Tax Cut Unfairness

And now, a trio of comments on Sinclair’s piece.

1. I think Sinclair’s right to point out that Beazley’s tax cuts are also regressive, a point that few (if any) other commentators have made. I’m no fan of Labor’s approach here.

2. Sinclair argues that the marginal utility of money doesn’t decline – in other words, giving $100 to Kerry Packer increases his happiness by just as much as giving $100 to a homeless guy on the street. His basis for arguing this is that money is fungible. Whereas we might get quickly sated with a single good (eg. pizza), we can buy lots of stuff with money. This definitely means that the marginal utility of money doesn’t decline as rapidly as the marginal utility of pizza. However, it doesn’t mean that the marginal utility of money doesn’t decline. Since everyone only has 24 hours in a day, there must be limits to the amount of stuff we can consume/enjoy each day. If this is so, the marginal utility of money will decline.

3. Sinclair argues that all tax cuts will be regressive. This is true if (a) you don’t allow for the possibility of introducing a negative income tax (or EITC) now in place in Britain, Canada, the US, and most of the rest of the developed world, and (b) you don’t allow for the possibility of raising the income tax threshold, but only for those earning below $50,000. The first was ALP policy in 1998 and 2001. The second was ALP policy in 2004. Both are progressive tax cuts.

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7 Responses to Tax Cut Unfairness

  1. Sinclair Davidson says:

    Thanks for the publicity. While I understand the registration for the main body of the AFR, I would have thought open-access for the op-ed page would be more valuable for them.

    The issue of diminishing utility for money is interesting. I suspect that the turning point is outside the range of most people – so Packer might not value another $100, but most taxpayer would. Especially the 96.5% on less than $100,000.

    The idea of varying tax thresholds is also very interesting. When I was asked (several months prior to the last election) what the ALP might do to in terms of thresholds I suggested progressive thresholds. The view was that these are too difficult to explain to the voters and wouldn’t get up. I was unaware the ALP had already suggested them.

  2. Andrew Leigh says:

    Sinclair, if a finance professor at RMIT didn’t hear about this aspect of the ALP’s tax policy, I think that’s a fair indication that they didn’t get the message out at all. I think the same is true of Labor’s 1998 & 2001 tax credit policies, which were very poorly sold.

  3. Steve Edney says:

    I guess there are two ways of looking at it. Either the goods you buy with money have a declining marginal utility, so you need more cash to derive the same utility – your first pizza slice is as good as the next two. Or you could consider that the money has less value as the same amount is going to buy you a slice of pizza that you value less.

    Obviously the fungibility of money makes a difference as there are a broad range of products you can exchange but at some point, once you’ve supplied the basics, the worth of the extra money is decreasing for most people at least.

    Of course what are the basics varies for different people, and is subject to change over time (my idea of basic is very different to when I was a student). Still, at least in the short term, there is effectively a declining marginal utility. I would suggest that the “value” of $100 for people on less than 100k varies dramatically with what income they are on.

  4. Sinclair Davidson says:

    At the risk is being overly profound: a $100 is a $100. 100 slices of pizza is another matter. The important point, to my mind, is that money is a store of value, money is a unit of account. Money is not a commodity per se. I’ve been trying to think of this in micro-economic terms: the demand for money (income) is derived from the demand for other stuff (pizza, beer etc). Each of these is subject to diminishing returns – in aggregate, however, human needs are insatiable. Even if there is only so much pizza one could eat in a day, there is always tomorrow.

    The comparisons between high and low income earners also, to my mind, violates Arrows impossibility theorem. Inter-personal utility comparisons are impossible. As JS Mill pointed out, to operate a progressive tax system ‘fairly’ requires more information about each taxpayer than the legislator (or anyone else) could ever know.

    The current progressive tax system is based on a one-size fits all (in the same tax bracket) policy. As we know these ‘one-size’ policies tend to be unpopular and inefficient.

  5. Sinclair Davidson says:

    Andrew’s probably too jet lagged, or too modest, to blow his own trumpet – the Australian Financial Review has, today, published his household tax analysis in thier Lies and Statistics column(registration required).

  6. spog says:

    What does an EITC do, that changes to the income test on income support payments does not? In any event, we’re about to have a mini EITC once the Mature Age Workers Tax Offset passes the Senate. Maybe someone could concoct a “natural experiment” with it?

  7. Andrew Leigh says:

    Sinclair, thanks for the promo. Utah rocks, btw.

    Spog, the income support EMTR is similar to an EITC conceptually — but only an EITC can actually make work more financially rewarding. And yes, you’re right on the mature age thingy. Will be fun to watch….

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