A progressive tax is a tax by which the tax rate increases as the taxable base amount increases.^{[1][2][3][4][5]} "Progressive" describes a distribution effect on income or expenditure, referring to the way the rate progresses from low to high, where the average tax rate is less than the marginal tax rate.^[6][7] It can be applied to individual taxes or to a tax system as a whole; a year, multi-year, or lifetime. Progressive taxes attempt to reduce the tax incidence of people with a lower ability-to-pay, as they shift the incidence increasingly to those with a higher ability-to-pay.

The term is frequently applied in reference to personal income taxes, where people with more income pay a higher percentage of that income in tax than do those with less income. It can also apply to adjustment of the tax base by using tax exemptions, tax credits, or selective taxation that creates progressive distribution effects. For example, a sales tax on luxury goods or the exemption of basic necessities may be described as having progressive effects as it increases a tax burden on high end consumption or decreases a tax burden on low end consumption respectively.^[8][9][10]

Progressive taxation often must be considered as part of an overall system since tax codes have many interdependent variables. For example, when refundable tax credits and other tax incentives are included across the entire income spectrum, the United States has the most progressive income tax code among its peer nations; although its overall income tax rates are below the OECD average.^[11]

The opposite of a progressive tax is a regressive tax, where the relative tax rate or burden increases as an individual's ability to pay it decreases. Sales taxes are often criticized because low income households must pay a greater share of their disposable income to a sales tax than wealthier households.^[12][13] In between is a proportional tax, where the tax rate is fixed as the amount subject to taxation increases.^[5]

History of intellectual debate[link]

The idea of a progressive tax has garnered support from macro economists and political scientists of many different ideologies, although there are differences of opinion about the optimal level of progressivity.^{[citation needed]} Some economists^[14] trace the origin of modern progressive taxation to Adam Smith, who wrote in An Inquiry into the Nature and Causes of the Wealth of Nations:

"The necessaries of life occasion the great expense of the poor. They find it difficult to get food, and the greater part of their little revenue is spent in getting it. The luxuries and vanities of life occasion the principal expense of the rich, and a magnificent house embellishes and sets off to the best advantage all the other luxuries and vanities which they possess. A tax upon house-rents, therefore, would in general fall heaviest upon the rich; and in this sort of inequality there would not, perhaps, be anything very unreasonable. It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion."^[15]

In the same book, Adam Smith also argued for a flat tax:

"The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state."^[16]

In the United States, advocates of progressive taxation tend to be found among the majority of economists.^[17]

Arguments for implementation[link]

• The higher one's income, the greater the fraction of it that tends to consist of economic rent rather than rewards for any commensurate contribution to production. By definition, economic rent is a factor payment exceeding that required to place a factor in its most productive use, so it can be taxed away entirely without impairing wealth production. Consequently, in the absence of taxes specifically levied on economic rent, a steeply progressive tax on the highest incomes can be expected to fall almost exclusively on economic rent, minimizing the excess burden of such taxation.

• A progressive tax reduces income inequality,^[18] which has been reported to have a number of societal benefits, such as lower homicide rates at all income levels.^[19] The difference between the Gini index for an income distribution before taxation and the Gini index after taxation is an indicator for the effects of such taxation. Richard G. Wilkinson argues that in a more unequal society, even middle class people on good incomes are likely to be less healthy, less likely to be involved in community life, more likely to be obese, and more likely to be victims of violence.^[20] Amongst the wealthiest quarter of countries, there is no relation between a country's wealth and general population health, but within a country, relative levels can have an effect.^[21]

• In a market economy, the larger an investment is, the higher its rate of return. This is due to both economies of scale and the increased range of investment opportunities. In addition to these economic forces, those who control greater amounts of capital within a society are able to participate more directly in shaping government policy, often in ways that further maximize their wealth. Thus, due to both economic and political realities within a market economy, it is a natural process for the wealthiest individuals and firms in a society to become disproportionately wealthier over time. In order to prevent the political instability resulting from the natural stratification of the populace into an ever smaller and wealthier aristocracy or moneyed class, and an ever larger working class, free market democracies should support progressive taxation and programs to enhance economic opportunity for the lower and middle classes.^{[citation needed]}

• In response to the concern that progressive taxation creates an unfair psychological burden on the wealthy; if the utility gained from income exhibits diminishing marginal returns, as many psychologists assert (see Weber-Fechner law), then for the tax burden to be shared in a utilitarian way the tax-bill must increase non-linearly with income.

• As income levels rise, marginal propensity to consume tends to drop. Thus it is often argued that economic demand can be stimulated by reducing the tax burden on lower incomes while raising the burden on higher incomes^[22]

• People with higher income tend to have a higher percentage of that in discretionary income, and can thus afford a greater tax burden (this is the “vertical equity” argument). Some^[who?] would claim that a person earning exactly enough money to pay for food and housing cannot afford to pay any taxes without its causing material damage, while someone earning twice as much can afford to pay up to half their income in taxes.

• Some believe that the wealthy have a disproportionately greater interest in maintaining societal goods typically supported by taxation such as security of property rights, defense and infrastructure, as they have much more to lose if these fail than do the poor. Public investments in defense and foreign aid often support assets abroad whose expropriation is a far greater risk than is the risk involving domestic investments.

• As long as after-tax income is a strictly increasing function of gross income, there is a monetary incentive to increase compensation received. Indeed, for any particular income goal, the higher the tax rate, the more compensation one must receive to reach that income goal. For this reason, progressive income tax may increase the incentive to produce among the largest producers (if higher production is truly associated with higher compensation).

