UK: Who should pay more? The rich or the poor?

The Economist

Tax progressivity
Somebody has to pay for government

Nov 23rd 2011, 15:50 by M.S.

PAUL KRUGMAN addresses several common conservative objections to the paper by Emmanuel Saez and Peter Diamond I talked about on Monday. The third one is that the very wealthy are job creators who should be rewarded, not taxed. "This", Mr Krugman says, "is where things get interesting."

[T]extbook economics says that in a competitive economy, the contribution any individual (or for that matter any factor of production) makes to the economy at the margin is what that individual earns — period. What a worker contributes to GDP with an additional hour of work is that worker’s hourly wage, whether that hourly wage is $6 or $60,000 an hour. This in turn means that the effect on everyone else’s income if a worker chooses to work one hour less is precisely zero. If a hedge fund manager gets $60,000 an hour, and he works one hour less, he reduces GDP by $60,000 — but he also reduces his pay by $60,000, so the net effect on other peoples’ incomes is zip.

...So, are conservatives comfortable with this analysis? I would guess not, that they have a deep-seated belief that the 1%, by working harder, are doing the 99% a big favor, creating jobs and raising incomes — and that this gain isn’t fully (or even largely) captured by the money they’re paid.

My point, then, is that this claim — and the lionization of high earners as people who make a vast contribution to society — is not, in fact, something that comes out of the free-market economic principles these people claim to believe in.

To make the same point another way: the Diamond and Saez paper is about deciding who should pay for government spending. Ultimately, it has to be paid for by somebody. If you tax rich people less, you tax regular and poor people more. And when you tax them, they, like rich people, have a certain propensity to work less ("deadweight loss"). Also like rich people, the money they pay in taxes is money they cannot spend, which leads to lower economic activity and lower GDP in the short run. Yes, high marginal tax rates at the top end will lead rich people to work less, but this is precisely the "income elasticity" that Messrs Saez and Diamond already account for in their paper. You may feel that their estimates of income elasticity are too low, but if so, that's the case you need to make. So why should considerations of economic growth lead us to be more reluctant to raise taxes on the rich than on working-class people?

When people argue that we should not raise taxes on the rich because the rich are "job creators", they leave out the crucial point that if the rich pay less in taxes, regular people pay more. To argue that growth concerns should lead us to restrain the tax code's progressivity over and above any income elasticity effects is to argue that regular people's money is literally not as good as rich people's money. This would not be a winning political message if it were clearly stated. And beyond its political and moral unpalatability, the argument that regular people's money actually does more than rich people's money to stimulate job growth, through increased broad-based consumption, seems at least as plausible.

http://www.economist.com/blogs/democracyinamerica/2011/11/tax-progressivity