Taxes are Tough

I recently wrote a blog post on how student loan forgiveness constitutes a regressive tax. You can find the argument here. You can also find some empirical evidence in the form of a working paper here, which I found on Marginal Revolution. While my overall stance hasn't changed, I've gotten some good feedback on that post, and I intend to address that feedback here and maybe later as well through a few other blog posts. I'll start with a particularly insightful comment and use that as the theme for this particular blog post. The comment goes like this (courtesy of David Jinkins at the econ department at Copenhagen Business School):

'' The way I see if, the federal government will now need to raise more than expected over the coming years to offset the revenue loss from the student loans. Doesn't whether the tax is regressive or not depend on how they do that?

I find discussions of progressivity of taxes complicated, because progressivity is always relative to a particular tax base, and people often have different things in mind -- income, expenditures, wealth, etc.''

David is absolutely right - whether or not this forgiveness program is regressive or not does indeed depend on how this revenue is ''made up''. That's because this loan forgiveness isn't a tax in that people have to pay money now - it's a tax in that the federal government lent people money to be paid back, and now that money is no longer going to be paid back. The federal government has now lost revenue that it was previously banking on, and revenue for the federal government comes in the form of taxes. So, my prior post was remiss to not consider potentially non-regressive ways the federal government could try to use to make this revenue back up. However, it's even more complicated than that when we consider the fact that governments are incapable of deciding how regressive or progressive a tax is.

Governments are incapable of deciding how regressive or progressive a tax is, because there is a difference between who receives the tax bill, or who receives the tax impact or tax burden, and who actually pays the real costs of a tax, or who actually receives the tax incidence. The difference between tax impact and tax incidence is explained very well in a few Marginal Revolution videos here and here.

I'll explain it very briefly here too - just because someone receives a tax bill and has to pay it does not mean that person pays the actual costs of that tax. We can see why with a clear example. My dad owned a gas station, so I'll use his old store as the focal point of my example. Say my dad is selling bananas at $1 per banana, which includes all current taxes. However, say the city of Jackson decides to increase the tax on bananas by $1, making the new price of bananas $2 (this would be a huge, unrealistic tax increase, but it makes the numbers easy to work with and doesn't change the implications of our analysis).

Who pays this tax? Well, the initial tax impact or tax burden falls on my father. When the city of Jackson goes to collect taxes, it doesn't go to each individual buyer of bananas and collect taxes from them based on how many bananas they bought - that would be very cumbersome and expensive to do. Instead, they go to the sellers of bananas (who are much smaller in number than buyers of bananas) and hand those people the tax bill based on how many bananas they sold. So, the sellers of bananas, my gas station owning dad in this example, receive the initial burden of the tax. However, they do not pay the entire actual costs of the tax.

That's because sellers like my dad can ''pass over'' part of the costs of the tax to consumers by raising the price of their bananas. Maybe my dad raises the price of bananas to $1.50 - now the consumers are paying part of the actual tax incidence, or the real costs of the tax. Keep in mind, my dad is unable to pass on the entire incidence of this tax, because when he raises his price of bananas, some people buy fewer bananas. The bananas that my dad is unable to sell at this new high price and the revenue he loses because of that constitute the portion of the final tax incidence he pays. Consumers pay the real costs of taxes by paying higher prices for the goods they consume, and sellers pay the real costs of taxes by selling less product and receiving less revenue in return.

So, if governments are incapable of deciding how this tax is passed on, what does determine who actually pays taxes? The answer is surprisingly simple and elegant - relative consumer and supplier elasticities. But forget about the word elasticity. That's just a pretentious word used to describe flexibility and willingness to substitute. If a consumer is very price elastic, that means as soon as the price of a good goes up just a little, that person buys a lot less. If a supplier is very price elastic, that means as soon as the price of what he sells goes down, he sells something else that can be sold at a higher price.

