New book on Taxing Banks Fairly

I received my copy recently of a book from Edward Elgar: Taxing Banks Fairly.

Don't believe me? Want proof? Here is me reading it...

It is developed from a couple of workshops, at one of which I gave a paper.

The book does something which I very much approve: it combines expert opinion about the practical options available with consideration of the moral issues surrounding the policies at hand. My view is that each one of these is somewhat bereft without the other.

Predistribution vs hourly averaging

Following on from my previous blog, I will now argue that earning subsidies, such as my hourly averaging proposal, are preferable to Predistribution. I will begin by setting out the mainstream economic view of the minimum wage and then consider this. My argument is that a minimum wage, if effective at raising hourly earnings will have much more serious economic effects than an hourly earnings subsidy. 

I will mostly focus my arguments on the aspects of Predistribution which would seek to raise wages either by imposing high minimum wages, by imposing collective wage bargaining, or by training workers so that employers can employee higher skilled (and therefore higher paid) workers. According to mainstream economic theory, policies of the above types will cause a mixture of price and unemployment increases. I will explain the logic of this.

In the absence of any government intervention workers and employers will make agreements whereby workers get paid at least their reserve price for labour—the point at which they would rather not do the job. Similarly, employers will demand labour up until the point that the price (wage) is equal to their willingness to pay. This willingness to pay valuation will reflect the relative price and productivity of labour compared to substitute inputs such as capital.

A minimum wage acts as a price floor in the market for low-skilled labour (as illustrated in Figure 1 below, assuming that the floor is set above the equilibrium market price i.e. that the minimum wage is binding).

At price p^min the wage is greater than employers’ marginal value of labour at the market equilibrium level. This will cause employers to substitute their demand towards capital inputs and higher-skilled labour for which the relative price has now reduced. As such only quantity Q^D is demanded at the minimum wage rate.

Figure 1 Illustration of Welfare Loss from Price Floor

At the same time, the minimum wage rate has induced the entry of workers whose reservation wage was below the prevailing market rate, such that quantity Q^s is now supplied. The minimum wage has therefore created a labour surplus equal to distance Q^s minus Q^D. This represents the induced involuntary unemployment that results from the imposition of the minimum wage.

The social welfare loss of the imposition of the minimum wage is represented by the shaded triangle. This is welfare loss is equal to i) the surplus foregone by employers who would previously have been able to employ quantity Q’ minus Q^D of labour at a price above its marginal value (area A) and ii) the surplus foregone by workers Q’ minus Q^D who would previously have earned a wage above their reservation rate.

Some workers are worse off as they will become involuntarily unemployed. Meanwhile firms will have greater costs. Affected firms which cannot change their production processes will have to pay higher wages yet their output will remain the same. Some firms will be able to alter their processes to get more from each worker by increasing their capital inputs. This will enable them to make better use of the more expensive workers they now employ, but will cost more than employing workers at the lower rate would have done. Where firms can pass on the higher production costs they will do so, usually because all firms in the same sector are affected similarly. However, where firms cannot charge higher prices then they will lose market share to their competitors (either firms in the same sector which operate with lower wages or sectors of the economy will lose out to other sectors).

Caution about textbook models

Of course, the real economy does not work exactly like a textbook or a model. Minimum wages do not always immediately produce the above effects, a point well-made by economists such as Card and Krueger. Indeed, the minimum wage in the UK did not have any obvious unemployment and price effects. However, there are many reasons why this does not disprove the mainstream picture. For example, it was introduced gradually during a period of economic growth, and at a level that was unlikely to be biting.

A second type of caution about textbook models is that they assume that firms are already maximally efficient and will therefore pass on any costs to customers rather than increase efficiency. This may muddy the textbook response further, though in an abstract discussion between broad policy options such as this one there is little to make of this point. It does mean, however, that in some cases the price rises resulting from Predistributive policies may be avoided to the extent that efficiencies can be found elsewhere.

If the minimum wage were raised from the current £6.50 to “living wage” levels (living wage advocates argue for £8.80 in London) or the Green Party proposal for a £10 minimum wage by 2020, then it would be much more likely to bite. The more the bite the more reasonable the expectation that the above described effects will occur.

The extent of the unemployment or price rise effect will depend upon the sector in question, and whether a) the cost can be passed on to consumers (increasing prices), b) whether it is possible to substitute capital instead of workers (increasing unemployment) and c) whether the work can be done elsewhere—either directly by the same employer or indirectly where an industry declines in one country and increases in another.

