Business ethics 88.
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What are the limits of legitimate tax policy?
This column generally focuses on contemporary newsworthy issues, but
every so often I prefer to discuss more fundamental issues of economic
fascinating paper designed to make economists re-examine basic economic
assumptions was published a few months ago by Harvard professors
Gregory Mankiw, author of one of the most popular introductory
economics textbooks, and Matthew Weinzierl. The title is "The optimal
taxation of height". (It is worth noting that Mankiw is impressively
tall; I have never met Weinzierl.)
The basic principle is so simple that if the authors hadn't
revealed their provocative intention the paper could have passed for an
ordinary public finance study. In public finance, the basic idea is to
attempt to raise revenue without discouraging work effort. But this is
a problem. Low taxes don't raise much revenue, and high ones discourage
work. One enticing solution is "lump sum" taxes: just charge everyone a
flat amount, and every single shekel they earn above that is theirs.
Now there is no disincentive to work!
The problem is that most people could never pay the tax.
Israel's annual tax revenues amount to over 100,000 NIS per household.
Many households don't even make that much, not to mention being able to
pay that much in taxes.
What we would like to do is be able to predict in
advance who will make lots of money and who little. We would put a high
lump-sum tax on the high-earning "types" and a low tax on the
low-earning types. Everyone would benefit. Tax revenue would be
unaffected but every person would pay zero taxes on all additional
income and would probably work, and earn, much more. Taxing
high-ability people also improves equity. These people can pay
additional taxes with less effort than other people, so taxes on them
reduce total welfare less than taxes on low-ability folks. (Note that
high-ability people already pay more than others but now they do so on
every single hour of work.)
The problem, of course, is identifying the types. You can't
just see how much people are making now. That translates into a very
high marginal tax rate: if every additional shekel I make this year
translates into a 30-agorot lump sum tax every subsequent year, then I
am paying a marginal tax of many hundreds of percent. I would almost
certainly be better off not working at all. (For the same reason you
can't base it on parents' income; good parents would go on welfare in
order to create low tax rates for their kids.)
say Mankiw and Weinzierl, all is not lost. One correlate of ability is
easy to measure and impossible to game: your height. Studies
consistently show that each additional inch of height translates into
about a 2% increase in earnings. It is possible to structure a tax so
that tall people pay more and total welfare is greatly increased. The
calculations the authors carry out conform in every detail to the
accepted paradigm for public finance policy.
A few orthodox utilitarians take the research at
face value and indeed advocate a height tax. But, as the authors point
out, most practitioners feel very uneasy about this. Why? The authors
suggest a number of reasons: Perhaps it is an intrusiveness issue:
government shouldn't know too much about us. Having your height on file
at the income tax authority might just be the beginning of an
encompassing information-gathering agenda. In places where height is
correlated with ethnicity, the tax could be considered racist.
Another theory is stigma. The authors quote Nobel laureate
Amartya Sen to the effect that being the beneficiary of subsidies
imposes a stigma; according to this approach, a tax on height would
ironically work to discriminate against the short.
Libertarians view the entire project of finding an optimal mix
of equity and efficiency to be an illegitimate form of wealth transfer.
To them, the height tax paradigm can serve as a reductio ad absurdum to
show how far our tax system already goes in the direction of social
Finally, there is the fairness issue. It is true that the
height tax is fair "on average"; people with higher ability pay more
than others. But it is still true that any given tall person pays more
tax than a short person of the same ability.
When I explain economics to non-economists, I have two kinds of
difficulty. Some ideas are easy for economists to grasp, but difficult
for lay people. It can be hard to get the concepts across. Other ideas
are easy for lay people to grasp, but difficult for economists. It can
be hard to explain why economists think that a concept is novel. (For
example, trying to explain how Amos Kahneman got a Nobel Prize for
showing that people aren't always rational.) Perhaps the dumbness of a
height tax is in the second category. But I do think that the height
tax is a thought-provoking concept that can make us reflect on the many
different aspects of fairness we consider when we set out to make a tax