Tax Subsides for 401(k)’s Work, But Not for the Reasons You May Think

Posted by on Nov 30, 2012

Filed Under (Finance, Retirement Policy, U.S. Fiscal Policy)

Earlier this week, the New York Times Economix Blog wrote a piece “Study Questions Tax Breaks’ Effect on Retirement Savings.”  The article summarizes the findings of a fantastic research paper issued by the National Bureau of Economic Research (NBER).  A quick summary of the paper written by the authors themselves can be found here.  The short version is that the researchers used data from Denmark (where much better date is available) to provide evidence that tax subsidies have little effect on overall savings rates.

Their main finding is that “when individuals in the top income tax bracket received a larger tax subsidy for retirement savings, they started saving more in retirement accounts.  But the same individuals reduced the amount they were saving outside retirement accounts by almost exactly the same amount, leaving total savings essentially unchanged. We estimate each that $1 of government expenditure on the subsidy raised total savings by 1 cent.”

The policy implications of their finding are extremely important given the current debate about fiscal policy in the U.S.  After all, if tax subsidies for saving do not actually increase saving, then perhaps we should re-think the $100 billion per year that we forego in tax revenue by exempting retirement savings from the income tax base?  Such a conclusion would be quite tempting to politicians who are desperately seeking ways of raising revenue without raising tax rates.

But I say “not so fast.”  Although I do not disagree with the empirical findings of the study, I strongly disagree with the assertions being made by some that this finding justifies the elimination of the tax preference for 401(k) and other retirement vehicles.

The study itself is an outstanding intellectual contribution, and one that will likely (and deservedly) end up being published in a leading scholarly journal.  I can personally vouch for the high intelligence and research integrity of the two U.S. authors.  Raj Chetty was named a MacArthur “Genius” earlier this year, and is widely expected to be awarded the prestigious John Bates Clark medal sometime in the next 6-8 years.  John Friedman of Harvard is also an emerging research star in the economics profession.

So, the researchers are top notch, the study is extremely well done, and the conclusion is that tax subsidies do not generate net much net savings.  So, why not simply eliminate the tax preference for 401(k) plans in the U.S. and raise a trillion dollars of revenue over the next decade?

Because of the important role of plan sponsors, that is why.

For better or for worse, the employer plays a central role in the U.S. retirement system.  Although there are several reasons that employers offer retirement plans and other employee benefits (e.g., to differentially attract certain types of workers, to help manage retirement dates, to motivate workers, etc.), there is little question that the large tax subsidy  looms very large in their decision to use retirement plans – as opposed to other types of benefits – to achieve these outcomes.

To qualify for favorable tax treatment, employer provided retirement plans, including the 401(k), must meet a long list of “plan qualification requirements.”  These requirements are what provide Congress and regulators the ability to influence the design of retirement plans.

An important example is the set of “non-discrimination rules” designed to ensure broad-based participation in an employer’s plan.  These rules provide incentives for plan sponsors to find innovative ways of encouraging saving by their employees.  Indeed, it is not much of a stretch to suggest that these rules are the reason we have seen the widespread adoption over the years of employer matching contributions, automatic enrollment, automatic escalation of contributions, and numerous other innovations in the retirement plan space that have been shown to increase saving.

The authors themselves note that “automatic enrollment or default policies that nudge individuals to save more could have larger impacts on national saving at lower fiscal cost.”  I agree that behavioral nudges have had an enormous impact.  But in an employer based retirement plan system, the only way to get employers to offer those nudges is to provide them with a compelling financial reason to do so.  In essence, tax subsidies are the nudge for employers to provide the nudge for employees.

Of course, this does not necessarily mean that the existing system should be treated as sacrosanct.  It may be that employers would continue to offer 401(k)’s – along with their numerous savings nudges – if the financial incentive were provided in a less expensive way (e.g., by capping deductibility).  That is a debate we ought to have (hopefully informed by evidence of the same high quality as the NBER study).  My point is simply that any policy discussion should recognize the very important role that employers play as trusted sponsors of the plan, and be careful not to throw out the baby with the bathwater.

