This essay started as a short post responding to an article by Greg Mankiw and grew longer than I expected, so to avoid cluttering the blog I switched formats. As you might guess from the potpourri in the title, the essay is intended to be readable by a broad audience. The portions which discuss the use or misuse of economic theory in the tax debate are, it is my fond hope, of interest to economists and accessible to non-economists, as is Mankiw’s article. I began this last week, so it doesn’t refer directly to this week’s big news of the Great Tax Compromise of 2010, but the ongoing negotiations were a major motivation.
I hope this has been enough of a teaser for you to click here.
The Leisure of the Theory Class 
30 comments
December 10, 2010 at 8:25 am
gappy
Interesting, thought-provoking paper. However, I think Mankiw’s usage of the term “desert” is correct. See “desert” at the Stanford Encyclopedia of Philosophy, or the recent book “Unjust Deserts” by Alperowitz and Daly.
December 10, 2010 at 10:03 am
Jonathan Weinstein
Gappy,
You are entirely correct…I have corrected the article. What confuses the issue is that in this context, where it means “that which is deserved,” the word is spelled like the Sahara but pronounced like a chocolate cake.
Jonathan
December 10, 2010 at 10:59 am
Dan Craig
Thanks for the essay. It’s refreshing to read a thoughtful, nuanced take on fairness.
One a purely presentational note, I think publishing it as a PDF is a bad idea. While LaTeX certainly produces a beautiful result, it renders it incapable of being included in many of the new long-form reading tools like Instapaper and ReadItLater. Yours is the perfect kind of essay for this, so it’s too bad it can’t make it up on Give Me Something To Read.
December 10, 2010 at 11:24 am
Jonathan Weinstein
Dan,
I started in html, but it was a bit hard to get the footnotes and everything to come out right. If anyone is interested in publishing somewhere that is broadly read, I would be happy to create an alternate version.
I heard from Professor Mankiw this morning, who, after recorrecting me on “deserts,” very kindly posted a link to the article on his blog. Thanks to him for that and for writing a stimulating article initially. His thoughtful, speculative piece suggesting a direction of inquiry has a lot of value. Such a piece has an important and often unfilled place alongside the many papers carefully and unimpeachably extending an existing literature by epsilon.
Jonathan
December 10, 2010 at 4:55 pm
Robert Johnson
Excellent essay! I came here from Mankiw’s blog. Seems he thinks you make some good points.
For me, the way you explain collective bargaining adds something I hadn’t considered.
“The marginal value of the owner,who is indispensable, is the full product of the industry. Is this fair? Reflect that if the workers can unionize and be treated as a single player, now the marginal product of the union is equal to that of the owner…”
December 10, 2010 at 4:58 pm
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December 11, 2010 at 8:09 am
jim c
The issue is not how we distribute income. Allowing the right-wing to call taxes redistribution of income is conceding defeat. The question of taxes is who is responsible for paying for our government and in what proportion. Buffett’s notion that he is more responsible for taxes than a minimum wage worker is the correct tact to take. Consider the benefits that ultra-high wage earners garner from living in the US. Not just the physical security, but the security of assets, and what were once transparent marketplaces. Think of how those benefits accrue to the wealthy and to the poor, and you have all the justification you need to have progressive taxes.
As for Obama’s tax plan, he would have been better off just extending the current rates and adding two new brackets, > $1Mil and > $5Mil, at like 39% and 42%. That would generate more revenue and shut up the likes of Todd Henderson who complains about being an overtaxed two income household. Households with income > $1M are more balance sheet concerns than cash-flow ones.
December 11, 2010 at 4:45 pm
jonathan andreas
Thanks for the essay. It is very good, but I have a quibble with this part:
“However, the leaky bucket is the only rationale that utilitarianism allows for unequal outcomes; there is no notion that the highly productive may deserve their wealth.”
Another important rationale for why utilitarianism allows for unequal incomes is compensating differentials. If taking out the garbage is unpleasant and professional basketball is pleasant, then the former should be paid more than the latter. Or perhaps the investment in training for pro ball is unpleasant which makes salaries go up in that field. Under certain assumptions, utilitarianism yields equal utilities but it usually does not result in equal pay. Some inequality is necessary to motivate people to work.
December 11, 2010 at 7:21 pm
srp
You need to correct your footnote on Rawls: He uses the veil of ignorance and combines it with risk aversion to rule out utilitarianism and support his maximin principle, the exact opposite of what you said.
