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Published online by Cambridge University Press: 15 February 2022
This Article examines ability taxation, which is a tax on a person’s earning ability or potential earnings, rather than earned income. Despite this regime’s longstanding favor as a theoretical ideal for fair and efficient taxation among public finance economists, certain political philosophers, and tax law scholars, insufficient effort has been made to provide an analysis of what ‘potential earnings’ means. This Article explores competing understandings of this notion, and situates them within a multipart taxonomy. In so doing, it unearths a tension at the core of the ability tax program involving a fundamental misalignment between the metaphysics (or correct conceptual analysis) of potential earnings and the economics of its taxation. It concludes that once we correctly understand its requirements, we should reject ability taxation as the first-best normative ideal it has been held out to be on the grounds that it is overly burdensome and unfair to certain individuals.
1. See Louis Kaplow & Steven Shavell, “Why the Legal System Is Less Efficient than the Income Tax in Redistributing Income” (1994) 23:2 J Leg Stud 667 at 667, 677; A Mitchell Polinsky, An Introduction to Law and Economics, 2d ed (Little Brown & Co, 1989) at 127.
2. See JA Mirrlees, “An Exploration in the Theory of Optimum Income Taxation” (1971) 38:2 Rev Economic Studies 175 at 175; Louis Kaplow, The Theory of Taxation and Public Economics (Princeton University Press, 2008) at 96; Harvey S Rosen & Ted Gayer, Public Finance, 9th ed (McGraw-Hill/Irwin, 2010) at 332-34; Anthony B Atkinson & Joseph E Stiglitz, Lectures on Public Economics (McGraw-Hill, 1980) at 356-62.
3. See Ronald Dworkin, Sovereign Virtue: The Theory and Practice of Equality (Harvard University Press, 2002) at 96 (defending a version of luck egalitarianism, dubbed “equality of resources,” where a tax on earning ability is viewed as a first-best normative ideal); GA Cohen, Rescuing Justice and Equality (Harvard University Press, 2008) at 68-74, 102-03 (arguing, contra Rawls, for a “strict” difference principle, according to which the talented can, as a matter of justice, be expected to use their endowments to maximally benefit the worst-off without being granted inequality-generating income incentives as remuneration, except where doing so would impose particularly severe labor burdens on the talented).
4. See Daniel N Shaviro, “Inequality, Wealth, and Endowment” (2000) 53:3 Tax L Rev 397 (offering numerous consequentialist and fairness-based arguments for endowment taxation); Lawrence Zelenak, “Taxing Endowment” (2006) 55:6 Duke LJ 1145 at 1181 (surveying the endowment tax literature and concluding that gradual steps towards an ability tax are likely justified); Bruce Ackerman & Anne Alstott, The Stakeholder Society (Yale University Press, 1999) at 155–77 (endorsing a “privilege tax,” based upon a person’s parents’ income, which could be viewed as a partial endowment tax on socio-economic endowment); Daniel Markovits, “How Much Redistribution Should There Be?” (2003) 112:8 Yale LJ 2291 (employing Dworkin’s luck egalitarian framework, which takes a tax on earning ability as a first-best ideal, to explore how much redistribution there should be).
5. These shall be discussed in section I of this Article.
6. For a discussion of this approach, see Kaplow, supra note 2 at 98-99.
7. See Emmanuel Saez, “The desirability of commodity taxation under non-linear income taxation and heterogeneous tastes” (2002) 83:2 J Public Economics 217 at 227–28.
8. See Erick J Sam, “Endowment Taxation and Equality of Resources” (2018) 22:1 Fla Tax Rev 243.
9. See ibid at 251-55.
10. See e.g. Rosen & Gayer, supra note 2 at 333.
11. Ibid at 417.
12. Ibid.
13. This will not always be the case, since the substitution effect must contend with a second and opposing behavioral incentive produced by an income tax. Ibid. Because an income tax extracts wealth from the taxpayer and leaves them poorer, they are pushed to work more than they would have in the tax’s absence. This is called the “income effect.” Ibid. In general, whether a taxpayer will work a greater, equal, or lesser number of hours will turn on the comparative sizes of the income and substitution effects.