Indeed, given that only about half of US workers have opportunities to save through their current employer, we should be looking for ways to encourage more employers to sponsor plans.  If we go after the tax incentives for retirement saving, we must be careful not to inadvertently destroy the plan sponsor infrastructure that is the foundation of retirement security for millions of Americans.


Relevant Disclosures:  I am a Research Associate of the NBER (through which the study above was released) and Associate Director of the NBER Retirement Research Center (through which the authors have received some funding for their study).  I am also a trustee for TIAA CREF, a provider of retirement plans to the not-for-profit sector.  I have also received compensation as a consultant or speaker for a wide range of other financial services institutions.  The opinions expressed in this blog (and any errors) are my own.

The Third “Justification” for a Progressive Income Tax

Posted by on Aug 31, 2012

Filed Under (Finance, Retirement Policy, U.S. Fiscal Policy)

Here is the third in a series of blogs that I started on May 18.  The first was called “Why YOU may LIKE Government ‘Theft’”.  In it, I listed four possible justifications for government to act like Robin Hood, taking from the rich to give to the poor.  The point is to think about whether the top personal marginal tax rate really should be higher or lower than currently, as currently debated these days in the newspapers.

However, perhaps we should also remember what is wrong with government using high marginal tax rates to take from the rich in order to help the poor.  The problem is that a higher personal marginal tax rate distorts individual behavior, particularly labor supply and savings behavior, by discouraging work effort and investment.  Since those are good for the economy, high marginal tax rates are bad for the economy!  In fact, economic theory suggests that the “deadweight loss” from taxation may increase roughly with the square of the tax rate.  In other words, doubling a tax rate (e.g. from 20% to 40%) would quadruple the excess burden of taxes – the extent to which the burden on taxpayers exceeds the revenue collected.

The point is just that we face tradeoffs.  Yes, we have four possible reasons that we as a society may want higher tax rates on the rich in order to provide a social safety net, but we also have significant costs of doing so.  Probably somewhere in the middle might help trade off those costs against the benefits, but it’s really a matter of personal choice when you vote: how much do you value a safety net for those less fortunate that yourself?  And how much do you value a more efficient tax system and economy?

In the first blog on May 18, I listed all four justifications, any one of which may or may not ring true to you.  If one or more justification is unconvincing, then perhaps a different justification is more appealing.  In that blog, I put off the last three justifications and mostly just discussed the first one, namely, the arguments of “moral philosophy” for extra help to the poor.   As a matter of ethics, you might think it morally just or fair to help the poor starving masses.  That blog describes a range of philosophies, all the way from “no help to poor” (Nozick) in a spectrum that ends with “all emphasis on the poor” (Rawls).

In the second blog on July 13, I discussed the second justification.  Aside from that moral theorizing, suppose the poor are not deemed special at all: every individual receives the exact same weight, so we want to maximize the un-weighted sum of all individuals’ “utility”, as suggested by Jeremy Bentham, the “founding figure of modern utilitarianism.”  His philosophy is “the greatest happiness of the greatest number”.   Also suppose utility is not proportional to income, but is instead a curved function, with “declining marginal utility”.  If so, then a dollar from a rich person is relatively unimportant to that rich person, while a dollar to a poor person is very important to that poor person.  In that case, equal weights on everybody would still mean that total welfare could increase by taking from the rich to help the poor.

The point of THIS blog is a third justification, quite different in the sense that it does NOT require making anybody worse off (the rich) in order to make someone else better off (the poor).  It is a case where we might all have nearly the same income and same preferences, and yet we might all be better off with a tax system that has higher marginal tax rates on those with more income, and transfers to those with little or no income.  How?  Suppose we’re all roughly equally well off in the long run, or in terms of expectations, but that we all face a random element in our annual income.  Some fraction of us will have a small business that experiences a bad year once in a while, or become unemployed once in a while, or have a bad health event that requires us to stop work once in a while.  To protect ourselves against those kinds of bad outcomes, we might like to buy insurance, but private insurance companies might not be able to offer such insurance because of two important market failures:

  1. Because of “adverse selection”, the insurance company might get only the bad risks to sign up, those who are inherently more likely to become unemployed or to have a bad year.
  2. Because of “moral hazard”, insurance buyers might change their behavior and become unemployed on purpose, or work less and earn less.