More importantly, I strongly question the idea that the rich benefit more from society (and the government) than the poor. I am surrounded by homeless people who engage in no productive activity at all but survive entirely on transfers from the government and passersby.
We also have the unfortunate examples of other societies where the rich pay for their own physical security, generate their own power, etc., while surrounded by masses of poor people; there, the rich do not seem to mind this situation at all, while the average person is greatly harmed by pervasive crime and property insecurity. The fact that America’s rich would not be as comfortable in such a situation is not a sign of their greed but of their relative egalitarianism–it seems odd to charge them higher taxes for that sentiment.
December 12, 2010 at 11:17 am
Max Manus
Great paper.
December 12, 2010 at 12:30 pm
Scott H.
I appreciate the knowledge and effort a piece like this requires. That said, I disagree with most of it. To keep the comment short I will address what was, for me, your key argument…
“A worker’s Just Deserts presumably do not depend on whether he lives in a union-friendly regime, but his outcome depends enormously. Whichever outcome seems fair to you, the other cannot be, so a blanket assertion that “Free market outcomes are fair” falls apart; it is either incomplete or self contradictory.”
Let’s take another example very much like your union example. Let’s say a mob boss goes into the office of a capitalist and requests a “protection contract”. Unfortunately, the capitalist is only willing to pay the marginal value above the current protection of the existing police force so he turns down the mob boss’s price. However, the mob boss’s bargaining power increases dramatically when he explains his willingness to use small arms fire on the capitalist’s immediate family members.
Now, you could take this example and adapt your argument to read: A mob boss’s Just Deserts presumably do not depend on whether he employs lethal violence, but his outcome depends enormously. Most free market defenders would argue that what the mob boss was doing was illegal and should be outlawed in a “free market”. The “free market” subsequently does not have to answer for this discrepancy of outcomes.
Well, monopoly in a market is also something that is illegal. As an example, if there is only one power company in town — a classic example of a monopoly — its freedom to do business is typically heavily regulated. We don’t just allow the power company to adopt monopoly pricing. It wouldn’t be fair. (As an aside, maybe you should go back and look at the appropriateness of your “lone capitalist” example in light of anti-monopoly principle and law with regards to free markets.)
The same should be said of organizations that seek to create a monopoly on labor. Those organizations are called unions. The union’s objective is to use labor monopoly, sometimes violence, and political means to shake down share holders. Just look at the way unions operate. Are the unions there during company startup? Are they helping the company get going by accepting less pay and helping mitigate the risk as the company’s sales begin to grow? The answer is no. The unions only show up later, after most risks have been successfully taken — once there is shareholder value to be “negotiated” away. The threat is simple; the unions will shut down the shareholder’s business unless their demands are met. Morally, I see a lot of similarities between mob bosses and union bosses. Ironically, sometimes mob bosses and union bosses are the same people! For these reasons, where unions and the mob touch business I decline to consider that an example of “free markets”.
I guess, for me then, you haven’t really established your key argument against “Just Deserts Theory”.
December 12, 2010 at 3:44 pm
Jonathan Weinstein
Scott,
Thank you for your thoughtful comments. In response, I think that there are good reasons that while we all agree the mob’s protection demands are unjust, many of us think that unions can lead closer to justice.
In regard to monopoly power: Yes, there are in principle laws against it, but you can’t seriously argue that antitrust laws are so strictly enforced that monopoly power doesn’t exist. In fact, casual observation suggests that monopolies and small oligopolies are the rule and not the exception, as is inevitable in a world with huge economies of scale.
Viewed in this light, while a union does create monopoly power of a sort, this can bring us closer to a just outcome if it is necessary to contravene the monopoly power of capital. So we can support unions while preferring a world with no monopoly power, much as we support maintaining a military while preferring an unachievable world where no one has one.
Following this thought further, clearly the balance between the union’s monopoly power and that of capital can in principle swing too far to the union. If I had to venture an example, the United Auto Workers (which to my understanding negotiates as a single entity with the multiple large auto manufacturers) could be one. But I think a world with no unions would be much more out of balance.
To expand on the passage you quoted, I think “freer is better” is often used as a cheap slogan to try to quell debate, when in fact, in almost any issue worth debating, there is a contest between different notions of freedom. From your comment, I think you would agree that to have a functioning, “fair,” free market system, we need to make difficult choices about how closely to regulate monopoly power, what form of union contracting to allow, how to regulate intellectual property…and tax policy. These are tricky issues where both sides will often be able to say they are on the side of freedom. For these reasons, I stand by my statement that “Free markets are fair” is either incomplete or self-contradictory. In my view, striving for a fair society is, unfortunately, difficult, and is best served by a constant and careful debate on many policy fronts, not by a single simple ideology.
