but for thinly traded assets (such as a private company or commercial paper during a crisis) it's all pretend. Also, you end up with weird effects. If a stock I own goes up 10% steadily over 2 years, it should be taxed the same way as a stock that drops the first year and rallies the second year. It's basically impossible to design a fair progressive capital gains tax.

#19 Barry Kelly on 10.19.14 at 5:45 pm

50% of the population owns 1% of the wealth. That's a perfectly democratic reason for taxing wealth at a lower rate than earned income.

I want to make a different point, though. You're arguing using a moral context, suggesting that risk justifies rewards, that because workers actually do risk their human capital, they deserve to have less of their rewards taxed.

But that's not right. What justifies rewards is improvement in aggregate welfare, where this aggregate welfare is defined a little bit differently in different societies. The more you improve aggregate welfare, the more you deserve to get. That's why we generally don't have a problem with entrepreneurs getting massive sums of money when they initiate creative transformations in the world.

Often they didn't risk much at all; they started at a young age, didn't have much, if anything, to lose, and were in an environment where they could succeed, an environment not available to most people on earth. So not only were they often not risking much, but they were also lucky. But they made a difference, and they reap rewards.

But that doesn't describe many, or even most of the wealthiest "capitalists" – capitalist purely in the sense of owning a lot of wealth that is necessarily in the form of investments, rather than actively trying to create a venture that requires access to capital.

I suggest a utilitarian argument, rather than a moral-based one. An increasingly unequal wealth distribution is harmful to aggregate welfare; a larger proportion of the population scrape by, and a smaller coterie at the top become even more fantastically wealthy. This is Piketty's observation from data, that the returns to capital exceed the returns to labour at almost all times in human history except for a brief period after the second world war, and that we seem to be trending back towards a 19th century style distribution.

The morality of the individual actions and events that create that trend are fine and worth discussing, but even if the individual actions are all perfectly moral, that doesn't mean that everything's going to be just fine. I don't want to live in a 19th century style economy, with a bunch of independently wealthy elite and the vast majority labouring full time on whatever whims the elite would like to direct their purchasing powers towards.

So for me the reason to tax capital gains at a higher, more progressive rate would be to limit the increase in social inequality, to avoid a certain kind of world emerging.

#20 Leo Sutic on 10.19.14 at 11:11 pm

I would say that a CS degree is a much, much, safer bet than a NASDAQ index. If you have any numbers disproving it, then please share. Looking around, I see many, many more who turned a CS degree into a continuous income stream then managed to turn stock market investments into the same.

Just ask yourself – how many people can *keep earning* money based on (a) work or (b) stock market deals?

I'd say most people fall into (a) and damn few into (b) – and the (b)s are probably damn lucky. Most people survive on (a), showing that many can turn their labor into a continuous income stream. Very few can pick stocks well enough to not lose everything in the end on (b).

I'd say that's a proof that capital gains are riskier – yet required for a functioning market economy – and therefore should be taxed lower as we want to incentivice people to gamble their money.

Government subsidies to universities are a way to mitigate the "risk" / opportunity cost of education.

"That you can't sell your degree just means you can't cut your losses, not? There exist monetary investments like that"

No. What I mean is that it is simply not something that is tradeable, any more than you can sell an apple you have eaten, gas you have burned or a novel that you have erased. The thing you bought has been consumed and ceased to exist in a shape that can be sold. (Well, unless you start up a school and start teaching CS, for example, but then you are not really selling your "degree".)

"50% of the population owns 1% of the wealth. That's a perfectly democratic reason for taxing wealth at a lower rate than earned income."

Barry, surely you mean the other way around?

#21 jkl on 10.21.14 at 3:40 am

Do be careful about inferring rationality from tax policy. Taxes have rates for the same reason countries have shapes: by use of force. (Politics being "war by other means", of course.) The tax regime du jour is that which is least objectionable to those who write the laws and those who elect them. It is "rational" only insofar as it, in that way, promotes social peace.

"an efficient market would provide a way to insure against the risk of poorly choosing your occupation"

No such insurance exists. It could, and you're not the first to suggest the idea.

Remember that "poorly choosing" is measured against change, and that humans are notoriously terrible at predicting even near-term events, never mind over a 40-year time horizon.

There's another effect, too: during your career, if you're any good, you get better at *something*; you specialize. As a programmer, you know technology X and language Y, and how are you to predict when the next language or environment becomes the new shiny? Visual Basic, anyone? Lisp? Cobol? VMS?

"Assuming that learning ability drops with age, the risk increases proportionately."

You don't need that assumption. The risk increases over time, with specialization. The new language/technology puts everyone on more or less the same footing, giving relative advantage to the inexperienced, whose wages reflect their lack of knowledge, compared to someone experienced (but in the "old" thing). Some of the experience might be useful, but only *some* of it.

One "solution" is to go into management instead, but that's also risky. A manager's salary is a function of his knowledge of the firm's business (among other things). If the firm is unsuccessful — or the industry is wiped out by national policy (textiles, steel) — that investment is also lost.