14. See ibid at 336, 341–43.
15. See ibid at 333.
16. See ibid.
17. Ibid at 332-33.
18. See Sam, supra note 8 at 259-62.
19. See Louis Kaplow, “Human Capital Under an Ideal Income Tax” (1994) 80:7 Va L Rev 1477 at 1477.
20. See Henry C Simons, Personal Income Taxation: The Definition of Income as a Problem of Fiscal Policy (University of Chicago Press, 1938) at 50.
21. Kaplow, supra note 19 at 1481-83.
22. See Sam, supra note 8 at 259-62.
23. See Lawrence Zelenak, “The Reification of Metaphor: Income Taxes, Consumption Taxes and Human Capital” (1995) 51:1 Tax L Rev 1 at 13; Sam, supra note 8 at 260-62.
24. See Kaplow, supra note 19 at 1504.
25. See Sam, supra note 8 at 262-264.
26. See e.g. Robert Nozick, Anarchy, State, and Utopia (Basic Books, 1974) at 228–29.
27. See David F Bradford, Untangling the Income Tax (Harvard University Press, 1986) at 155–56; Daniel Shaviro, “Endowment and Inequality” in Joseph J Thorndike & Dennis J Ventry Jr, eds, Tax Justice: The Ongoing Debate (Rowman & Littlefield, 2002) 123 at 123-24.
28. Shaviro, supra note 4 at 406.
29. Shaviro, ibid at 417–18; Shaviro, supra note 27 at 140–41.
30. Influential articulations of luck egalitarianism include Eric Rakowski, Equal Justice (Clarendon Press, 1991); Richard J Arneson, “Equality and Equal Opportunity for Welfare” (1989) 56:1 Philosophical Studies 77; GA Cohen, “On the Currency of Egalitarian Justice” (1989) 99:4 Ethics 906; Ronald Dworkin, “What Is Equality? Part 2: Equality of Resources” (1981) 10:4 Philosophy & Public Affairs 283.
31. See e.g. ibid at 293.
32. See Sam, supra note 8 at 269-82. A further efficiency or welfarist objection is that endowment taxation might divert individuals from low paid work or non-market activity that comes with various positive social externalities or imputed incomes. See Liam Murphy & Thomas Nagel, The Myth of Ownership: Taxes and Justice (Oxford University Press, 2002) at 123–24; Linda Sugin, “A Philosophical Objection to the Optimal Tax Model” (2011) 64:2 Tax L Rev 229 at 245-46.
33. John Rawls, Political Liberalism (Columbia University Press, 1993) at 228 [emphasis added].
34. See John Rawls, A Theory of Justice, revised ed (Belknap Press, 1999) at 52–78.
35. See John Rawls, Justice as Fairness: A Restatement, ed by Erin Kelly (Belknap Press, 2001) at 158.
36. See Kirk J Stark, “Enslaving the Beachcomber: Some Thoughts on the Liberty Objections to Endowment Taxation” (2005) 18:1 Can JL & Jur 47 at 49.
37. David Hasen, “Liberalism and Ability Taxation” (2007) 85:5 Tex L Rev 1057 at 1063 n 15 [emphasis added].
38. Ibid at 1062, 1087.
39. See A John Simmons, Moral Principles and Political Obligations (Princeton University Press, 1979) at 57–100.
40. Murphy & Nagel, supra note 32 at 121–25
41. See e.g. Shaviro, supra note 4 at 414.
42. Sam, supra note 8 at 281. For the concept of an endowment realization ratio, see Chris William Sanchirico, “Progressivity and Potential Income: Measuring the Effect of Changing Work Patterns on Income Tax Progressivity” (2008) 108:7 Colum L Rev 1551 at 1568.
43. Sam, supra note 8 at 281.
44. Ibid.
45. For an accessible introduction, see Theodore Sider, Logic for Philosophy (Oxford University Press, 2010) at 199-226.
46. Zelenak, supra note 4 at 1162-69.
47. See ibid at 1163; Richard Musgrave, “Maximin, Uncertainty, and the Leisure Trade-Off” (1974) 88:4 Quarterly J Economics 625 at 631; Arneson, supra note 30.
