Harvard economist Greg Mankiw has written a new paper, one inspired by candidate Barack Obama’s response to a question posed by “Joe the Plumber” during the presidential campaign of 2008. Joe asked then-Senator Obama about his proposal to raise taxes on high-income households by letting GW Bush’s tax-cuts expire. The candidate responded, in part, “It’s not that I want to punish your success. I just want to make sure that everybody who is behind you, that they’ve got a chance at success, too…. I think when you spread the wealth around, it’s good for everybody.”
I don’t think it is an exaggeration to say that the single most important difference between the political left and the political right is over the questions of whether, and to what extent, “spreading the wealth around” is a proper function of government.
Looking ahead, I fully expect the issue to remain at the center of political debate. One reason is that the tax cuts signed into law by President Bush in 2001 and 2003 will expire next year unless Congress takes action to extend them.
Another, perhaps more important, reason is that the U.S. federal government is running a large budget deficit and faces an ominous fiscal gap looming on the horizon. As the baby boom generation retires and starts claiming Social Security and Medicare, government spending will slowly and steadily continue to rise as a share of the economy. It is possible that Congress will suddenly read Milton Friedman’s book Capitalism and Freedom, become committed classical liberals (in the 19th century use the term), and decide to scale back the size and scope of government. But, more likely, Congress will find past entitlement promises hard to break, and so it will have little choice but to raise taxes to levels unprecedented in U.S. history.
Which naturally raises the question: Whose taxes should go up?
N. Gregory Mankiw, “Spreading the Wealth Around: Reflections Inspired by Joe the Plumber”, February 2010.
Professor Mankiw, who chaired GW Bush’s Council of Economic Advisers, shares his former boss’s view that wealthy citizens ought to be taxed lightly. This follows from what Mankiw calls the “Just Deserts Theory” of optimal taxation:
Under a standard set of assumptions, a competitive economy leads to an efficient allocation of resources. But we economists often say that there is nothing particular equitable about that equilibrium. Perhaps we are too hasty in reaching that judgment. After all, it is also a standard result that in a competitive equilibrium, the factors of production are paid the value of their marginal product. That is, each person’s income reflects the value of what he contributed to society’s production of goods and services. One might easily conclude that, under these idealized conditions, each person receives his just deserts.
N. Gregory Mankiw, “Spreading the Wealth Around”.
This a good paper and, as one might expect from the author of a best-selling economics text, very didactic. But it gives a false impression of 19th-century liberals. Mankiw implies that classical liberals opposed taxing the wealthy for the purpose of aiding those less fortunate. This is not true. Adam Smith, who famously wrote “Great nations are never impoverished by private, though they sometimes are by public prodigality and misconduct.”, has impeccable liberal credentials. Yet he supported progressive taxation and redistribution of income, as the following quotes show:
No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable. It is but equity, besides, that they who feed, cloath and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, cloathed and lodged.
Adam Smith, Wealth of Nations (1776), Book I, Chapter 8, paragraph 35.
It is not very unreasonable that the rich should contribute to the public expence, not only in proportion to their revenue, but something more than in that proportion.
Adam Smith, Wealth of Nations (1776), Book V, Chapter 2, paragraph 71.
In all fairness, I should point out that Mankiw does allocate space to the concerns of Adam Smith:
As long as people care about others to some degree, then antipoverty programs are a type of public good. That is, under this view, the government provides for the poor not simply because their marginal utility is high but because we have interdependent utility functions. Put differently, we would all like to alleviate poverty. But because we would prefer to have someone else pick up the tab, private charity can’t do the job. Government-run antipoverty programs solve the free-rider problem among the altruistic well-to-do.
N. Gregory Mankiw, “Spreading the Wealth Around”.
But Mankiw does not atribute this to Adam Smith, nor does he develop the line of thought fully. My concern is that a casual reader might miss this nuance, focus on the disproportionate space allocated to “Just Deserts Theory”, and fail to question, for example, whether large bonuses are “just deserts” for managers whose failing firms have been bailed out by taxpayers.
Bottom line: this excellent paper is worth reading, but beware of political bias.