Who would have predicted GM's bankruptcy in 2005, much less in 1965? You work for the City of Detroit, safe as houses, for 40 years. Then one day you wake up and find *it* went bankrupt, and your guaranteed pension — which you accepted in exchange for lower wages, and which you had every right and reason to depend on — is no longer guaranteed.

The future is spectacularly hard to predict, far beyond our poor powers to understand or control The CIA didn't foresee the fall of the Berlin Wall or the Arab Spring. Nuclear power was supposed to lead to electricity "too cheap to meter", not to Germany and Japan shutting down their functioning plants. The US was supposed to be an oil importer because it had depleted its oil supply. And some poor schmoe is supposed to "choose well" his career at age 22 until 62?

I don't know what this says about tax policy except one thing: the notion that economic winners somehow chose better and contributed more beggars belief. They were in the right spot at the right time. They caught the wave instead of it catching them. By rights, they should be grateful, not proud, and more than willing to share their good fortune with the society that made it possible. Because too many people think the winners deserve their windfall, the tax regime is too kind to them.

#22 Yossi Kreinin on 10.21.14 at 9:47 am

@jkl: state borders may be influenced by force, but the modern state is usually encompassing all or most of the speakers of the given language in an area, and one economic reason is that it's easier to tax people who'll have hard time emigrating to a neighbor country and finding work in today's language-centric world. An idea by David D. Friedman, AFAIK. So it's not so arbitrary and not so detached from economic considerations perhaps.

And I don't "infer rationality" from anything, and your point about the lack of insurance is my point exactly. But things have reasons, and often those reasons are not as arbitrary as they seem at first glance.

And of course I should be more than willing to share whatever I earned from computer programming with people who bet on professions I myself find much more enjoyable but avoided because my feeble ability to predict the future sensed an income problem there – and looky looky, I was right on target. And everybody could have come up with PageRank in their sleep like Larry Page. "Being in the right place at the right time" indeed.

I see where you're coming from though, and forgive me for my slight allergy to some of it – I'm from Soviet Russia.

@Barry Kelly: you claim that I argue from a moral standpoint (I don't – you want to reward risk to the extent that you think that taking it is necessary to increase the general welfare; entrepreneurs that you mention, for instance, often fail and if you rob those who succeed of too much of their reward as proposed by jkl here, then fewer people will take those risks in the first place.)

And you then proceed to argue against inequality without considering the impact of Piketty-esque policies on general welfare! Well, I can tell you that with a sufficiently high wealth tax, income tax, etc. I would not have done any computer programming, I'm hardly unique, and the amount of work done by people capable of it will generally go down if they have no chance to get "rich" off it, whatever "rich" means (and it always starts with confiscating wealth from the top 0.1% and at the end they'll rob 90% of the people at least.)

Why is inequality in itself a bad thing? Utilitarianists argue that the total wealth matters, roughly, and Rawlsians argue that the wealth of the poorest matters the most, roughly, and it does not follow from either that the riches of the richest person are a problem after passing a threshold. What practical argument leads to focus on that "problem"? That rich people will capture the government? The USSR had no nominally rich people and a fully "captured" government. I don't get this inequality fighting business and I don't like the collateral damage.

@Leo: how many people make money from a CS degree? Zero. From a CS degree and then continuously working? Plenty. But that should not be compared with someone buying a portfolio with a small amount of money, rather with someone buying it with a lot of money, about the amount earned during his many years by a worker, I think. And yes, if you invest the amount of money earned by a programmer over 40 years, you'll earn as much or more per month in dividends as he'd make working, even under ZIRP, I believe. Now this investor is risking much less than the worker is what I claim; because he can flee tech stocks if programming becomes largely automated (or maybe the stocks even go up then) and he doesn't hold just tech stocks to begin with, but the worker cannot flee his occupation as easily.

And a CS degree is not like an apple that is eaten – it's not that tasty. It's more like an electricity plant that you built in a state that precludes the reselling of said infrastructure – the two taste about the same, a ton of effort invested in the hope of reaping a reward. Definitely not an apple. If the state then pays less for electricity, you can't cut your losses, just like you can't unlearn what you learnt if it's no longer in demand. Or an even better example – an electricity plant that you build after demolishing perfectly good houses in the hopes of making a profit. Certainly you'll never get those houses back. But that doesn't mean that a fair name for what you did was "consumption". It was an investment that failed.

But one thing that I certainly agree with is that labeling things is one creative part of the generally creative business of accounting!

#23 Dmitry Novik on 10.23.14 at 7:59 am

"It is therefore not entirely uninteresting " … what a wonderful instance of an academic language!

Does it implicitly assume that in human speech double negation has softer meaning than simply saying the positive? :)

#24 Jack on 10.26.14 at 6:25 am

It's ludicrous that we tax people's actual effort more than we tax people simply to sit on a pile of cash, whether "invested" in the stock markets (which have almost no long-term risk whatsoever), or simply holding resources.

We should shift the entire tax system to one that taxes resources, not effort. For example, Henry George's idea that we should tax rent from land ownership to the full rental value of that land. This would end pure land-price specualtion, and shift the incentive toward actually developing that land. We could even avoid inflation that way, since simply owning a share in a company would become a wasting investment after tax – unless you put further effort into your investment to actually grow the company.