Now, it's important to keep in mind there are two very broad reasons someone can be very inelastic, or unresponsive to price changes. They could be unwilling to substitute away from buying or selling the good they currently buy or sell, or they could be unable to substitute away. Maybe someone is inelastic in their consumption of a particular good, because they are unwilling to stop consuming that good - cigarette and coffee addicts know the pain of having costs passed onto them well. Maybe someone is inelastic in their consumption of a good because they are unable to avoid consumption of that good without severe consequences - I once needed an EpiPen on my person at all times, and I would have paid a lot to be able to keep it on me.

There are a lot of different ways the federal government of the United States could make up revenue lost from student loan forgiveness, but all those ways involve some kind of a tax. Even if the feds just print money, we'll all experience a tax in the form of inflation and lost value for each dollar we own - Americans are beginning to develop an appreciation of this phenomenon now after having supposedly forgot about its deleterious effects throughout the 70s. Whether or not these taxes are regressive will depend on who actually pays them, and the federal government has no say over that. Who pays the taxes, we've seen, depends on who is less able or willing to substitute away from paying those taxes by selling something else or buying something else.

So, to decide whether student loan forgiveness is regressive, we have to first decide how the federal government is likely to make this revenue up. Then we have to decide whether whatever is taxed can be substituted away from. Then we have to decide, if these taxes can be avoided at all, who is more likely to avoid them - the rich or the poor?

There are ways to institute a tax that is unavoidable and that can't be substituted away from, and that would be one of the best ways to make a tax not regressive in nature. That's because, while poor people may be more willing to substitute away from consuming high-priced goods and selling low-priced goods compared to wealthy people, they probably aren't as able. Take a poor person who works a minimum wage job and buys only off-brand, dirt cheap products. What is this person going to substitute away from? They already sell their labor at the cheapest rate allowed. Even without this tax increase, if they were able to find work they like at least as much as their current job at a higher wage, presumably they would have done so already. They already buy the cheapest products available. Substitution, even given a tax increase, would only entail buying more expensive products.

We could charge a lump-sum tax on every person that doesn't change based on the behavior of the person. But even that gets complicated. Do we increase taxes based on number of people in the family (which is higher for families with more children)? Then the tax becomes regressive again, because poor people tend to have more children than wealthy people. Ok, so we don't tax kids. Then we have to decide on a percentage, which is going to be regressive unless the percentage increases with income, as a flat tax constitutes a higher percentage of a poor person's income relative to a rich person's income. BUT, if the tax goes up with a person's income, it's not really an unavoidable lump-sum tax, because people can substitute away from working! And, of course, while wealthy people may lose more from substituting away from working because the opportunity cost of not working is higher for them compared to someone making less money, I think it's difficult to argue that someone on the poverty line living paycheck to paycheck is more able to avoid a tax based on income compared to someone who makes millions or billions of dollars.

I write all this, because taxes are tough - to David's point. Not only is it difficult to decide how regressive taxes are after they've been levied, but it's impossible to decide how regressive a particular tax will be once it's levied - that is determined by forces much greater than the power of any government agency.

Now, there are some steps the U.S. federal government took to make this version of student loan forgiveness less regressive. People who earn more than $125,000 individually or $250,000 as a family do not qualify for forgiveness. So, there are a great many doctors, lawyers, and business executives who will not be bailed out by the poor. Thank God. Still, those who make $100,000 and are educated will be bailed out by people who make, say, $20,000 and are uneducated. That makes me uncomfortable. The U.S. federal government also allows people to have $20,000 (as opposed to the normal $10,000) forgiven if they applied to college under certain grants reserved for low-income individuals. That helps make the current student loan forgiveness program less regressive. Still, people who graduate from college and grew up on the poverty line still experience much better life outcomes, on average, than those who do not go to college and grew up on the poverty line.

So, student loan forgiveness, and government subsidized education in general, are still likely regressive in nature, especially along certain margins. While I can't say that for certain, because taxes are tough, I place a much higher likelihood on the chance that these programs are regressive in nature compared to the likelihood I place on these programs representing true help for the poor. And since many people who disagree with me often feel the need to qualify their argument with the fact that they don't benefit from these programs, I'll qualify my arguments with the fact that I have benefited tremendously from programs like these. That doesn't ipso facto mean I support them.