Arguments against implementation[link]

• Higher taxes lead to capital flight.^[23][24]
• Progressive taxes fail to decrease real income inequality.^[25]
• Progressive taxation creates work disincentives. Depending on tax rate, the incentive to stay in a lower tax bracket may be higher than one to move in to a higher bracket.^[26]
• Regardless of higher nominal tax rates, revenues do not tend to increase with progressive taxation (see Hauser's law).^{[27][page needed]}
• According to James A. Dorn, progressive taxation violates the principle of equality under the law.^[28]
• Progressive taxes lower savings rates.^{[citation needed]} High-earners have a lower average propensity to consume, so shifting the tax-burden away from them will increase the aggregate savings rate, which should increase steady state growth (if the savings rate is initially below the Golden Rule savings rate).
• Progressive taxation shifts the total economic production of society away from capital investments (tools, infrastructure, training, research) and toward present consumption goods. This could happen because high-income earners tend to pay for capital goods (through investment activities) and low-income earners tend to purchase consumables. Smithian and neo-classical growth theory says that spending more on consumption goods and less on capital goods will slow the rise of the standard of living, and possibly even reduce it since capital goods increase future production possibilities.
• Poll taxes are economically efficient.^[29]
• Increase in tax loopholes such as income splitting techniques.^{[citation needed]} This creates an incentive for business owners to split their business into smaller, less efficient ones for a lower tax bracket. It also encourages production from less efficient smaller businesses than larger ones.
• The increasing energy expended on tax avoidances which occur with greater progressivity produces an increase in the work of accountants and lawyers. Because tax avoidance creates no net wealth this work is unproductive, and can make taxes on the rich less efficient than on the middle class, who have less motivation to exploit tax loopholes.^{[citation needed]}
• Justice in representation: economic equity is sometimes used to argue against progressive taxation, on the grounds of representation being out-of-proportion to taxation: While the top 5% in income in most countries pay over half the taxes^[30] they have only 5% of the voting weight. This argument can be reversed into the plutocratic case that if tax is to be progressive it should be accompanied by greater say in elections for those who contribute most.
• Policymakers are argued to be under a pressure from lower and middle income voters to limit higher incomes by the means of progressive taxation. A few economists argue against inequity aversion: "If policy makers' primary goal is … economic prosperity for all, they should avoid focusing on the politics of envy." (Gregory Mankiw)^[31]

Measuring progressivity[link]

Models such as the Suits index, Gini coefficient, Theil index, Atkinson index, and Robin Hood index are sometimes used to factor progressivity through measures of inequality of income distribution or inequality of wealth distribution.^[32]

Effective progression[link]

An effective progression^[33] can be computed from inequality measures. The following example uses the Gini coefficient:

Failed to parse (Missing texvc executable; please see math/README to configure.): r_{Gini} = \frac {1-G_{netto}}{1-G_{brutto}}

Inflation and tax brackets[link]

Many tax laws are not accurately indexed to inflation. Either they ignore inflation completely, or they are indexed to the Consumer Price Index (CPI), which tends to understate real inflation. Here, this article about investing from USA Today will explain why the Consumer Price Index isn't an accurate measure of inflation. ^[34] In a progressive tax system, failure to index the brackets to inflation will eventually result in effective tax increases (if inflation is sustained), as inflation in wages will increase individual income and move individuals into higher tax brackets with higher percentage rate. One example is the United States Alternative Minimum Tax; since it is not indexed to inflation,^[35][36] an increasing number of upper-middle-income taxpayers have been finding themselves subject to this tax.

Marginal and effective tax rates[link]

The rate of tax can be expressed in two different ways, the marginal rate expressed as the rate on each additional unit of income or expenditure (or last dollar spent) and the effective (average) rate expressed as the total tax paid divided by total income or expenditure. In most progressive tax systems, both rates will rise as amount subject to taxation rises, though there may be ranges where the marginal rate will be constant. With a system of negative income tax, refundable tax credits, or income-tested welfare benefits, it is possible for marginal rates to fall as amount subject to taxation rises: this can still be seen as progressive providing that the marginal rate is higher than the average rate at any particular level, since the average rate will rise; high marginal rates for those with low means can lead to a poverty trap within a progressive system, even if they face negative average rates.^{[citation needed]}

Base of taxation[link]

Income[link]

The key concept of progressive income taxation is that income is considered in different steps, where income earned between certain points will be taxed at a certain rate. This is done to avoid creating incentive traps, where earning more might actually decrease your income (e.g., if income up to 10,000 is untaxed and after 10,001 you pay 10%, you will receive 9,000.90 if you make 10,001 and 10,000 if you make 10,000). The size and severity of the different steps varies a great deal and the differences inside the term "progressive" can be enormous. In this sense, it is not surprising that most economists support progressive taxation to some degree - the primary differences come when looking at the maximum income taxes that the highest earners might have to pay.

Expenditure[link]

While a tax on expenditures can be structured like a pure sales tax, many proposals make adjustments to decrease regressive effects. Using exemptions, graduated rates, deductions, credits or rebates, a consumption tax can be made less regressive or progressive, while allowing savings to accumulate tax-free.^[37][38] A sales tax on luxury goods or the exemption of basic necessities may be described as having progressive effects as it increases a tax burden on high end consumption or decreases a tax burden on low end consumption respectively.^[8][9][10] Economist Alan J. Auerbach of University of California, Berkeley states that "annual income is not an especially accurate measure of one's ability to pay. A household's consumption tends to fluctuate less from year to year than its income does, and in some respects offers a better measure of a family's sustainable standard of living. Averaged over periods longer than one year, which smoothes out fluctuations in annual income, consumption taxes look less regressive relative to income than they look on an annual basis."^[38] Tax reform proposals that transition from an income tax to a consumption tax would be more equitable because consumption requires a balance between known and complex social costs.

