Optimal Taxation with Rent-Seeking (2011) | Hacker News Reader

Optimal Taxation with Rent-Seeking (2011)

nber.org

48 pointsamelius16 comments

So the argument is: if we lower taxes on ownership of capital that can produce "rents" (i.e. stocks, real estate, etc), the value of that capital flies upwards so high that people are discouraged from buying in due to inflated asset prices. So then we can have a relatively smaller more entrenched group of people who controls all the productive assets.

Sounds wonderful. Long live the king.

Can you give an example of capital value flying upwards so high that people are discouraged from buying in due to inflated asset prices?

Southern California homes?

Are they really disconnected from rents in that area, as well as reasonable expectations of future growth in demand - given low interest rates, which mean you have to consider the performance of the asset far into the future?

In other words, if these assets were any cheaper, would they not be underpriced vs their intrinsic value, making it a great investment with someone with enough capital - thus bidding the prices back up?

This is typical of soft science papers in economics. Authors haven’t explored major aspects and clearly they had some prior beliefs and went after it. For example, when capital stays in the hand of few, it also means wealth accumulation happens much more rapidly at the top. In capitalistic society, not having capital means significant portion of your earnings is returned to someone else who is targeting passive income. When you go in the mall and pay $100 for a dress, $10 goes to someone who simply is owner of the mall and rarely visits it if at all, another $10 goes to owner of factory who never works there but has legal titles, another $10 goes to owner of farm that produced cotton but never put sweat in that farm -and so on. A vast majority of your purchase price ends up to rent seekers one way or another. This is why rich becomes richer.

Sounds like what's happening in many interesting areas these years, to be honest.

  One might be tempted to expect a similar result to apply to the more general two
  sector model when only rent-seekers are the top earners. In fact, since the top earners
  are all rent-seekers, rent-seeking imposes a negative externality, and the government has
  a desire to redistribute from high-earners to low earners, this seems like a clear case for
  high marginal tax rates on high earners, as discussed in the introduction. As Theorem 4
  demonstrates, however, this intuition is not complete. The key reason is the additional
  sectoral shift effect not present in a one sector economy: By lowering the marginal tax
  rate on the top earning rent-seekers, total equivalent effort E increases and thus wages
  in the rent-seeking sector fall. As a consequence, some agents now find it profitable to
  leave the rent-seeking sector and become traditional workers. Since the traditional sector
  is socially more productive, this shift is always welfare enhancing (S > 0)

This took me a fair while to grok. So I think the point is that a Pigovian tax rate[0] is what you'd expect with a rent seeking sector and a non-rent seeking sector (trying to minimize the negative externalities of rent-seeking).

Now if we have nothing but rent seekers in the top income bracket and try and set their tax rate independently, you'd think that you should set it to the rate which is the value of the negative externalities that that sector produces, right?

The reason for the difference appears to be that in doing so, you make some of the people who would have been rent seekers switch from rent seekers to non-rent seeking behaviours, so to be pareto optimal, it "costs less" in taxes than the pigovian tax, because the logical thing decreases the "attractiveness" of being in the rent seeking sector, and the (logical) agents move to the socially benificial sector, thus producing an outsized effect of net good.

Is this right? can someone confirm whether I'm reading this correctly?

[EDIT] formatting

[0] https://en.wikipedia.org/wiki/Pigovian_tax

The way I understood it (by way of the paper's gold panning illustration) is that with a progressive tax system based on total aggregate income (i.e. you don't distinguish rent income from non-rent income), high marginal tax rates result in a multitude of rent-seekers each collecting a fraction of the total available rents. This is so because as their income for the year accumulates and their marginal tax rate increases, the tax rate overcomes the collection effort required. Once they've maximized their income they rest for the remainder of the year. If they're not collecting rents that means someone else can. The market in rent-seeking supports a larger number of rent-seekers, which diminishes the base of people doing productive work.

