Cutting Taxes on the Rich Causes Inflation, Again

In my previous post on cutting taxes on the rich and inflation, I explored Jame’s Kroeger’s thesis that, past a certain point, tax cuts for the rich just inflate the price of positional luxury goods and hence do not benefit the rich people. I found some supporting evidence, such as the CLEWI rise and the evidence that marginal tax cuts aren’t good for growth (i.e. don’t increase production).

Apparently we aren’t the only ones to note this type of argument, as I stumbled across something similar in Moshe Adler’s Economics for the Rest of Us. Adler argues that inequality may create price inflation, by giving firms with market power an incentive to provide fewer goods at higher prices. The logic is simple: if the distribution of income is more unequal, the rich will be willing to pay significantly more than the poor and so, in absence of ability to discriminate, the profit maximising price for a firm will be higher.

Adler has a variety of supportive evidence. Firstly, he cites the 14% decline in musicians performing at concerts, instead choosing to perform at private parties for larger sums, and netting a 20% increase in revenue to boot. Secondly, he notes that in New York, high square footage apartments bought by the rich have been on the up, in conjunction with a more than doubling of price per square foot. Thirdly, he mentions that doctors have begun to charge large sums for face time, and as a result are seeing fewer patients. To top it off, he presents survey evidence that rich people often only do these things because other rich people do them, rather than because they need the extra space/goods/time. This is in line with Kroeger’s ideas about positional luxury goods.

But the problem here isn’t just about price rises. As Adler notes, inequality actually reduces the size of the economic pie as well as altering the distribution of it, because fewer goods are provided at a higher price.

The net result of these effects is that fewer goods are produced, and the rich do not get anything that they wanted before other rich people had it, whilst the middle and poor get less. This is pretty substantital evidence against low marginal tax rates.

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  1. #1 by Blue Aurora on March 16, 2012 - 6:37 pm

    Good post, Unlearningecon. You make a good argument against tax cuts for the wealthy.

    However, I have a question that’s off-topic…can you please respond to my last e-mail?

    • #2 by Unlearningecon on March 16, 2012 - 6:45 pm

      Funnily enough I just sent you an email, although it was unrelated.

      Sorry, I only didn’t respond because there didn’t seem to be anything to respond to directly. Perhaps I need to improve my reading comprehension.

  2. #3 by Dave Marsay on March 16, 2012 - 9:56 pm

    Anecdotally, there seems to me to be a strong causal link between London city rewards and house price inflation in the Cotswolds, but little obvious link to their or their families’ happiness. At the other end of the scale increased income seems to lead to increased happiness supported by increased production, rather than increased inflation. If this is so, then presumably utility would be maximized by reducing tax at the lower end. I even think that some (most?) rich folk would be happier with less poor neighbours. But governments are driven by what their supporters think is good for them. Any solution would seem to require a much greater public understanding of economics than we have. Blog on!

    • #4 by Unlearningecon on March 16, 2012 - 11:43 pm

      Thanks. Yes, the obvious example of this (that I somehow failed to note) is the vast disparity between prices in cities and rural areas. This highlights another thing economics fails to take into account – geography.

  1. The Poverty of Mainstream Debate, Part IV: Laffer, Taxes and Trickle-Down « Unlearning Economics
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