Implementation[link]

This unreferenced section requires citations to ensure verifiability.

There are various ways that a progressive income tax can be implemented:

Increasing percentage rates[link]

When implementing a progressive tax with increasing percentage rates, the percentage of tax of each dollar increases as the total revenue (or income) increases. For example, a tax of 15% on all income earned up to $50,000, plus a tax of 25% on each dollar earned between $50,001 and $100,000, plus a tax of 34% of all income earned above $100,000. The United States currently uses increasing percentage rates in the form of tax brackets.

Single tax rate[link]

A progressive tax rate can also be achieved by combining a single flat rate with a threshold (or deduction). For example, all income up to $100,000 is earned tax free; income above $100,000 is taxed at 35%.

Formula[link]

A progressive tax rate can also be achieved by mathematical formula. A simple progressive tax is described by a linear equation of the form y=mx+b, relating tax rate y to income x with the slope m being greater than zero. Setting the slope m to zero would convert this to a flat tax. A progressive tax by formula can also implement a negative income tax by setting the y-axis intercept b to a value less than zero. No additional verbiage is needed to implement a negative income tax within a progressive tax system. Tax rates can be altered as often as needed by simply adjusting the values of the variables in the equation, no rewriting of tax laws, codes, etc. are needed. More complex progressive systems can be created by using a non-linear equation.

Examples[link]

Distribution of U.S. federal taxes for 2000 as a percentage of income among the family income quintiles, with richer groups paying more

Most systems around the world contain progressive aspects. New Zealand has the following income tax brackets (as of 1 October 2008): 12.5% up to NZ$14,000, 21% from $14,001 to $40,000, 33% $40,001 to $70,000, 39% over $70,001, and 45% when the employee does not complete a declaration form.^[39] All values in New Zealand dollars and exclude the earner levy. Australia has the following progressive income tax brackets: 0% effective up to A$6000 (PAYG taxed at 15% then fully rebatable at the end of the financial year), 15% from $6001 to $25000, 30% from $25001 to $75000, 40% from $75001 to $150000, and 45% tax for any amount over $150000.

In the United States, there are five "tax brackets." ranging from 10% to 35%. used to calculate the percentage of taxable income (of individuals).

If taxable income falls within a particular tax bracket, the individual pays the listed percentage of income on each dollar that falls within that monetary range. For example, a person in the U.S. who earned $10,000 US of taxable income (income after adjustments, deductions, and exemptions) would be liable for 10% of each dollar earned from the 1st dollar to the 7,550th dollar, and then for 15% of each dollar earned from the 7,551st dollar to the 10,000th dollar, for a total of $1,122.50. This ensures that every rise in a person's salary results in an increase of after-tax salary.

See also[link]

• Tax incidence
• Laffer curve
• Proportional tax
• Regressive tax
• Robin Hood effect
• Suits index

Notes[link]

External links[link]

Wikimedia Commons has media related to: Marginal tax rates

Wikiquote has a collection of quotations related to: Taxation

• The Progressive Income Tax: Theoretical Foundations
• What's Wrong with the Progressive Income Tax

Milton Friedman

Chicago School of Economics
Born	(1912-07-31)July 31, 1912 Brooklyn, New York
Died	November 16, 2006(2006-11-16) (aged 94) San Francisco, California
Nationality	American
Institution	Hoover Institution (1977–2006) University of Chicago (1946–77) Columbia University (1937–41, 1943–45, 1964–65) NBER (1937–40)
Field	Economics
Alma mater	Columbia University (Ph.D.), 1946, University of Chicago (M.A.), 1933 Rutgers University (B.A.), (1932)
Opposed	John Maynard Keynes, John Kenneth Galbraith, Murray Rothbard
Influences	Adam Smith, Irving Fisher, Frank Knight, Murray Rothbard, Jacob Viner, Harold Hotelling, Arthur Burns, Friedrich Hayek, Homer Jones, Ludwig von Mises, Henry Simons, George Stigler
Influenced	Margaret Thatcher, Alan Greenspan, David D. Friedman, Anna J. Schwartz, Ben Bernanke, Gary Becker, Thomas Sowell, Harry Markowitz, Chicago Boys, William F. Buckley, Jr., Cato Institute
Contributions	Price theory, Monetarism, applied macroeconomics, floating exchange rates, volunteer military, Permanent income hypothesis, Friedman test
Awards	John Bates Clark Medal (1951) Nobel Memorial Prize in Economics (1976) Presidential Medal of Freedom (1988) National Medal of Science (1988)
Signature

Milton Friedman (July 31, 1912 – November 16, 2006) was an American economist, statistician, and author who taught at the University of Chicago for more than three decades. He was a recipient of the Nobel Memorial Prize in Economic Sciences, and is known for his research on consumption analysis, monetary history and theory, and the complexity of stabilization policy.^[1] As a leader of the Chicago school of economics, he influenced the research agenda of the economics profession. A survey of economists ranked Friedman as the second most popular economist of the twentieth century behind John Maynard Keynes,^[2] and The Economist described him as "the most influential economist of the second half of the 20th century…possibly of all of it."^[3]