By contrast, imagine if all the rents went to a single rent-seeker. In that situation only one individual is doing unproductive work instead of many. Assuming that the rents were going to be collected regardless, then we're better off if there's only one individual pursing that unproductive activity than many.

How do you ensure there's only one rent-seeker? By creating conditions that favor someone monopolizing the rent-seeking market. You can do so by taxing high income earners less than you might otherwise, preserving the incentive for a single rent-seeker to collect all the rents. The lone rent-seeker is taxed less, but that's okay because he's keeping everybody else out of the rent-seeking market. Taxes on other high-income earners is less but that's okay, too, because they're doing productive activity--generating wealth and thus more taxable surplus--and now there's more of them.

Like the Laffer Curve the devil is in the details.[1] But it's an interesting point.

[1] I don't mean to impugn the paper by comparing it with the Laffer Curve and the toxic political economics surrounding it. I just mean to say that the quantitative values matter.

Isn't there a fairly toxic political question buried in this paper as well? Who is going to decide which behaviors are rent-seeking and which are productive?

Yes, if pundits and lobbyists abuse this paper by relying on it to expound policies that it can't actually support. (Maybe they already have?) But that's a more general problem with how our political culture permits politicians and pundits to abuse science in their rhetoric.

There's also a problem in academia where intense pressures to publish and to be cited incentivize researchers to make radical claims, exaggerate the practical utility of their findings, gloss over weak points, etc, ripe for political fodder. I won't claim to understand all the technical details in the paper but I didn't sense any of that in the paper. The authors seemed to establish a fair analytical context, and they plainly articulated a limited policy conclusion--"it does not necessarily imply that taxes should be more steeply progressive". (Emphasis added.) Those don't feel like weasel words; just true and straight-forward without inviting misinterpretation.

It's a cool paper that credibly does what it sets out to: explore what can happen (in a formal and fair but, clearly, limited model) when you give rent-seeking a first-class treatment and carefully analyze how it interplays with the rest of the system.

By contrast, Arthur Laffer very actively advertised his research as justifying policies that it simply could not. And he continues to do it--he actively promoted the 2017 tax cut using the same intentionally misleading arguments he always has.

The part of that paragraph where it falls apart for me is the assumption that a well capitalized rent seeker is going to decided to become productive instead of finding other opportunities to do rent seeking.

That doesn't seem to fit real life very well.

If that happens, the only effect is that you create a class of ultra-wealthy under-taxed rent seekers who still produce nothing.

I've actually thought about this recently. The more equity that a smaller number of elites acquire, the less value they place on their own money, the more willing they are to throw money around and drive up prices for certain items, such as real estate - this warps the market. It's almost as if the top 0.01% become an economic black hole consuming more and more resources to acquire what's left.

But notice, it doesn't affect random assets. You don't see people hoarding and speculating on cars to a ridiculous degree, because cars depreciate.

Likewise, with real estate, the actual improvement values depreciate over time. What can appreciate is the value of the land.

But there's other areas that see such influxes of cash desperately seeking a return, like venture capital, ponzi schemes, cryptocurrency, and so on. However, much of that is akin to gambling and the losing bets mainly just harm the losers of the bets.

With land speculation manias, and related natural resource speculation manias, everyone becomes a loser. Cost of living skyrockets, and so does the cost of new production and hiring.

Hurry, hurry! Ukrainians want to sell their land quickly (at least that is what our imposed leaders tell us):

https://voxukraine.org/en/land-prices-and-size-of-the-market...

  Cost of living skyrockets,
  and so does the cost of new production and hiring.

Doesn't automation make wages diminishing? Also, please, read this:

https://www.reddit.com/r/POLITIC/comments/7hqo7d/to_have_em_...

What do you think about the right for secession, if citizens were embezzled of their land by unfair privatization process?

e.g. Cottage industries that 'monetize' everything.

I'd wish to see an immensely large taxation on non-primary residence properties; something like 15-20%/year. I'm not aware of any examples or good studies on consequences of such action, but I'd expect the affordability of actually owning your home to significantly increase and remove the exorbitant rent cost.

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