Robert Murphy on Progressive Taxation and Subjective Utility

The Austrian argument against progressive taxation, from Robert P. Murphy’s Lessons for the Young Economist (2010), is as follows:

“If preferences are subjective to each individual, and cannot even be measured or quantified for each individual, then obviously it would make no sense at all to try to combine or aggregate individual preferences into ‘social’ preferences. Unfortunately, even professional economists often engage in just this type of reasoning. Many people (try to) justify progressive income taxation, for example, by claiming that ‘a dollar means more to a poor man than to a rich man.’ The idea is that taking $1 million from Bill Gates won’t lower his utility very much, whereas handing out $1,000 to a thousand different homeless people will greatly boost each of their utilities. Therefore, the typical argument goes, total or “social” utility has been increased by the redistribution of some of Bill Gates’s wealth.

… For now, we point out that the typical justification for it is absurd. You can’t add up different amounts of utility from various people. In fact, if you use the alternate term preferences it will be more apparent why combining them from different people is an impossible task.” (Murphy 2010: 42).

The trouble with this is that, just because it is impossible to aggregate the subjective utilities of different people or find some objective unit of measurement with which to make objective interpersonal utility comparisons, it does not follow that an economic argument for progressive income taxes, on basis of diminishing marginal subjective utility, has failed.

Of course, there are problems with the so-called “law” of diminishing marginal subjective utility, as I have shown here, but there is reason to think it is true as a generalised statement.

If any Austrian economist accepts the “law” of diminishing marginal utility (or accepts it merely as a general principle), it follows that a very rich person should, generally speaking, derive less utility from an extra dollar than a person who is very poor, even if one cannot measure the utility in some objective quantity like “utils.”

If indeed there is good reason to think that the value of an additional unit of income to a person who is already very rich is considerably less than the value of an additional unit to someone who is poor, then redistribution of income to promote happiness and reduce hardship has sound economic justification.

And indeed empirical evidence seems to show that as wealth rises, the happiness that one derives from additional income falls or levels off after about $70,000 (US) (e.g., a fascinating discussion of this topic here).

Curiously, it was none other than the Austrian economist Friedrich von Wieser who prided himself on having provided a solid economic justification for progressive taxation on the basis of diminishing marginal utility. Modern Austrians apparently choose to forget this embarrassing fact.

The argument against progressive taxation that we cannot objectively “measure” the utility lost by the rich man as compared with that gained by the poor man does not necessarily refute the argument from diminishing marginal utility: for it requires a highly unrealistic assumption, as we shall now see.

If we were to take two poor people both with the same income, and imagine one becoming extremely rich while the other remains poor, the argument against progressive income tax could only work if the utility the rich man derived from a unit of money while poor was vastly – and indeed unrealistically and extremely – greater than that of his fellow, so that as each additional unit of money the man received – even to very high levels like millions or billions of dollars – the diminished utility still remained so high that it exceeded that of his fellow who still remained poor.

Now of course individuals display variation and can and do have different degrees of subjective utility in terms of the satisfaction that they derive from any good x (and even from a unit of money), but to believe that all or most rich people derive greater utility from one unit of their money than a poor person from one extra unit again requires the ridiculous assumption that, if (hypothetically) or when (in reality) they were poor, all or most of these rich people derived a degree if utility vastly – and indeed unrealistically and extremely – greater than that of other poor people.

This, quite frankly, violates everything we know about human psychology, neuroscience and evolution. Human beings are all products of Darwinian evolution; they have the same fundamental biochemistry and neural processes in the brain; the mind and all its emotions, like happiness, satisfaction and pleasure, are causally dependent on brain processes. People do display individual variation in many traits – such as height, eye colour, and no doubt in what economists call utility – but not to the extent that average people have such a vast difference between them as would be required in the case we have imagined above.

But we need only think of height here. Most human beings have a height between 5 feet and 6 feet, and even exceptions (apart from highly usually things like dwarfism and gigantism) do not deviate too far from this range. Height is a product of genetics and environmental influences. There is every reason to think that the propensity to feel emotions like happiness, satisfaction and pleasure – the emotions that the word “utility” in an economic sense describes – are a product of genetics and environmental influences too, with individual variation, but not so vast that the utility felt by two average people while poor is so vastly different that one million dollars or $100 million – under the principle of diminishing marginal utility – given to one man would still not reduce his utility from one extra dollar to a level below that experienced by the other poor man from one extra dollar.

In short, Austrians, like neoclassicals, if they really accept the “law” of diminishing marginal utility without the ridiculous assumption we have identified above, then the economic argument for progressive taxation from diminishing marginal utility is hard to refute.

Of course, they might make a moral argument from Rothbardian natural rights or Hoppe’s argumentation ethics, but this is clearly a different type of argument from the one based on subjective utility.

BIBLIOGRAPHY
Murphy, Robert P. 2010. Lessons for the Young Economist. Ludwig von Mises Institute, Auburn, Ala.

