What are the limits of legitimate tax policy?This column generally focuses on contemporary newsworthy issues, butevery so often I prefer to discuss more fundamental issues of economicethics.
Afascinating paper designed to make economists re-examine basic economicassumptions was published a few months ago by Harvard professorsGregory Mankiw, author of one of the most popular introductoryeconomics textbooks, and Matthew Weinzierl. The title is "The optimaltaxation of height". (It is worth noting that Mankiw is impressivelytall; I have never met Weinzierl.)
The basic principle is so simple that if the authors hadn'trevealed their provocative intention the paper could have passed for anordinary public finance study. In public finance, the basic idea is toattempt to raise revenue without discouraging work effort. But this isa problem. Low taxes don't raise much revenue, and high ones discouragework. One enticing solution is "lump sum" taxes: just charge everyone aflat 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 topay that much in taxes.
What we would like to do is be able to predict inadvance who will make lots of money and who little. We would put a highlump-sum tax on the high-earning "types" and a low tax on thelow-earning types. Everyone would benefit. Tax revenue would beunaffected but every person would pay zero taxes on all additionalincome and would probably work, and earn, much more. Taxinghigh-ability people also improves equity. These people can payadditional taxes with less effort than other people, so taxes on themreduce total welfare less than taxes on low-ability folks. (Note thathigh-ability people already pay more than others but now they do so onevery single hour of work.)
The problem, of course, is identifying the types. You can'tjust see how much people are making now. That translates into a veryhigh marginal tax rate: if every additional shekel I make this yeartranslates into a 30-agorot lump sum tax every subsequent year, then Iam paying a marginal tax of many hundreds of percent. I would almostcertainly be better off not working at all. (For the same reason youcan't base it on parents' income; good parents would go on welfare inorder to create low tax rates for their kids.)
But,say Mankiw and Weinzierl, all is not lost. One correlate of ability iseasy to measure and impossible to game: your height. Studiesconsistently show that each additional inch of height translates intoabout a 2% increase in earnings. It is possible to structure a tax sothat tall people pay more and total welfare is greatly increased. Thecalculations the authors carry out conform in every detail to theaccepted paradigm for public finance policy.
A few orthodox utilitarians take the research atface value and indeed advocate a height tax. But, as the authors pointout, most practitioners feel very uneasy about this. Why? The authorssuggest a number of reasons: Perhaps it is an intrusiveness issue:government shouldn't know too much about us. Having your height on fileat the income tax authority might just be the beginning of anencompassing information-gathering agenda. In places where height iscorrelated with ethnicity, the tax could be considered racist.
Another theory is stigma. The authors quote Nobel laureateAmartya Sen to the effect that being the beneficiary of subsidiesimposes a stigma; according to this approach, a tax on height wouldironically work to discriminate against the short.
Libertarians view the entire project of finding an optimal mixof equity and efficiency to be an illegitimate form of wealth transfer.To them, the height tax paradigm can serve as a reductio ad absurdum toshow how far our tax system already goes in the direction of socialengineering.
Finally, there is the fairness issue. It is true that theheight tax is fair "on average"; people with higher ability pay morethan others. But it is still true that any given tall person pays moretax than a short person of the same ability.
When I explain economics to non-economists, I have two kinds ofdifficulty. Some ideas are easy for economists to grasp, but difficultfor lay people. It can be hard to get the concepts across. Other ideasare easy for lay people to grasp, but difficult for economists. It canbe hard to explain why economists think that a concept is novel. (Forexample, trying to explain how Amos Kahneman got a Nobel Prize forshowing that people aren't always rational.) Perhaps the dumbness of aheight tax is in the second category. But I do think that the heighttax is a thought-provoking concept that can make us reflect on the manydifferent aspects of fairness we consider when we set out to make a taxsystem.