Tag Archives: taxes

“Relative to opportunity” evaluation and anti-discrimination laws

Most countries have some anti-discrimination laws, requiring employers to pay people with different productivities equally, or to give someone who took parental leave their job back after they return. One reason why unequally productive people are paid equally is evaluation “relative to opportunity”, i.e. the bar for a promotion or a raise is lower for someone from a historically disadvantaged group or who has family responsibilities. Suppose that there is a consensus in society for supporting certain groups. Why might the cost of this support be placed only on specific employers, namely those who employ the target group? Why doesn’t the support take the form of direct subsidies from the government to the target group, financed by taxing all employers equally?
An explanation from political economy is as follows. Clever people in society or government want to pay a larger subsidy to high-income members of the target group, perhaps because the clever people are themselves high-income and belong to the target group. However, the majority of voters would not like high-income people getting a bigger subsidy. So the clever people disguise the subsidy as something that looks equal, namely every member of the target group gets the same duration of parental leave, the same guarantee of their job back at the end of leave, the same privileges and special treatment for promotions and raises. The value of these guarantees and privileges is greater for higher-paying jobs. For example, a promotion from a high-paying job usually gives a bigger salary increase than from a low-paying job. A guarantee of getting a high-paying job back after parental leave is worth more than a guaranteed low-paid job. Thus the support provided to the high-income members of the target group is more valuable.
Further, productivity at a high-income job is typically more responsive to the employee’s human capital, and the skills deteriorate faster. A truck driver who has not driven for some years retains a greater fraction of driving ability than a surgeon retains from surgical technique after not operating for the same number of years. The productivity difference between an employee returning from parental leave and someone continuously employed is on average greater for higher-paying jobs. So the cost to an employer of keeping a job for a returning employee instead of hiring a new person is greater if the job is higher-paid. The subsidy to the high-income members of the target group thus costs more per person.
Income is positively correlated with intelligence, so the smart members of the target group are likely the wealthy members who benefit from this kind of unequal subsidy. They are likely to vote and campaign in favour of the unequal support, instead of an equal cash subsidy for everyone. The less smart members of the target group who lose from an unequal subsidy (compared to an equal one) are less likely to understand that they lose. This makes them abstain from opposing the unequal subsidy.
In effect, the smart members of the target group redistribute a baseline-equal subsidy from the less smart (and less wealthy) to themselves, at the social cost of losing some efficiency in the economy. Keeping a job for someone when a more productive potential hire is available means losing the difference in the productivities of the two people. Such efficiency losses are typical of re-distributive policies that are not cash transfers.
In principle, the cost of the current policies could still be equally distributed between employers by taxing them all and subsidising those who employ the target group. Or equivalently, taxing only those who don’t employ the target group. However, to equalise the cost to employers, the firms employing highly-paid members of the target group must be compensated more than the ones employing low-paid members. The differential compensation to firms would call attention to the unequal support that people with different incomes are receiving, thus weakening the disguise of the subsidy. The clever people want to avoid that, so do not campaign for equalising the costs of anti-discrimination laws across employers.

Why taxes hit the middle class

The poor don’t have much wealth or income, so not much to tax. The rich find it worthwhile to hire accountants and lawyers to find loopholes useful for avoiding taxes. Optimizing one’s taxes is almost a fixed cost (does not depend much on the wealth or income), but the benefit is proportional to what is taxed. In other words, there are economies of scale in tax evasion. The middle class is not rich enough for professional loophole-seeking to be profitable, but has enough to tax.
This is only theoretical reasoning. Empirically, the average tax rate increases in income, as far as I know. Whether the rate of increase should be higher or lower than at present is a matter of political preference.
To avoid the unequal treatment based on the ability to hire tax advisors, the tax system should be simple. Changing income from one form to another (salary to dividends for self-employed for example), or changing the source (foreign corporation vs its domestic subsidiary) should not change the tax rate. Minimizing loopholes means no special deductions for belonging to select groups (farmers, pensioners, veterans, parents).
The existence of a profession for providing tax advice to ordinary people is a sign that the tax code is too complex. Those in a common salaried job should be able to understand and file their taxes themselves.

Lobbying for free insurance

In many countries, farmers have managed to obtain free insurance from the government – if there is a bad harvest (due to drought, flood or anything else), the government compensates the farmers using tax revenue. On the other hand, if the harvest is unusually bountiful, the farmers do not pay a windfall tax to the government (which would reduce the tax bill of other people or provide more public services). There is thus no premium for the insurance that the rest of society provides to agribusiness.
A thought experiment: the insurance for the agricultural industry is bought from some insurance company who has to pay the farmers if the harvest is bad.  The premiums paid to the insurer are taken from the general tax revenues each year. If the insurance company just breaks even (perhaps due to enough competition between insurers, profits are driven to zero), then the movement of money is the same as in the case of “free” insurance by the government.
Agribusiness has managed to pump some money out of other taxpayers with the free insurance. Their success is explained by the classic lobbying theory: if the benefits of lobbying go to a small group, each member of which gets a large sum, then each member of that group has an incentive to put in the effort and money for influencing politicians. If the cost of lobbying is borne by a large group (say the taxpayers), each member of which only pays a small amount, then members of the paying group do not find it worthwhile to make the effort to counterlobby. The savings are too small to be worth the time and money.
If some politician tries to reduce the subsidy to farmers, they are targeted with intense negative publicity. The agricultural industry claims itself to be necessary for “food security” or “feeding the people”. Nevermind that large amounts of food are currently shipped worldwide. Only the import barriers to foreign-produced food are keeping it out of the domestic market. And food security – who takes a country by blockading it into submission these days? A force large enough to surround the country and cut off food import is large enough to take it by storm, which is considerably quicker. Food security really means preventing the rise of food prices. But this is a financial problem and has a financial solution – insurance against a price rise.
If reducing the farming subsidy does not work, a similar effect can be achieved by providing the same subsidy to everyone and raising taxes. Only the administrative costs are higher than in the case of reducing the subsidy. Other industries could argue that they are affected by the weather or other “national emergencies” and deserve compensation from the government. For example, rainy weather reduces ice cream sales and tourism revenues, so the ice cream sellers and the tourism industry could lobby for the same free insurance as the farmers get. If the world price of some natural resource falls, the miners of that could claim an event beyond their control is threatening them with bankruptcy and ask the government for help. If the tastes of the public change so that some form of entertainment is no longer profitable (theatre, opera, classical music), the providers of that can claim to be important for preserving the national culture and the very civilization itself and ask for taxpayer support… wait, that already happens. It is described in the Yes, Minister and Yes, Prime Minister books.
Of course in reality, the subsidies differ across industries, depending on their lobbying prowess. But if the subsidies were proportional to the tax payments of their receivers, they would neatly cancel with the extra taxes levied to finance them. So the government could abolish subsidies by enlarging the set of receivers to include everyone.
By providing free or subsidized insurance, the government is crowding out private insurance – why insure and pay premiums if the government compensates the loss without premiums? This is especially a problem for risks that are common to many voters. For example, a flood is likely to affect the whole neighbourhood, not just one house. In case of flood damage, the people in the neighbourhood can jointly lobby for the declaration of a disaster zone and a public subsidy for rebuilding. So no need to buy flood insurance. With very few buyers, insurance companies stop offering the product.