Hard Heads, Soft Hearts

I just finished reading Alan Blinder's excellent book "Hard Heads, Soft Hearts" (1987).  It is interesting, well written, and at times, laugh-out-loud funny.  For example, this comes amongst his withering criticism of supply-side economics (p. 87):

The supply siders had learned their history lesson.  Monetarism had stormed the Keynesian castle with statistical evidence, but little theory.  Rational expectationists had attacked with a powerful new theory, but no evidence.  Combining the best features of both tactics, supply siders armed themselves with neither theory nor evidence....  It proved to be an effective arsenal.

Here are a few of my highlights:

1. The book has a chapter on taxes, which mentions the regressive nature lower tax rates on capital gains (as I mentioned here).  He also notes that the gap between capital gains and income taxes is abused in many tax shelters and that deductions for business expenses of travel, dinners, etc. are also quite regressive.


2. His chapter on protectionism has some new points.  Readers with an economics background will know that protection for one industry usually comes with (even larger) costs paid by consumers across the country.  However, Blinder also points out that other workers can also lose out.  This occurs when the output of one industry is input to another.  For example, tariffs on steel increase prices to auto companies, so we may trade auto jobs for steel jobs.  This also occurs when other countries retaliate with protectionist measures aimed at other industries.  For example, rather than increasing tariffs on our steel (where they are already winning), they raise tariffs on our computer software (where they are losing), so we trade computer jobs for steel jobs.  Thus, the total cost to the economy is often larger than the wages of the jobs we are supposedly "protecting".  Blinder references a study showing, for example, that saving one auto job costs over $100K per year to the rest of us.


3. Finally, in politics, he notes that the special interests often win out because the benefits to them are visible while the costs to the general interest are hidden, or in Blinder's eloquent words, because "the benefits are concentrated, visible, and well understood, while the diffuse, subtle, and barely visible costs are sprinkled like a light mist across the electorate".  He describes how the 1986 tax reform succeeded by requiring those costs to be visible.  Specifically, since the tax changes were required to be revenue neutral, any deduction for a special interest had to be paired with a tax increase somewhere else.  This caused nearly all proposed amendments benefiting special interests to be voted down.

Income vs. Wealth

While we're on the subject of rich and poor, another issue comes to mind: income versus wealth.

Conservatives often decry the progressive income tax on the grounds that it does not put a higher burden on the wealthy, necessarily, but rather on those that currently have a high income. The latter may be people who are still a long way from being wealthy. For example, it could be a doctor who is paying off hundred thousand dollar loans she took out to pay for medical school. This doctor is clearly not wealthy.

In a world where the tax man had perfect information, would it really make sense, though, to be taxing based on wealth rather than income? I would argue not. Why should someone with a modest income who has managed to save up a significant amount of money over time be taxed at a higher rate than someone who has a higher income but spends it all as fast as it comes in? That would clearly be rewarding the wrong behavior.

The example of a doctor paying off loans seems bad because it is a case of investment: in this case, the doctor is investing her money in educating herself so she can earn a higher income in the future. Typically, we only tax the profits of investment, not the revenues. Perhaps the tax code could be fixed to better handle those cases. However, they are often sorted out already in the form of deductions. Special provisions for paying off school loans are usually popular with politicians. Other investment cases are likely similar.

If we have deductions for investment cases and we don't want to reward people for not saving money, then what's wrong with taxing income instead of wealth?

Capital Gains

The Legitimate Skeptic is an equal opportunity contrarian. Having criticized a left-learner yesterday, it is time to criticize some right-wing views.

Suppose I save up some money, buy a second house, and rent it out to make extra money. That rental income is taxed at up to 35%. If, instead, I lend my money out directly, then the money I make is capital gains and is taxed at 15%. Does this make any sense?

Conservatives will say that capital gains should be taxed differently because the money has been taxed already. However, only the principal has been taxed, and it is not taxed a second time. It is just the interest, which has not been taxed before, that is taxed in scenarios I described.

It seems to me that income is income, no matter from whence it comes. The fact that we tax capital gains at a lower rate than other income enables the rich to get richer more easily than the poor. This is clearly out of line with a principles of a country that prides itself on economic mobility.