With those kinds of market failure, the private market might fail altogether, and nobody is able to buy such insurance.  Yet, having such insurance can make us all better off, by protecting us from actual risk!

Potentially, if done properly, the government can help fix this market failure.  Unemployment insurance is one such attempt.  But the point here is just that a progressive income tax can also act implicitly and partially as just that kind of insurance:

In each “good” year, you are made to pay a “premium” in the form of higher marginal tax rates and tax burden.  Then, anytime you have a “bad” year such as losing your job or facing a difficult market for the product you sell, you get to receive from this implicit insurance plan by facing lower tax rates or even getting payments from the government (unemployment compensation, income tax credits, or even welfare payments).

I don’t mean that the entire U.S. tax system works that way; I only mean that it has some element of that kind of plan, and it might help make some people happier knowing they will be helped when times are tough.  But you can decide the importance of that argument for yourself.

Next week, the final of my four possible justifications for progressive taxation.

Free advice to airlines

Posted by on Aug 26, 2012

Filed Under (Other Topics)

This past week, I reached Gold Status on American Airlines, which, along with some economics credentials, makes me qualified to give airlines some advice.

In my opinion, the most frustrating experiences of flying are the lines: bag check, security, boarding. I’m not going to debate security procedures here, but I will talk about the best way to reduce the boarding line: start charging passengers for carry-on baggage that doesn’t fit under their seat.

There’s nothing more frustrating than watching a long line of people try to stuff their clearly too-large roller suitcases into the overhead bins. Actually, there is: when it turns out that there isn’t enough space in the overhead bins and people have to start checking their carry-ons. The delay created by these phenomena costs the airlines a lot of money. A few years ago, a study calculated that padded schedules, which happen because airlines anticipate delays, cost them about $4.1 billion that year. Reducing the time that it takes people to board the plane could shave off some of that cost. Reducing the amount of stuff people bring on the plane would definitely reduce boarding time.

What would happen if airlines started charging for carry-on bags? Presumably, people would (a) pack fewer things and (b) check more bags. An alternative would be to stop charging for checked bags. However, that option would probably raise costs because people would pack more things into their suitcases and bring more suitcases with them. Fuel costs already make up around 40% of airlines’ costs, so adding more bags (and thus weight) to planes by not charging people what they cost to transport is not desirable.

Why don’t airlines charge for carry-on bags already? I’m guessing it’s some kind of game theoretic equilibrium where it’s good for everyone to charge for carry-ons, but bad to be the first mover. This is certainly consistent with what happened to free bags and meals: once someone started charging for checked bags and stopped serving meals, everyone else followed. Though Spirit already charges $20 per carry-on and will start charging $25 in November. Care to follow, anyone?

Consumer Choice: The Ethics of Eating Animals

Posted by on Aug 21, 2012

Filed Under (Other Topics)

Beef Magazine is the last publication I expected to find an article to write about given that I have previously posted entries about plant-based substitutes for meat (here) and a United Nations report urging vegan diets (here).  However, a recent article published by Beef Magazine, which summaries the results of a survey on the “factors impacting public perceptions of animal welfare and animal rights,” caught my attention.  The article titled “Consumer Perceptions Will Determine Agricultural Practices” reports many findings from the survey, but I will focus on the three most interesting results.

  • 91 percent of people agree that animals need to be treated humanely in order to qualify as “ethical food”.

This finding highlights the fact that food is not just calories and nutrients, but a meaningful and important part of people’s lives.  Food can invoke wonderful childhood memories.  Some people turn to comfort foods when having a bad day.  Food is often the center of social gatherings.  Given the prominent connection between emotions and food, it is comforting that the vast majority of people agree that humane practices are necessary for ethical food.

  • 75 percent of people would vote for a law that would require farmers to treat animals more humanely.

Despite the generally pro-market leanings of Americans, clearly most people do not trust for-profit farmers and corporations to always deliver humane outcomes.  Intuitively, people understand that market forces often result in a race-to-the-bottom due to pricing pressure, and thus laws are necessary to enforce ethical standards.

  • 81 percent of people believe animals and humans have the same ability to feel pain.

