Discouraging Effort and Success

Why do we tax labor? We know that any tax on an activity discourages people from engaging in that activity by reducing the rewards for doing it. So why do we tax hard work, production, and wise investment? Do we really want less of those things?

We need to fund our government (some claim), so we need to tax something. Why not tax behaviors that we want less of? Wouldn't that be killing two birds with one stone?

What would happen if we ditched all income taxes (including capital gains, and corporate income taxes) in favor of taxation levied exclusively against consumption? How would our society change?

I imagine a system wherein my income is not monitored by the government, but the total amount of my consumptive spending is instead. It's easy enough to do - just give up cash and require banks to report the amount of spending. As long as my consumptive spending total for the tax period stays below a legally established minimum, I pay no tax. But when my total rises above that level, I begin to pay tax out of each additional dollar spent. So if I don't spend much beyond the limit, the taxation I experience will be very low.

There are many advantages to such a system. For one, we'd stop punishing smart and hardworking people for being so productive. Every dollar they earn would be theirs to keep. This would include dollars earned for good investments (capital gains). Similarly, we'd stop punishing businesses for competence in producing and selling products and services to people who need them. When a highly successful business has to pay a large amount of income tax while its less successful competitor pays no tax (due to writing off business losses) the playing field is being unfairly tipped to reward poor performance! Not only that, but why tax production at all when production is what gives us the things we need and desire?

Also very important is the fact that taxing consumption, instead of labor, production, and investment, allows individuals to adjust their tax liability to fit their circumstances and desires. If I don't want to pay so much in taxes this year, I can reduce my consumption and pay less. And, I bear no penalty for working extra hard to earn additional money to fund my future, or my children's future.

Under this kind of system saving would be strongly incentivized. For those who wished to avoid taxation, saving and wise investment would be the safest harbor for their money. Everyone would be faced with compelling reasons to defer spending to a later date. Government subsidized retirement could become unnecessary for average Americans.

It's possible to take this idea to a more extreme level and suggest that leisure (time spent not producing or learning) could be taxed when it exceeded a certain minimum amount. This could spur the indolent and chronically unemployed (whether poor or wealthy) to return to productivity, lending their efforts to the improvement of society.

Undoubtedly there are many weaknesses in such a plan, and opportunities for clever gaming of the system. But that is no different from our current system for taxation.

Are there structural problems with this proposition?

The Future of Labor

In 1850 about 50% of Americans made their living as farmers or farm laborers. In 2000 it was about 1%. Increases in productivity can dramatically decrease the demand for labor in a particular part of the economy. This is all for the best, but it is difficult for the displaced laborers.

I haven't seen data to support it, but the conventional wisdom is that demand for unskilled labor is in steady decline. One story to illustrate this idea is that increased automation in factories eliminates unskilled positions, but may increase the number of skilled positions in the form of an expanded technical staff who develops and maintains the automation equipment. I think that story is at best an oversimplification of reality (e.g. increasing automation may mean that a factory doesn't eliminate jobs but trades skilled labor, like machinists, for unskilled labor in the form of machine operators who only need to push some buttons and measure parts), but even if it's accurate it doesn't tell us what's happening to the number of unskilled labor positions in the overall economy.

Productivity increases in an industry lower the cost of production for that industry, meaning that society can spend less on that industry's products. That's why I spend a smaller percentage of my income on food than did my grandfather, and why fewer people are working on farms today than were in 1850. As we've gotten to be better at producing food we have saturated demand. The US produces more food than it knows how to consume. You can just as easily blame farm worker displacement on the 'low' demand for food as on high farm worker productivity.

Interestingly, increases in farm worker productivity have lowered the costs of non-farm products as well, because all that displaced farm labor was freed up to be used to produce more valuable items like cars and houses. And now we're choking on too much supply of those items as well (due to increasing productivity), and workers are again being displaced.

As Arnold Kling puts it:

"...before you tell me that we are outsourcing to China, you should remember that (a) our manufacturing output has been increasing, even though the number of people working in that sector is declining; and (b) employment in China's manufacturing sector has been shrinking, also."

So what is the future of labor, skilled and unskilled? Continual displacement from one industry to another, and a falling cost of necessities and luxuries. These are near certainties. But what else? Will the unskilled be left behind? The unskilled will always earn less and be less productive than the skilled, but I don't see any evidence that they are simply being left without work. I do see that average, middle class people are spending more of their income on paying someone else to care for their lawns, to service their cars, and to clean and repair their homes.

One day cars will be rolling off of 'lights off' manufacturing lines, with only a handful of humans monitoring entire factories. I don't believe that we'll have high unemployment, or (more to the point) a human welfare crisis when that day arrives.