Predistributive policies like the minimum wage may not end up causing mass unemployment. However, this would be because they would cause major shifts in the direction of economy. Employers who can pass on their costs to customers will largely continue as before, while those which cannot will decline. For example, retail spending would be maintained. However, the difference is that industries with competitors or sites with less onerous minimum wage regulations would switch production to those cheaper locations.

Supporters of Predistribution might respond that ideally the minimum wage would apply to all the employers in the world. However, even this would mean that employers would have to provide work that was worth doing at that minimum wage. Employers would have to alter their production methods in order to make sure it is worthwhile employing all their staff at a higher rate. The new methods of production would, by definition, be different from that undertaken in the absence of the minimum wage, and these methods are clearly less efficient than the alternative. Employers will pass this loss in efficiency on to consumers in higher prices for their products (assuming they are unable to make efficiencies elsewhere). Even those who do not purchase these products will be affected as those who pay more for the affected products will have fewer resources to expend elsewhere (or invest) than they would have done without the minimum wage.

A final important point is that price rises are not only going to occur in industries heavily affected by the minimum wage. The rises in prices will filter through the rest of the economy as other sectors will make use of goods or services provided by these industries. If the latter industries have more expensive inputs then they will often pass these on in price rises as well. For example, if it becomes more expensive to run a transport distribution company then these costs will be passed on to all businesses using this service. These increased costs will be passed on to the consumers who buy items that have been transported—which is pretty much everyone.

Market interference is acceptable

Now, I am fully in favour of interfering in markets to assist the less fortunate, and also to respond to market failures. I’m not a free-market ideologue. My disagreement with Predistribution therefore arises where policies to raise wages or productivity interfere with the market in a counterproductive fashion.

Earning subsidies such as those I propose would also interfere with markets. However, if they are well-designed they will do little to alter the overall pattern of employment. The primary outcome is that most people receive more income for doing similar work to that which they would have done otherwise. Predistributive interventions, on the other hand, will interfere in a much more profound manner.

Essentially my argument is that Predistributive policies may help some people, but will often make a lot of other people worse-off. My tax proposals are highly progressive and so I am happy to make some people worse-off if it makes society as a whole more just. However, Predistributive policies are likely to make some less well-off members of society worse-off as well as many of the better-off.

The distributive effects of Predistributive policies may not be as consistently progressive as its advocates assume. If economic growth is reduced as a result of the economic inefficiencies generated by the policies then this could make everyone economically worse off, potentially reducing tax revenues as well. Price rises would also impact on everyone’s spending power, as their income would not go as far as it would have otherwise.

The main way in which some of the least economically fortunate will definitely end up much worse off is if they are rendered unemployed. This would not only occur because the unemployment rate would be expected to increase, but also because those most desperate for work (and therefore have a reservation wage) are the most likely to miss out on work. The change in the job market may induce other workers to take jobs or work longer and they would take the place of those who want the work more.

All of these points mean Predistribution can create a group of people who are rendered worse off than they would have been otherwise.

Predistribution vs. Hourly Averaging

As I have explained, Predistribution will produce at least one (and possibly all) of several deleterious effects; increasing prices, increasing involuntary unemployment, and shifting economic activity in unwanted directions.

For the above reasons, the overall distributive effects of Predistributive policies may not be as universally progressive as its advocates may assume. Some unfortunate people may end up worse off than they would with much less intervention. Even for those who would earn more, countervailing factors—such as lower levels of economic efficiency and higher prices—would eat into their gains.

The international nature of the economy adds further problems. If one state adopts wage-increasing policies it may make some of their industries less competitive, which will worsen the balance of trade and the ensuing impacts of this further down the line. If all countries adopt the Predistributive policies then this is likely to cause mass involuntary unemployment and harm global economic growth.

I think Predistributive policies are preferable to leaving everything to the market. However, they interfere with market-led efficiency much more intensely than hourly averaging would. As long as it is possible to generate the tax revenues necessary to provide earning subsidies then this is clearly the way to go.

What is Predistribution?

In a previous blog I set out the methods of taming capitalism. One approach has a new name, but is based upon some longstanding proposals. This is the idea that government should intervene in the economy not in order to redistribute from relatively free-market outcomes, but rather to pre-distribute.

