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I used to be a dirty, greedy investment banker. Now I quit for all kinds of reasons, and my expected tax payments were not among them. For argument’s sake, let’s assume that my total compensation today would have been $1,000,000 had I remained doing what I was doing.  Today, I am involved in the “ennobling” teaching profession, making less than a tenth of what I would be earning on Wall Street. When some folks hear that, they indicate that it “must be hard” to forego that kind of income.

Actually, it’s not. I am happier today than I would be if remained a banker. I have more interesting interactions with students, I have more freedom to work on the topics that interest me, I have much more free time, and I find the work much less stressful (not in the way you think). My “utility” (in econspeak) is considerably higher today than it otherwise would have been.

Let’s assume that we have a flat tax system with no deductions and also assume that my current compensation is $50,000 per year. Suppose that the tax rate is 30% for all income. Thus, as a banker I’d be paying $300,000 per year in taxes and as a teacher only $15,000. Rather than celebrate my choice to leave Wall Street, why am I not instead vilified as plundering the public purse and making society poorer? Those are both true.

As a banker, I was producing $1 million of wealth for the world each and every year. When I left, that was $1 million less being created (lest you believe supply curves don’t slope up). Now, at best, I am contributing $50,000 to the world. I made he world $950,000 poorer through my choice of careers. And think about the public purse! I am causing the treasury to lose $285,000 each and every year as a result of my actions.

Who is “worse”? Me, switching careers, or if I had remained a banker but decided to be a tax evader and fudged on $285,000 of my taxes each year?

Three additional thoughts:

  1. If indeed I am shirking my public duty by withdrawing from a high paying job, couldn’t we make a case that I should be taxed MORE today than I was as a banker?
  2. Wouldn’t Keynesians argue I am doing damage to the economy since I reduced “aggregate demand” by $950,000?
  3. Thinking about this got me to think some more about the “tax the rich meme.” See tomorrow’s post for more.

8 Responses to “Tax Evasion versus Tax Avoidance”

  1. chuck martel says:

    The assumption is that if you’re not filling the role of investment banker, someone else is and is collecting that income and paying the taxes so there’s no net loss to the economy or the state.

  2. sherlock says:

    Chuck, that assumption means that there are a fixed amount of investment banker positions, which I do not believe is the case. Also, holding your assumption to be true, the new investment banker was doing something else before he took over Rizzo’s position. What about that wealth that is now gone? Are we just going to keep assuming someone immediately takes over the vacated position and is also immediately competent at what they are doing (i.e. no learning curve in the new position)?

  3. chuck martel says:

    The new investment banker that took over Rizzo’s position had been filling potholes for NYC. When he left that spot a guy named Steve Maloney got it because his cousin Bert is a foreman. Steve had been out of work for almost a year, partly because he liked being on unemployment and got to take his two kids to the zoo everyday during the summer. When they went back to school he got sick of watching daytime TV and decided to go back to work. It looks like he could get laid off before Thanksgiving. He talks about going to North Dakota to work in the oil fields but everybody knows he’s just blowing smoke. He’ll just go back on unemployment.

    It’s not my assumption.

  4. blink says:

    “When I left, that was $1 million less being created… Now, at best, I am contributing $50,000 to the world. I made he world $950,000 poorer through my choice of careers.”

    I disagree. A correct measure of one’s “contribution” is the *difference* between the value created and the compensation received. If you were a marginal investment banker, the value you produced for others would be very close to what you received in payment — a contribution close to zero. You say you prefer the teacher job package to the investment banker job package, so the presumption should be that society is *better off* with you as a teacher. There may be special cases (e.g., Michael Jordan playing baseball), but teaching and investment banking are unlikely to prove exceptions.

    Even the tax argument may fail if we allow for adjustments (as the other commenters consider). Perhaps someone else takes your old job; perhaps other investment banker’s wages rise ever so slightly no that you are no longer competing with them.

    Now if you want to argue that society is worse off because taxes distorted your decision and lead you to choose an inefficiently large amount of non-monetary benefits vs. monetary benefits, I will readily conceded the possibility.

  5. wintercow20 says:

    Follow the goods and not the money. The “value” of me to “society” is not a function of what I get paid, it is a function of whether the goods and services I produce are valuable. What I will concede is that my Wall Street job probably was not of great value, and that the difference in value between it and my current “contribution” is overstated in the example. But the goods matter, the money does not. The analysis would be the same whether my bank paid me zero or ten times my worth. Those prices are transfers.

  6. Harry says:

    Mike, if you had followed Sherman McCoy into investment banking, where they cut the big cake and daddy gets to pick up the crumbs, a million bucks a year after taxes might be enough to pay for a 1200-square-foot apartment on the upper east side. You being a New Yorker know more about this than I, but I worked on Wall Street for two years, living in Manhattan, and moved out.

    Now, I would expect you to put aside a sufficient portion of whatever the government allowed you to keep, which is a whole lot less than half. Remember your two-million condo gets school taxes and city taxes to pay for the police, firemen, and social workers. Maybe that would be enough to buy a few hundred acres, and expand the herd in Upstate New York.

  7. blink says:

    @5 Wintercow: “Follow the goods and not the money.”

    Yes! (Still: investment banking is probably sufficiently competitive to assume wage ~ value of the marginal product and that +/- one worker is marginal so wage is a reasonable proxy for value created.) My claim is that you originally ignored the costs, or else you do not count yourself as part of “society” which makes no sense. Revealed preference says you are better off, so who is worse off? Maybe professors whose wages are now bid down, but that is pecuniary and offset by the opposite effect for other investment bankers anyway.

  8. Rod says:

    If they paid you a million bucks, you can bet you produced very much more wealth than that. Let’s say your cut for an IPO was $1,000,000. You sold $100 million or more in stock, which went to the owners of the company, and which probably got invested in something better or at least as capable of success. If all you did was create $1 million of stock sales, they would not pay you — they’d fire you.

    Karl Marx would also pay you nothing, relying on the labor theory of value. He would also disallow private ownership of “the means of production,” so he’d just knock down an India Pale Ale instead of buying shares in the IPO.

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