Desirable Effects of Income Taxation IV Dissipative Signaling
From now on, these posts will be reviews of the established literature. I will assume, as is standard, that people are completely selfish. The point is to show that, even if people are selfish, there are desirable incentive effects of income taxation.
As is often the case, the results of 50 year old theory turn out to depend on the assumption of symmetric information. If some agents know things that other agents don’t know, then free market outcomes can easily be Pareto inefficient.
One very old example is due to A Michael Spence who considered a model in which people don’t learn anything useful in college, but get degrees just to prove they can. Spence was dean of Harvard’s faculty of Arts and Sciences, so he should know. Basically the idea is that what matters is having the diploma not knowing how to read it. In fact, I personally possess a diploma signed by a Michael Spence which is written in Latin — a languge which I can’t read (although I can guess that Cantabrigia is the very old word for Cambridge).
In this model getting a degree requires unpleasant effort and is not accompanied by any useful or delightful knowledge. The point is that more able people can get the degree with less unpleasant effort. Also employers want able employees and pay people they know are able more.
The model has 2 Nash equilibria. In one, no one gets a degree. In the other, only the able get a degree — the effort demanded (potential including the major and maybe even a GPA above some level) is just enough to scare away the less able.
This equilibrium is inefficient. Students study and suffer for no socially valuable reason. The (partial) solution is an income tax. By reducing the (post tax) reward given to those who demonstrate ability, the temptation of the less able to try and fake it is reduced. This means the required amount of signaling is reduced. This helps the able.
If there are lots of able people and few less able people, the tax can cause a Pareto improvement. It can be cheaper for the able to pay the less able to admit that they are less able, than to scare them off with a very demanding signal..
Even if the tax and transfer is not Pareto improving, it increases money metric welfare (the silly measure which is not increased by lump sum taxes and transfers which take from the rich and give to the poor).
Signaling is probably a very general phenomenon. This is suggested by the phrase “dress for the job you want, not the job you have”. My mom tried to convince me that it was worth the effort to learn how to spell as it worked as a signal (she didn’t convince me but — hey spell checkers eliminated that signaling mechanism — also taught me how to spell most words with instant feedback).
There is another still more obvious way in which asymmetric information might create good incentive effects of income taxation. The more informed party is often tempted to lie to the less informed party. There is a huge literature on mechanisms which can prevent this. In the real world, one of them is prosecution for fraud. Here the gain from lying is often some number of dollars, and the potential loss is not. The income tax can keep people out of grey areas of the law.
It is true that the income tax doesn’t tell people which way to head out of the grey area. The income tax is not relevant to blatant criminals who must hide what they do and who, with notably rare exceptions, do not suffer if they add income tax evasion to their other crimes.
On the third hand, another desirable effect of the income tax was the conviction and incarceration of Al Capone.
I’m going to add absurd CEO compensation to the list. I consider extremely generous CEO compensation to be legal embezzlement. It isn’t prosecuted, but, if the CEO goes to far, it can be profitable for a predator to get 5% of the rent (boodle) by taking over the firm. Or shareholders might revolt and elect a board which fires the too greedy CEO. It is a fact that tax cuts were followed by the explosion of absurd CEO compensation. I don’t think that was an accident (although allowing people to hide income as capital gains was as important as the top marginal income tax rate).
Here again, I have to not an undesirable effect. The point is that the income tax makes greedy CEOs more risk averse. That is good. It also makes greedy potential entrepreneurs more risk averse, which is less ideal. The point is that, short of prosecution, there are lots of relatively rare punishments which scare people and which are not purely economic. I think that they are generally socially useful. Their relative strength compared to monetary incentives is increased by income taxation. I think that, on balance, this is a good thing.
A high income tax makes bosses more generous, Since your workers are in a much lower tax bracket, you can raise their take home wages by a dollar at a cost of maybe 20 cents out of your own pocket.
Yes . . .
