Tuesday, January 16, 2018

The Republican Tax Reform: Part 2 —Why Tax Reform Only Occurs Occasionally

I’m not a political scientist, so I can’t tell you why they think this happens this way.

But I can 1) describe it, and 2) explain what economists think happens.

So, suppose we start at some point in time with a just-cleaned-up tax system. It’s sleek and efficient and makes people as happy as a tax system can.

What happens next? Politicians and bureaucrats find things they don’t like and try to fix them. Fair enough: we put them there to do something rather than do nothing.

Now, here’s the economics. There’s a subfield called public choice. One of its implications is that in representative government, these things get passed if they have concentrated benefits and diffused costs. You spread the cost over as big a group as possible, and it becomes so small that people don’t complain about it much. But you gather all those costs together and transfer that as a benefit to a smaller group. Now it’s concentrated, and those people can be very vocal.

Now … um … lather, rinse, repeat. A lot.

What you end up with over many years is a sleek and efficient tax system that has turned into a Frankenstein monster because you keep stitching new parts to it.

But now you run into a new problem, loss aversion, and the more complex form of that (brought into economics by psychologists) known as prospect theory. Basically, people don’t like perfectly even games like flipping coins because they worry more about losses than they feel good about gains.

So when we decide we need tax reform, the benefits are the part that is widely diffused, and the costs are often concentrated. Except because they are costs rather than benefits, those small group are going to be more vocal when undoing taxes than when they were being put together.

The result of this is a pattern of taxes getting incrementally worse for a long time, followed by a cathartic reform. It’s a very asymmetric process.

In the case of this tax reform, we really haven’t had a serious tax reform at the national level since 1986.

And it’s probably reasonable to not expect another one until you’re in middle age.

So this is a big deal.

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