Thursday, 19 July 2012

Taxes on Capital- good for our descendants?

This is Steve Landsburg explaining why lowering Capital taxes is the best thing we can do for our descendants- 
'There are only three things you and I can do to make the future world a better place.  First, we can consume less, leaving more resources behind. Second, we can work harder, planting trees, building factories and writing poems that will live on after we’re gone. Third, we can innovate, advancing science and technology so that our children’s children’s children can make better use of the resources they inherit.
'As it happens, there’s one key policy variable that drives all three of these things, and that’s the tax rate on capital income (which includes interest, dividends, corporate income and capital gains). Capital taxes are a disincentive to save, and when people don’t save they consume instead. Capital taxes are a disincentive to work and a disincentive to innovate.
This is not a plea for lowering taxes in’s simply an observation that if your goal is to leave a better world for our descendants, then your best bet is to support lower capital taxes.
Landsburg is making 3 obvious mistakes
1) Lower Capital taxes mean we will Consume less leaving more resources behind for our distant descendants.
This is not true. If Capital formation declines as a result of a tax then the Capital stock will be lower than it would otherwise have been. Thus Income, and therefore ultimately Consumption will be on a much lower growth path ceteris paribus. This would mean that our distant descendants would have more not less non-renewable resources than would otherwise be the case.
2) Disincentives to work may not arise. If Saving are precautionary and/or for care in old age, Capital taxes may increase Work effort. (The Income effect of the tax outweighs the substitution effect). Some types of work Landsburg mentions- e.g. writing poems and planting trees- may increase if there is a disincentive to work. In any case, Capital taxes mean that everybody's 'Permanent Income' has gone down and so they will scale down their expectations and adopt a more frugal life-style.
3) The disincentive to innovate may be a good thing for our distant descendants. It may be that technologies which we have had an incentive to adopt at the moment have potentially catastrophic consequences down the line. 'Gee! The bursar tells me our University has just received a 10 billion dollar windfall. Let's go ahead and steal a march on the Japs by spliting the photon from its long-time boyfriend.' Sure, that's an innovation that wouldn't have happened but for lower taxes on Capital. Shame it blew up the Universe. Still.

One compelling argument for taxes on Capital Gains is that changes in the legal framework over the last 30 years has increased wasteful competition in  a frothy type of 'innovation' or financial engineering. In this case, since the legal framework has vested rents, it makes sense to claw back a portion of those rents so as to maintain that very framework without which those rents would melt into thin air.

What, then, is the best thing we could do for our descendants? Dunno, but it's probably got something to do with contraception.


Rajiv said...

Taxes on Capital are good if the marginal efficiency of Capital is negative- for example if increased capital formation is for the purpose of strengthening barriers to entry or wasteful in some way.

Anonymous said...

"Capital is dead labor, that, vampire-like, lives only by sucking living labor, and lives the more, the more labor it sucks." Karl Marx,

Anonymous said...

Taxes on Capital could have saved Spain from over-investment in Housing stock.