48. Zelenak, supra note 4 at 1166. For analysis tending in this same direction, see also Kristi A Olson, “The Endowment Tax Puzzle” (2010) 38:3 Philosophy & Public Affairs 240 at 265. While Zelenak’s suggestion enjoys intuitive appeal, it is unclear how metaphysically heterogeneous items, i.e., welfare and income, could be meaningfully aggregated.
49. Kaplow, supra note 19 at 1481.
50. See e.g. Zelenak, supra note 23 at 9.
51. Ibid.
52. Ibid at 9-10; Kaplow, supra note 19 at 1505 n 65.
53. Zelenak, supra note 23 at 10.
54. Ibid.
55. See e.g. Bruce A Ackerman, Social Justice in the Liberal State (Yale University Press, 1980); Joseph Raz, The Morality of Freedom (Oxford University Press, 1986) at 110-33; Will Kymlicka, Liberalism, Community, and Culture (Clarendon Press, 1989) at 76-83, 95-97.
56. The ‘harm principle’ arguably receives its fullest explication in Joel Feinberg, Harm to Others: The Moral Limits of the Criminal Law, Vol 1 (Oxford University Press, 1984).
57. See Joel Feinberg, Harm to Self: The Moral Limits of the Criminal Law, Vol 3 (Oxford University Press, 1986) at 27-94 for in depth-treatment of different conceptions of autonomy and theories of its value.
58. Or, in the cases of various sorts of psychopathology, internal interference.
59. See John Stuart Mill, On Liberty (John W Parker & Son, 1859).
60. Ibid. Commitments to neutrality and autonomy also plausibly undergird John Rawls’ influential account of political liberalism. See Rawls, supra note 33.
61. Couldn’t the prospective tax instead be administered subsequent to the completion of the taxpayer’s education, say on their 23rd birthday? Yes—in theory. In practice, however, market forces would likely conspire to make a mockery of the government’s good intentions, and to produce similar results as a tax imposed prior to consummation of academic training. Knowing that they would ultimately need to lock themselves into years of employment in order to acquire liquidity, citizens would race to line up their preferred positions in advance. Those who waited until the deadline would often be beaten to the punch by their more punctual peers, and forced into jobs where they exhibited little interest. To avoid being left in the dust, taxpayers would often have to pledge substantially prior to the completion of their education.
Furthermore, even if this sort of race did not arise, a prospective endowment tax administered on one’s 23rd birthday would still lead to the sort of professional ‘lock-in’ discussed below. While a person would not be robbed of the opportunity to explore different educational pathways, they would still have to contractually commit themself to many years of employment upon completion of their education, and thereby forfeit the opportunity to explore different careers feasible with their educational credentials.
62. Rawls recognized that the appraisal of potential income is a highly time-dependent enterprise when, in his exchange with Richard Musgrave over the endowment tax, he asked “at what time of life the tax is to be assessed.” John Rawls, “Reply to Alexander and Musgrave” in John Rawls, Collected Papers, ed by Samuel Freeman (Harvard University Press, 1999) 232 at 253. See also Sanchirico, supra note 42 at 1564-65, 1571-72 (distinguishing between ‘long run’ and ‘short run’ potential income, and employing the latter because it is a more epistemically tractable measure).
63. See Sugin, supra note 32 at 252.
64. For this description, see Shaviro, supra note 27 at 123-24.
65. Because a partially raw ability tax is equivalent to a partially cultivated tax—in virtue of holding part but not all of a person’s life history prior to the relevant tax year fixed—the following distinctions are also applicable to the latter tax.
