Sunday, February 26, 2006

Soak the rich? Nah we luv 'em

A standard question in public economics arises if the distribution of income is skewed towards those on lower incomes and we live in a one-person-one-vote democracy. These characteristics describe most developed economies. A question: Why don't the low-income majority soak the rich and appropriate their wealth? Why not levy hefty wealth, capital gains and luxury good taxes as well as steeply-progressive income taxes?

I think there are at least four modern answers to this:

  • The population of 'low-income' earners are well-versed in public economics and understand that soaking the rich will have adverse incentive effects on their entrepreneurial flair leaving those on low-incomes worse-off.
  • The young don't seek heavily progressive taxes because even, if they start off poor, they have a naive optimism and a positive probability in the future of 'making it'. Hence they don't seek hefty redistributions lest they suffer future disadvantage. The old who have not 'made it' will not vote to 'soak' because they will have strong demands for public goods such as health care and government-supported pension schemes.
  • Citizens may believe that 'soaking the rich' will be ineffective since, compared to the poor, the wealthy have better opportunities to evade taxes.
  • Progressive taxes may emerge as the solutiion to a bargaining problem between rich and poor when the demand for public goods is normal, so demand increases with income. This idea is being pursued by my PhD student Mr Minh Huynh. A variant is the notion that progressive taxes are the price the rich pay to avoid being overthrown by the poor.

A fifth possible explanation is:

  • That we may love the rich and not want to harm their economic prospects.
Before you abandon this post in a search for sanity consider the adoration directed by members of the public towards the late Kerry Packer and the claims by Adam Smith himself on affection for the wealthy by the 18th century poor in England. In Theory of Moral Sentiments Smith argues that while there is a prevalent sympathy to sympathize with those less fortunate there is also a propensity to sympathise with the rich:

‘When we consider the condition of the great, in those delusive colours in which the imagination is apt to paint it. it seems to be almost the abstract idea of a perfect and happy state. It is the very state which, in all our waking dreams and idle reveries, we had sketched out to ourselves as the final object of all our desires. We feel, therefore, a peculiar sympathy with the satisfaction of those who are in it. We favour all their inclinations, and forward all their wishes. What pity, we think, that any thing should spoil and corrupt so agreeable a situation! .... Every calamity that befals them, every injury that is done them, excites in the breast of the spectator ten times more compassion and resentment than he would have felt, had the same things happened to other men. It is the misfortunes of Kings only which afford the proper subjects for tragedy. They resemble, in this respect, the misfortunes of lovers. Those two situations are the chief which interest us upon the theatre; because, in spite of all that reason and experience can tell us to the contrary, the prejudices of the imagination attach to these two states a happiness superior to any other. To disturb, or to put an end to such perfect enjoyment, seems to be the most atrocious of all injuries...... A stranger to human nature, who saw the indifference of men about the misery of their inferiors, and the regret and indignation which they feel for the misfortunes and sufferings of those above them, would be apt to imagine, that pain must be more agonizing, and the convulsions of death more terrible to persons of higher rank, than to those of meaner stations’. (TMS, p. 51-52).
Fascination with the lives, deaths and clothing of celebrities is an instance of this. What I find particularly interesting is that Smith saw such adoration of the rich as a moral mistake but one necessary to maintain the stability of an elitist social structure:

‘This disposition to admire, and almost to worship, the rich and the powerful, and to despise, or, at least, to neglect persons of poor and mean condition, though necessary both to establish and to maintain the distinction of ranks and the order of society, is, at the same time, the great and most universal cause of the corruption of our moral sentiments. That wealth and greatness are often regarded with the respect and admiration which are due only to wisdom and virtue; and that the contempt, of which vice and folly are the only proper objects, is often most unjustly bestowed upon poverty and weakness, has been the complaint of moralists in all ages’. (TMS, p61-62).
Smith's views are discussed by Asfraf, Camerer and Loewenstein in a recent Journal of Economic Perspectives article 'Adam Smith as a Behavioral Economist'. It is a good read.


Minh Huynh said...

If there is ample opportunity for those who are poor to become rich then the poor have less of an incentive to soak the rich. So the progressivity of taxes is a reflection of the equality of opportunity in society. If the poor are able to someday become rich then there is less resentment towards those who are rich. The rich may also have greater resources to ‘vote with their feet’ and get up and take their business elsewhere if they are being over taxed. The fear of ruin if the rich leave gives them bargaining power to stifle the progressivity of taxes.

hc said...

Dear Minh, The first three sentences in your comment I agree with - taxes can be less progressive the greater is the opportunity for the poor to become rich. This reflects on risk-taking attitudes of the poor.

The second part of your comment deals with the implications of the attitudes of the rich. They will not offer capital, entrepreneurship etc if taxes are too high. This is the first point I raised in my post. The poor will understand that if the rich are taxed excessively they will undersupply the things the poor want. This relies on the poor understanding some incentive economics and not being myopically greedy.