The Welland Tribune

How should we tax people’s good fortune?

- William Watson is acting chair of McGill University’s economics department. WILLIAM WATSON

How much would you miss $100, if someone took it from you? We’d all miss it somewhat but most modern theory of taxation assumes that someone with a $100,000 income would miss it less than a person with $10,000 in income.

If you only have $10,000, $100 is much closer to your “bottom dollar,” which an old phrase (“I’d bet my bottom dollar on that”) says is your most valuable dollar of all.

Or, as we say in economese, “The marginal utility of income declines.”

So if you’re trying to devise a tax system that maximizes social utility, the obvious choice is, well, communism: Make everyone’s income the same. If you don’t, you can always take from a (somewhat) richer person and give to a (slightly) poorer person and be reasonably confident the utility loss to the rich person is less than the gain to the poor person.

Reality intrudes here because if everybody gets the same income no matter how hard they work, many people will stop working. If that happens, pretty soon there won’t be any income to redistribu­te. Knowledge that incentives are important has always tempered the levelling instinct.

But suppose taxes had no effect on income. Then you should just level, right? Maybe. That’s what a lot of economists would say. But a new research paper by Matthew Weinzierl of the Harvard Business School suggests ordinary folk disagree.

The debate revolves around “brute rents.” A rent is income that just falls into your lap, either through luck or because some bureaucrat or politician decides you’re the person at the end of their rainbow so you get the pot of gold.

Tax theory says brute rents can be taxed 100 per cent and redistribu­ted to the poorest person in society first, then the next poorest and next poorest and so on. If you’re poor enough, you may get some of the rent back. If not, you lose it all. That’s not a problem for economic efficiency, however: You did nothing to get the rent. High taxes can’t discourage you from doing what you didn’t do in the first place.

To test how people feel about rents, Weinzierl set up a neat web survey that he paid 2,500 people $3 each to take (not a rent: no answers, no $3). After some demographi­c questions, he asked them their opinion on a slightly more complicate­d version of the following problem:

Two people are offered a deal in which one gets $60,000, the other $30,000. Together they must pay $18,000 for the privilege — not in advance but after the fact. From their point of view, it’s pure gain, a brute rent: It fell out of the sky. They don’t know in advance who gets which amount. But they’re asked in advance how the $18,000 should be allocated between the two of them.

Pure tax theory says the person getting $60,000 should pay the full $18,000, taking him or her down to $42,000, and then another $6,000 to the other person so they both end up with $36,000. There’s no disincenti­ve effect; they’re both ahead $36,000. Because incomes are equalized, additional transfers can’t increase social welfare.

Though the possibilit­y of the $60,000-winner paying the whole $18,000 plus a transfer is offered explicitly, only one-quarter of respondent­s said that’s what should happen. Another one-quarter say the $60,000 winner should pay the full $18,000, but only that. The next most popular answer is to split the cost two-thirds, one-third since that’s how the benefit broke down.

It seems most respondent­s at least partly agree with philosophe­r Robert Nozick’s dictum that “Whether or not people’s natural assets are arbitrary from a moral point of view, they are entitled to them, and to what flows from them” — or, as Weinzierl describes their view, “inequality due to luck is acceptable unless proven otherwise and therefore not the proper object of redistribu­tion.” I wonder if Canadians, especially Canadian Liberals, would agree.

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