Friedman's challenges to what he later called "naive Keynesian" (as opposed to New Keynesian) theory^[4] began with his 1950s reinterpretation of the consumption function, and he became the main advocate opposing activist Keynesian government policies.^[5] In the late 1960s he described his own approach (along with all of mainstream economics) as using "Keynesian language and apparatus" yet rejecting its "initial" conclusions.^[6] During the 1960s he promoted an alternative macroeconomic policy known as "monetarism". He theorized there existed a "natural" rate of unemployment, and argued that governments could increase employment above this rate (e.g., by increasing aggregate demand) only at the risk of causing inflation to accelerate.^[7] He argued that the Phillips curve was not stable and predicted what would come to be known as stagflation.^[8] Friedman argued that, given the existence of the Federal Reserve, a constant small expansion of the money supply was the only wise policy.^[9]

Friedman was an economic adviser to conservative President Ronald Reagan. His political philosophy extolled the virtues of a free market economic system with minimal intervention. He once stated that his role in eliminating U.S. conscription was his proudest accomplishment, and his support for school choice led him to found The Friedman Foundation for Educational Choice. In his 1962 book Capitalism and Freedom, Friedman advocated policies such as a volunteer military, freely floating exchange rates, abolition of medical licenses, a negative income tax, and education vouchers.^[10] His ideas concerning monetary policy, taxation, privatization and deregulation influenced government policies, especially during the 1980s. His monetary theory influenced the Federal Reserve's response to the global financial crisis.^[11]

Milton Friedman's works include many monographs, books, scholarly articles, papers, magazine columns, television programs, videos, and lectures, and cover a broad range of topics of microeconomics, macroeconomics, economic history, and public policy issues. His books and essays were widely read, and have had an international influence, including in Communist countries.^{[12][13][14][15]}

Early life[link]

Friedman was born in Brooklyn, New York, to recent Jewish immigrants Jenő Friedman and Sára Landau from Beregszász in Austria-Hungary (now Berehove in Ukraine), both of whom worked as dry goods merchants. Shortly after Milton's birth, the family relocated to Rahway, New Jersey. A talented student, Friedman graduated from Rahway High School in 1928, just before his 16th birthday.^[16][17]

Friedman graduated from Rutgers University in New Jersey, where he specialized in mathematics and initially intended to become an actuary. During his time at Rutgers, Friedman became influenced by two economics professors, Arthur F. Burns and Homer Jones, who convinced him that modern economics could help end the Great Depression. After graduating from Rutgers in 1932, Friedman was offered two scholarships to do graduate work; one being Mathematics at Brown University and the other being Economics at the University of Chicago.^[18]Friedman chose the latter, thus earning an M.A. in 1933. He was strongly influenced by Jacob Viner, Frank Knight, and Henry Simons. It was at Chicago that Friedman met his future wife, economist Rose Director. During 1933–34 he had a fellowship at Columbia University, where he studied statistics with renowned statistician and economist Harold Hotelling. He was back in Chicago for 1934–35, spending the year working as a research assistant for Henry Schultz, who was then working on Theory and Measurement of Demand. That year, Friedman formed what would prove to be lifelong friendships with George Stigler and W. Allen Wallis.^[19]

Public service[link]

Friedman was initially unable to find academic employment, so during 1935, he followed his friend W. Allen Wallis to Washington, where Franklin D. Roosevelt's New Deal was "a lifesaver" for many young economists.^[20] At this stage, Friedman said that he and his wife "regarded the job-creation programs such as the WPA, CCC, and PWA appropriate responses to the critical situation," but not "the price- and wage-fixing measures of the National Recovery Administration and the Agricultural Adjustment Administration."^[21] Foreshadowing his later ideas, he believed price controls interfered with an essential signaling mechanism to help resources be used where they were most valued. Indeed, Friedman later concluded that all government intervention associated with the New Deal was "the wrong cure for the wrong disease," arguing that the money supply should simply have been expanded, instead of contracted.^[22] In the publication Monetary History of the United States by Friedman and Anna Schwartz, they argue that the Great Depression was caused by monetary contraction, which was the consequence of poor policymaking by the Federal reserve and the continuous crises of the banking system.^[23]

During 1935, he began work for the National Resources Committee, which was then working on a large consumer budget survey. Ideas from this project later became a part of his Theory of the Consumption Function. Friedman began employment with the National Bureau of Economic Research during autumn 1937 to assist Simon Kuznets in his work on professional income. This work resulted in their jointly authored publication Incomes from Independent Professional Practice, which introduced the concepts of permanent and transitory income, a major component of the Permanent Income Hypothesis that Friedman worked out in greater detail in the 1950s. The book hypothesizes that professional licensing artificially restricts the supply of services and raises prices.

During 1940, Friedman was appointed an assistant professor teaching Economics at the University of Wisconsin–Madison, but encountered antisemitism in the Economics department and decided to return to government service.^[24][25] Friedman spent 1941–43 working on wartime tax policy for the Federal Government, as an advisor to senior officials of the United States Department of the Treasury. As a Treasury spokesman during 1942 he advocated a Keynesian policy of taxation. He helped to invent the payroll withholding tax system, since the federal government badly needed money in order to fight the war.^[26] He later said, "I have no apologies for it, but I really wish we hadn't found it necessary and I wish there were some way of abolishing withholding now."^[27]

Academic career[link]

Early years[link]

In 1943, Friedman joined the Division of War Research at Columbia University (headed by W. Allen Wallis and Harold Hotelling), where he spent the rest of World War II working as a mathematical statistician, focusing on problems of weapons design.^[28]

During 1945, Friedman submitted Incomes from Independent Professional Practice (co-authored with Kuznets and completed during 1940) to Columbia as his doctoral dissertation. The university awarded him a Ph.D. during 1946. Friedman spent the 1945–46 academic year teaching at the University of Minnesota (where his friend George Stigler was employed). On February 12, 1945, his son, David D. Friedman was born.

