Utopia, you are standing in it!

John Rawls is often put forward by political progressives as the starting point for political philosophy. Rawls pointed out that behind the veil of ignorance, people will agree to inequality as long as it is to everyone’s advantage.

Rawls was attuned to the importance of incentives in a just and prosperous society. If unequal incomes are allowed, this might turn out to be to the advantage of everyone.

Rawls lent qualified support to the idea of a flat-rate consumption tax (see A Theory of Justice, pp. 278-79). He said that:

A proportional expenditure tax may be part of the best scheme [and that adding such tax] can contain all the usual exemptions.

The reason why Rawls lent qualified support to the idea of a flat-rate consumption tax was because these taxes:

impose a levy according to how much a person takes out of the common store of goods and not according to how much he contributes.

A simple way to have a progressive consumption tax is to exempt all savings from taxation. Taxable consumption is calculated as income minus savings minus a large standard deduction. Different countries use different terms to describe the minimum amount that must be earned before any taxes are paid.

Income tax must be opposed on social justice grounds, but not progressive consumption taxes.

Given that the super-rich – the top 0.1% of income earners – do not spend much of their incomes, especially on the way up building their businesses, they could be rather over-taxed!

Steven Kaplan and Joshua Rauh’s “It’s the Market: The Broad-Based Rise in the Return to Top Talent”, Journal of Economic Perspectives (2013) found that:

• Rising inequality is due to technical changes that allow highly talented individuals or “superstars” to manage or perform on a much larger scale.
• These superstars can now apply their talents to greater pools of resources and reach larger numbers of people and markets at home and abroad. They thus became more productive, and higher paid.
• Those in the Forbes 400 richest are less likely to have inherited their wealth or have grown up wealthy.
• Today’s rich are working rich who accessed education in their youth and then applied their natural talents and acquired skills to the most scalable industries such as ICT, finance, entertainment, sport and mass retailing.
• The U.S. evidence on income and wealth shares for the top 1% is most consistent with a “superstar” explanation. This evidence is less consistent with the gains in earnings of the top 1% coming from greater managerial power over the determination of their own pay in the corporate world, or changes in social norms about what managers could earn.

Today’s super-rich are highly productive because they produce new and better products and services that people want and are willing to pay for. These rewards for entrepreneurship and hard work guide people of different talents and skills into the occupations and industries where their talents are valued the most. The efficient allocation of talent and income maximising occupational choices were important to Rawls’ framework.

Another important role for incentives is it rewards entrepreneurial alertness. People will look for and take advantage of hitherto unnoticed business opportunities if they are rewarded for doing so. These private rewards for greater effort, excellence and superior alertness are the driving force of the market. Most of the innovation that drives modern prosperity would not have occurred but for the lure of profit.

Rawls was keen on stiff inheritance taxes to prevent the “large-scale private concentrations of capital from coming to have a dominant role in economic and political life”. His support for inheritance taxes was out of concern with a concentration of political power rather than improving incentives.

Rawls overrated the power of the rich to buy political influence as do many on the Left. They do not understand Director’s law of public expenditure and the theories of the median voter and the expressive voter. The major political parties all chase the swinging voter in the middle class.

Rawls’ views on incomes taxes and the rich are rather under-discussed among his champions on the progressive Left. Google John Rawls and income taxes and you do not get many hits or papers of any substance.

With his emphasis on fair distribution of income, Rawls’ initial appeal was to the Left, but left-wing thinkers started to dislike his acceptance of capitalism and tolerance of large discrepancies in income. Many moved on. Rawls excluded envy from deliberations behind the veil of ignorance. This may be why he lost some of his initial appeal to some.

You must admire his consistency. Rawls was happy for people to be super-rich as long as they saved and invested their resources. Everyone in society gains from those investments and is better off.

Robert Lucas (1990) estimated that a revenue neutral elimination of all taxes on income from capital and on capital gains would increase the U.S. capital stock by about 35% and consumption by 7%. Hans Fehr, Sabine Jokisch, Ashwin Kambhampati, and Laurence J. Kotlikoff (2014) found that eliminating the corporate income tax would raise the U.S capital stock (machines and buildings) by 23%, output by 8% and the real wages of unskilled and skilled workers by 12%. Is taxing the rich worth this large a lost wage rise?