In contrast to this statistic, the Vegetarian Research Group’s annual survey found that only 5 percent of Americans are vegetarian and approximately half of those are vegan (source).  I suspect that most people understand that animals feel pain because of interactions with companion animals (i.e. cats and dogs).  Yet killing is inherently violent and killing is required for eating animals.  If animals can feel pain, then why do we as a society choose to kill them for food?

Furthermore, the pain of animal slaughter extends to humans too and is endured by those who work in the slaughterhouses.  According to Bureau of Labor Statistics data analyzed by the The Atlantic, “The rate of serious injuries in meat-packing (as measured in lost workdays) is…the highest: more than five times the national average in private industry.”  At a more granular level, Timothy Pachirat’s new book Every Twelve Seconds provides a first-hand account of working at an industrial slaughterhouse and explores “how, as a society, we facilitate violent labor and hide away that which is too repugnant to contemplate.”  The title of the book refers to the kill rate at the slaughterhouse, 2500 cattle per 8 hour shift or one animal killed every 12 seconds.

Consumers have the ultimate power of choice.  Through our purchases we can collectively determine how our food is made and demand that it be ethically sourced.  We can choose to live our ethics in the supermarket check-out line.

Paul Ryan’s Budget is Not Nearly as Radical as the Status Quo

Posted by on Aug 15, 2012

Filed Under (U.S. Fiscal Policy)

I find myself bemused by the sheer number of commentators that have labeled vice presidential candidate Paul Ryan a “radical” because of his views on the federal budget.  His core view – that we ought to keep federal spending as a share of GDP at a level approximately equal to where it has been for the entire lifetimes of most Americans – strikes me as far less radical than the current policy status quo.

Let’s start with some basic facts.  In the post-war period in the U.S., federal spending has averaged just under 20 percent of GDP.  (You can confirm this for yourself by going to the White House OMB site and downloading Table 1.2).  There have clearly been some ups and downs over this period for a variety of reasons, but it has never exceeded a quarter of GDP except for 2009 – the depths of the Great Recession – when outlays reached 25.2% of GDP.

In other words, for 60 years – through military conflicts great and small, through booms and busts, through the creation and demise of countless government programs, and through tectonic shifts in the global economic landscape, the U.S. has found it possible to keep government at about 20% of GDP.  And throughout this period, the economic engine of the U.S. remained the envy of the world, even now in the aftermath of the Great Recession.

Absent substantial changes to our public policies, however, U.S. government spending as a share of GDP is projected to rise at an unprecedented rate.  According to the CBO’s “extended alternative fiscal scenario,” which they describe roughly as a continuation of current policies, spending as a share of GDP is projected rise to 35.7% of GDP in just the next 25 years.  This seems to me to be prima facie evidence that our future fiscal problems are being driven by rising spending, rather than a lack of revenue.

Given this, what sounds more radical?  Suggesting that we make cut the growth rate of spending to keep the ratio of government-to-GDP near historical levels, as Paul Ryan has suggested?  Or allowing government to grow from 20% to over 35% of GDP?

Google’s definition of radical is “affecting the fundamental nature of something.”  A failure to change policy course would affect the fundamental nature of the U.S. economy.  Now that is radical.

If we want to avoid this, then we need to re-think the role of government.  Most of the future projected growth of government is due to a rising health care costs and an aging population.  One cannot slow rising health care costs and population aging simply by cutting spending, as any serious student of the budget – of which I consider Paul Ryan to be one – already knows.  Nor is it obvious we really want to stop all those trends – at least some of the rise in health spending brings new health benefits, and most of us are quite happy to live longer.

What we can do is recognize that our programs need to change with the times.  Remaining life expectancy today, conditional on reaching age 62, is about 50% longer than it was in the 1960s.  Yet we continue to encourage people to exit the labor force early.  Even worse, we have created a mentality where most Americans seem to believe that they have a God-given right to have their retirement income and health care expenses paid for by taxpayers after they reach age 62 or 65.  At a minimum, we should recognize that if people are living both longer and healthier lives than they were in decades past, we ought to make them wait longer to start receiving benefits.