University of Chicago[link]

University of Chicago

During 1946, Friedman accepted an offer to teach economic theory at the University of Chicago (a position opened by departure of his former professor Jacob Viner to Princeton University). Friedman would work for the University of Chicago for the next 30 years. There he helped build an intellectual community that produced a number of Nobel Prize winners, known collectively as the Chicago School of Economics.

At that time, Arthur Burns, who was then the head of the National Bureau of Economic Research, asked Friedman to rejoin the Bureau's staff. He accepted the invitation, and assumed responsibility for the Bureau's inquiry into the role of money in the business cycle. As a result, he initiated the "Workshop in Money and Banking" (the "Chicago Workshop"), which promoted a revival of monetary studies. During the latter half of the 1940s, Friedman began a collaboration with Anna Schwartz, an economic historian at the Bureau, that would ultimately result in the 1963 publication of a book co-authored by Friedman and Schwartz, A Monetary History of the United States, 1867–1960.

Friedman spent the 1954–55 academic year as a Fulbright Visiting Fellow at Gonville and Caius College, Cambridge. At the time, the Cambridge economics faculty was divided into a Keynesian majority (including Joan Robinson and Richard Kahn) and an anti-Keynesian minority (headed by Dennis Robertson). Friedman speculates that he was invited to the fellowship because his views were unacceptable to both of the Cambridge factions. Later his weekly columns for Newsweek magazine (1966–84) were well read and increasingly influential among political and business people.^[29] From 1968 to 1978, he and Paul Samuelson participated in the Economics Cassette Series, a biweekly subscription series where the economist would discuss the days' issues for about a half hour at a time.^[30]

Friedman was an economic adviser to Republican presidential candidate Barry Goldwater during 1964.

Nobel memorial prize and retirement[link]

In 1976 Friedman won the Nobel Memorial Prize in Economics "for his achievements in the fields of consumption analysis, monetary history and theory and for his demonstration of the complexity of stabilization policy."^[1] During the banquet speech he made a reference to “the Prize in Economic Sciences in Memory of Alfred Nobel”. In that he was the first recipient to do so, and it wasn’t until 2006 that a recipient of the prize called it by its proper name.^[31] During 1977, at age 65, Friedman retired from the University of Chicago after teaching there for 30 years. He and his wife moved to San Francisco where he became a visiting scholar at the Federal Reserve Bank of San Francisco. From 1977 on, he was affiliated with the Hoover Institution at Stanford University. During the same year, Friedman was approached by the Free To Choose Network and asked to create a television program presenting his economic and social philosophy. The Friedmans worked on this project for the next three years, and during 1980, the ten-part series, titled Free to Choose, was broadcast by the Public Broadcasting Service (PBS). The companion book to the series (co-authored by Milton and his wife, Rose Friedman), also titled Free To Choose, was the bestselling nonfiction book of 1980 and has since been translated into 14 foreign languages.

Friedman served as an unofficial adviser to Ronald Reagan during his 1980 presidential campaign, and then served on the President's Economic Policy Advisory Board for the rest of the Reagan Administration. During 1988, he received the National Medal of Science and Reagan honored him with the Presidential Medal of Freedom. Milton Friedman is known now as one of the most influential economists of the 20th century.^[32][33] Throughout the 1980s and 1990s, Friedman continued to write editorials and appear on television. He made several visits to Eastern Europe and to China, where he also advised governments. He was also for many years a Trustee of the Philadelphia Society.^[34][35][36]

Scholarly contributions[link]

Economics[link]

Friedman was best known for reviving interest in the money supply as a determinant of the nominal value of output, that is, the quantity theory of money. Monetarism is the set of views associated with modern quantity theory. Its origins can be traced back to the 16th-century School of Salamanca or even further; however, Friedman's contribution is largely responsible for its modern popularization. He co-authored, with Anna Schwartz, A Monetary History of the United States (1963), which was an examination of the role of the money supply and economic activity in U.S. history. A striking conclusion of their research was one regarding the role of money supply fluctuations as contributing to economic fluctuations. Several regression studies with David Meiselman during the 1960s suggested the primacy of the money supply over investment and government spending in determining consumption and output. These challenged a prevailing but largely untested view on their relative importance. Friedman's empirical research and some theory supported the conclusion that the short-run effect of a change of the money supply was primarily on output but that the longer-run effect was primarily on the price level.

Friedman was the main proponent of the monetarist school of economics. He maintained that there is a close and stable association between price inflation and the money supply, mainly that price inflation should be regulated with monetary deflation and price deflation with monetary inflation. He famously quipped that price deflation can be fought by "dropping money out of a helicopter."^[37]

Friedman's arguments were designed to counter popular claims that price inflation at the time was the result of increases in the price of oil, or increases in wages: as he wrote,

Inflation is always and everywhere a monetary phenomenon.

—Milton Friedman, 1963.^[38]

Friedman rejected the use of fiscal policy as a tool of demand management; and he held that the government's role in the guidance of the economy should be restricted severely. Friedman wrote extensively on the Great Depression, which he termed the Great Contraction, arguing that it had been caused by an ordinary financial shock whose duration and seriousness were greatly increased by the subsequent contraction of the money supply caused by the misguided policies of the directors of the Federal Reserve.

The Fed was largely responsible for converting what might have been a garden-variety recession, although perhaps a fairly severe one, into a major catastrophe. Instead of using its powers to offset the depression, it presided over a decline in the quantity of money by one-third from 1929 to 1933 ... Far from the depression being a failure of the free-enterprise system, it was a tragic failure of government.

