Jach's personal blog

(Largely containing a mind-dump to myselves: past, present, and future)
Current favorite quote: "Supposedly smart people are weirdly ignorant of Bayes' Rule." William B Vogt, 2010

Progressive Taxes

I used to be of the opinion that we should have flat taxes, either amount-wise or percentage-wise. That is, after all, the mathematically fair solution if you divide on total money taxed.

There are two obvious, killer problems with that, though. One, it severely hurts poor people. 50% of $1 is a lot more than 50% of $1000 if those two amounts are all two people have, but the cost of a loaf of bread is still 99 cents and so one person has to go hungry. The second problem, is that the government then doesn't have enough income to support itself unless the percentage is so high. (And as you raise the percentage, the poor suffer more and more.)

So the crafters of our tax laws realized these two problems, and they went a step further by introducing tax brackets. You pay 20% on all income under $X, but every dollar you make above $X, you might get taxed 30% until you hit $Y, and so on. Obviously someone with $1000 does not need $1 as much as someone who only has $2 and wants a gallon of milk, so the idea of the tax bracket again makes sense if you want to ease the suffering of the poor.

Is that the only argument, though? The poor would suffer more if we taxed differently, so we have to tax the way we do? I don't think so, and I believe there can even be a sort of fairness in the progressive form.

The rich seldom generate wealth. That is the realm of entrepreneurs, who may become rich, but Warren Buffet is not rich for creating anything, he's rich for being savvy on the stock market. Carlos Slim is not rich for creating anything, he's rich for similar reasons to Buffet: he invested in a lot of different areas. Bill Gates on the other hand had a strong hand in creating a massive amount of wealth, both directly (Microsoft) and indirectly (whatever people have made using Microsoft products), and when he was at Microsoft he managed to capture a lot of that direct wealth. Now his wealth again stems from similar areas as Buffet and Slim.

So the rich do not usually generate wealth, but manage to capture a large share of the total wealth in the system, whether it's through investments, stock markets, moving oil around, or through inheritance. That wealth has to come from somewhere, though. Imagine for a moment the pre-Industrial Revolution world. Oil was not important, and so there weren't any oil tycoons like there have been the past century. The richest people were royalty and church heads, who captured their wealth through taxes (to state and God). The richest were only rich because there were others to take wealth from.

Fast forward to today, and there are hordes of items that require oil in some fashion, so oil is worth a lot, and the oil corporations are pretty skilled at capturing a lot of the wealth that oil contains. But they can only do that because there are people to make use of products using oil. If there were no cars, no plastic, no rubber, in short, if there were none of the technologies such that we were back in the pre-Industrial Revolution era, oil would again be worth less and the corporations would die. They wouldn't be able to capture the wealth like they used to.

The extent to which a rich person relies on the rest of society for his riches is a function of the society's population and technological level relative to the rich person. In a population of 10 roughly equivalent people, it would be hard to capture a lot more than 1/10th of the wealth without taxing or without creating more wealth and capturing a lot of it. The group functions best when the differences are more or less 0, since cooperation is the best strategy and no coveting goes on, and the group members presumably follow a tit-for-tat strategy along with having a sense of justice which in turn lowers attempts to exploit the group. If one tries to exploit another to capture more than 1/10th of the wealth, the other will retaliate and may try to get the rest of the group to retaliate as well. Yet if someone did manage to get, say, 4/10th's of the wealth, it's in all of their interests (because they would all rather the cooperation continue instead of descending into a system of tat-tat) and naturally progressive taxes are a solution to reflattening the wealth spectrum. A flat tax would keep that one person at the 4/10th ratio, a progressive tax would actually move him back down.

Anyway, since it's hard to capture huge portions of wealth in a small group without taxes (larger groups rely on taxes to keep that hardness), one creates more wealth instead, trying to capture it as it's added, typically through inventing some new tool or process or discovering a useful material. In the case of inventing a fish net, he could capture all its wealth by keeping it to himself. This seems to be the default option, since humans are often selfish and are poor at extrapolation. Anyway, let's continue. With the benefit of the first invention, he might then invent a cart to haul all his fish around. He finds he has more fish than he can eat, so he starts traveling around selling his excess. What would he do without other people to sell to? The fish would go to waste. It's not that he can't capture the wealth provided by his cart, it's just that the wealth generated goes to zero with no one else around. He had enough fish without the cart, the cart is a technology specifically useful for capturing more of the total wealth of a group.