Jonathan
December 13, 2010 at 4:22 am
Patch
Scott, I think that your statement reflects an understanding of monopoly power that is not the understanding of today’s economists. In modern models like the Dixit-Stiglitz model of product heterogeneity, every company has a little bit of monopoly power. The reason for this simply is that all products differ a bit from all others. Of course, that is not a perfect way of modelling reality (there indeed are perfect substitutes in reality – which would not be possible in such a model). But it shows that monopoly pricing (or rather: monopolistic competition) does not exactly depend on laws alone. If your company is the only company hiring IT experts in town, then you have a high degree of monopoly power. Every single one of your workers might feel as if he was in a hold-up situation every time he negotiates wages.
December 12, 2010 at 1:06 pm
bwillman
This is all fine stuff, but I think there are two broad issues to understand better. (Well, many, but 2 that apply here.)
1. People mostly don’t want equality – they want to “win” where winning is different for each person, but getting exactly the same wealth outcome, or even some adjusted-for-fairness-wealth-outcome, isn’t winning. Note that it’s not about being objectively better off, or risk-adjusted objectively better off, it’s about “winning” in the human biological/social/polticial sense.
This is a problem with unions ‘we are all the same” – sure, but of course, that means none of us can be better….
2. It ignores certain realities of power, politics, and systems. *on the whole* the well-off are better than other people at doing some set of things our society/economy reward. You can change the system, but you will mostly change the rules for deciding “who is a winner”.
Only one person is President, only one person can be the paramour of the most desireable member of the opposite sex, only a few people live in the apartment with the niciest view. From feudalism to communism, there are always “winners” (and “losers”) and no system achieves equality anything like a utilitarian ideal.
December 13, 2010 at 4:27 am
Patch
I like your essay very much, but there is one point that I miss. In a way you treat the entertainers, for example, just like Mankiw does – having a high marginal productivity etc. I guess that is not appropriate: “The high earnings of a few in show business might better be regarded as prizes in a lottery” (Robinson/Eatwell, 1974) might be a bit harsh, but as celebrity success is a kind of network effect (utility by talking about certain celebrities and being able to talk with your friends about the latest show), it might very often be a product of coincidence whether “possible showmaster X” or “possible showmaster Y” gets the huge paycheck.
December 13, 2010 at 11:05 am
Jonathan Weinstein
Patch,
Good point — I didn’t give as much space to that argument as I perhaps should have, but I did mention it here, on page 6:
if the inventor or entertainer is extracting rents from network effects and they are not actually much better than a replacement, their Shapley value might be much less than half their income.
I mentioned network effects because this is what reinforces the tournament winner: if all my friends listen to Britney, then I benefit from listening to Britney regardless of how good she is.
December 13, 2010 at 10:58 pm
Eilon
Very interesting and thought provoking. One comment on the use of the Shapley value for taxation: is it clear that the axioms defining the Shapley value make sense in this problem? I always feel uneasy when people apply the Shapley value in various situations without asking whether its axioms are reasonable. I guess that we do want to keep symmetry to be fair, and we need efficiency to collect all required taxes. But the axiom of null-player is not clear; after all, the state does give money to the poor and disabled. And what does linearity mean here? If Canada and the US are united into one country, will, say, IBM have to pay the sum of its taxes? But such a union will presumably lower costs for IBM, so maybe it should pay more! All in all, before applying the Shapley value (or any other solution concept of coalitional games) it is important to check whether the axioms defining it make sense.
December 14, 2010 at 1:12 pm
Jonathan Weinstein
Eilon,
I did think about the axioms, and perhaps should have included a discussion. Here are my thoughts:
Symmetry: (Says that equal contributions get equal allocation.) If anything is a notion of fairness, this is.
Null player: (Says that a player who contributes zero to any coalition gets zero.) The meaning of zero is flexible, i.e. based on a normalization. We could agree that we give everyone enough to stay alive and then allocate the rest via Shapley value, that is, we call bare subsistence zero.
Linearity: This says that if society has a list of completely independent productive activities, A, B, C, etc., then the amount I keep should be the sum of the amounts I would keep if each were the only activity. This is probably the least obvious but it does sound reasonable. Your example is not quite apropos because if costs are reduced when the nations combine, the feasible sets are not being combined additively so the Shapley value need not either.
