Warren Buffett wrote in the New York Times today advocating for a higher tax burden on the mega-rich. Initially reactions seem to have divided along partisan lines--Democrats are praising Buffett for his courage, while Republicans are berating him for his cowardice. The Republican argument follows that if Buffett really thinks the mega-rich should be paying more in taxes, he would simply write a check for the difference in his current tax rate and what he believes is appropriate. This simple moral argument appears to have numerous supporters, as demonstrated by this slightly older piece by Gregg Easterbrook. There is a problem with Easterbrook's logic, however. He assumes that by voluntarily paying more in taxes, any rich person who advocates for higher taxes would appear more sincere and that this would lead to an appropriate increase in taxes being raised by law.
I'm personally at a loss as to why Easterbook thinks voluntarily payments by wealthy individuals would make a Congress more likely to raise taxes on the rich. Perhaps he believes that Congress will feel guilty and "do the right thing." This view of Congress is so painfully naive that I can't imagine this to be Easterbrook's argument. It resembles evil Disney villains who realize the error of their ways only in the humbling light of the sweetness and light that is the Disney hero. This is not an American Congress.
The fact of the matter is that Easterbrook is not truly considering how Congress operates. He is simply calling into question the sincerity of President Obama, Bill Gates, Warren Buffett, and any other wealthy person who might advocate for a tax increase on their own tax bracket in an attempt to discredit their position. Easterbrook hardly touches on the merits of such an increase (he seems to indicates it's a necessary along with other measures, but that point is certainly muddled among all the ad hominem attacks on these men), and he relies on incorrect notions of how individuals affect social decisions to come to his bizarre conclusion that unless Obama, Gates, Buffett, and other start voluntarily paying more in taxes, our deficit problem will get worse.
It is worth examining what effect, if any, the voluntary payment of excess taxes would have on society. Mathematically we have tools to do just that. The field of game theory provides the means to model the effect of individual behavior on the behavior of a group, and simple game theory models provide some insight on Easterbrook's erroneous conclusion.
In game theory, a matrix of possible outcomes based on each individual's decision is constructed and a weight is assigned to each outcome to allow for the maximization of "utility." Without going into too much detail about the nature of game theory, some simple examples can be used to approximate various scenarios of voluntary excess tax payments by individuals in society. For the first example, let's assume the total relevant population consists of Warren Buffet, whom we will simply call "Mr. A," and one other super-rich person who doesn't share his views, whom we will call "Mr. B." In this scenario, Mr. A would like for everyone to pay $500 more in taxes. These tax dollars will then be used for the benefit of the total population (n=2 in this scenario). The resulting matrix of outcomes looks like this:
B's choices
pay more don't pay more
A's choices
pay more -$500, -$500 -$500, -$0
+$500,+$500 +$250, +$250
Totals: $0 , $0 -$250, $250
don't pay -$0, -$500 - $0, -$0
more +$250, +$250 +$0, +$0
Totals: $250, -$250 $0, $0
The first line of each cell is the individual costs of their decision. -$500, -$500 indicates that Mr. A and Mr. B chose to pay $500 more in taxes in the top left cell. The second line of each cell is the benefit received in the form of government services due to the increase in voluntary taxes paid. +$500, +$500 indicates that each individual gains $500 in extra government services. The totals line indicates the combined cost in additional taxes as well as the individual increase in benefits. Mr. B's motivation is to maximize his personal total gain in the matrix. To calculate this, we must simply find the cell(s) with the largest total benefit for Mr. B, which is the second entry in each cell. Looking at our outcome matrix, we see that Mr. B maximizes his personal benefit in the top right cell. This means that Mr. B is hoping for Mr. A to voluntarily pay more, while he pays nothing extra.
Mr. A has chosen to pay additional taxes because he believes, similarly to Mr. Easterbrook, that by doing so, this will lead to Mr. B paying more in additional taxes. However, Mr. B considers the graph above and wants to maximize his personal gain, therefore he pays nothing extra. This results in a personal gain of $250 for him, the best he can hope for under any circumstance.
After paying extra taxes, Mr. A is now angry that Mr. B did not follow suit. Therefore, Mr. A now STOPS paying additional taxes the next year. Mr. B, always looking to maximize his personal benefit, goes back to the outcome matrix. He can still choice to pay more, but why would he? This results in a total loss of $250. His best move is to simply continue to pay no additional taxes. Now, however, he simply maintains the status quo and no one gains anything. As it turns out, Mr. A cannot persuade Mr. B to pay additional taxes by paying more taxes in this overly simplistic scenario.