Friedrich von Wieser on Progressive Taxation

It is not often you find an Austrian economist justifying progressive taxation, but here is the early Austrian Friedrich von Wieser using the subjective marginal utility theory of value to do just that, albeit in a very conservative manner:

“The ultimate basis for any progressive rate of taxation is to be found in the general scale of desires. According to this basis the personal value of the money unit is appreciably higher for the first thousand than for the second and is hardly to be compared with the appraisal in the case of the 99th or 100th thousand. Furthermore, the difference between the first and second thousand is appreciably greater than that between the 99th and 100th. Thus, all tendencies of the modern policy of taxation find a firm theoretical basis in the concept and laws of economic value.

It is not the function of the state in any of its administrative branches to interfere with the private constitution of the economy. This is an historically tested social institution which the state is bound to accept. This holds also in the administration of taxes. The state should never so use its prerogative of taxation as to eliminate existing inequalities of income and property; but in determining the contributions to be demanded of its citizens it should take into consideration the gradations of personal value that are the expression of the inequalities of income and property. The plan of the state’s management would offend economic principle were the private economies which are being assessed to be treated as units of equal wealth.

A consideration of personal valuation in the assessment of taxes and progressive taxation in particular has its prototype in a phenomenon of commercial exchange that was discussed in the case of a monopoly of supply in connection with the doctrine of joint costs. It was seen that a monopolistic classification of the demand, popularly felt as exploitation, may at times be the only available method of sufficiently increasing the yield of a socially required enterprise to ensure its continued operation. Special reference was made to experiences in connection with the operation of railroads and canals. Had it not been for the rule to charge what the traffic will bear, many extensive enterprises could not have been carried through. A progressive tax is the application of the principle to the whole administration of the state. Precisely as the railroad tariff classifies both travellers and merchandise in order to realize the large revenues that are required for the financial obligations of the road, just so a progressive rate classifies tax payers in order to assess each according to his tax-paying ability. It has become recognized that each must pay taxes according to the margin allowed by his circumstances, if the public economic process is to be maintained. A progressive tax-rate and a consideration of personal wealth in a system of taxation are therefore logical applications to public economy of experiences practically tested in private economies. The heavy burdens falling upon financially weaker households, owing to the increased demands of modern public economy, can only be relieved by a policy that continuously undertakes so to assess the compulsory contributions of citizens that the more wealthy are taxed correspondingly higher. By such a distribution of taxes a public economy may obtain the widest possible extension of its boundaries without violating in any particular the limits drawn for private economy.

Up to a certain point the modern state thus approaches the socially equalizing use-value computation of the simple economy. But it does this without offence to the spirit of the private constitution of the economy itself, for it refrains from interfering with private property as such and the historically transmitted inequality of its distribution. Modern policies of taxation do not seek to rectify the existing distribution of wealth. They are intended to do no more than adjust the incidence of the burden of taxation in accord with the distribution of wealth, so that the margin of use by the state economy may be extended through the larger contributions of those citizens whose incomes allow them a broader margin of use in their private economies.” (Wieser 1927: 433–434).

Of course, by modern standards, this is a very conservative justification of a limited progressive tax system, not concerned with abolishing or seriously diminishing historical inequality of wealth.

But, by the standards of his day, Wieser was regarded as a type of progressive liberal, as Hayek noted:

“I was personally a pupil of [sc. Eugen von Böhm-Bawerk’s] … contemporary, friend and brother-in-law, Friedrich von Wieser. I was attracted by him, I admit, because unlike most of the other members of the Austrian school, he had a good deal of sympathy with a mild Fabian socialism to which I was inclined as a young man. He in fact prided himself that his theory of marginal utility had provided the basis of progressive taxation, which then seemed to me one of the ideals of social justice.”
F. A. Hayek, “Coping With Ignorance,” July 1978
http://www.hillsdale.edu/news/imprimis/archive/issue.asp?year=1978&month=07

It is often forgotten that there was a liberal and interventionist wing of the early Austrian school.

But, to return to the main point, Wieser’s defence of the “historically transmitted inequality” of wealth on economic grounds is not convincing. Once the theoretical economic justification for vast or significant inequality of wealth falls apart (as it did indeed after Keynes’s revolution in economics), then the same idea from marginal utility theory can also be used to support some degree of wealth redistribution. (I am not thinking of total wealth equality, however, but simply a reduction of gross inequality to eliminate poverty).

If indeed there is good theoretical reason to think that the value of an additional unit of income to a person who is already very rich is considerably less than the value of an additional unit to someone who is poor, then redistribution of income to increase happiness and reduce hardship has sound justification.

And indeed empirical evidence seems to show that as wealth rises, the happiness that one derives from additional income falls or levels off after about $70,000 (US).

This is a fascinating discussion of this topic here, in the context of a debate about secular ethical theory and the scientific basis of ethics.


BIBLIOGRAPHY
Wieser, F. von. 1927. Social Economics (trans. A. Ford Hinrichs), Adelphi Company, New York.