Jonathan
December 14, 2010 at 10:27 am
turpentine
This is one of the best pieces I have read on the question of redistribution and fairness. Finally someone who sheds lights in an intelligent manner on what econ theory really has to say on the topic, without simply trying to throw a smoke screen by using complex terms to impress the audience. Great job.
I was thinking: why not re-work it a little and submit it to a major newspaper? You have enough intuition, quotes and examples to make it a very fluid read for the general population, and I would see this as the supreme example of a public good. I am convinced we need to ensure that this type of analysis is not confined to the small and voodoo world of academic economists.
December 14, 2010 at 12:58 pm
S
Good read. I did not understand how it follows from f(.) concave (and continuity) that .5<=c<=f(.5) I can see .5<=c and .5<=f(.5) but not c<=f(.5) Any volunteers? Thanks!!
December 14, 2010 at 1:19 pm
Jonathan Weinstein
Hi S,
Maybe I should have explained this one; it’s Jensen’s inequality applied to f and a uniformly distributed X. Jensen says that the average f(x) is less than f(average) which means precisely c <= f(.5).
December 14, 2010 at 2:09 pm
faithkills
It’s true that buffet has an affinity to aggregate capital, but I much doubt it’s only in this particular milieu. In fact I suspect it works in any milieu where one can observe government interventions in markets and use them to your advantage, or secure those interventions directly.
In our system capital is largely aggregated _due_ to interventions. Real ‘free market’ tycoons like Hill, Gates, or Jobs aggregate capital because they provide better and better products and lower and lower prices. _That_ aggregation serves society where it is. It’s risible to think that government could use it more efficiently.
For outfits like BP, big oil in general, GS, or big banks and finance in general, of GE and Halliburton, big war in general, there’s nothing the consumer can do about it. The capital is aggregated by main force. Hedge fund managers, and secondary operators, don’t use main force but they observe the use of main force and profit thereby. Eg Buffet. You make billions fast by rapid market changes. Those don’t occur very often without interventions to be useful.
That second class of capital I would love to see taxed. After all it only exists because of taxation in the first place.
Who should pay? Or rather, who should pay less? I would say that those that should pay least are those that cause the least systemic risk or moral hazard.
A progressive _income_ tax however is a horrible, anti productive, and soul oppressing idea. Workers should be able to become rich by effort and saving. Their fairest tax would be something like the fair tax. Who buys more? The wealthy, axiomatically. And _that_ is why I suspect there is so much resistance to it. The wealthy would have to pay more. (I’m in no way associated with the fairtax ppl fyi)
December 14, 2010 at 4:15 pm
reader
I think you may have misunderstood the whole plot of Atlas Shrugged. The productive members of society went on strike by moving to their valley. Eventually, when only non-productive members were left (or critical mass was achieved), the beggar society collapsed in on itself. The collapse was necessary before the constructive rebuilding process could begin.
The book ends with the productive members leaving the valley and putting each of their respective talents to use across the US. Atlas Shrugged was never about “elites escaping to a private society and abandoning the world forever”.
December 15, 2010 at 4:02 pm
Jonathan Weinstein
Hi reader,
The book describes in detail a functioning micro-scale capitalist society in “Galt’s Gulch” with just the elite strikers, some of them working in menial jobs. The proportion who would have to do so seems understated, although it would naturally be lessened by an engine that creates energy from thin air. The importance of economies of scale seems very unappreciated also. There is a clear position that the elite are better off in the Gulch.
You’re right to point out that their ultimate aim was to wait for the Stalin/Leninist dystopia around them to collapse and then rebuild a just society, but the rebuilding was described in much less detail than the capitalist utopia in the Gulch. In the rebuilt world, I wonder how sympathetic they will be if labor feels they are not getting their fair share and goes on strike?
The picture I’m trying to give is that both the inventors and laborers benefit from having the other around, and from the stability provided by government. They inevitably negotiate for the surplus created when innovations are used in mass production. Rand, with Stalinism in mind, depicts a society where the inventors are underappreciated and their products seized without payment by a corrupt government. In such an extreme world, I would actually have a lot of sympathy for Galt and friends if they went on strike and demanded a better deal. Do we live in such a world? No, we make heroes of innovators and they can become billionaires; the only debate is whether they keep a few percent more or less. Does the New Deal lead down a slippery slope to Stalinism, as the novel suggests? History has said no. No, not even considering our “radical” new health-care plan.
Jonathan
December 16, 2010 at 6:19 pm
faithkills
You overlook the reality that real innovators, business entrepreneurs, as opposed to political entrepreneurs, may only aggregate capital inasmuch as they benefit society. They benefit society by their existence, as do laborers.
