There is an ongoing debate as to whether governments should increase taxes on the top 1% of the population and redistribute their wealth. On one extreme there is the argument by Harvard professor Greg Mankiw and his defense of the top 1%. On the other extreme are his opponents as summarized in a post by Paul Krugman, who appears to also join them against Mankiw’s defense. I argue in this article that both of these positions are extreme because the top 1% tax issue is from one side evaluated based on its economic contribution and from the other side based on the disparity of opportunity, amongst other things, leading to a false dichotomy fallacy.

Should the top 1% be taxed at a much higher rate, at 75% or even at 90% as some have suggested? This becomes an economic policy issue but only after some philosophical problems are first resolved. For example, what does exactly the top 1% represent? Can we place on the same level playing field someone like Bill Gates and someone who just inherited a lot of money?  If someone joins the top 1% by adding to productivity, like Mr. Gates has done with his Microsoft Corp., then it may not be reasonable to place him in the same group as someone who inherited a lot of money from his parents and does nothing useful other than spending it or seeking for financial returns.

Is it right to put in the same top 1% group someone who invented a medicine that has saved the lives of millions with someone who invented a machine that has displaced millions of people out of work? I do not think it is because although one may define such set axiomatically, the properties of some of its members may be conflicting with respect to key metrics that measure economic prosperity. It is a fallacy to group all those people together solely based on the amount of their wealth. Similarly, someone who inherited a lot of money but spends a lot of it and contributes to output should not be consider a member of the same group with someone who inherited money, spends next to nothing but instead looks for more return through financial investments in hedge and stock funds. Again, it is not right to group all those individuals together and then start a debate on whether to tax them at a higher rate or not. It is not only a fallacy, it is a very dangerous way of looking at things that can create even more inequality and contribute to many other problems, even to economic turmoil.

Thus, so far I have identified four 1% ( even more general for tax purposes) groups:

A. Those who are self-made and have contributed to higher employment

B. Those who are self-made but have contributed to higher unemployment

C. Those who inherited money but spend a good portion of it every year

D. Those who inherited money, do not spend it but are looking for returns

I argue that each of the four groups should be taxed differently and this may be also a solution to the escalating problem of a digital society and the rapid loss of jobs due to robotic technology growth. Only after a proper classification is made based on philosophical aspects that define what kind of society we would like to have, economic policy is justified. For example, I would suggest taxing the original self-made inventors that contribute to employment growth at just 10%. This will create a high incentive for people to look for employment growth opportunities. At the same time I propose, for example, a heavy tax on digital technology that directly displaces jobs, not on the top 1% only by the way, at a rate of 75%. This will force them to be very selective and target only invention that have a strategic impact, not just displace jobs. Then for a tax on inherited money capital gains I propose a rate of 30% if evidence is presented that 50% of the gains were spent in consumption of goods or services. Finally, a tax of 70% on capital gains of investments that solely seek high returns by indiscriminately investing in the financial markets.

It is surprising to me that such important philosophical  issues, as the tax rate imposed of the top 1%, are approached in fallacious ways that involve false dilemmas and dichotomies, without considering the boomerang effects that this may have. Taxing all rich indiscriminately at a very high rate removes incentives for pursuing the painful path of developing something new and useful at the benefit of rivaling societies. Inventing significantly new technologies is a path that the common wisdom thinks, mistakenly, it is often accidental or due to lack. But the truth is that it is a stressful and very risky path involving a lot of pain and personal cost that cannot be followed just for glory. Those few who can follow this path will seek to escape from an environment of high taxation, or do nothing, something that happened to the Soviet Union and appears that many have already forgotten and seek for indiscriminate income redistribution.

At the same time, it is not ethically but also not economically correct for some who are at the top 1% or even 5% with inherited money to use it for speculative purposes only and enjoy the same benefits as the others who follow the painful path of inventing and creating something new with significant economic and other impact.

So why is it that the problem is presented as tax or not tax more the top 1%? There are some possible explanations about that. Rent-seeking, for example, by inherited money that supports politicians in their election campaigns is one explanation. Those people would like to be put in the same group as the others who earned their money. Fallacious thinking should not be ruled out and nowadays it is very common and slips through even in peer-reviewed journals. Then, it is also the case that envy plays a big role in the stand people take. I am not rich, actually I am borderline poor but I never thought that rich people should be punished just for being rich. Leibniz said this is the best of all possible worlds and there is sufficient reason as to why things are the way they are, i.e. as to why some people are richer and some others are poor. Trying to force a power (Pareto) distribution of income to become more normal will take a lot of energy wrongly spent. Equality or inequality should not be the issue but in economics everything should be evaluated in terms of its impact on major metrics that measure progress and prosperity, employment being the most important at a low inflation rate. If John makes a remarkable discovery that allows planes to be made from a much lighter but stronger material, as an example, and soon joins the 1%, should he be taxed at the same rate as someone who inherited the money from his parents and spends his life at resorts and clubs? Philosophy says no, economics should also say no. Common sense says no, politics should also say no. Those that argue the opposite have obscured motives and possibly a hidden agenda. If we reach the point that we must defend common sense, the game will be lost forever.

Related post

http://krugman.blogs.nytimes.com/2013/06/22/greg-mankiw-and-the-gatsby-curve/
http://www.digitalcosmology.com/Blog/2012/12/11/the-new-digital-world/