Bob Frank and David Friedman on redistributive taxation and positional goods

by on May 12, 2010 at 7:36 am in Economics, Philosophy | Permalink

Remember Bob Frank's argument that wage compression in private firms implies some (possibly libertarian) case for progressive taxation?  Here is Frank's original column.  Here is David Friedman's critique.  Here is Frank's reply.  (Angus, by the way, offers another critique.)  So many issues are at stake, here is one of them:

He [Friedman] goes on to suggest that my argument implies that “the rich ought to be in favor of grinding down the poor…” These remarks betray a curiously dark conception of human nature. Being concerned about relative position surely does not imply taking pleasure in the knowledge that others are poor. If it did, middle-income people would spend long hours observing people in poor neighborhoods, thereby to boost their own self-esteem. That they don’t choose to spend their time this way doesn’t mean they don’t care about relative position.

What do people spend their time doing?  To the extent I care about relative position, what do I do?  I take actions to raise my preoccupation with areas I am good at, which is my version of spending long hours observing people in poor neighborhoods, yet without having to feel I am deliberately slumming, which would lower my self-esteem.

In this sense I think Frank should accept Friedman's attempted reductio.  That said, I don't accept Friedman's claim that Frank's theory predicts that "the rich ought to be in favor of grinding down the poor."  Subtle self-deception about one's own merits is, at least in today's America, a more effective recipe for generating utility.  So I believe in the ubiquity of status-seeking, though I see the process as more positive-sum than Frank does.  I can think my area of expertise is really important and you can think the same, without it being zero-sum.

That all said, what exactly is the problem with redistributive taxation?  Why can't we, for Benthamite reasons, have two rates of twenty and thirty percent instead of one rate of twenty-five percent?  Status-seeking or not?

I read this paragraph as best summarizing Frank's point of view:

High social rank, as noted, has substantial instrumental value, and low social rank entails substantial concrete costs, irrespective of whether people care about rank per se. Forcing a productive person to buy more social rank than he wants is objectionable, but the alternative is to give all of society’s most productive members a valuable asset free of charge. That asset would command a high price in the libertarian’s ideal world in which purely voluntary societies could form and dissolve at will. And since its value is a direct consequence of the substantial costs associated with low social rank, a society without redistributive taxation should strike libertarians as even more objectionable.

Here is David Friedman's final response.

Addendum: David Henderson comments.

Pedro May 12, 2010 at 8:18 am

Frank’s argument seems rather peculiar because in a world where the income distribution would be used solely with a view to offset status differentials, you’d expect income and real resources not to be remotely as relevant measures of status as they are now. And the only reason they wouldn’t be entirely useless is if, as David mentions, status is mostly important in competing for mates, in which case I’d expect real resources to still hold some sway.

Nate May 12, 2010 at 8:29 am

I’ve long held that the popularity of The Wire was in fact middle income spending long hours observing people in poor neighborhoods to boost their self-esteem. (Yes, I was a fan of the show as well, but I often wondered if this was a subconscious reason for its appeal to at least some people.)

Andrew May 12, 2010 at 8:50 am

Does anyone even know what the government is actually doing to status on-net, bottom-line and how much they spend to to it?

He makes an interesting observation, but I can easily take the other side to explain why the redistributionists are so flummoxed over the rejection of their offers- the labor market has already done a pretty good job of compensating for status. Additionally, robots and foreigners don’t care about status and they don’t vote.

Andrew May 12, 2010 at 9:24 am

(glad Angus does it so I don’t have to. And if Frank wants to turn everything into a version of university no thanks. I’m managed by an advisor and get my funding from a different one who brings down 3x what my advisor makes, probably because they get their name on a lot of stuff that they provide zero input to other than financing. These people invented rent seeking. Academia is only different to the extent it is worse. I wish these guys would straighten out their own purview before worrying about ours.)

Mario Rizzo May 12, 2010 at 9:52 am

“Why can’t we, for Benthamite reasons, have two rates of twenty and thirty percent instead of one rate of twenty-five percent?”