There are good reasons to have Social Security and Medicare.  But we need to recognize that the fiscal burden they are placing on taxpayers is going to grow rapidly in the years to come, and that the best way forward is to reform them to make them sustainable for future generations.  Paying for these rapid cost increases through an inefficient tax system that depresses investment, discourages entrepreneurship, penalizes work, and retards economic growth is the real “radical” solution – and the one that should work hard to avoid.

Energy and Environmental Policies are All Interrelated

Posted by on Aug 3, 2012

Filed Under (Environmental Policy, Finance, U.S. Fiscal Policy)

Recent debate at the state and national level has focused on whether to enact a climate policy to control greenhouse gas emissions such as carbon dioxide.  The fact is, however, that we already have policies that affect such emissions, whether we like it or not.  Such policies can be coordinated and rational, or they can be piecemeal, inconsistent, and counter-productive.  Almost any policy designed to improve energy security, for example, would likely affect oil prices and energy efficiency, just as any policy to encourage alternative fuels would also affect energy security, electricity prices, consumer welfare, and health!  Here is a guide for thinking about how some of these policies work, and which combinations might work better than others.

The most obvious existing policy that affects carbon dioxide emissions is the gasoline tax that applies both at state and federal levels.  If that tax encourages less driving and more fuel-efficient cars, then it also impacts urban smog and global warming as well as protecting us from the whims of oil-rich nations with unstable governments.   In fact, with respect to the price at the pump, a tax on emissions would look a lot like a tax on gasoline, and vice versa.  Averaged over all state and federal taxes, the U.S. gasoline tax is about $0.39 per gallon, far less than around the rest of the world.  Most countries in the OECD have a tax over $2/gallon.

For the most part, the U.S. has chosen to avoid tax approaches to energy and environmental policy and instead uses various mandates, standards, and subsidies.   Cars sold in the U.S. are required to meet emission-per-mile standards for most local and regional pollutants like fine particles, sulfur dioxide (SO2), nitrous oxides (NOX), and volatile organic compounds (VOC) that contribute to ozone smog.  Those rules make cars more expensive but have successfully cleaned the air in major cities and around the country.  They also have the side effect of reducing greenhouse gases.  Another mandate is the “Corporate Average Fuel Economy” (CAFE) standards that require each auto manufacturing company to meet a minimum for the average miles-per-gallon of their fleet of cars sold each year.  For each big gas-guzzler they sell, the company needs to sell more small fuel-efficient cars to bring the average back down.  To meet this standard, every car company must raise the price of their gas guzzlers (to sell fewer of them) and reduce the price of their small fuel-efficient cars (to sell more of them).  The effect is the same as having a tax on big cars and subsidy on small cars.

These energy and environmental policies are also intricately related to other tax policies, as well as government spending!  For any chosen size of government and overall tax bite, any dollar not collected in gasoline tax is another dollar that must instead be collected from payroll taxes, income taxes, corporate profits tax, or state and local sales tax.  When looked at through that lens, gasoline taxes may not be that bad – or at least not as bad as some of those other taxes we must pay instead. 

Every state and local government is also worried about the pricing of electricity by huge electric companies that might naturally have monopoly power over their customers.  Production efficiency requires a large plant, so a small remote town might be served only by one power company (with no competition from neighbors far away, since too much power is lost during transmission).  So the public utility wants to regulate electricity prices, perhaps with block pricing that helps ensure adequate provision to low-income families.   Yet the pricing of electricity inevitably affects electricity use, which affects coal use, urban smog, and greenhouse gas emissions.  These policies are intricately related.

And these policies are related to government spending, since they affect car and gasoline purchases and therefore required spending on roads and highways as well as train tracks and mass transit in cities.  These environmental and energy policies affect human health, and therefore health spending by government – as necessary to pay for additional illness caused by emissions from cars, power plants, and heat from burning fossil fuel. 

We have no way to avoid these inter-connections.  You are a consumer who wants lower gas taxes and electricity prices, but you also own part of the power company and auto manufacturers through your mutual fund or pension plan.  You pay other taxes on income and purchases, and you breathe the air, so you are affected by emissions and need health care.  We might as well think holistically and act for the good of everybody, because we are everybody!

