When Ideological Bubbles Trump Economic Thinking

Authored by Paul Mueller via The American Institute for Economic Research,

Sometimes smart people make remarkably naïve or deeply problematic comments because their view of the world has been molded by narrow ideology, reinforced by significant consensus in their social circles.

Recently Esther Duflo, a Nobel prize winning economist, revealed herself to be such a person. In a Financial Times interview with Simon Mundy, she said the West owed a “moral debt” of about $500 billion annually to the global south due to its contribution to climate change and the resulting harm.

I’ve questioned such a calculation elsewhere. And I am not commenting on her published economic work, some of which is no doubt decent. Instead, I want to highlight how outrageously naïve global elites, in this case within the economics profession, have become. There are three major examples of Progressive groupthink in this relatively short interview.

Example 1 – People advance the public good by paying taxes

I think we need to rely on taxation because that is the way in which traditionally we ensure that everyone in the economy, private companies and individuals, contributes to the public good. 

Setting aside the dubious claim that all or even most government spending advances the “public good,” what a narrow view of the world!

Does this mean that farmers or doctors or mechanics only contribute to the public good when they pay taxes? The question (should) answer itself! This reasoning suggests that her taxes contribute to the public good, not her research. But perhaps if her work is funded by tax dollars…

The idea that taxes advance the public good informs her claim that we ought to further tax the ultra-wealthy. The super rich don’t and won’t contribute to the public good because, she thinks, they can basically avoid paying taxes.

Example 2 – The ultra-rich don’t pay taxes

In terms of the ultra-rich, I think everyone has recognized [sic] the fundamental unfairness in the fact that the ultra-rich are not being taxed on the income that they are making from their wealth. You are being taxed on the income you’re making by interviewing me; I’m being taxed on the income I’m making as an academic. But if we are sufficiently wealthy to have a lot of money invested in various places, and we keep reinvesting this money, we never have to take it out, and therefore, we are never taxed on it. If [the super-rich] want to consume, in a lot of cases, they will borrow against their wealth. So it’s a loan, not an “income” — so they are not taxed on it. That seems to be fundamentally unfair.

This view that the ultra-wealthy can avoid paying taxes by simply reinvesting their money indefinitely has become canonical in Progressive elite ideological circles due to the peddling of misleading or even incorrect data on income and wealth inequality by economists like Picketty, Saez, and Zucman. They do not seem to care much about the nuanced disincentives of different kinds of taxation. 

A capital gains tax, for example, is a third-order tax. Companies already pay corporate income taxes which, all else equal, reduces the price of a stock. And when people buy stock initially, they usually do so with previous income that has also already been taxed. Group think among elites means that many of them have never even questioned the validity of this data or the downsides of taxing “capital” because it is all “based on a lot of empirical work.” 

As a result, a smart economist like Duflo can say that a 2-percent wealth tax is “not going to be a big burden on the ultra-rich, because 2 percent of their wealth is only 30 percent of their income from their wealth, which is currently untaxed.” As if ultra-wealthy people have a simple mixed stock/bond portfolio that averages a seven or eight percent return annually without any volatility.

For some reason Duflo seems to think that the ultra-wealthy don’t pay taxes. Leaving aside the fact that they obviously pay significant property and sales taxes, they often fund consumption with loans but that only lets them defer their taxes, not eliminate them. Afterall, they have to repay bank loans periodically and they can only do so by realizing (taxable) income or capital gains.

And while the effective tax rate the ultra-rich pay may be small in some years, or even though their tax payments may be small relative to their net worth at a given moment, Duflo misses a major difference between stable employment income and how entrepreneurs amass fortunes: equity and risk.

Take Elon Musk, someone she mentions by name as one of the ultra-wealthy who should pay a global wealth tax. Yes, his net worth is enormous, but so is its volatility. On paper, Musk lost about $165 billion dollars in one year (November 2021 to December 2022). In the past four months he has lost close to $20 billion dollars in the market value of his Tesla shares.

In what world does a 2-percent tax on someone’s wealth equal “only 30 per cent of their income from their wealth”? Such a comment epitomizes the naivety among many Progressive elites.

Then Duflo makes a freshman error when talking about whether raising taxes reduces people’s incentives to work hard and innovate. She says that her “comfort with taxation…is based on a lot of empirical work that shows that rich people will not stop working or inventing because taxation is higher.” This comfort, no doubt, comes from an uncritical acceptance of Piketty-Saez-Zucman data and highly problematic narratives. 

Ever since the marginal revolution in the 1870s, Econ 101 has included the idea of marginal analysis. Economists should not ask questions like: “will people stop work or stop inventing” as if some on-off switch is being thrown. Instead, we ask “how much more” or “how much less” of a certain behavior will occur, and then argue about the significance of that magnitude.

Example 3 – Politicians can and will easily implement this proposal

It’s really necessary. And it’s reasonable. It’s not that hard.

That’s what she thinks of her proposal to raise $500 billion in taxes annually and redistribute it to countries disproportionately harmed by climate change. She thinks a novel tax on wealth can be implemented at a global level with all the revenue going to targeted recipients — it defies belief! Why would power-hungry and spendthrift legislators let go of the new tax revenue? 

Duflo might suggest that we need a “nonpolitical” global organization to enforce and collect the tax. But that begs a similar question: Why would power-hungry and spendthrift legislators authorize or allow such an agency to have such authority? That a Nobel Prize-winning economist can hold these naïve views and fail to use simple economic reasoning should give us pause about how ideology and echo chambers can dull our reasoning. 

Industrialization, and the carbon emissions that accompanied it, created more benefit for people in poor and developing countries than all the philanthropy and anti-poverty programs in history combined, many times over.

That a leading expert in development economics ignores this is nigh unforgivable.