The above is the quotation that did not appear in my first attempt.

Nicholas Weininger May 12, 2010 at 11:20 am

It still perplexes me that neither Friedman nor Frank addresses what seems to me the obvious critique, that the “costs” of low social rank are not costs we should worry about, because they are entirely the fault of those who bear them.

Here is an analogy to make this clearer. Suppose a black family moves into a racist, previously all-white neighborhood. They gain the satisfaction of being pioneers of integration, of living where their parents would not have dared to try to live. Their neighbors feel worse off because they are racists and don’t like living around black people. Is the “cost” they have borne something the black family should be obliged to compensate them for in return for the psychological benefits to them of living in the neighborhood? Is the black family creating a negative externality that we should worry about balancing out?

Most people would say no, because they recognize that racism is bad, and is the fault of the racist, however common a human tendency it may be. But envy, while also very common, is no less unequivocally bad, and no less unequivocally the fault of those who engage in it.

Mesa May 12, 2010 at 11:53 am

Frank’s argument is essentially not to tax people so that they pay equal amounts of ‘utils’ in foregone consumption, but carried to it’s logical conclusion to equalize incomes entirely. You can certainly make an argument with any monotonic utility function that the maximum utility to society derives from complete income equalization (for a given fixed total output). This I think is the essence of the progressive project. It runs afoul of more traditional liberal (or libertarian) ideas of individual property rights and procedural justice in a big way, not to mention having enormous dead weight loss and economic growth issues.

j r May 12, 2010 at 12:53 pm

there’s an element of frank’s argument that i have not seen addressed, so i wonder if i am missing something. this idea that private sector pay is progressive by design seems deeply flawed. making people feel better is one possible reason why the best member of a work crew gets paid about the same as the worst member. it could simply be that employers lack a reliable way to quantify each employees relative value. it could aslo be that the best worker isn’t necessarily worth all that much more than the worst worker. how do you tell which cubicle jockey is the best at filing TPS reports? how much value is there to a firm in having the best janitor than there is in having a mediocre janitor?

if you look at industries where there are clear and reliable indicators for employees performance and the gains from employee preformance translate directly to gains for the firm, you find that regressive pay policy atrophying. how much will lebron james be making under his next contract? according to frank’s logic, this should mean that no NBA players want james coming to their team and his present teammates should want him gone. is that the case?

Glen May 12, 2010 at 3:20 pm

I found Friedman’s first critique mildly interesting, but I found his rejoinder (which you did not link) absolutely devastating: http://daviddfriedman.blogspot.com/2010/05/my-response-to-robert-franks-reply.html

Friedman’s main point, at least in his rejoinder, is that Frank is being inconsistent about the locus of the status externality. When arguing against Friedman’s “rich should want to grind down the poor” reductio, Frank says the status externality is extremely local in scope (relating to your neighbors and coworkers). But in making the case for government redistribution, he treats the status externality as having wide scope (relating to people across the nation whom you’ve never even met). He can’t have it both ways.

If it’s true that the status externality is local in scope, then it doesn’t justify nearly as much in terms of government redistribution. And Frank’s own examples demonstrate that markets are reasonably good (though not perfect) at effecting such redistribution at the local scale, such as within a firm.

Slocum May 12, 2010 at 6:16 pm

Know why leftish acacademics are such big fans of high tax rates & income redistribution? I suspect that one reason is because so much of their own compensation is in forms that are either untaxable or implicit. Let’s poll private-sector workers and ask them how much of a pay reduction they’d be willing to accept in exchange for:

- Lifetime job security
- Summers off
- Defined benefit pension plans
- Gold-plated health care plans
- Sabbaticals
- Frequent employer-paid foreign travel
- Highly flexible working hours

In most years, my income is higher than most tenured academics, but I have don’t have those things, and I would agree to cut my hourly in half (with a much lower tax bill!) in exchange for all of the above.

So I say let’s do the research to establish cash value equivalents for the goodies in the list (shouldn’t be hard to do the polling), impute the income to tenured academics, report it on their W-2s, charge them taxes on the total…and then see how big a fan Frank remains of his idea.

