“There is only one way to make everyone wealthy–and that’s AI and robotics. My prediction is that work will be optional.” – Elon Musk
Muskian hyperbole aside, AI and related technologies such as robots and quantum computing could have a profound effect on human labor. And if machines broadly replace workers, as Musk and many others believe, this transformation poses an existential threat to the US tax system, which is largely built on taxing labor income.
Depending on how you count, between 65% and 83% of federal tax revenue is collected on wages and salaries. To the degree that tech replaces workers, taxes on labor income may decline. And, with the federal government running a nearly $2 trillion annual budget deficit, losing even fraction of those labor-related tax revenues would be a fiscal disaster.
Payroll Taxes
The largest share of labor-related tax is the payroll tax that supports Social Security and some of Medicare. Even if current revenues don’t fall, Social Security and Medicare’s Part A hospital insurance trust fund both face insolvency in eight years or less.
To the degree tech replaces workers who may find lower-paying employment, their payroll tax payments will shrink. In old age, they may receive smaller Social Security checks. But since the benefits for current retirees are paid by taxes of actively working people, the program’s near and medium-term solvency would be at even greater risk.
Income Taxes
Individual income taxes on labor dwarf taxes on capital. The top rate on wage income is 37.5 percent, while the top rate on capital gains is 23 percent (20 percent plus the 3 percent net investment income tax). The corporate tax rate is even lower at 21 percent. Some is paid by workers, though economists disagree on how much.
A large share of capital income goes entirely untaxed, both because firms can avoid taxes on their earnings and because a large share of assets held until death by individuals is excluded from taxation.
Since labor is more highly taxed than capital in most of the world, this concern stretches beyond US borders. AI presents a risk to the tax bases of many countries.
How much will AI and similar tech impact firms and their workers? Of course, no-one, even Musk, can predict that. By the changes could be profound.
Impact On Jobs
One new study using a model called the Iceberg Index estimates that AI already replaces about 2 percent of wages in computing and technology, or about $211 billion. But the same analysis finds 11.7 % of labor income, or $1.2 trillion, is at risk in administrative, financial, and professional services.
In October alone, as many as 30,000 jobs disappeared due to AI, at least according to businesses themselves. Take these estimates with a grain of salt since some employers may be blaming AI for layoffs that are caused by, say, declining sales. But still….
The Wall Street Journal reports (paywall) that China is moving far more aggressively than the US to replace human labor with AI. At one factory, the technology has increased by 10-fold the intervals where workers must intervene with malfunctioning machines.
But AI may impact more than factory workers. For example, it may take 1,000 highly specialized construction workers to build a data center but only about 20 to run a mid-sized facility.
Higher-wage white collar workers may also be at risk. IBM’s CEO thinks he can replace one-third of his human resources department with AI in five years. Who will need highly-paid law firm associates once AI can do legal research faster and better? Already, new technology may be replacing customer service reps, computer programmers, and even some software engineers.
Some low-wage workers, such as home health aides, may be least affected by AI and automation. But most pay few, if any, income taxes.
Overblown Fears?
Many economists and social commentators say AI concerns are overblown. They argue past technological advances led to more human work, not less. While the nature of labor changed profoundly, both the number of jobs and worker productivity increased. Many workers may lose jobs but they will get others, perhaps paying more.
MIT economist David Autor puts it this way, “Innovations opened fundamentally new vistas of human possibility. Simultaneously, they generated new employment and new demands for expertise.”
A Shock To Federal Revenues
But Autor’s fellow MIT economist and Nobel prize winner Daron Acemoglu sees the impact of AI on labor markets very differently. It will, he predicts, “widen the gap between labor and capital income.”
A key question: Will AI and related tech substitute for human labor or complement it? And if it enhances labor, who will reap the fruits of that increased productivity?
Historically, more efficient workers are paid more, and thus would pay more in taxes. But some increased productivity will increase returns to owners of capital, who pay lower rates of tax.
Similarly, new tech may affect business profits in very different ways. Some companies could use AI to boost earnings and perhaps pay more in taxes. While it hasn’t happened yet, it could.
At the same time, some service businesses, say accounting, may become so commodified by widely available AI that their profits plummet. Carter Price and Akshaya Suresh, authors of a new paper on AI and taxes for RAND Corp., note that during the technology-driven industrialization of the late 19th century, prices fell by 2% annually.
The RAND authors present four different scenarios for a tech-driven future, In one, which they call “business as usual,” tax revenues may increase. But in others, they fall. Their conclusion: “Labor replacing-AI could be a significant shock to the economy and federal revenues.”
We can’t predict AI’s future. But policymakers need to recognize the extreme risks to a labor-based tax system that already fails to generate the revenue necessary to fund the government we seem to want. And if AI’s impact on labor is as profound as some predict, they’ll need to react quickly, before tax revenues collapse.