“You are right that a tax on labor reduces capital accumulation, just as a tax on capital reduces labor. Those are distortions. But the capital tax introduces the *additional* distortion of taxing early labor more heavily than late labor.”

For most wage earners, can’t the early/late labor distortion be largely neutralized with a rifle shot like the IRA rather than introducing the “distortions” against labor inherent in eliminating all taxes on capital. The distortions I have in mind are…

* the implied shift in tax burden to labor,
* the greater benefits labor would receive under other tax policies that would still increase capital accumulation and
* the impact of greater wealth inequities on differentials in political power?

If my analysis is correct, shouldn’t labor be opposed to your proposal? Or at a minimum, isn’t there a strong logical foundation for labor’s opposition?

Under Bush we had a lot of FTAs but almost all were with small oil producing dictatorships, allowing those groups to move their product in to our market easier http://en.wikipedia.org/wiki/United_States_free_trade_agreements#Past_free_trade_agreements

Now I didn’t name off free-trade specifically under Bush, but international institutions. Like the WTO and international legal regimes like the Rome Statute. The kinds of things that make foreign business more comfortable working in and with American Business.

Regarding war’s affect on employment- This isn’t 1945 anymore. We have about 200k soldiers in Iraq and another 70k in Afghanistan. We had 16 Million in WW2. We lost a half a million men in WW2. The affect this war has is much different.

The old wars were fought with guns, men, tanks, and planes, and lots of them. Today’s wars just don’t have much of any of them. missiles replace planes, and a lot of men, and most of the tanks too. Our enemy is usually without an airforce so a few good choppers replaces a million fighter planes.

The way war machines are built has changed too. Manufacturing is not the employment engine it used to be. Maybe for airplanes, but we use few of those. Guns, missiles, hum v’s etc, roll off automated assembly and employ reletively few.

The finance of today’s war has served to channel a great deal of tax payer money into the hands of very few but large private corporations. They former VP was on the board of Haliburton up until he took office. But he’s clean because his own personal shares of the company were frozen during his term in office (where’s that sarcasm mark?).

You wrote: “Well, we had a great expansion of free trade in the 1990s. And a great withdrawel from international institutions in the 000s. Also there were two wars.”

I’m not doubting you, but I’m not sure that I know exactly what you mean by great expansion of free trade in the 90’s and a withdrawl from international institutions in the 000’s. Can you elaborate a little, because I’m not sure I think of the 000’s as having less free trade than the 90’s, but I would think of the 000’s as less regulated than the 90’s. Again, not doubting, just trying to better understand what you are saying.

I’ve been thinking about your wars comment from earlier. While I’m not a fan, I do believe war contributes to employment (i.e. the military now fills the recruiting quota they couldn’t fill just a couple years ago, not because people are “choosing” to join the military but rather because they have no other alternative ways to pay the bills. Bomb makers get paid to build replacements etc.), so 2 wars would skew the stats more toward the correlation Krugman was pointing out rather than detract — I think.

* Seems to me that we “must” agree taxes on capital and taxes on labor are distinct because, if they are not distinct, what is the point of advocating eliminating all taxes on capital vs eliminating all taxes on labor?

The distinction is that under a labor tax, labor in all periods is taxed equally, whereas under a capital tax, labor in different periods is taxed at different rates.

You are right that a tax on labor reduces capital accumulation, just as a tax on capital reduces labor. Those are distortions. But the capital tax introduces the *additional* distortion of taxing early labor more heavily than late labor.

* Seems to me that we “must” agree taxes on capital and taxes on labor are distinct because, if they are not distinct, what is the point of advocating eliminating all taxes on capital vs eliminating all taxes on labor?

It must be because they are *distinct enough* to have differential impacts (between capital and labor) on something we seek or seek to avoid, such as accumulated wealth, capital spending, income from returns to labor or capital, changes in economic inequality, etc.

In choosing one tax policy alternative over another, why are we not just making choices, based on values we seek, from a set of possible values (some endorsed by economic theory, some outside the reach of economic theory and therefore “irrational”), where some values are in conflict and some overlap? And what is the basis for making one choice over another?

Presumably the answer is that one option optimizes a set of values most or all of us can agree upon. But I wonder how we make this calculation if we admit to the set of values to be optimized, values that lie outside economic theory and are “irrational”. Is it because economic theory encompasses *all* possible values not just those we commonly think of as economic?

* When you say “A tax on labor would have reduced the quantity of that capital and hence reduced (forever) the stream of income for that capital”, why doesn’t this apply as readily to direct taxes on labor as it does to indirect taxes on the “historical” labor of capital owners via taxes on capital?

