Tuesday, February 19, 2013

In memoriam: Armen Alchian

Armen Alchian, one of the greatest non-Nobel economists, has died. He was noted for his work on the contingency of property rights, but this story (from "Principles of Professional Advancement", in the July 1996 edition of Economic Inquiry (vol 34, issue 3) has always stuck in my memory:
RAND was not sure what an economist would do. I certainly didn't know either. But I learned a lot about "big real world problems'--too big to comprehend, usually. Since it wasn't clear at first what an economist could do that was pertinent, the task was to snoop around, look at the problems being analyzed (defense problems, usually) and try to see how economics could help.
What we economists did first was detect how economics was being ignored, in particular how costs and interest rates were ignored in making military-strategy decisions. Another "complicated, surprising" proposition was that for assigning nuclear material to the Air Force versus the Navy, it was not deemed necessary to know whether it was more important for the Navy or the Air Force to have more fissile material. But of course, that would be very desirable to know. With the idea of indifference curves between nuclear material and labor (as inputs), marginal rates of substitution between the two in the Navy and also in the Air Force would indicate directions in which to revise the allocations. That "revelation" gave the economics group some extra clout.
I cite these as two examples of how the simplest concepts and propositions in economics have mega-ton power. In that vein, I like to brag that I did the first "event study" in corporate finance, back in the 1950s and 1960s. The year before the H-bomb was successfully created, we in the economics division at RAND were curious as to what the essential metal was--lithium, beryllium, thorium, or some other. The engineers and physicists wouldn't tell us economists, quite properly, given the security restrictions. So I told them I would find out. I read the U.S. Department of Commerce Year Book to see which firms made which of the possible ingredients. For the last six months of the year prior to the successful test of the bomb, I traced the stock prices of those firms. I used no inside information. Lo and behold! one firm's stock prices rose, as best I can recall, from about $2 or$3 per share in August to about \$13 per share in December. It was the Lithium Corp. of America. In January, I wrote and circulated within RAND a memorandum titled "The Stock Market Speaks." Two days later I was told to withdraw it. The bomb was tested successfully in February, and thereafter the stock price stabilized.

Wednesday, February 13, 2013

Feasibility of the Guaranteed Minimum Income

A guaranteed minimum income (GMI) is a tax scheme designed to replace welfare, social security, and other poverty-support systems with a single unified system that ... guarantees a minimum income to everyone. In the future times, I'll post about why such a system is manifestly a great idea. For now, I want to examine its feasibility. This calculator inputs the proposed guaranteed minimum income and a marginal tax rate schedule, and uses census data to estimate total expenditures, total receipts, and net tax revenue.

A couple of quick notes. First, units are percentages of GDP/capita. Second, the census data are for individuals age 15 or higher; this should result in a significant positive bias, since the distribution does not account for children. Third, I make no estimates about the impact of tax changes on revenues; one should bear the concavity of the Laffer curve in mind.
Update: According to the CIA world factbook, roughly 20% of the US population is less than 15 years old. I therefore added 22% to the lowest income bracket in order to account for this.
Graphs Pre-tax/post-tax curve:
Income distribution:
Net receipts in each tax bracket:

Wednesday, February 6, 2013

What's your rationale for progressive taxes?

What's your rationale for a progressive tax? I see two general categories:

• People should pay back to society in measure of their benefit from society.
• People should pay back to society in measure of their ability to do so.
Both call for people to pay more taxes as they earn more money, but I'd argue that they imply two very different tax structures.

The first, people should pay back to society in measure of their benefit from society, implies a regressive tax. The tax paid on each additional dollar should be lower than the previous. Why? Because marginal utility from income falls. To wit: Warren Buffet has not benefited proportionally more from society than I have, so he should pay proportionally lower taxes than me.

Perhaps more suggestively, people benefit from income increases in two basic ways: higher consumption and greater security. The greater component by far is increasing consumption, so paying back to society proportional to your benefit from society implies a consumption tax. Consumption taxes are widely held to be regressive.

The second, people should pay back to society in measure of their ability to do so, implies a progressive tax. The tax paid on each additional dollar should be higher than the previous. Why? Because, again, marginal utility from income falls. Warren Buffet loses proportionally less than I do when his after-tax income falls, so he should pay proportionally more in taxes.

Note that this does not consider other benefits and costs of taxes. The progressivity/regressivity of the tax code should depend on effective marginal rates, marginal incentives, the importance of investment, deadweight loss estimates, and so on.

The moral of the story: Be careful of your justification for your preferred tax structure. If you want people to pay back because they've benefited, you're implicitly arguing that you want poor people to pay proportionally more than rich people, because poor people benefit more relative to their income than rich people.