—Milton Friedman, Two Lucky People, 233

Friedman also argued for the cessation of government intervention in currency markets, thereby spawning an enormous literature on the subject, as well as promoting the practice of freely floating exchange rates. His close friend George Stigler explained, "As is customary in science, he did not win a full victory, in part because research was directed along different lines by the theory of rational expectations, a newer approach developed by Robert Lucas, also at the University of Chicago."^[39]

Friedman was also known for his work on the consumption function, the permanent income hypothesis (1957), which Friedman himself referred to as his best scientific work.^[40] This work contended that rational consumers would spend a proportional amount of what they perceived to be their permanent income. Windfall gains would mostly be saved. Tax reductions likewise, as rational consumers would predict that taxes would have to increase later to balance public finances. Other important contributions include his critique of the Phillips curve and the concept of the natural rate of unemployment (1968). This critique associated his name, together with that of Edmund Phelps, with the insight that a government that brings about greater inflation cannot permanently reduce unemployment by doing so. Unemployment may be temporarily lower, if the inflation is a surprise, but in the long run unemployment will be determined by the frictions and imperfections of the labor market.

Friedman's essay "The Methodology of Positive Economics" (1953) provided the epistemological pattern for his own subsequent research and to a degree that of the Chicago School. There he argued that economics as science should be free of value judgments for it to be objective. Moreover, a useful economic theory should be judged not by its descriptive realism but by its simplicity and fruitfulness as an engine of prediction. That is, students should measure the accuracy of its predictions, rather than the "soundness of its assumptions. His argument was part of an ongoing debate among such statisticians as Jerzy Neyman, Leonard Savage, and Ronald Fisher.^[41]

Statistics[link]

One of his most famous contributions to statistics is sequential sampling. "Friedman did statistical work at the Division of War Research at Columbia. He and his colleagues came up with a sampling technique, known as sequential sampling, which became, in the words of The New Palgrave Dictionary of Economics, 'the standard analysis of quality control inspection.' The dictionary adds: 'Like many of Friedman’s contributions, in retrospect it seems remarkably simple and obvious to apply basic economic ideas to quality control; that however is a measure of his genius.'"^[42]

Public policy positions[link]

Federal reserve[link]

Friedman believed that if the money supply was to be centrally controlled (as by the Federal Reserve) that the preferable way to do it would be with a mechanical system that would keep the quantity of money increasing at a steady rate. However, instead of government involvement at all, he was open to a "real," non-government, gold standard where money is produced by the private market: "A real gold standard is thoroughly consistent with [classical] liberal principles and I, for one, am entirely in favor of measures promoting its development." He did however add this caveat, "Let me emphasize that this note is not a plea for a return to a gold standard.... I regard a return to a gold standard as neither desirable nor feasible—with the one exception that it might become feasible if the doomsday predictions of hyperinflation under our present system should prove correct."^[43] He said the reason that it was not feasible was because "there is essentially no government in the world that is willing to surrender control over its domestic monetary policy." However, it could be done if "you could re-establish a world in which government's budget accounted for 10 percent of the national income, in which laissez-faire reigned, in which governments did not interfere with economic activities and in which full employment policies had been relegated to the dustbin..."^[43]

He was critical of the Federal Reserve's influence on the economics profession. In a 1993 letter to University of Texas economics professor and former House Banking Committee investigator Robert Auerbach, Friedman wrote:

I cannot disagree with you that having something like 500 economists is extremely unhealthy. As you say, it is not conducive to independent, objective research. You and I know there has been censorship of the material published. Equally important, the location of the economists in the Federal Reserve has had a significant influence on the kind of research they do, biasing that research toward noncontroversial technical papers on method as opposed to substantive papers on policy and results.^[44]

School choice[link]

In his 1955 article "The Role of Government in Education" Friedman proposed supplementing publicly operated schools with privately run but publicly funded schools through a system of school vouchers.^[45] Reforms similar to those proposed in the article were implemented in, for example, Chile in 1981 and Sweden in 1992.^[46] In 1996 Friedman, together with his wife, founded the The Foundation for Educational Choice to advocate school choice and vouchers.

Conscription[link]

Milton Friedman was a major proponent of a volunteer military, stating that the draft was "inconsistent with a free society."^[47][48] In Capitalism and Freedom, he argued that conscription is inequitable and arbitrary, preventing young men from shaping their lives as they see fit.^[49] During the Nixon administration he headed the committee to research a conversion to paid/volunteer armed force. He would later state that his role in eliminating the conscription in the United States was his proudest accomplishment.^[9] Friedman did, however, believe a nation could compel military training as a reserve in case of war time.^[49]

Libertarianism and the Republican party[link]

He served as a member of President Reagan's Economic Policy Advisory Board during 1981. During 1988, he received the Presidential Medal of Freedom and the National Medal of Science. He said that he was a libertarian philosophically, but a member of the U.S. Republican Party for the sake of "expediency" ("I am a libertarian with a small 'l' and a Republican with a capital 'R.' And I am a Republican with a capital 'R' on grounds of expediency, not on principle.") But, he said, "I think the term classical liberal is also equally applicable. I don't really care very much what I'm called. I'm much more interested in having people thinking about the ideas, rather than the person."^[50]

Public goods and monopoly[link]

Friedman was supportive of the state provision of some public goods that private businesses are not considered as being able to provide. However, he argued that many of the services performed by government could be performed better by the private sector. Above all, if some public goods are provided by the state, he believed that they should not be a legal monopoly where private competition is prohibited; for example, he wrote:

There is no way to justify our present public monopoly of the post office. It may be argued that the carrying of mail is a technical monopoly and that a government monopoly is the least of evils. Along these lines, one could perhaps justify a government post office, but not the present law, which makes it illegal for anybody else to carry the mail. If the delivery of mail is a technical monopoly, no one else will be able to succeed in competition with the government. If it is not, there is no reason why the government should be engaged in it. The only way to find out is to leave other people free to enter.

