Yes, there’s loss aversion and such in there and that’s certainly part of the effect, so maybe it was a bad example. The point I was mostly trying to make is that it’s actually not linear at any value, but it’s close at low values. That is $20k is worth very nearly 2x as much as $10k, but $200k is definitely not worth twice as much as $100k.
Perhaps a better example might be a new car. A $10k car is pretty much the cheapest new car you can get, and a $20k new car is considerably nicer. You’ll probably get a lot more features, room, power, whatever. Now consider a $100k car vs. a $200k car. You’ll probably get a little more power and a few more features, but the difference isn’t nearly as noticeable. Do you think this does a better job of illustrating the concept?
Of course, it’s been several years since I studied it, so I won’t promise that I’m doing the best job of recalling or explaining it.
That’s very reasonable. However, the exceptions are there for a reason. If the government wants to encourage certain behaviors (from home ownership to charitable giving) it is far more efficient to combine lots of programs into one event, filling out your income tax form. First, it is better to just not send the money than to send the money in and then have the government give it back. Second, through judicious use of withholding the average person can spread the benefit throughout the year instead of getting it in one chunk. Third, no matter how complex the tax code is, it is simpler than having hundreds of separately administered programs, each with their own forms and requirements.
But I think the plan just as well when utility is computed on taxable income, not gross income.
Just quibbling. My daughter and I are teaching a class on behavioral economics as applied to engineering next week. I do the engineering parts, she does the behavioral economics part. She actually shows the utility curve demonstrating loss aversion, and it is definitely nonlinear.
Without reading the thread, I know for a fact there will be a half dozen or so rationalizations that are without logic. Things like “the rich make more use of public resources.” And other nonsense.
The best and most logical answer is that we can.
That’s it.
Decreasing marginal utility is bullshit.
Using more resources is bullshit.
Even that assumption that they have more to give is bullshit.
I noticed today that Obama is planning to increase taxes on people making more than $200,000 to pay for his jobs program. It is true that if it only costs $22k to live in a given area, a person making $200k can afford more taxes. But that ignores the possibility that he/she may already be living pay check to pay check. Increasing the tax burden means they’ll have to cut back on spending. Is that something we really want to promote right now?
And given that they will have to cut back, are we confident the government will spend their money better than they will? If they were planning to have construction work done, and delay that as a result, so that the government can pay for more infrastructure work, are we really better off?
Part of the global effort to fix the banking crisis was to increase the amount of capital a bank had to have on reserve. If that guy making $200k saves less, that’s less capital the bank has in reserve.
Personally, I strongly disagree with tax exceptions because I don’t think taxes are the appropriate vehicle to go about social engineering (in fact, I think the government should largely stay out of it), but that’s not really relevant to the conversation. One could still have exceptions build into a continuous utility-based rate, you would just input the adjusted incoming into the function.
In fact, I could see this methodology being a method to simplify even our current tax system but by using a continuous utility-based function to determine the tax rate, thus you can maintain the current complexity (for better or for worse) but you also gain the benefit of being able to adjust tax revenue with a single value that fairly distributes the burden and prevents politicians from raising or lowering taxes for one group without also raising or lowering them for another.
I just think that IF we’re going to go with a progressive tax system, all this quibbling over the various brackets is inevitably not going to be fair because someone will end up over-paying or under-paying their fair share. I think it’s only fair that if we’re going to raise or lower taxes that everyone should be affected, not just the wealthy or the poor or the middle class. Sure, a 1% tax break for the middle class may be a larger 2-3% tax break for the wealthy, but a similar marginal tax increase for the middle class would also be comparatively larger for the wealthy as well.
You’re right, my terminology is bad. It’s what I get for typing bits between doing work. It’s definitely non-linear; in fact, my whole point is that it’s non-linear. What I meant when I said nearly linear was that the ratio of utility value to monetary value is nearly 1:1 at low values but the ratio gets lower as those values increase, but I was grabbing the wrong word for that property out of my vocabulary. At least I think we’re on understanding even if I was using the wrong word.
