Tax Me Justly

   In a world with increasing within-country inequality and a backlash for democracy, what should be the new policy to rally progressive egalitarians? Radically redistributive tax change is one such option. Consider the US, where President Trump’s 2017 tax reform mainly included tax reductions for companies and high-income earners. In response, prominent politicians in the Democratic Party are now proposing substantially redistributive changes to tax policy. Receiving the most attention, Alexandria Ocasio-Cortez has proposed increasing marginal income tax rates for the very high earners to 70 percent. Elizabeth Warren is calling for a 2 percent wealth tax on wealth above $50 million and 3 percent above $1 billion, while Bernie Sanders is running for the presidency on a plan to expand the estate tax, increasing the taxation of inheritances.

Although the proposals differ widely in their political feasibility and economic impact, what is common is their priority on reducing inequality. To evaluate such proposals, economic theories of taxation have at least since James Mirrlees’ ground-breaking work in the 1970’s focused on the trade-off between efficiency and equality, or between increasing the total and dividing it equally. Choosing the level of efficiency and equality requires value-judgements, which economists are (perhaps correctly) sceptical of making. A recent trend in economics is therefore to clearly separate between, on the one hand, value-judgements about justice, and, on the other hand, economic theory and empirics. A framework for such distinctions is important not only for the economist’s conscience but can be crucial in times of falling trust in experts, as it separates the researcher’s choice of what is considered just from developing the most empirically relevant theory.

Analytically, a policy choice can be separated into the preference for, say, lower income inequality, and the optimal way to reach it. One can then apply relevant economic theory to reach the set of given distributive objectives in an efficient manner. This also has real-world impact, since egalitarian priorities need not imply that every apparently egalitarian policy is an effective policy. In fact, it is not even the case that the seemingly most progressive tax policy needs to be the most redistributive. As a life-long Labour voter in the U.K., Mirrlees was surprised to learn that the implications of his own tax theory were that a flatter tax system led to more just outcomes given an egalitarian priority and economic limitations. Taking his own research seriously, he ended up recommending a less progressive tax system than he initially had thought just.

There should be potential for progressives gathering on preferences about justice rather than specific policies, and then taking policy lessons from such economic research. For example, highly relevant for taxation of high-income earners is empirical research on at which marginal tax rate revenue will start to fall rather than increase, due to people working less, evading more taxes and so on. For the wealth tax, research on the capability of technical measures to avoid loopholes and obtaining information about ownership of assets is crucial. These research topics are clearly relevant for the tax policy choice and are in themselves unrelated to the priority of reducing inequality. In general, the empirical revolution in economics should make economic research findings more useful for a variety of policy design questions, including tax policy.

Of course, not all persons have similar views about justice, which sometimes implies they will support significantly different tax policies even when informed by relevant research. Yet, some tax policies can bring about more justice almost independently of specific views. One case is taxation of economic rents, which is as close one gets to the unattainable free lunch, possessing the potential to lower inequality without reducing efficiency. Take, as one such example, property taxes. A well-designed tax on property will have limited effects on overall property investment, while it redistributes from the property-owning rich to the poor. It is hard to think of a consistent and widely accepted view on justice that would limit the use of such taxes. These tax policies therefore need not rely on any specific views about justice and could in principle gather broad support.

Not all required revenue can be generated by rent taxes, and there may be policy disagreements between, for example, those who prioritize reducing poverty without a concern for the wealth of the very rich, and the egalitarians prioritizing reducing inequality reduction in lifetime income for all. Even when priorities differ, some tax policies should collect support across views. One instance is the view that the ability to pay is what should matter for the tax burden one has to bear. Financial Times columnist Martin Sandbu has argued that if ability to pay matters, taxes on wealth should be prevalent. A similar policy conclusion can be reached by an egalitarian prioritizing reduction in inequality of lifetime income.

With the US tax debate in mind, can we draw similar conclusion be about tax policy in other countries? It is conceivable that the views about justice differ across countries, such that tax policies should also differ. One specific possibility is that Europeans prioritize equality of outcomes, while Americans prioritize opportunities more. Now, applying the argument made above, it may be the case that while Europeans motivate progressive taxation by egalitarianism, Americans could motivate the same tax policies with different views about justice.

Relatedly, some may be surprised to learn that Scandinavian countries do not have particularly progressive tax systems compared to other European countries. The main difference is rather the total tax level, which is then used to finance a larger welfare state. This should remind progressive politicians that who pays the tax is at best half the picture, and that the amount of revenue raised is at least as important. Here, economic analysis returns, as considerable amounts of research has been conducted to provide accurate measures of revenue effects of different tax policies.

While increasing state ownership, restricting trade or limiting immigration are all policies that may reduce within-country inequality, these policies are all excessively costly in terms of economic growth and fairness. In contrast, some radical tax policies can significantly reduce inequality while not affecting, or even increasing, economic growth. The underlying priorities, be they equality of opportunity or reducing poverty, decides that inequality reduction is the objective. Then, whether wealth taxes, progressive income taxes or inheritance taxes are more effective in reducing inequality is a scientific question.  Some policies, such as rent taxes, may even be effective in satisfying many of the various priorities of justice simultaneously.

Even with clear priorities and empirical research at hand, politicians will need to convince the electorate. Still, I believe in separating the priorities from the science, to encourage wider cooperation than pro-wealth tax or pro-inheritance tax factions, and to move the political debate to views about justice rather than details about tax loopholes or empirical findings. Imagine then a society where politicians are discussing their priorities, what they think is just, rather than details in a policy proposal (of which they anyway know very little).

Economists are still learning how to separate such value judgments from their scientific hypotheses, but regardless of how radical your views about justice are, findings in economic research are relevant. The lesson is that, like for Mirrlees, no matter how much you want to reduce inequality, a just tax system according to your own view may not look the way you imagined.

Kristoffer Berg is an Economics PhD student at the University of Oslo.

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