Today I Learned...

A while ago I read Farewell To Alms, whose basic thesis was that Europe industrialized before Asia because Europe had worse hygiene. More specifically, Europe had both a higher birth rate and a higher death rate (in part because their atrocious sanitary conditions encouraged disease), and that led to more selection pressure, making Europeans smarter and more industrious than Asians. At the time I thought the book had some serious holes but also some interesting ideas. After reading more history, I increasingly want to withdrawal what praise I gave it. If disease led to economic prosperity, Africa would look like Dubai.

Learning history in school, I vaguely knew that at one point China had been pretty advanced, but then regressed somehow. And it's true, they did suppress a few technologies, like gun powder. But China was the world's superpower for much longer than I appreciated- probably right up until the industrial revolution. Europe went off to other lands in search of precious medals because China would give them spices for them*. And a lot of the civilizations they conquered were pretty advanced themselves, but were crippled by European diseases (so I guess the poor hygiene thing did work out for them after all).

The industrial revolution happened in England because coal was cheap and labor was expensive (why the difference in the cost of labor? I don't know, but I'll bet it's interesting). But more generally: the rules of the game had changed, and the winners under the old rules are never the winners under the new rules. It's true of people, it's true of companies, and it's true of countries. That is because a lot of what looks like genius is actually happening to have your gifts be the right thing for the moment, and happening to bet on the right horse **. Not that success is randomly attaching itself regardless of your skills, but that different skills have radically different values in different contexts. Big tech companies are obsessed with acting like start ups because start ups have the most growth, but that's because we're only looking at the successful ones. Thinking you can predict the next big thing is like thinking you can predict lottery numbers by studying the characteristics of the winners.

America was the winner under the last system. It was never going to be the winner under the next system. I don't know if the system has changed yet, but it seems highly plausible. So many of America's advantages are due to inertia, or network effects, or the tallest pygmy effect, rather than things we do right now. If we lose those, they are not coming back, even if we fix everything.

Breaching the debt ceiling may very well be the thing that catalyzes that loss. And then things will get much, much tougher for us. I'm consoling myself with the idea that this was going to happen eventually, and postponing the inevitable will only make it worse. The best case scenario is we pull at IBM/England, and that involves a much more intimate relationship with reality than the country has had recently.

*source: Debt: the first 5000 years.

**Queen of Versailles is a documentary about a family that made billions of dollars on time share properties, who are spending a small portion of the proceeds on the biggest/most expensive house ever. The business was built on the worst of the pre-crisis banking practices, and is decimated when the banks curtailed that. There were good businesses that went under because the credit markets froze or demand temporarily dropped, but this is not one of those: this corporation's very existence depended on toxic banking. The money dries up, and you watch them make stupider and stupider choices- to keep going with the $100 million house, to refuse to downsize or sell the business. I couldn't get over how someone smart enough to make that much could money be that dumb. The answer is probably that he would have had the same money making model whenever he went into business, and it just happened to be the right model for the moment.

I am broadly in favor of a progressive tax system, by which I mean people with more money paying more money, not just in absolute numbers but as a percentage. This sentence deliberately vague, because progressive by what measure is surprisingly hard to define. Not only is progressive taxation the right thing morally, it's the only thing practically. I do, however, have some problems with the income tax system we currently have.

First, it punishes income volatility. Logically, it shouldn't matter whether you get paid on 12/31 or 1/1, but if you do really well one year and really poorly on the other, the date that check clears matters, because you'll pay a higher rate on it if you receive that income in the good year (in the extreme, it could be a third of the check, more if it's subject to FICA, more still if there's state or local taxes). This has a number of negative features:

• Higher income levels are more variable and pro-cyclic, meaning the government loses revenue when it needs it most.
  
• it discourages entrepreneurship. Let's say there's a 50% chance a new business I'm considering starting will do awesome, and a 50% chance it fails. Let's further pretend I have a gainfully employed spouse or abundant savings, so each dollar is worth exactly the same to me. In a frictionless world I should start this business if the rewards of it going awesome are double those of my next best alternative (if X is the rewards of my day job, E[own business] > 2*x*.5). But that's only true if they're taxed at the same rate. If we have a progressive structure, the risky option needs to have that much more upside.
  
• To steal terminology from Chris Rock, this extracts money from the rich but leaves the truly wealthy unscathed, because they have enough money to spend some of it smoothing out their income. I do not believe there is any way around this: money buys you flexibility.
  