I’m not buying the utility value argument because it is an average across the group. The utility value to any two people in a given tax bracket is not necessarily the same. It also assumes that the government can use the money better than that particular individual can. One rich guy might spend his money on hookers and blow, while another uses it invest in businesses that employ thousands of people. So, it’s not just the utility value to the person, but to society as a whole.
It was not my point that one was better than the other. I think they both have their roles.
This couldn’t be more wrong. Wealth benefits all. Companies are started by people who have, or have access to, some degree of wealth. People like Steve Jobs, Bill Gates, John D. Rockerfeller all made a LOT of money. But the world wasn’t the poorer for it, it was better. Aside from the benefits of their products themselves, they created thousands and thousands of jobs. Jobs people used to buy homes, send their kids to college, take vacations, etc.
You’ve presented a false dilemma. See above.
Uh, yeah. So what? So is written language, and eating with a fork.
As opposed to what—non-manmade laws? And you might want to ponder the fact that these governments and these laws aren’t things that were always there, or popped up one day out of nowhere. We created governments to, in part, create laws that we find beneficial. and property rights are among the most important.
Say what?! States don’t have natural rights. Where the hell are you getting this from? States are constructed to protect the natural rights of people. You may want to look up what “natural rights” means. Hint: it is not synonymous with legal rights.
Hmmm, let’s see…taking some of what people have is a lesser measure than taking all of it. Yep. Gotta give you that one. Brilliant observation.
You’re damn right about that. If people like him don’t continue what they’ve been doing, a whole lot of us won’t have jobs that give us incomes that allow us to buy computers so we can post on a message board.
This is actually a good point and it’s something I think should be worked into a tax system. For instance, from a quick Google search, the median household income is around 50k. I live in the DC metro area and in my county the median is more than twice that at ~120k. To an average American, 100k sounds like a lot because it’s probably twice what they’re making. To someone in my area, 100k doesn’t really sound like all that much. Is it fair to tax someone making 100k in the DC area at the same rate as someone living in say southern VA or WV?
It would probably add a whole lot of extra burden, but I imagine you could also adjust utility to cost of living as well.
The way I’m using utility here is a more specialized term and isn’t about how well the money is spent or what it is spent on. I actually think my car example did a good job of illustrating this concept, but it attempts to encapsulates the overall satisfaction that one can achieve with something. Returning to my car example, spending twice as much money doesn’t get you twice the power, twice the features, twice the room, etc. At low values, like the difference between 10k economy and a 20k sedan, you’re paying twice the money for the latter one and the difference is noticeable, but now compare a 50k Corvette to a 100k Porsche or a 50k BMW to a 100k one the relative difference is noticeably smaller but you’re still paying twice the price.
Or another example. I can go to McDonalds and get a cheap meal for $5-6. I can go to a place like Chilis or Friday’s or whatever and get roughly the same amount of food for $10-12. Same amount, but costs twice as much. I can go to a nicer restaurant still and pay $20 for that same amount of food or to a really fancy place and pay $50-100 for the same amount of food. One might be able to argue that a sit-down restaurant tastes about twice as good as McDonald’s, but does that really fancy and expensive place that charges $50 a plate really taste as much better than a $25 plate place as the difference between cheap fast food and low-end sit-down restaurant?
Utility isn’t a measure of how well you will spend it, so it’s not a measure of whether the government or the person will spend it better. Hell, just as easily as a rich person can waste his money on hookers and blow, a poor person can waste his money on booze and meth.
But it still relates back to something we can see in everyday life with income. In my area, someone making 50k probably has a small apartment and a small car whereas someone making 100k probably lives in at least a nice apartment, but likely a townhouse or larger and probably has a fairly nice car. But compare someone making 1M to someone making 2M and they both probably have really nice houses and really nice cars and you probably wouldn’t see a whole lot of difference between their lifestyles. In both cases one person makes twice as much as the other, but the relative difference in life styles is much smaller in the latter case. This is what utility measures.
