In a previous post, I explained my reasoning for picking choice number three out of Bryan Caplan’s list. I wanted to further explain how hard it is to remove yourself from normative statements. I submit the following:
- Marginal tax rates can affect growth by reducing incentives and productivity, which can lead to a higher level of absolute poverty in the long run.
- In the long run, growth is very important as it lowers the level of absolute poverty, so we ought to avoid very high marginal tax rates, which can adversely affect growth through incentives and productivity.
As you may have surmised, the second sentence is a normative statement. But why is it a better statement than the first? Well, it all depends on the receiver. When talking to other economists, neither statement is actually “better”. Why? Because economists intuitively understand how growth relates to welfare. Consider the following (hypothetical scenario):
Country one has high marginal tax rates of around 70%, high levels of redistribution, and is thus very egalitarian. Country two has low marginal tax rates of around 20%, very modest levels of redistribution, and is thus relatively inegalitarian. Normalize economic growth at 10%, and suppose every 10% increase in marginal tax rates translates into -.5% growth. Country one ends up growing at a rate of 9%, while country two’s growth rate is 6.5%. What does the growth patterns in each country look like if country two starts with a GDP of 11, and country one start with a GDP of 10?
While initially, the the efficiency losses in the country two may be compensated by redistribution, in the long run, it becomes an exercise in pure leveling down. A short 15 years later, everyone in country one is better off in an absolute sense, as country two has an income of 26% less than country one. The problem in places like China is there not that they have a poor income distribution (indeed, their gini is similar to the US). The problem is that they have a lower absolute level of income. This is why high levels of economic growth is particularly important in poor countries.
However, this is very counterintuitive to the lay person who supports redistribution (unfortunately so, as it often leads them to conclusions that are opposed to observed reality in many areas). So, going back to the original statements, the first is unlikely to move popular opinion. For an economist to have any impact at all, the second statement has to be made — even though the proof substantiates both statements. This is why it is important that economics doesn’t divorce itself from normative judgement…but is careful in it’s methodology to use normative statements to describe real effects.