—Milton Friedman, Friedman, Milton & Rose D. Capitalism and Freedom, University of Chicago Press, 1982, 29

Welfare[link]

Friedman made newspaper headlines by proposing a negative income tax to replace the existing welfare system, and then opposing a bill to implement it because the bill proposed to supplement the existing system rather than replace it.

Drugs[link]

Friedman also supported libertarian policies such as legalization of drugs and prostitution. During 2005, Friedman and more than 500 other economists advocated discussions regarding the economic benefits of the legalization of marijuana.^[51]

Economic freedom[link]

Michael Walker of the Fraser Institute and Friedman hosted a series of conferences from 1986 to 1994. The goal was to create a clear definition of economic freedom and a method for measuring it. Eventually this resulted in the first report on worldwide economic freedom, Economic Freedom in the World. This annual report has since provided data for numerous peer-reviewed studies and has influenced policy in several nations.

Along with sixteen other distinguished economists he opposed the Copyright Term Extension Act and filed an amicus brief in Eldred v. Ashcroft.^[52] He supported the inclusion of the word "no-brainer" in the brief.^[53]

Friedman argued for stronger basic legal (constitutional) protection of economic rights and freedoms in order to further promote industrial-commercial growth and prosperity and buttress democracy and freedom and the rule of law generally in society.^[54]

Honors, recognition, and influence[link]

Friedman allowed the Cato Institute to use his name for its biannual Milton Friedman Prize for Advancing Liberty beginning in 2001. A Friedman Prize was given to the late British economist Peter Bauer during 2002, Peruvian economist Hernando de Soto during 2004, Mart Laar, former Estonian Prime Minister during 2006 and a young Venezuelan student Yon Goicoechea during 2008. His wife Rose, sister of Aaron Director, with whom he initiated the Friedman Foundation for Educational Choice, served on the international selection committee. Friedman was also a recipient of the Nobel Prize in Economics.

Hong Kong[link]

Friedman once said, "If you want to see capitalism in action, go to Hong Kong."^[55] He wrote in 1990 that the Hong Kong economy was perhaps the best example of a free market economy.^[56]

One month before his death, he wrote the article "Hong Kong Wrong – What would Cowperthwaite say?" in the Wall Street Journal, criticizing Donald Tsang, the Chief Executive of Hong Kong, for abandoning "positive noninterventionism."^[57] Tsang later said he was merely changing the slogan to "big market, small government," where small government is defined as less than 20% of GDP. In a debate between Tsang and his rival, Alan Leong, before the 2007 Chief Executive election, Leong introduced the topic and jokingly accused Tsang of angering Friedman to death.

Chile[link]

During 1975, two years after the military coup that ended the government of Salvador Allende, the economy of Chile experienced a severe crisis. Friedman accepted the invitation of a private foundation to visit Chile and speak on principles of economic freedom. He spent seven days in Chile giving a series of lectures. One of the lectures was entitled "The Fragility of Freedom," and according to Friedman, "dealt with precisely the threat to freedom from a centralized military government."^[58] Friedman encapsulated his philosophy in a lecture at Universidad Católica de Chile, saying: "free markets would undermine political centralization and political control."^[59]

Friedman also met with military dictator President Augusto Pinochet during his visit. He never served as an adviser to the Chilean government, but did write a letter to Pinochet outlining what Friedman considered the two key economic problems of Chile. The letter listed a series of monetary and fiscal measures deemed a "shock program" to end hyperinflation and promote a market economy.^[60] His letter suggested (among other, more specific prescriptions) that a brief period of cutting government spending would reduce its fiscal deficit and thus reduce the rate of increase of the quantity of money in the country that was driving inflation. The economist did however admit his knowledge of Chile was "too limited to enable [him] to be precise or comprehensive" and that the measures he outlined were "to be taken as illustrative."^[60] Friedman felt that there might be a brief period ("measured in months") of higher unemployment, followed by recovery once inflation was tamed. His letter also suggested that cutting spending to reduce the fiscal deficit would result in less transitional unemployment than raising taxes to do so. Later, Friedman said he believed that market reforms would undermine Pinochet.^[61] Chilean graduates of the Chicago School of Economics and its new local chapters had been appointed to important positions in the new government soon after the coup, which allowed them to advise Pinochet on economic policies in accord with the School's economic doctrine.

According to his critics, Friedman did not criticize Pinochet's dictatorship at the time, nor the assassinations, illegal imprisonments, torture, or other atrocities that were well known by then.^[62] In his 1980 documentary Free to Choose, he said the following: "Chile is not a politically free system, and I do not condone the system. But the people there are freer than the people in Communist societies because government plays a smaller role. ... The conditions of the people in the past few years has been getting better and not worse. They would be still better to get rid of the junta and to be able to have a free democratic system."^[63][64] In 1984 Friedman stated that he has "never refrained from criticizing the political system in Chile."^[58]

Friedman defended his activity in Chile on the grounds that, in his opinion, the adoption of free market policies not only improved the economic situation of Chile but also contributed to the amelioration of Pinochet's rule and to the eventual transition to a democratic government during 1990. That idea is included in Capitalism and Freedom, in which he declared that economic freedom is not only desirable in itself but is also a necessary condition for political freedom. He stressed that the lectures he gave in Chile were the same lectures he later gave in China and other socialist states.^[65] During the 2000 PBS documentary The Commanding Heights (based on the book), Friedman continued to argue that criticism over his role in Chile missed his main contention that freer markets resulted in freer people, and that Chile's unfree economy had caused the military government. Friedman suggested that the economic liberalization he advocated caused the end of military rule and a free Chile.^[66]