The Folly of Breed-Specific Legislation

Posted by on Jul 20, 2012

Filed Under (Other Topics)

Earlier this month, despite desperate appeals to reverse his execution order, Lennox, a simple family dog from Belfast (UK) was killed (source).  The Belfast City Council (BCC) in Northern Ireland had condemned Lennox to death for the crime of resembling a pit bull.  The BCC’s justification was compliance with the “The Dangerous Dogs (Northern Ireland) Order 1991”, which defines any dog deemed to have pit bull “characteristics”, as inherently dangerous and bred for fighting.  The law requires the seizure and destruction of such dogs.

The Order is an example of breed-specific legislation (BSL) in effect across many jurisdictions around the world.  Pit bulls often are the target of BSLs, but other breeds are affected too, such as Rottweilers and German Shepherds (source).  Many major cities in America have BSL that outlaw pit bulls, including Denver and Miami (source).  The idea behind BSL is to reduce dog bites and subsequent death in humans from these “dangerous” breeds.

Do these BSLs work?  The answer is no.  A study by the U.S. Centers for Disease Control and Prevention (CDC) that reviewed a large sample of human dog bite-related fatalities over a 20-year period found, “Although fatal attacks on humans appear to be a breed-specific problem (pit bull-type dogs and Rottweilers), other breeds may bite and cause fatalities at higher rates.”  In other words, it is a common misperception that pit bulls are inherently more dangerous than other dogs.  Furthermore, analyses of specific BSLs find them to be ineffective, such is the case of the pit bull ban in Prince George’s County, MD (source).

In fact, all BSLs do is punish law-abiding citizens with harmless companion animals, as in the case of Lennox.  Criminals use pit bulls for fighting, but that is neither the fault of those dogs specifically, nor the breed in general.  Instead of BSLs, experts recommend breed-neutral legislation that focus on the deeds instead of breeds, as well as preventative measures such as mandatory spaying/neutering and compulsory leash laws  (source).  Poorly socialized, vicious dogs do exist and need to be taken seriously, but steps should be taken to protect the public in accordance with breed-neutral laws already on the books.

Finally, on a personal note, my partner and I have two beautiful pit bull mixes.  Lucy and Emmy are two wonderful and loving ladies.  Every once in a while, they steal food from the table, but then again what dog doesn’t?!

Tour de LIBOR

Posted by on Jul 17, 2012

Filed Under (Finance, U.S. Fiscal Policy)

Anyone struggling to understand the LIBOR scandal could do worse than observe the way the Peloton behaves in this year’s Tour de France. All riders in the Peloton receive the same time at the end of the race. It’s like everyone getting the average rate in LIBOR rate benchmark setting. Furthermore it leads to the similar collusive behavior.

Sometimes the collusion is used to good, or at least gentlemanly, effect, such as waiting for Mark Cavendish and others who were victimized by the “tack” attack. At other times it negates the race by turning it into a rest period – a parade.

But presumably the Tour officials instituted the “same time” rule to avoid worse behavioral consequences – a scramble to the finish with attendant increased probability of crash and injury among bunched riders. Possibly it was originally also because of the difficulty of measuring individual times.

Analogous difficulties, rationales and discussions were present when the Chicago Mercantile Exchange introduced the Eurodollar futures contract in 1981. It was the first contract cash-settled to an index, LIBOR, rather than a deliverable deposit. The Exchange conducted its own standardized survey of banks for LIBOR settlement. The seemingly superior alternative, a deliverable instrument, was exposed to have its own problems when the failure of Continental Bank and the delivery of its certificate of deposit caused the failure of the domestic CD futures contract in 1984.

The BBA formalized its LIBOR calculation in 1985 in part because of the success of the Eurodollar contract itself. The exchange switched from CME calculated LIBOR to the BBA LIBOR for settlement purposes after 1997.

No doubt it is time to improve BBA the calculation. It has been gamed and gamers should suffer the consequences – that includes the calculation agent.

However, when there is an illiquid market, or when a market becomes illiquid, there are pluses and minuses to index settlement or transactional delivery. There are almost certainly better ways to provide a benchmark, but it remains the case that there is no perfect way. When changes are made or suggested lets game them in advance to anticipate behaviors. Radical changes may precipitate even worse practices.