And, again, I’m not necessarily arguing that progressive taxes are a good thing, but if the counter-argument is that everyone should pay the same rate, then I’m not sure that applying that rate directly to the dollar amount is an appropriate response to resolve that issue. If we’re going to tax people fairly we should tax based on what they can get out of it, which is utility, and because the utility of larger sums of money is lower on a per dollar basis than smaller sums of money, then it logically follows that taxes rates need to be higher on larger sums of money so that the total utility is roughly the same.
I think we have to be careful to distinguish between gross and taxable income here. The current tax code does, in a crude way, take into account CoL differences. By far the largest contributors I can think of are 1) real estate prices and 2) state and local taxes, including property tax.
Generally, if real estate prices are higher, home loan sizes are higher, and corresponding mortgage interest deductions are higher. Furthermore, state and local income taxes and property taxes are deductible, further reducing taxable income. Now these deductions on taxable income disproportionately benefit high earners, since the deduction effectively reduces the amount of money taxed at the highest marginal rate.
If we posit a reduction/elimination of these deductions in a simplified tax code, there might be an argument for adjusting standard exemptions for regional differences. But I’m skeptical that this matters much, since incomes tend to follow the local cost of living.
On a related note, it doesn’t seem that anyone here is arguing against a progressive tax rate, since even “flat tax” proponents allow for a standard exemption. The complexity of the tax code is figuring out income, not taxes. If you’re a W-2 employee, that’s easy. If you’re a small business (including 1099 self-employed contractor) or corporation, it’s not so simple.
All of these arguments for a progressive tax system seem only one step removed from: “Hey, who needs more than a million dollars a year? Take the excess and give it to the poor.”
You’re going to make people doing research on utility rates very happy. But I agree this makes sense. 20 years ago, when everyone did their taxes by hand, this would be impractical, but today it might work, especially since those who couldn’t afford a computer probably won’t be paying anyway, or could be charged a linear rate.
As for exceptions, it is going to happen because of politics, and doing it in the tax code seems more efficient than the alternatives. But it doesn’t affect your main point.
Thaler showed that the effective discount rate people would pay to get an early prize is much greater for small amounts of money than large - 277% to get a $15 prize 3 months early, 345% to get it one month early (different study) down to 73% to get a $250 prize 3 months early, and 23% to get it 3 years early. The discount rate is a lot higher for gains than for losses. This is from the paper “Some Empirical Evidence on Dynamic Inconsistency” published in 1981. I discovered from working on this stuff that people are stranger about this than one can ever imagine.
Last year we did an anchoring experiment in class. The results were so good that they were significant though we only had 20 people in the pool.
True, if you’ve got Jack Benny or Scrooge McDuck in the population, their marginal utility will be different from the norm. Some people will resent every penny, some will feel they got off easy. I doubt you’d want us to measure utility on a per person basis - a 50 question quiz along with your 1040?
As for utility versus the government, that gets handled when they set the budget. We’re just talking about how to divvy up the tax bill once it gets set. The magnitude of the bill isn’t important here.
In the old Bell System, since they had people everywhere they had regional adjustments based on location. It was a mess. I lived in Princeton, but the data was for Trenton, and there is a hell of a lot of difference in cost of living between those places. People in New York did well, people in Oklahoma felt they got screwed, and pretty much no one was happy, so they finally got rid of it.
Good idea in principle - execution is a lot tougher.
It wasn’t Steve Wynn. It was some Jewish guy nobody ever heard of.* He is heavily involved in gambling in Asia. Like I said, a back-room guy.
More to the point, it seems that a progressive income tax is a better way to share the pain of paying taxes. A dollar to a poor man is a lot of pain. Ten dollars to a rich man is not nearly as much pain.
*If I had as much money as he has, there is no way a person like me would even know someone like me even existed.
It’s nice to think that people accumulate great wealth by putting off consumption and doing something productive. But it’s not necessarily the case. The guys who ran Enron ($60 billion), for example. Bernie Madoff. ($65 billion) Bernie Ebbers ($11 billion) Richard Scrushy. ($2.9 billion) Of course, we only know the ones that get caught. But I’d argue the notion that people make great fortunes by hard work and sacrifice is mostly a myth.