The most obvious way to pre-distribute is to set a very high minimum wage. Another (independent) method would be to bolster the power of trades unions, perhaps by insisting that employers only employ those who are part of a trade union. A close alternative to the previous approach is to compel employers to bargain with their staff as a whole over the wage rate they pay.

These approaches clearly differ from my hourly average subsidy proposal, which is a form of earning subsidy. My approach allows employers to compete with one another and to make agreements with their employees. If people are low-paid as a result of this process the hourly subsidy will make up the difference.

There may be further aspects of Predistribution which are compatible with other proposals including my own; for example government provision of training. Improving the skills of the workforce may mean that workers can earn more than they would otherwise. I advocate training schemes as part of the guaranteed work/training programme that I consider an integral part of hourly averaging. The aim of the scheme I advocate is not to increase gross pay, however, but rather to increase the chances that people will be able to find useful employment. It may have the same outcome but the aim is not primarily about predistribution.

The advantage of Predistribution over earning subsidy proposals such as mine is that it requires significantly less government spending. The primary Government spending commitment is the increased amount that government must pay its employees more as a result of the policies. Advocates of Predistribution are attracted to the proposal either because it would enable governments to reduce taxes throughout society, or (much more likely) because it would leave more tax revenues to be spent on other things.

So why bother with earning subsidies if Predistribution is a much cheaper and more effective option? I advocate earnings subsidies as the interference in the market should be much less damaging and more effective than “predistributive” interventions. I will make this argument in my next blog.

Government Provision of Goods and Services as redistribution

The diagram in my previous post omits another prominent way of redistributing, popular in the UK until recently. This is redistribution through the provision of goods and services by government. Providing can be a means of redistribution, and in many cases this is to be applauded. However, there are degrees to which this can occur.

I will assume that the provision of certain basic goods and services (democracy, law and order, defence) in a redistributive manner is uncontroversial. (Murphy and Nagel, in their excellent book 'The Myth of Ownership' make this point).

However, some would propose that government should provide a lot more services, and that this should be the primary way of creating a more equal capitalist society. This was common in the UK in the middle of the 20th century, for example.

If the government provides services on a universal or limited basis then this is a means to redistribute resources. This could be done by providing some service or good to all people (and not just because it is a public good that cannot be provided by the market), or on a targeted basis to those deemed to be most deserving or suitable.

A good example is the state provision of housing (I will ignore the universal provision of education and health, since there are further specific reasons to provide these on a universal basis).

The problem I have with state provision is that it will favour those who are selected for the benefit—people who get state-provided housing for less than those who purchase or rent privately. Those who are not chosen will not benefit (except in rare cases where the provision corrects for a market failure). In order to avoid this favouritism the good could be provided to all people, but this is likely to reduce the choice available to people.

The latter example shows a further problem; that the provision of goods and services that can be provided by the market will often be inefficient. Simply giving people the money would be a more cost-effective way of achieving the desired redistributive effect. This is certainly the case in the extreme example where everyone has their housing provided by the state, but this point no doubt also applies to many other cases as well.

The economic argument against providing goods and services directly to people is very strong. However, there may be some further justifications that supporters could draw upon:
1. People can't be trusted with money - if you give them money they might waste it but if you give them something clearly good then it will benefit them.
2. Universality and solidarity - that providing these goods represents the value of society.
I'm not convinced by these lines of arguments, but I'd be interested if anyone wants to try to defend them below...

Ways of Taming Capitalism

Free market capitalism is a system that works very well for a small number but not always very well for regular working people. I propose a tax system that would radically redistribute income from the most economically fortunate to those who work for low wages.

There are various responses to this which have been tried at various times and to various degrees, and it is worth mapping out the differences. We can distinguish between redistributive and predistributive ways to make capitalist societies fairer. (It is arguable that all the approaches are really redistributive in the traditional sense of the term, though I will follow the recent trend in distinguishing Predistribution as a separate approach).

In the redistributive camp are proposals that would take tax revenues and spend them to improve the position of the worst off in society. There are many ways of doing this, and I will briefly outline these in the diagram below.

The proposals above are not all mutually exclusive. However, since all - if they are to make a real difference - are going to have high costs and/or economic effects it is unlikely to be practical to have more than one at a time.

My proposal (in italics above) is a form of hourly earning subsidy. The only other hourly income subsidy proposal I know of is that proposed by Nobel-Prize winning Economist Edmund Phelps in his book Rewarding Work. Phelps' proposal would provide money to employers in exchange for the employment of full-time, low-paid workers. This money would then be passed on to the workers in higher wages. My proposal would instead take account of the number of hours that people work (up to a maximum), and provide a subsidy to them if their lifetime average is below a certain level. My argument is that there is no reason to limit the subsidy to those in full time work.