#25 Yossi Kreinin on 10.26.14 at 11:43 am

Aren't housing bubbles already detached from rent prices? (Baker more or less defines an asset bubble as "prices high above the level where unless you sell the asset there's no way to make an ROI comparable with the rest of the economy", and for instance the famous US housing bubble was just like that – prices were so high that you'd need to rent for upwards of 30 years to get the money back.)

#26 xyzzyz on 10.26.14 at 12:35 pm

> Also from the Google there's the claim that since nominal capital gains are taxed, the tax rate is actually higher than it looks because of inflation.

This is misguided point of view. A lot of, if not most capital gains profit comes from funds or securities backed by real assets, like stocks, or real estate, or steel, oil etc. These are completely immune to inflation, and the inflation is just the baseline of their value.

If investors are expecting large inflation, they can just shift their capital to real assets. Inflation therefore should not be seen as a tax on capital as a whole, it should rather be seen as a factor reducing profit on some special types of investment, like money market funds.

#27 Dmitry Novik on 10.30.14 at 10:02 am

@ak-47: Why taxing consumption is "fair" as opposed to other taxes? I don't quite understand exactly it is wrong to tax income, but OK to tax consumption?

Sales tax is actually depressing the economy more than other taxes, because it urges you to consume less.

#28 Yossi Kreinin on 10.30.14 at 10:22 am

Erm… consuming less means saving more, which is better, if you think about the economy the way a single family living in some isolated hut thinks about its economy. (And planet Earth is just an isolated hut in the universe hosting a family of 7 billion.) Obviously past the point where you're hungry, it's better for your weight management as well as your survival chances to store surplus grain rather than eat what you can right now.

That's one argument for sales taxes and against the income tax. Income taxes discourage production, while sales taxes discourage consumption. Producing and saving a lot but not consuming much is better compared to working less and consuming all you can.

And certainly with rich people, you want to tax consumption so they don't blow their money on planes and mansions (built by real people from real materials – those people and materials could have been used for something else), but you don't necessarily want to tax their income because that income results from productive work done by someone for someone, not a private jet or a mansion for the rich guy. (As in, if he owns one more restaurant that's another place for people to eat and work so a good thing.)

The one counter-argument I can imagine is that you cannot reach full employment without much far-from-necessary consumption taking place. Perhaps that is right – I never quite follow this stuff – but that just points at our little family in the isolated hut being a tad dysfunctional… certainly you wouldn't want to eat more bread just to keep your grandpa occupied, toiling in the field so you can have more bread. You'd probably all work less or something…

#29 Dmitry Novik on 10.30.14 at 11:07 am

The genuine concern about ecology indeed can be a good point to limit consumption, I agree.

Not so with economy. There is no such thing as "Producing and saving a lot but not consuming much" in the long run, and I am afraid will never be. Production does not exist by itself but is driven by consumption. When people start buying less, the output levels fall accordingly as no company will pile stocks to maybe sell them in future generations.

Indeed, you can save more this year to spend more next one, but you cannot save for generations ahead, as over long term supply always equals demand. Economy wise, trimming consumption means sliding into recession.

As for mansions, etc. – well, rich people need to have their ways spend their earned money somehow, just like me and you, and this might be not only charity :)

#30 Yerachmiel Ha'arnav on 12.04.14 at 9:43 am

The discussion only briefly touched upon what I think is the main reason that capital gains tax will never equal labor's income tax rate. Besides having unparalleled access to politicians, capital is much more mobile than labor, as pointed out by Ovidiu R.

I'll attempt to answer the question poised by Yossi to Ovidiu:

"
why don't corporations fight to lower the income tax, given that it's not a cost on workers any more than it is a cost on corporations? (To attract a worker, corporations need to pay $X but in order for the worker to actually get $X, they need to pay $X*factor where factor goes up with the tax rate.)
"

A: Companies have pay enough to beat the alternative, which is equally hampered by income tax. The competing offers that the same worker gets are equally degraded by the tax, so the worker's preference is not very frequently changed by it. The only effect of the tax on the company's ability to attract and retain workers is in making work unattractive altogether. This effect exists, but is limited. The company's owners would probably prefer to have a high income-tax discourage some workers from working, rather than suffer a high corporate or capital-gains tax which would affect them directly. Since the govt has to be financed in one way or another, I suppose that income tax on labor is the lesser evil from the owner's POV.

#31 Yossi Kreinin on 12.05.14 at 9:45 am

@Yerachmiel: at the very least, progressive taxation encourages people to work less hours, and makes it harder for employers to motivate people to work more hours; with programmers it's a very visible effect. Likewise, it's harder to attract workers to a given industry, and to poach workers from competitors given a progressive tax, in a situation where you genuinely need more skilled people more urgently than most because you'd get a better payoff once you attracted them than most.

#32 Yossi Kreinin on 12.05.14 at 3:52 pm

@Yerachmiel: …that said, I think your argument is rather interesting; "the lesser evil" might be exactly what it is given the employers' alternatives.

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