66. Given this construction, the type of probability advocated here is a form of epistemic probability. Epistemic probabilities occupy a halfway position between objective probabilities (sometimes called ‘chances’), which are ‘out there in the world,’ and subjective probabilities (‘credences’), which are an agent’s degrees of confidence in a proposition. As they are often construed, epistemic probabilities reflect a logical relation between a hypothesis and its evidence. Here, the hypothesis is a particular branch line’s realization, while the evidence is the sum of the Market’s information. For a self-contained and accessible discussion of different interpretations of probability as applied to decision theory, see Martin Peterson, An Introduction To Decision Theory (Cambridge University Press, 2009) at 133-63. See also Michael D Resnik, Choices: An Introduction to Decision Theory (University of Minnesota Press, 1987) at 61-80; Itzhak Gilboa, Theory of Decision Under Uncertainty (Cambridge University Press, 2009) at ch 4-5.
67. In the example provided in the Appendix, for instance, Taxpayer’s potential earnings are $200,000 under the intra-world ex post regime but only $100,000 under the intra-world objective ex ante regime.
68. = ($110 - $100)/$100
69. = ($115 - $100)/$100
70. Taxpayer’s maximum conceivable income would equal the $11,000 that the wheel pays out minus their initial $100 investment.
71. The ‘losers’ here are those who would have placed their money on the retrospectively lucky wager (the wheel) if an ex post tax had been in effect to incentivize their gambling, but in fact lose out on this lucky payoff by placing their money on the antecedently wise investment (the fund) in the presence of an ex ante tax. In our Spin of the Wheel example, if an ex ante tax were in effect and Taxpayer opted for the fund when, as luck would have it, the wheel goes on to pay out $11,000 for ‘Red 42,’ Taxpayer could theoretically be compensated by the ‘winners’ (that is, those taxpayers who also prudently invest in the fund, but who would have played the wheel if an ex post tax were in effect and lost their entire $100 on ‘Black 37’) such that Taxpayer still earns $10,900 but at least some of the transferors end up slightly better off than they otherwise would have been had the ex post tax been in effect.
72. See section III.A, above.
73. See e.g. Cohen, supra note 30 at 934; Rakowski, supra note 30 at 76-77; John E Roemer, Equality of Opportunity (Harvard University Press, 2009) at 6-7; Sam, supra note 8 at 267 n 71.
74. As explained in section III.C.ii, above, the method of determining maximum earnings in each of these branchlines will vary depending on how one ultimately comes down on the questions of (i) ex post versus ex ante taxation, and (ii) objective versus subjective taxation.
75. Rawls, supra note 35 at 158.
76. Rawls, supra note 62 at 253.
77. Rawls, supra note 35 at 158.
78. Sugin, supra note 32 at 252. It should be noted that Rawls and Sugin both take this context sensitivity to suggest that endowment may not be measurable, even as a theoretical matter. However, as I hope my framework for appraising cross-world earning ability illustrates, this more skeptical conclusion does not follow.
79. Allen Buchanan et al, From Chance to Choice: Genetics and Justice (Cambridge University Press, 2000) at 79-80.
80. In correspondence, Daniel Shaviro has suggested that the property of earning ability might be thought conceptually analogous in certain respects to that of fitness as employed in evolutionary theory. Subsequently, I discovered that my cross-world measure of earning ability bears some resemblance to the account of fitness as ‘dispositional property’ that is advanced by the philosopher of science Robert N Brandon in his Adaptation and Environment (Princeton University Press, 1990).
81. See Kaplow, supra note 19.
82. Professor Sugin seems to imagine cases bordering on this outcome when she warns against excessive taxation of high ability but low earning individuals who fail to achieve their income potential due to luck of the draw in a winner-take-all market. See Sugin, supra note 32 at 253-54.
83. Contra Sugin, who also warns against reducing taxes on those who are lucky enough to gain a clear windfall in the actual world (e.g., a lottery winner). Ibid at 254.
84. For a survey of the general philosophical literature on abilities, see John Maier, “Abilities” in Edward N Zalta, ed, The Stanford Encyclopedia of Philosophy (Fall 2014 ed), online: https://plato.stanford.edu/archives/fall2014/entries/abilities/.
85. That is, an ability tax that is cross-world, objective, ex ante, and perfectly raw. See section III.D.iii, above.
86. But see section III.A, above, for reasons why, in practice, this may be practically infeasible.
87. Further note that those scenarios in (b) and (c) would generally be prospectively monetizable because the market will tend to be more rational and return-oriented than the individual taxpayer.