Iceland[link]

Friedman visited Iceland during the autumn of 1984, met with important Icelanders and gave a lecture at the University of Iceland on the "tyranny of the status quo." He participated in a lively television debate on August 31, 1984 with socialist intellectuals, including Ólafur Ragnar Grímsson, who later became the president of Iceland.^[67] When they complained that a fee was charged for attending his lecture at the University and that hitherto, lectures by visiting scholars had been free-of-charge, Friedman replied that previous lectures had not been free-of-charge in a meaningful sense: Lectures always have related costs. What mattered was whether attendees or non-attendees covered those costs. Friedman thought that it was fairer that only those who attended paid. In this discussion Friedman also stated that he did not receive any money for delivering that lecture.

Estonia[link]

Although Friedman never visited Estonia, his book Free to Choose exercised a great influence on that nation's then 32-year-old prime minister, Mart Laar, who has claimed that it was the only book on economics he had read before taking office. Laar's reforms are often credited with responsibility for transforming Estonia from an impoverished Soviet Republic to the "Baltic Tiger." A prime element of Laar's program was introduction of the flat tax. Laar won the 2006 Milton Friedman Prize for Advancing Liberty, awarded by the Cato Institute.^[68]

United Kingdom[link]

Milton Friedman influenced the thinking of Alan Walters and Patrick Minford, two of Margaret Thatcher's main macroeconomic advisers. See the book Margaret Thatcher's Revolution: How it Happened and What it Meant, edited by Subroto Roy & John Clarke, Continuum 2005

Criticism[link]

Keynesian criticism[link]

During the financial crisis of 2007–2010, several Keynesian economists such as James Galbraith and Joseph Stiglitz blamed the free market philosophy of Friedman and the Chicago school for the economic turmoil.^[69]

After Friedman's death in 2006, Keynesian Nobel laureate Paul Krugman, praised Friedman as a "great economist and a great man," but criticized him by writing that "he slipped all too easily into claiming both that markets always work and that only markets work. It's extremely hard to find cases in which Friedman acknowledged the possibility that markets could go wrong, or that government intervention could serve a useful purpose."^[70]

Austrian school criticism[link]

In 1971, libertarian economist Murray Rothbard criticized Friedman's efforts to make the government more efficient as detrimental to individual liberty, concluding "...as we examine Milton Friedman’s credentials to be the leader of free-market economics, we arrive at the chilling conclusion that it is difficult to consider him a free-market economist at all."^[71] Friedman's position on governmental control of money changed since 1971 when this criticism was made.^[72] In a 1995 interview in Reason magazine he said the "difference between me and people like Murray Rothbard is that, though I want to know what my ideal is, I think I also have to be willing to discuss changes that are less than ideal so long as they point me in that direction." He said he actually would "like to abolish the Fed," and points out that when he has written about the Fed it is simply his recommendations of how it should be run given that it exists.^[9]

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Other criticism[link]

In her book The Shock Doctrine: The Rise of Disaster Capitalism, journalist and author Naomi Klein criticized Friedman's ideology and the principles that guided the economic restructuring that followed the military coups in countries such as Chile and Indonesia, drawing analogies between the way that Friedman proposed using the social "shock" of the coups to create an economic "blank slate" with Ewen Cameron's controversial medical experiments that used electroshock therapy to create a mental "blank slate" in patients with mental disorders.^[73] Based on the extent to which the application of neoliberal policies has contributed to income disparities and inequality,^[74] both Klein and Noam Chomsky have suggested that the primary role of neoliberalism was as an ideological cover for capital accumulation by multinational corporations.^[75] Chilean economist Orlando Letelier asserted that Pinochet's dictatorship resorted to oppression because of popular opposition to Chicago School policies in Chile.^[76] Klein's book has been criticized. In the October 2008 issue of Reason magazine, Swedish historian Johan Norberg called her book a "disastrous ... polemic" and criticized the book as exaggerating some facts and ignoring others, subjecting Friedman to "the most malevolent distortions of a thinker's ideas in recent history." Norberg states that "Friedman's view was the opposite of what Klein claims" and "twists [the] relationship [between Friedman and Pinochet's regime] beyond recognition," concluding that "Klein is dead wrong about Friedman."^[77] Tom Redburn wrote that Klein "accuses Friedman of being the godfather of a Mafia-like gang", stated that "her argument constantly overreaches because her goal is not really to tame capitalism so much as to taunt it", and that Klein is "blind to the necessary role of entrepreneurial capitalism in overcoming the inherent tendency of any established social system to lapse into stagnation."^[78]

Personal life[link]

According to a 2007 article in Commentary magazine, his "parents were moderately observant [Jews], but Friedman, after an intense burst of childhood piety, rejected religion altogether."^[79] He described himself as an agnostic.^[80]

Friedman wrote extensively of his life and experiences, especially in 1998 in his memoirs with his wife Rose, titled Two Lucky People. He died of heart failure at the age of 94 years in San Francisco on November 16, 2006.^[81][82] He was survived by his wife (who died on August 18, 2009) and their two children, David, who is a philosopher and anarcho-capitalist economist, and Janet. David's son, Patri Friedman, is the executive director of the Seasteading Institute.^[83]

See also[link]

liberalism portal

• Works of Milton Friedman
• Friedman–Savage utility function
• Friedman rule
• Friedman's k-percent rule
• Friedman test
• List of economists
• List of Jewish Nobel laureates
• List of notable Presidential Medal of Freedom recipients
• History of economic thought

Notes[link]