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Principal Agent Problems and Progressive Taxation

Wednesday, March 02, 2011
I think I have one potential solution to the problem of prospective corruption I mentioned yesterday. Okay, this is a little wonkish, but bear with me.

Traditionally liberals have argued that richer Americans should pay a greater proportion of their income in taxes on a number of different grounds, including:

1) Taxes are necessary for a civilized society and they have a greater ability to pay
2) The wealthy benefit disproportionately from the existing socioeconomic order
3) Poorer and middle class citizens have a greater marginality propensity to consume, and therefore lower taxes on those groups will lead to greater economic growth. Conversely, concentration of wealth at the top leads to asset bubbles.
4) Economic arrangements should be to the benefit of the least advantaged member of society.
5) Capitalism has a natural tendency to concentrate wealth and progressive taxes are need to fairly distribute the social surplus.
6) Excessive concentrations of wealth can undermine democracy in the short term (because of the rich's greater ability to influence the political process) and the long term (because of the creation of hereditary oligarchies and the related negative effects of a declining middle class)

It's not an exhaustive list, and the categories aren't sharply defined, but you get the idea. So what I've been thinking is that there is a seventh argument, namely that steeply graduated tax rates can help address principal-agent problems. Principal-agent problems are one in which there is a difference in the incentives between those who "hire" others to perform a task (the principals, and those who are the ones who actually perform the task (the agents). Economists are quite familiar with principal-agent problems in the private sector, where CEO's have an incentive to pump up stock in the short term without any concern for the long-term good of the shareholder's company. In politics the principal-agent problem manifests itself as the difference between the policy preferences (ideal or express) of the voters and the career interests of elected officials.

Got it? Great. So here's my (very tentative) idea: if we heavily tax incomes above a certain amount, then there won't be a big pot of gold waiting for congresspersons once the leave office. Right now they have a reasonable prospect of becoming millionaires or deca-millionaires. But if there were a 70%+ marginal tax rate on the top incomes - which we had until 1980 - AND there weren't a million loopholes, then suddenly selling one's soul doesn't look so profitable.

Now I'm not talking about a 70% tax rate on people making $100K, or even $370 K, which are no at the 28% and 35% rate respectively. (Did you know that making 350K puts you in the top 1% of households? I didn't.) No, I'm talking about the top .01% or so of income earners, 140 thousand people who right now make 2 million a year and earn 10% of all the adjusted gross income in the United States (see the tax foundation if you don't believe me).

It would only be a start, unfortunately, since the average net worth of members of Congress is over six million. We should do something about that too.
Posted by Arbitrista @ 3:29 PM
  • Nope, that's going a little too far for me. I don't think anyone should have to give more than 50% in taxes. One for me and one for you.

    Of course, that still leaves the matter of loopholes to close up tight. And I would like to see MUCH better regulation over those entities/individuals accumulating enormous amounts wealth to make sure it was earned in an ethically acceptable manner.

    If it were up to me, I'd make it legal, for instance, for the government to seize businesses and/or bank accounts of those who have a long record of fines for breaking regulations or who have falsified official documents.

    Take those mines with unsafe working conditions and give them to the unions. BP lied on the permit application they submitted when they said they could fix any leak that might happen? Don't wait for them to cough up payment or risk their later default. Just grab their American assets. Put it right there on the application, so they know the consequences ahead of time.

    There's probably as much chance of any of that happening as a 70% income tax getting passed. Hopefully, our legislators will come up with more moderate ideas that will accomplish most of what we'd like to see happen. *sigh*

    At this point though, to be honest, I'd be happy just to see enough regulation to get the financial and insurance industries back to doing business in the way those industries were originally set up to operate. Their profits would only be a fraction of what they've been making the last few decades, but that's the way it's supposed to be. Hit the reset button and put them back in 50s or 60s.

    By Blogger Rebecca, at 9:42 PM  
  • Well, a 70% marginal rate would in a lot of cases still not result in a 50% effective tax rate. It's not like you hit a magic number and all of your income is taxed at 70% - it's every additional increment.

    Plus I don't think people who earn more than a million or two dollars a year have generally done anything to "earn" it. Mainly they're just extracting rents. If one person is making 10 million a year there are a whole bunch of people who are making minimum wage who I suspect in the aggregate are contributing more to the company. The people who make those huge incomes are generally just top management or financiers who don't really DO anything. Frankly the same thing goes for entertainers.

    By Blogger Arbitrista, at 6:44 AM  
  • Actually, it works out to pretty much a flat rate if your raking in millions. You hit the top bracket pretty quickly.

    Entertainers and sports figures don't bother me so much because their careers tend to be pretty short for the most part.

    I was thinking more in terms of people who found businesses, rather than just run them. People who really work hard to honestly build something profitable should be allowed to keep at least half of what they make. I still don't think the top bracket should be more than 50%.

    When I think of people just running businesses, I think of those assholes in the financial industry who are responsible for bringing this country to its knees. That's why I'd love to see major reforms in that sector. Like a big extra tax on their bonuses or whatever.

    And I'd like nothing better to see minimum wage raised to a real living wage.

    I thought this president was going to address those things. But it turned out he's an asshole too.

    By Blogger Rebecca, at 11:52 AM  
  • Oh, actually people who own the business (like small business) usually self-incorporate. Most of the money goes back into the business anyway.

    By Blogger Arbitrista, at 12:02 PM  
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