• By the same token, it punishes new wealth more than old. If all of your relatives are in a position to loan you money if you have a truly catastrophic emergency, you can get away with a smaller emergency fund, and put more of your money into forms that are tax-advantaged but liquidity-disadvantaged (and the same goes for your relatives).
  

Second, it requires collecting a lot of information. As a libertarian, I find this downright unsettling. But it also presents a lot of practical problems. It's not too bad if you're working strictly W2 jobs and maybe have some interest income, but if you freelance, or own your own business, or work in several states, it's a paperwork nightmare. The time it takes to manage this is not free, it comes at the expense of productive activity (as does the time it takes to audit it). And it's an additional discouragement for entrepreneurship.

My third point is not a criticism of the income tax but is a criticism of some of its proponents. When discussing progressive taxation I would like to propose the following rules:

• You may not justify increasing the income tax by talking about what percentage of wealth the most wealthy have.
  
• You may not justify increasing the income tax by talking about what percentage of pre-tax income the highest earners have unless you also specify what percentage of the income tax they pay and what you think the ideal percentage is. Especially since there's a reasonable story and some evidence that progressive taxation and a strong safety net increase pre-tax income disparity.
  

Many European countries use a VAT (similar to a sales tax), but that is, depending on how you count, neutral or regressive, and definitely not progressive. I have two potential solutions, both of which have their own problems.

1. All property tax, all the time.
Pros: Property ownership is already public, and easy to track. It's not perfectly progressive but will ultimately hit people with wealth and income harder than people without. Hard to cheat at, except for property valuation games.
Cons: determining current value of property is a nightmare, not sure why I'm fine with property taxes but dislike wealth taxes.

2. Progressive consumption tax
Imagine if the second 10k you spent had a higher sales tax than the first 10, and third 10k even more so. It's as if everything you didn't spend went into a 401k.
Pros: Progressive. Doesn't discourage work, investment, or entrepreneurship.
Cons: easy way to do it still involves giving government creepy amount of information. Hard way involves lots of paperwork and leaves openings for cheating, although not necessarily more than those already available for income and sales tax.

Doh. I can't believe I got this far in anti-poverty measures without trumpeting the negative income tax. The NIT is exactly what it sounds like: above earnings of $N, you pay taxes per normal. Below $N, you receive a bonus proportional to how much you earned. People who earn less receive a larger bonus proportional to their earnings, but the system is calibrated such that you are never punished for earning more. It's similar to the EITC, but more finally tuned, and unlike most forms of public assistance I have no problem with it being given to healthy childless adults, because I think the benefits are worth the relatively small cost. The NIT doesn't have to be exclusive to other forms of aid to the poor, but I think it a perfect world it would be the dominant if not only form. You can also make additional adjustments like making the refund percentage a function of the number of dependents/of.

So here's what this accomplishes:

• Yay incentives to work. I can't find it now, but I've written before on how the minimum wage is bad, and if we want people to be paid more for work, we should just do it. I also think this would improve marginal workers treatment at the hands of employers, because if the employer is paying less in cash the worker can extract more in non-financial benefits.
  
• Yay incentives to declare income. For one, this will help with opening a business/getting credit/getting housing/getting transportation. For two, while I more or less view taxes as a necessary evil, tax cheats make my blood boil, in part because I think my taxes are way too high and pay for a bunch of things I don't like and yet I pay them anyway. But it's human nature to not declare the income if you can get away with it, especially when you're living that close to the edge. So if we can fix the system to reward people for the right behavior, that's awesome. Admittedly, it creates a new incentive to cheat by inflating your income, but I think that cost is outweighed by the other benefits.
  
• It destroys the penalty for moving from informal to formal work (up to $N), reducing the likelihood people get stuck in the informal zone.
  
• It gives everyone a piece of ownership in the country. Technically everyone pays income tax because the idea that payroll taxes are earmarked for Social Security/Medicare, but somehow this hasn't translated well. If NIT was combined with PAYGO, you would know that voting for a new program would cost you money, regardless of your income level, and I think that's good.
  

Disadvantages:

• This doesn't handle people can't work. This isn't so much a cost as an acknowledgment that if we want to take care of them, we'll need a different program.
  
• In order to maintain a reasonable marginal tax rate, you either have to set $N very very high, probably higher than I'd be willing to do, or have the extremely low earners suffer from insufficient funds. You could fix this with a separate block grant, but that weakens the incentive to work (although not as much as the current system, so it's still a Pareto improvement).