Ian N May 12, 2010 at 8:00 pm

@DJ Lesvic: Could you cite a (non-gated) good article/discussion/blog-post discussing how redistributive taxation increases income inequality? I tried google but failed to find any sources.

DG Lesvic May 12, 2010 at 9:35 pm

By the way, Ian, in that piece of mine that I just referred you to, you will find not just my own input, nor even just of Hayek and Mises, but of Rothbard, Kirzner, and, yes, David Friedman, among other such notables, responding directly to me.

A vital chapter in the history of economic thought that you will find nowhere else.

Ian N May 12, 2010 at 10:44 pm

@DG Lesvic: Some papers can only be accessed if you subscribe to the journal they appear in (or your organization does); these papers are ‘gated’.

You suggest that market anticipation of further redistribution can cause the market to over-correct wages, thus increasing inequality. Two issues that occur to me with this:
1) Perhaps current wages are a result of expected large future redistributions (and thus more unequal than they should be based on supply/demand); when actual redistribution becomes law, the market could conclude that this will be the rate going forward and remove the current inequality from the system.
2) If the markets can over-correct in expectation, then your engineers and janitors would be working at after-tax rates other than their respective equilibrium wages at some periods of time; why couldn’t they do this normally?

The largest problem I have with your argument is that it lacks empirical support; are there any empirical studies that support your hypothesis?

DG Lesvic May 13, 2010 at 2:00 am

Ian,

Thank you, thank you.

As for your #1, that is the damndest thing. When I read that, I thought to myself that you had simply overlooked my treatment of that matter, and that it would be a simple thing to direct you to it. But to my horror I discovered that it wasn’t there, as it was supposed to be. It had been there in earlier versions of the text, and how it got deleted from this one, I can’t imagine. Of course, I’m the culprit, the only one who could have deleted it. But how I could have done so and why I did so I can’t figure out.

At any rate, here, from the earlier version, is what should have been, and, now, thanks to you, is in the current version.

“Even if the market didn’t anticipate increasing rates of redistribution, but merely constant rates, and therefore wouldn’t overcompensate for the current rates, it would still fully compensate for them, and that would leave the poor with the same proportions as before – but of a smaller total.

The total itself would be smaller, for, to draw manpower from higher to lower paid occupations is to draw it from more to less productive occupations. That means less production and a lesser accumulation of capital.

So, even when the market returns to the most productive allocations of manpower, it returns with less capital than it would otherwise have had.

With less capital to invest in better means of production, there will be less production and a smaller total net income than otherwise.

So the poor wind up with the same proportion of a smaller total net income – no better off in proportional terms and worse off in absolute terms.”

As for your #2, sorry, but I don’t get the point of the question at all.

Why couldn’t they do what normally, and what do you mean by normally, the absence of redistribution? I’m puzzled.

As for “empirical studies” and “empirical support,” how could you observe the Invisible Hand?

Economics is not an empirical but theoretical science.

Again, thank you, thank you, I am deeply appreciative and indebted to you for catching my omission.

You’re great.

CH May 13, 2010 at 5:06 am

mulp, now I see why you love taxing others. Either you are terrible at math, or your current personal tax obligations are near zero. Top shelf stuff.

Steve Roth May 13, 2010 at 10:56 am

Ian, if you’d like empirical research on the subject, I can’t think of a better place to start than Lane Kenworthy.

http://www.lisproject.org/publications/LISwps/188.PDF

You can follow his citations of course, and also those who have cited this paper, here:

http://scholar.google.com/scholar?cites=3692345145446374515&hl=en&as_sdt=100000000000000&as_vis=1

DG Lsevic’s statement that “the latest and irrefutable thinking in economics is that [redistribution] doesn’t reduce but increases [inequality]” is … somewhat distanced from reality.

Steve Roth May 13, 2010 at 11:41 am

@Larry, I think your comment is spot-on in all respects, in particular the “progressive” part (because progressive tax systems seem to be associated with greater prosperity and prosperity growth in prosperous countries, while also increasing equality — a win/win).