I have discussed Universal Basic Income/Negative Income Tax proposals in previous blogs, and plan to discuss the others in future blogs.

How radical is the CLIPH-rate tax?

My tax system proposals are in many ways very radical. However, they may not be radical in the way that everyone would think of the term.

The proposal to calculate tax (or for some a subsidy) taking account of the number of hours that people have worked (or been excused from work) in their lifetime is a significant break from previous ways of calculating taxation. In this sense, hourly averaging is a radically new proposal.

The CLIPH-rate tax is also radical in the way it would change the economy and the distribution of resources therein. Everyone would effectively become working class, since all would need hour credits from working in one form or another. The difference in income between the highest and lowest earners would be radically reduced.

Of course differences in wealth would remain, since some would spend all their income while others would save. Nevertheless, the differences would be much less marked than they are in any other capital-based economic system.

However, radicalism can also means something further which does not apply to the CLIPH-rate tax. This is the idea that society should be altered and reimagined through the process of revolution or class warfare.

My tax proposals pursue equality through a continual redistribution of income from the fortunate to the less fortunate rather than any kind of revolution or change in social or human nature. People would still pursue their interests in a society with a market and almost all of life would work as it does not.

The CLIPH-rate tax proposal is not radical in this latter sense of the term, and some may see this as a bad thing. Some may simply want society to be totally different than it is and blame capitalism and free markets for the problems they perceive with current societies. The CLIPH-rate tax offers nothing to such radicals.

However, the CLIPH-rate tax does offer a challenge to those who defend the status quo; while the other radical plans may appear utopian the CLIPH-rate tax does not require the leap into the dark that revolutionary radicals propose. To those who believe in capitalism and markets, the challenge is to say why can’t there be radically more redistribution, given that it is possible within a capitalist economy?

(Photo Credit: Flickr Creative Commons/Ed Gaillard. Occupy Wall Street marched into Lower Manhattan on September 17)

What are the Politics of the CLIPH-rate tax?

I believe an argument can be made for my taxation proposals from a number of political philosophies. However, in terms of political ideologies, my proposals occupy an unusual position that does not fit neatly on the usual political compass. This means that it does not readily fall within the common political positions.

I believe this is a huge strength for my proposals: I believe it should be attractive to a large number of people who currently take positions across the political spectrum. However, while this is an advantage in the long-term, it could be a hindrance in the short-term. After all, while there is something about the proposals that most people would like there will often be another element which goes against their current thinking.

For those on the political right the proposal should be attractive as it contains strong private property rights, and encourages work and personal responsibility. Work is encouraged because the number of hours people work (as a generalisation of the scheme) is taken into account in determining tax rates: people who work longer for their income will be taxed at a lower rate. It encourages personal responsibility as the redistribution is calculated on the basis of the amount of work someone does and not the amount of wealth they have. If someone chooses to spend their income in the short term they will not be entitled to any additional resources later on as a consequence.

For those on the left the proposal should be attractive for the amount of redistribution it can provide. I believe my proposals, if applied consistently, should enable the most economically fortunate to be taxed sustainably at the highest possible rates. In parallel, it would provide the highest possible economically sustainable subsidies to workers.

I would think that on the basis of the advantages specified above the approach should be appealing to centrists, who would also approve of my liberalism and some of the related proposals I make. As the originator of the proposals I would consider myself a liberal person.

One way to put the political position of the CLIPH-rate tax is that of a superior version of the so called “third way.” This garnered attention in the 90's and which is associated in the UK with the New Labour movement, and is somewhat related to Clinton’s position in the USA. Left-wingers are now disillusioned with this approach to politics as it was ineffective at delivering economic equality; New Labour was too in thrall to the market and thereby blinded to special interests (often of the very wealthy and the finance industry).

Despite this criticism of the first iteration of the third way approach to politics, I do not think that the answer for progressives is to revert back to statist solutions. Instead, we should be developing taxation and earning subsidy policies that make use of the best of the market while assisting those who do not do as well from the market economy.

The proposals in Rethinking taxation are designed to achieve what the initial third way failed to do. Tax those who do well out of the market system and do as much as possible to support those who work hard but receive relatively little in return.