A few months ago, I stumbled upon a research paper teeming with fascinating discoveries. It was a rigorous economic study, but came decorated with a colourful animation reminiscent of an Animal Crossing game. And it was an AI simulation. Little agents acting like citizens would gather resources, build houses and trade with one-another. All the while, a different agent came up with new tax policies that would redistribute the wealth of these virtual citizens.
This experiment taught me a lot. It got me thinking about the dominant opinions people hold about how their wealth should be allocated (or retained). It seems like even prominent speakers, whose thoughts inspire and mould the minds of their many millions of listeners, have a very weak grasp of even the most basic economic principles and arguments. One of these, I believe, is the common opinion that the free market economy is the best of all.
The free market argument is the heart of Capitalism. The concept centers around the power of supply and demand. In order to achieve the optimal price, where both consumers and producers are satisfied, these two forces must eternally perform a balancing act. Another description for this driving force towards optimal prices (also called price equilibrium) is the ‘guiding of the invisible hand’.
Living under the free market definitely sounds better than say, living under the thumb of a monarch, oligarch or fascist ruler. Certainly, in the time of Adam Smith (who founded the theory), this way of living sounded more Utopic than it does in today’s context. But think about what it would to have a corporation control all the means of production- doesn’t that sound terrifying (and plausible, given the hegemony of Big Tech over the world today, especially Amazon)?
For a country to be truly said to have a free market, you would need to take out any external forces, for example, government influence: taxes, subsidies, and other forms of legislation. After all, to do anything else might threaten push against the veritable invisible hand. So, in that scenario, how exactly does a country build infrastructure? How does it build education systems? How does government even come to exist, if it has no agency to take some of wealth from individuals who live within its borders? So, unless you want to live in a city straight from the Golden Age of Piracy, it’s unlikely you’d ever find yourself living in a free market society. Even Smith made the argument there are certain functions a government needs to perform, and he explicitly states that the rich should be taxed in “something more than in proportion” to their wealth.
When most people talk about the free market, they implicitly concede a few things like the need for taxation (at least, I hope so). So, given some basic concessions like a tax on people’s property and revenue, what other problems does the free market principle run into? The most obvious problem is this: how do we decide who to tax and how much do we tax them? It’s one of those questions that can turn a conversation turbulent, with sparks of passion flaring on both sides of the debate. This controversy can be distilled to two fundamental elements: productivity and equity. Both are good, but it can easily be a zero-sum gain.
It turns out that in at least a few economic models, a free market tax policy system maximizes productivity. But having large amounts of production doesn’t mean that a high number of people will reap the rewards of it. This is the basic problem of wealth inequality, and it it is so rampant in the USA that the three richest men own more wealth than the poorest 50% of the country. Chances are, if you’re reading this, that you and I are both in the top 5% of the world in terms of wealthy living. Our little 5% club, a tiny speck on the globe compared to remaining 7 billion people, own 80% of the world’s wealth. When you look at the staggering salaries of top brain-surgeons, you might nod with approval. After all, a brain surgeon is far more useful to society than a rural farmer or janitor. Unfortunately, this is not the current state of wealth inequality. Most Nobel Peace price winners, scientists, and brain surgeons fall sharply outside the top 1% of richest Americans in the USA.
The real wealth holders tend to be people who inherited it, making up about 50% of the country, and also, financial executives and CEOs. Daniel Kahneman analyzed 25 wealth advisers, and their performance over 8 consecutive years. Looking at whether these advisers improved their clients returns year after year, as well as determining what skills these advisers displayed, Kahneman ultimately found a near 0 correlation between the work of the advisers and the return on their clients investments. CEOs, in a similar vein, have a near 0 correlation with the performance of the companies they work at.
This is just a bit of buttressing to highlight possible problems with valuing productivity over equity. I’m not anti-capitalist any more than I am anti-communist. As Martin Luther King (Jr) says, “Both represent a partial truth”. If we combine capitalist and socialist ideas, perhaps we can find the best economic model for everybody. And most countries to do this, including the USA. Generally, it’s called a ‘mixed-market economy’ or just ‘mixed economy’.
It’s funny how quickly people are to declare that the USA is a capitalist economy- it’s totally not. It has a taxation system, subsidies, a federal bank, a medicare programme, and much, much more….
Some Conservatives and Libertarians are trying to crack down on some of these policies, but for the most part, people are in favour of these entities existing. And what the US tax policy today is attempting to do, and rightly so (speaking both morally and for long term economic wellbeing), is balance the trade-off between productivity and equity.
However, coming up with a good policy to do this is one of the greatest challenges for any country to rise up to. You can tax those who produce the most value and wealth, but then, they may end up demotivated, deflated, and ultimately, you end up losing out on many of the gains they once provided. You can leave them with most of their wealth, but then how will you supply resources and opportunities to the underprivileged classes? It’s a problem that has existed since the neolithic era. Thankfully, that was a long time ago, and now AI is here to show us how it’s done.
In the experiment I discussed in the beginning of this post, there were two sets of AI agents. One was the citizens, gathering resources and trading, and the other created tax policies that governed how these resources were ultimately redistributed. The researchers created simulations for how the society functioned under three different kinds of philosophies: the free-market policy, the US federal policy and the Saez formula. It also allowed the AI model to come up with its own tax policy, in an attempt to maximize on both productivity and equity. And the result was astounding: it came up with a policy that had relatively high levels of production while retaining high levels of equality, compared to any of the other tax policies tested in the simulation.
People are scared and skeptical to let AI make decisions that shape our everyday lives in such a significant way. But at the end of the day, economics is a mathematical and empirical field, which more often than not suffers due to irrational decision making. If we know and agree on our objectives (maximizing productivity and equity), perhaps it shouldn’t be up to us to figure out the exact formula to get there. I for one, think it’s time we take some of the AI’s tax policies to Congress, and test them out on a real-world marketplace.