Also the emphasis on transparency. Taxes have their incentive/disincentive effects not just through their rates and schedules, but through their “saliency”: whether the tax is immediately apprehensible to people at the moment they are making decisions.

@mulp, I think perhaps you’re responding knee-jerk to the overall idea, without the context. It’s not crazy to suggest that tax systems that more heavily encourage encourage work and savings over consumption could result in a better economy for all. Couple this with a major expansion of the Earned Income Tax Credit — also encouraging work — and you start to see a system that could result in greater efficiency and greater equity. Again, a win-win.

The EITC, by the way, would also benefit greatly from greater salience: it should show up on every paycheck rather than arriving once a year.

Another by the way: It’s worth noting that the seminal idea behind the EITC is Milton Friedman’s “negative income tax,” but (perhaps?) improved by adding a work requirement.

Also, like other “tax expenditures,” EITC should show up on the expense side of the government ledger, not the revenue side. Could call it the Living Wage for All Americans Dividend or some such (think: Alaska oil-revenue kickbacks to citizens), though that would die politically…

DG Lesvic May 13, 2010 at 3:54 pm

Steve,

Here’s a little sampling of the reactions to my theory, and my responses.

Prof. Tom Hazlett asked why, if redistribution really improved the relative positions of the rich, wouldn’t they lobby for it?

Because compensation in relative terms is not necessarily compensation in absolute terms.

Prof. Jack High; “there is no reason why, if the tax were $10,000 that the wage rate would go up to $60,000 from the original $50,000. It might, but as a rule it would not†¦†

As a rule, it would tend to, for otherwise there would be an undersupply of engineers, and the market always tends toward equilibrium.

Prof. Fritz Machlup of NYU: “the writing is really not acceptable†¦†

Prof. Israel Kirzner of NYU: “I found it written with keen intelligence, but I do have several difficulties†¦The ‘idea’ seems to depend on the existence of equilibrating forces operating upon income amounts – while what economic theory recognizes is the operation of equilibrating forces upon factor prices. You have not, it seems to me, demonstrated that redistribution necessarily distorts these prices.†

But the income amount of an engineer and the factor price of engineering labor are the same thing.

But the most interesting of all was surely Rothbard’s response.

You wouldn’t want to miss that.

DG Lesvic May 13, 2010 at 6:33 pm

Steve,

And, not to keep you in too much suspense, the argument that David Friedman used against my theorem, and, Larry White and Tom Hazlett, too, was the old fallacy of mutual determination.

I don’t suppose, though, that we’ll see Prof. Friedman, or White or Hazlett, either, trying to do so out in the open.

DG Lesvic May 14, 2010 at 11:48 pm

James,

I know I promised not to make fun of your name anymore, but you’re making it too hard on me.

What Frank misses, and you too, is that taking from the rich to give to the poor does not reduce but increases inequality.

DG Lesvic May 15, 2010 at 2:28 am

Ian,

As Mises explained,

Since they are all complex, “Every historical experience is open to various interpretations and is in fact interpreted in different ways†¦History can neither prove nor disprove any general statement.†

While a proponent of redistribution would say that, without it, there would have been more inequality, an opponent would say that there would have been less.

So, which was the fact, that inequality was greater or lesser than it would otherwise have been?

Only the theory of redistribution, priori to historical evidence, could tell you.

DG Lesvic May 15, 2010 at 2:45 am

Let me add to that:

What he couldn’t observe, we still know, through theory alone. We know that the market, tending toward equilibrium per se, tends toward full employment, equilibrium between the supply of and demand for labor, and, interference with it, toward disequilibrium, an oversupply of labor, and chronic, massive unemployment.

Isn’t that worth knowing?

DG Lesvic May 15, 2010 at 11:28 am

By the way, I just noticed this from Mario Rizzo above.

“Tyler, please. You should have taken my course this past semester.”

Well, Mario, I’ll say this for Tyler.

He doesn’t banish his critics.

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