No doubt the Tour de France officials feel the same way about the Peloton time calculation.

The Second “Justification” for a Progressive Income Tax

Posted by on Jul 13, 2012

Filed Under (Other Topics, U.S. Fiscal Policy)

Way back on May 18, I wrote a blog called “Why YOU may LIKE Government ‘Theft’”.  In it, I listed four possible justifications for government to act like Robin Hood, taking from the rich to give to the poor.  This combination of economics and philosophy is meant to help each of us think about what really should be the top personal marginal tax rate: should it be higher or lower than currently?  This topic is hotly debated these days in the newspapers!

In that blog, I listed all four justifications, any one of which may or may not ring true to you.  If one or more justification is unconvincing, then perhaps a different justification is more appealing.  I put off the last three justifications to later blogs and mostly just discussed the first one, namely, that some “ethicists” in the field of “moral philosophy” have found ethical justifications for extra help to the poor.  The moral justification may be the most common or usual one; you might think it morally just or fair to help the poor starving masses.  That blog describes a range of philosophies, all the way from “no help to poor” (Nozick) in a spectrum that ends with “all emphasis on the poor” (Rawls).

But that’s not the only reason to have some degree of progressivity in our income tax system (taking higher percentages of income from those with more income).  The second justification basically says okay, let’s skip the moral theorizing.  Instead, suppose the poor are not deemed special at all.  Suppose that ALL individuals receive the exact same weight.  Suppose the objective is to maximize the un-weighted sum of all individuals’ wellbeing (or what we call “utility”).  Actually, this is perhaps the view of Jeremy Bentham, who came to be considered the “founding figure of modern utilitarianism.”  His philosophy is “the greatest happiness of the greatest number”.  That is, just add up all individual utilities, without weights, and maximize that sum.

So far, that might sound like no justification for taking from the rich to give to the poor.  However, we did not say just add up their incomes, or to maximize total GNP.   Instead, one might also believe that utility is not proportional to income, but is instead a curved function, as in the diagram below.  In other words, “declining marginal utility”.  If so, then a dollar from a rich person is relatively unimportant to that rich person, while a dollar to a poor person is very important to that poor person.  In that case, equal weights on everybody would still mean that total welfare could increase by taking from the rich in order to help the poor.

The only remaining question is the degree of curvature, or the rate at which marginal utility declines.  If it is a nearly straight line, then we might not want much redistribution.  But if it has a lot of curvature, then the sum of utilities could be maximized by taking more from the rich than we do currently.

So, what do you think?  I invite your comments.

Heat waves and climate change

Posted by on Jul 10, 2012

Filed Under (Environmental Policy)

The recent weather extremes over much of the US have created a flood of articles about the link between these heat waves and climate change. Here is one example. For other examples, just go to Google news and search for “heat wave climate change”. Or you can just keep reading this blog post.

Are these recent events being caused by climate change? The answer is “maybe”. Certainly, climate change is predicted to increase the number of heat waves. But attributing a particular event to climate change is very difficult, even when the event is as extreme as the heat waves of the last two weeks. Of course, if such events are more likely under the “climate change” scenario than under the “no climate change” scenario, we should reasonably think that climate change is more likely than not. But because such heat waves are possible during the “no climate change” scenario as well, we cannot rule out that these temperatures would have occurred even if climate change were not a possibility. So all we can do is make statements like, “There’s an 80% chance that the heat wave was due to climate change, and a 20% chance that it was part of natural fluctuations.” (like this guy).

What should we do in light of this uncertainty? Pay attention to the science and the scientists rather than the weather fluctuations. 97% of scientists agree that climate change is real and caused by humans (see this paper for details). Given the high degree of consensus and the time it takes to for carbon dioxide to dissipate in the atmosphere, we shouldn’t wait until we’re sure that we’re experiencing the predicted effects of climate change firsthand. As evidenced by the deaths and misery in the past weeks (see this article for more), extreme weather still has the power to kill, even in developed nations. Trying to figure out a cost-effective way to address climate change is what we should focus our efforts on (more on that in a later post).