Having gone through that tedious exercise, now let's expand the model. Let's include a "Congress" and a federal deficit of $1,000. Mr. A and Mr. B will continue to be the only taxpayers though. In this scenario, Congress must come up with an additional $1,000, but they are reluctant. Mr. A decides to pay an additional $500 in taxes hoping that this will persuade Congress to raise the rates on everyone. Because we have introduced a deficit, our matrix now has no additional government benefits, and the total benefit for each individual is now equal to the individual cost only, or the top line in each cell of our matrix. What happens now?
After Mr. A pays his additional $500, Mr. B must decide what maximizes his personal gain. It still appears that paying no additional taxes is his best bet. Here's where the analysis gets tricky. Congress now has a deficit of only $500. Congress must raise the base tax rate only enough to collect $500 total. Therefore, Congress raises taxes on both Mr. A and Mr. B by $250 each. Mr. A is now pissed! He wanted taxes to be raised by $500 each! Therefore, he stops making an additional voluntary payments after Congress raises taxes by the lesser amount. Only then does Congress have the need to raise taxes again to the full amount Mr. A thought was appropriate. Mr. A could have continued to pay an additional $500 to balance the federal budget, but then he's paying $750 more than the original base, while Mr. B is only paying $250. This is not what Mr. A wants.
In fact, the only way that Mr. A can have Congress raise the tax rate to the amount he wants is to not pay any additional taxes. Until Mr. A stops paying additional taxes, Congress will never have the incentive to completely raise the tax rate for everyone. The rational decision for Mr. A then becomes simple. His best decision to maximize personal benefit and eliminate the federal deficit in our model is to never pay voluntary additional taxes in the first place so that Congress must raise the tax rate by the full amount.
While this model is overly simplistic, the logic holds in larger, more complex scenarios like the one addressed in Mr. Buffett's article. By paying additional taxes voluntarily, Mr. Buffett and all the mega-rich who think like him would be creating a disincentive to Congress to fully accomplish their goal. Paying extra actually acts as a hindrance to their goal, and the rational conclusion is to never pay additional taxes voluntarily. With that being said, Mr. Easterbrook is simply wrong.
I don't know how to get congress to see the error of their ways other than through bold actions. Logical debate certianly has not done it so far. Frankly I have zero faith that congress will do anything positive on their own. I think it's kind of nieve to think they can. You can put your faith in more logic and "debate" I'll put mine in bold actions. We'll see what drives real positive change first. I guess I don't know for sure but I have a hunch it will be the bold action. History tells me so.
ReplyDeleteThanks for the comment, but what from history tells you Congress responds to "bold action?" My view is that Congress responds to share drops in market share value over anything else.
ReplyDelete*sharp drops
ReplyDeleteThis game theory explanation makes things very clear. I said the same thing with no real proof. Thanks for providing the proof. Now -- do you see anything that will work to get congress to raise taxes on those making over one million dollars?
ReplyDeleteWith American politics as polarized as they are, it would require a large shift to the left. Republicans of all stripes refuse to consider any tax increase, and thanks to the large lobbying effort behind the tax cuts, they aren't budging any time soon. Basically, pray for progressive Democrats if you want to see a shift in the top end.
ReplyDeleteI have some hope for comprehensive tax reform that will expand the tax base, reduce the loopholes, and lower some of the marginal rates (you don't need them as high if the deductions are removed). However, hoping that reform will have high end tax increases is probably not politically viable still.
I keep seeing references to game theory but never looked into it. Nice example.
ReplyDeleteBut is the logic really that people expect to persuade congress to raise rates by giving voluntarily? Do you even need game theory to discredit that? I can't imagine Congress ever doing something for any other reason than it had to, at least as far as tax increases. Giving them money voluntarily lets them off the hook.
Actions always speak louder than words. What makes you think more hot air from a rich white man will influence congress?
ReplyDeleteI really can't believe so many people don't think Obama and Buffet should back up their claims with actions. This is why we have the congress we have. Voters don't expect actions to match the retoric!
ReplyDelete@Aynrandvirgin--no, you don't need game theory to discredit it. The basic notion that someone should gain Congressional influence by "donating" money is inherently corrupt. It's describing de facto bribery. However, there is a persistent notion that voluntarily paying an increased tax rate is in the interest of the advocate. Game theory shows us that the opposite is true.
ReplyDelete@Action Boy--whoever said I thought he was going to influence Congress with a NY Times Op/Ed piece? I'm simply pointing out the flawed logic of his critics. Moreover, who really believes Buffett is really trying to influence the CURRENT Congress himself? Op/Ed pieces like this one aren't intended for Congress; they are intended for the voting public. Buffett is attempting to persuade the electorate which would indirectly affect future Congresses by changing their political composition.