Every tax is a value-added tax

I've got to do something about that title, but it's what I've got.

I'm just coming off of the 4th Annual Biophysical Economics Conference in Burlington, and there was an exchange from a session on Friday that I wanted to follow up on.

Josh Farley, from the conference host, UVM's Gund Institute for Ecological Economics, gave an interesting talk about money in the context of an economy dealing with shrinking availability of natural resources to drive economic growth. Among the potential policies he mentioned was the very reasonable idea of taxing degradation of natural resources.

This would raise some potentially tricky issues of measurement (What will you use as an index of natural resource degradation, and how will you determine the impacts of specific actions on that index?), but it is sound in principle: tax the things you don't want, in order to discourage them, rather than taxing the things you do want, like labor. And one huge piece of an environmental-degradation tax is actually farily simple to implement: a carbon tax. (Simple in technical terms of how would the tax be specified in in law and collected in practice; from a political perspective, of course, it looks well nigh impossible.)

In the following Q&A I mentioned something that had occurred to me a few days earlier, which is that every tax, whether you call it a tax on capital, a tax on labor, a tax on environmental degradation, or explicitly a value-added tax, is in fact a tax on value added.

Josh disagreed, pointing to activities like financial manipulation, which plausibly add no value at all, but which are taxable. (I don't know that I'm getting his reply exactly correct, since I'm going from memory, but I'm pretty sure that was the gist of it.)


And I half agree with Josh. I'm sure anyone at that conference could come up with more than one example of an activity that earns money for the individual but does not in fact add value for society as a whole. A good one might be Enron's gaming of the California electricity market. (This one's dear to my heart, since I had coauthored a paper not long before looking at how to do more or less what Enron did--not as a manual, mind you, but pointing to something that system operators in a decentralized electricity system would have to be aware of and have tools to prevent.)

Or you could think of golden parachutes for executives who were paid a bunch of money to leave a company. The whole reason they were asked to leave was that they were messing up, so the parachute wasn't payment for adding value--it was payment to get the ex-CEO to please, please stop destroying value.

Or there's the issue of the ratio between CEO pay and the salary of the median worker at the company. Over the last 40 years, that ratio has risen roughly by a factor of 10. It's hard to see why CEOs' productivity would have gone up ten times faster than the productivity of the people they manage, and if it hasn't done that, then one of two things must be true. Either CEOs are now seriously overpaid relative to the value they add, or in the 1960s they were seriously underpaid. Whichever is true, the link between CEO pay and value added is weak at best.

So I agree with Josh that there are activities we could tax that are not themselves things that add value.

But I still say that every tax is a tax on value added.

Take the case of high CEO pay. Let's say we had some objective way of measuring the CEO's contribution to value added, and it was $1,000,000, but the CEO's compensation is actually $5,000,000. So the $4,000,000 difference is value that the CEO didn't add. But it is still value added. How do we know? Because if the company had $5,000,000 to pay the boss, it must have gotten it from somewhere. It had revenues, and it had costs for intermediate goods, and the difference was value added. Some of that went to the "shop floor" employees (though obviously not as much as they deserved, if the boss was getting 5x a fair rate). The rest is for the executive suite, including the CEO.

But what if a piece of the CEO's compensation was in stock options? When those are sold to turn them into cash, the money didn't come from inside the company. True, but it came from somewhere. Some of it came from the people who bought the exercised options from the CEO, and they got their purchasing power to do that by adding value somewhere else. And part of it came from dilution of the ownership rights of the company's existing shareholders--their claims on the value the company adds were diminished by the creation of new shares to satisfy the executives' options.

The bottom line is this: anyone in a position to be taxed must have somehow gotten ahold of some value added. They may not actually have done the work that added the value, they may even be doing things that are distorting the economy and reducing the overall ability to add value. But the whole reason to engage in such machinations is exactly to lay claim to some piece of value added somewhere. If that weren't happening, if the value weren't being added somewhere, there'd be nothing to tax.