Political entrepreneurs don’t provide value in exchange for their capital aggregation. One might argue that the former type tend to become the latter when they fail to maintain market share without government regulation, subsidies, tariffs, tax credits, licensing, contracts, or bailouts, eg GM, GS, and that’s certainly an interesting discussion.
Your assertion that innovators and laborers benefit from each other being around erroneously implies someone is making the opposite case.
On the other hand some business gains quite a lot from such things as public education and public health care. Why else does Walmart support Obamacare? They want to socialize their health care coasts. Similarly why people other than the employers who need a certain education in their workers or the worker himself should pay for their education is a question rarely asked, much less who benefits. The individual seems to benefit but the _employers_ benefit in much more concentrated fashion from again socializing the costs of an educated workforce. You may say, yes!, see, the employer benefits more and should pay! And I agree, but they should pay directly, this cost has no justifiable reason to be externalized on the taxpayer. It also introduces the massive economic and human waste of highly ‘educating’ everyone who can fog a mirror who are no more equipped to be employed for most jobs than someone with a high school education. Further all this false demand drives up the costs for those that actually need a higher education. Subsidies raise costs, and we subsidize everyone. There’s no reason for higher ed to be expensive other than that simple fact. BASF should be paying to educate chemical engineers, not Starbucks. Ford should be paying to educate mechanical engineers, not Walmart. CBS should be paying to educate journalists, not the taxpayer. Insurance companies should be paying to educate actuaries, but the taxpayer. H&R black should be paying to educate accountants, not the taxpayer. Individuals should be paying for their art history degree if they really love art history.. and should that occur, art history degrees will become quite reasonably priced indeed.
December 21, 2010 at 8:28 pm
cemil
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January 17, 2011 at 11:34 am
Dion
I would have expected more rigorous analysis from the Kellogg I graduated from. For example, if you make a lot of money the last $10k doesn’t matter much neglects the reality that a worker earning rents of $30k is likely paying at least this amount under our current system (federal and state income tax, local and property tax, FICA including the hidden employer contribution, unemployment insurance, Medicare,…). This effective marginal rate exceeds what your discussed dark ages’ serfs paid to their masters, and certainly that $10k would make a very dramatic difference in these peoples lives. It is high marginal tax rates that destroy opportunity for advancement and lock people into a quasi-cast system. Case in point, if your 50% marginal tax rate is acceptable, why don’t more states within the common environment of the United States tax at this level? By looking at the US as a whole, one can normalize for protection of property, economic system and other benefits that Warren Buffet enjoys. A regression can then by run considering the correlation between state taxation (including corporate incentives) and private job/economic growth. Your “verbal” arguments would like silly in relation to this r-squared.
January 20, 2011 at 9:06 pm
Todd Melby
Very interesting article. One point that stood out to me and has stood out to me in the recent past is the position of people like Buffet saying they should pay more taxes. The very glaring fact is that they don’t voluntarily do that. He instead gives an enormous sum of money to charity. He must view the charity as creating more value or being a greater benefit than the society he supposedly cherishes for getting him to where he is today.
Instead, he sounds like he is more than willing to offer up other people’s money to pay for “society”. If his view of fairness was truly selfless, he would gladly pay extra taxes. Instead he waits for a law to force others to join him. That isn’t a very selfless view of fairness.
This is just an observation of elites that rubs me the wrong way.
January 20, 2011 at 9:46 pm
Jonathan Weinstein
Todd,
Suppose Warren is just finishing 4th grade. He tries to convince each of his 20 classmates to kick in $5 to get the teacher a new printer. They won’t go for it. Warren really loves his teacher, though, so he spends $20 on his own to get her a completely different gift, a DVD, all the while regretting that because he couldn’t get everyone to act together they couldn’t get the printer. You seem to be saying that Warren is then a young hypocrite…should he instead have gotten her a $20 gift card towards a printer? I think Warren’s behavior (the young and old versions) is not the least bit inconsistent or unprincipled.
Jonathan
August 31, 2011 at 9:11 pm
Anonymous
Further all this false demand drives up the costs for those that actually need a higher education. Subsidies raise costs, and we subsidize everyone. There’s no reason for higher ed to be expensive other than that simple fact. BASF should be paying to educate chemical engineers, not Starbucks. Ford should be paying to educate mechanical engineers, not Walmart. CBS should be paying to educate journalists, not the taxpayer. diş beyazlatma konuları her zaman lazerle diş beyazlatma yapıtracaklar içindir…