What I’m getting at is: just as a tax on capital reduces capital accumulation, why doesn’t a tax on labor reduce capital accumulation? A tax on labor means labor has less income and is less able to sock away savings. They also have less to spend which reduces income to business which reduces returns to capital and capital accumulation.

On the other hand, if we eliminate all taxes on labor, why would we not increase capital accumulation? Labor has more income, saves more or spends more, the spending increasing returns to capital, etc.

If, and I have no idea what economic theory says on this point, eliminating taxes on labor leads to *less* capital accumulation than eliminating taxes on capital, it seems to me that this differential must be plugged back into the calculations of the benefits to labor of eliminating taxes on capital, further reducing the attractiveness to labor of eliminating all taxes on capital vs eliminating them on labor.

Why doesn’t this all boil down to an argument that *all* taxes should be reduced equally? Or, climbing out on a limb here, why shouldn’t they be reduced to a level at which the marginal value of an additional dollar to labor lost through taxes is equal to the marginal value of an additional dollar lost through taxes to capital?

A few thoughts in response to your exchange:

Re: Steve’s quote: “A tax on capital…”

I think I understand this at the top level of economic theory. Maybe you (or Tagore) can educate me on how this is an argument in support of eliminating all taxes on capital considering…

* most of the benefits go to capital owners not labor

* tax burdens necessarily and permanently shift from capital to labor through increases in direct taxes on labor or inflation, offsetting much if not all of labor’s eventual indirect gains through increases in capital accumulation (unless we assume that expenditures are cut in the same amount, which hasn’t been specified here, and raises the prospect that labor will be a net loser in expenditure cuts)

* there are tax policy alternatives that provide labor with greater, more immediate benefits (both in absolute terms and comparatively) and still lead to increases in accumulated capital

* increasing economic inequality also increases differentials in political power, making labor more vulnerable to capital in future policy changes (tax and expenditures), changes that may not benefit labor or even be at labor’s expense.

Re: the irrationality of individuals’ economic decisions: I saw a report this morning about how a big percentage (80% I think) of homeowners who are way under water (up to 50%) on their mortgages, nevertheless don’t walk away from their homes despite the fact they could turn around and buy an identical house at the lower market price.

They don’t do the economically rational act despite the fact that laws prevent mortgage holders from seizing any other assets (other than the home) or income. (I don’t think it’s reasonable to assume this behavior is attributable to homeowners lacking information about their alternatives.)

Why no they behave this way? Because they’re ashamed to walk away from their mortgage debt. (I have personal experience watching this dynamic. Most of us probably do.)

Now if emotions drive such significant economic decisions of individuals, shouldn’t that give us considerable pause about following economic theory and logic to strongly advocate policies in the real world, especially policies based on the theorized responses of individuals? (I’ll stipulate that businesses and corporations are more likely to make rational decisions, though imperfectly.)

I’m not arguing that economists should have no role in policy decisions. I’m saying that their policy advocacy should be weighted (by economists and by policy makers) with a lot more circumspection than is typically the case, especially with economic ideologues on the right and left.

If this is a reasonable chain of logic, I think it applies in the case of the tax proposal we’re discussing.

The responses of capital, acting largely (though not exclusively) in the realm of economic decision making, are much more likely to conform to economic theory than are the actions of individuals who are more likely to respond through a powerful and persistent filter of “irrational” (i.e., non-economic) values.

In the case we’re discussing, the actions of capital, and therefore the benefits they reap, are far more predictable than the actions of individuals, whose benefits can only be maximized if their behavior conforms to economic theory. Any response based on “irrational” factors would seem to sub-optimize the benefits theory claims they would receive.

Good post. I agree correlation does not imply causation, and I’m not sure if Krugman was implying causation. My point in referencing the Krugman article was the claim made in Steve’s original post:

“A tax on labor discourages work. A tax on capital discourages work disproportionately among the young, distorting saving decisions and retarding economic growth. So a tax on capital has all the disadvantages of an extra tax on labor, and more besides.”

I was just pointing to a period in our recent and current history where the claim does not appear to be the case. Causation hasn’t been shown in the original claim either (it might be that humans are not rational in the sense that is implied by the logic of the argument, or if they are, it might be the effect is so small as to be inconseqential).

At the very least, if we accept Krugman’s data, we know there are much bigger fish to fry than tax on capital when it comes to the generation of economic growth, otherwise we would have seen stagnation in the 1990’s and growth in the 2000’s, but it was the other way around. What are those fish?