How might the inventor capture more wealth than his inventions directly produce? By sharing his invention. Making nets for others, teaching them to make carts. Each net, each cart, adds a little more wealth to the system, but more importantly the group is made of other humans, each with the capacity to invent, and with the advantages of someone else's invention they might get the insight to make one of their own. Someone sees all these carts rolling around randomly, and comes up with the idea of roads. Whoever first invented the cart then benefits in turn by being able to capture the wealth generated by the person who came up with roads.

Where do taxes come into this? The idea of the tax is to force invention-sharing, or in other words redistribute some wealth. It recognizes that individuals are not the best at allocating their wealth efficiently for system-wide benefit, but individuals tend to allocate their wealth for short-term personal gains (even to the point that they ignore larger long-term gains). Taxes recognize that a group of smart people unattached to a lump of money should be able to decide its use better than one person attached to the money. Taxes can recognize the importance of an idea like roads, and take money from all the cart-pushers to pay people to build those roads, which in turn benefits the cart-pushers. Perhaps the benefit to an individual cart-pusher is small, but to all the cart-pushers it can be great. Or perhaps the individual benefit is just greater when more people have the same benefit: a road from your house to my house isn't very useful, but a road from my house to your house to another guy's house is more useful, even if I only ever visit your house. Whatever the case may be, the group of individual cart-pushers is seldom smart enough to realize what they can benefit greatest from and have the ability to agree on some form of money pooling to get it done. (There may be disputes over who uses the road most should pay most which get ugly fast.) Progressive taxes in particular are only natural considering the non-cart-pushers have no inventions yet; there's nothing to share.

Taxes also can provide the wealth needed for a person to start generating their own ideas. If I have enough food I don't have to worry about my next meals, I can think about other things and potentially one of those things is something that will increase the total wealth pool of society (and if I'm lucky I can capture a good amount of that as it's added). So the problem to solve is getting me to the point where I have enough food. Maybe I have enough food because I invented a fish net. Maybe I have enough food because my friend gave me his invented fish net. Maybe I have enough food because my elected representatives saw I needed more food and took some extra fish from the guy who invented a fish net and gave them to me. (He didn't notice me and even if he did, being attached to "his" fish he might not want to give them to me specifically; he might not like my breath.) The solutions are many, but taxes provide a quick and easy way to solve the problem for many people at once. Yes it's wealth redistribution, but it's aimed at increasing the total wealth pool of a group, which means that all individuals can potentially capture more wealth than they have as the pool grows.

Ask an angel investor for his success rate, he'll be the first to tell you that it's hard to figure out who to give money to that will result in creating enough wealth to capture and recuperate any losses. So direct aid programs are naturally going to be inefficient as well. Though while 8/10 people cause a loss, the other 2 may generate enough wealth to capture that it pays for the other 8, and if the chance of that happening is high enough that's a good goal. Hence the government spends a lot of infrastructure, it's a good bet that the average will favor profit, and it's not direct cash. (Not all roads are necessary, but there's enough necessary networks of them that are so useful that they take care of any costly ones.)

If you're more individual-minded, remember that the effects of taxes which benefit the group also tend to benefit the individual taxes. One road may not be very useful to a person, but a whole network connecting many people can be very useful. Guess who gets preference in disaster situations? The people who paid the most taxes. And the tax money of the rich helps fund an army and police force which protect that money from sheer robbery. In the case of protection, protecting more should indeed cost more, and so progressive taxes win there too.

Of course, believing in Anarchy I think we'll eventually stop having taxes. But that will happen when we don't have to worry about whether enough individuals will donate enough effectively enough to do the job of the government, and I'm convinced that will only happen when our technology is good enough the only concern is raw energy and that we can get from the sun for "free". Until then, progressive taxes are a great way to try and flatten the wealth spectrum (which people want since that helps cooperation) and to force idea-sharing (to benefit the group and individuals through mutual creation).

Posted on 2011-04-16 by Jach

Tags: government


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