Waldmann
it would be nice to see the theorists refuted on their own terms, but i have my doubts about any argument that begins by assuming something that isn’t true.
first, people are not completely selfish, second they are not well informed, and third they can be pretty stupid at reasoning from even good information.
kaleberg
maybe some bosses are generous. i think most of them would rather keep the twenty cents for themselves.
an honest government (another contrafactual assumption) could make the analysis that a higher wage or higher tax would improve the economy and even make the bosses richer. but we haven’t had an honest government since FDR. (not that he was strictly honest in everything he said, but he was honest in what he did…that is, faithful to the idea of improving the economy and protecting the poor (workers) from the hazards of life under capitalism and, oh yes, defeating fascism).
today we seem to have fascism with a kinder and gentler face*…which may be why “neoliberalism” doesn’t work: the rulers can’t help but think of their own interests, even while the believe they are following “sound economics”
*no public show of force. except when necessary.
Coberly,
You are correct and ROTFLMAO funny. Waldmann was correct, but not as funny and may take a careful read to understand in detail. If a frog had wings then it would not bump its ass every time it jumped. “If…, then” conspire to either inform or confuse as they qualify arguments according to ones perceptive ability.
In any case, this topic is moot. So, I would not lose any sleep over it.
Thorstein Veblen was really on to something.
Looked it up. Thorstein Veblen died here on Sand Hill Road, now address to many a Venture Capitalist Firm.
Ron
i did not turn down a full ride, nor was i ever a true nerd (or even especially talented), but I had some encouragement and visited the campus where I had a friend who was a post doc. while i was there i got the feeling that this was where all the evil i felt in my lesser colleges emanated from. other than that most of what i have been saying is not meant to be God’s word. Nevertheless I learn something from your corrections.
Ken,
I never read The Theory of the Leisure Class, but on the surface of the many synopses of it that I did read, then it implies social order derived from inheritance rather than mythic meritocracy.
Ron
I still believe in reptile hearted beings from outer space.
i did look at a video with a man who wrote a recent book on the ruling class. he didn’t say anything interesting except that about 6000 people control pretty much everything. I don’t know if they are meritocrats, or if the meritocrats just work for them. meanwhile i suspect that if one looks, the ancient inherited aristocracy is still around. [I think Bruce Webb would have told me that no, they pretty much killed themselves off fighting their cousins for power.]
Coberly,
As I looked for a conclusive definition of meritocracy I found instead different enough definitions to defeat any conclusions. In common usage then merit implied ability, but one must still question ability as to whether it is proven by standardized test or accomplishment. Our friend Charles, a.k.a., Thomas Hobbes believed that accomplishment was the only acceptable proof. Then that led to the belief that if someone were wealthy, then they deserved it. So, then the tax collector is better at distinguishing earned income from unearned income than the philosopher.
Is it possible that when the dinosaurs faced impending extinction because an asteroid was headed to planet Earth, then rather than drill into the asteroid and explode it with a nuke, they chose to leave the planet in space ships? The human form version of the asteroid story is recounted in the 1998 film Armageddon starring Bruce Willis, who nobly stayed behind to set off the nuke that blew up the asteroid. Along with A Dog’s Journey and Apollo 13, Showtime has been providing nonstop inspirational films continuously since the first peak of the pandemic. Maybe cable TV programmers are the real meritocracy. They are at least better liked than billionaires, politicians, and bureaucrats.
Ron
Opiate of the people? I like Bruce Willis. His idea of comedy suits me almost as well as Road Runner.
I have read a couple of books about “the” meritiocracy. seems well defined. trouble with the books is that though they had an insight that something was not well, the authors couldn’t let go of their own membership in the meritocracy well enough to say clearly that graduation from Harvard does not guarantee honesty or even reasonably deep thought in the subject of their own specialty.
On the other hand, centuries of hindsight shows up the limitations of Hobbes, Calvin, and … other deep thinkers.
Coberly,
Yes sir.
A Harvard degree is closer to a standardized test than an actual achievement. When I think of achievements then I think of Jonas Salk, Henry Ford, and founders of Doctors Without Borders, Max Recamier and Bernard Kouchner. Ford started out as an apprentice machinist. OTOH, doctors without degrees do go to prison if they are caught. So, degrees have their place, just not the end all or even the be anything more than a prerequisite to some achievements.
Anyone that thinks that religion OR television is the opiate of the masses really got ripped off when they scored their opium. Not my thing, none of them, but I understand their place in society at least within the limitations of human empathy. The depressed seek depressants, which is a bit difficult to comprehend, such as alcohol and opiates to dull the pain. Religion and TV each offer a little bit of escape from reality without the mind numbing depressant. Those that have a difficult time dealing with reality in large doses do benefit from some escape, but it is not healthy to life in the here and now with any kind of obsessive compulsion.
As for myself, then Tom Rapp expressed it best in a line from his 1968 song “Sail Away” from the album These Things Too, “I do not want to escape from reality, I want reality to escape from me.”
not so sure that religion, as practiced, or television especially, are not mind numbing depressants. (religion as thought about by careful thinkers is not mind numbing.)
but neither is alcohol at first. currently dealing with an alcoholic in the family. he was recently told by a doctor that he was inches away from killing himself with alcohol. his reponse was to go out and buy a bottle of tequila and drink it all. i had been suspecting that he wanted to kill himself. this seems to confirm it.
i don’t think he started drinking with that in mind. but alcohol seems to reduce one’s ability to cope with reality and then offers itself as the cure for the depression that follows from that. does not appear to be a way anyone from outside can do anything to stop it…. maybe short of taking the victim out into the deep woods and getting him lost without alcohol. i don’t know much about AA, but I think it begins with some last desperate decision of the victim that he wants to be cured. i think religion works the same way… unless you fall into a cult disguised as religion.
as for degrees, i don’t know about ordinary harvard graduates, only the “successful” ones. probably a degree from anywhere is often achieved by people expecting it to be a ticket to success. as such it is worthless…except of course if the same level of ambition keeps them working at it… i am afraid that “it” is something they don’t really give a damn about except as a path to “success.”
Coberly,
I was raised with religion. In my case sending me off to church with the deacon’s family living across the street from us each Sunday was how my parents obtained such privacy as they desired for a couple of hours each week. It made them happy and the moral logic of it was not foreign to me. I was more trouble for the church people (except one minister until he got fired) than it was for me. I actually took religious ethics seriously to the consternation of my congregation. My attempt to racially integrate services was probably what got our pastor fired.
In adult life I have found that the fellowship of the Church is beneficial to the community. Also, in recent years with funerals vastly outnumbering weddings in the circle of family and friends, then that promise of an afterlife helps people rationalize their feelings for lost loved ones. Then the Church is like a crutch for a broken heart.
well, maybe it’s a crutch. but you don’t throw away your crutches just because they are not real legs.
on the other hand, the church might know something. perhaps something that most (some?) people don’t understand very well, but who among us understands “god” (whatever that means) anyway?
while i am sure that the people running around yelling “god” as their excuse for treating their neighbors badly aren’t very clear on the concept, somehow the concept remains.
i think we would all have broken hearts if we did not hold our breath and look bravely into tomorrow’s work schedule, with the help of a crutch or without it.
Coberly,
“… but you don’t throw away your crutches just because they are not real legs…”???????????????????????????????????????????????????
[Yeah, I am not feeling you there. Also, I don’t know any “people running around yelling “god” as their excuse for treating their neighbors badly,” but maybe have seen something like that on one of the Law and Order TV series.
Back in 1965 my Southern Baptist congregation was only ready to have just a few token blacks come to our services rather than hold joint congregational services. That sucked, but even they did not blame their shame on God. They knew what they were, which was why they had to get a young firebrand minister that would direct his righteousness against beer at Bowl America rather than institutionalized racism.]
maybe my poetry is too obscure. calling christianity a crutch is usually understood to be a put down…by people who think having two strong legs makes them superior to some guy with a crutch.
as for people who call themselves christians citing Paul to prove god hates gays…well, their ilk is a standard of at least fiction if not real life (i think they are real)…but if any of them had read the next paragraph in Paul’s letter to the Romans they would have understood that he was saying someting else entirely. something that would have made themselves ashamed of themselves, if they had any understanding, if they had any shame.