April 2019 newsletter – Sir James Mirrlees

James Alexander Mirrlees was born in 1936 in Minnigaff, Kirkcudbrightshire, in Galloway.  His mathematical excellence led to undergraduate study first in Edinburgh and then in Cambridge.  He began to attend economics lectures, motivated by an interest in philosophy and social science and a desire to apply mathematical skills to questions of ethical significance.

He went on to graduate study in the subject under David Champernowne and Richard Stone and became involved in various economic projects on growth in Cambridge, working for example as research assistant to Nicholas Kaldor.  Academic visits abroad reinforced his academic and practical economic interests.  In 1963 he became a teaching fellow at Trinity College Cambridge and completed a doctoral thesis on optimal accumulation under uncertainty, examined by Kenneth Arrow. In 1968 he moved to Nuffield College, Oxford, where he became the Edgeworth Professor and remained until moving back to Trinity in 1995. In 1996 he was awarded the Nobel Prize, jointly with William Vickrey.  After retirement in 2003 he became Distinguished Professor-at-Large at the Chinese University of Hong Kong and Master of Morningside College.  His period as Royal Economic Society President from 1989 to 1992 was one of several positions at the head of learned societies including President of the Econometric Society in 1982 and President of the European Economic Association in 2000.

His earliest work in economics was the work with Nicholas Kaldor exploring technical change, investment and growth.  Interest in growth questions, particularly those concerned with the optimum level of saving, continued throughout his career.  His engagement with economics had been driven by a conviction that the reduction of poverty in the underdeveloped world was ‘what really mattered in the world’ and he wrote also on development.

His work with Ian Little on the appraisal of public projects was of particular practical significance. Here they sought to bridge the gap between the abstract concepts of cost-benefit analysis and the practicalities of social investment decision-making in developing countries through extended and meticulous practical advice on performing project evaluations in settings of pervasive market failures and weaknesses of policy.  Their work advocated use of shadow prices based on border prices for traded goods and outlined practical methods for consistent social costing based on shadow wages and prices of traded inputs for nontraded goods.  The influence of their work on methodologies adopted widely in donor agencies in the 1970s, particularly by the World Bank, was welcome and the decline in interest since is a source of regret.

The work for which he is best known is on taxation and incentives that began in the 1960s. His work with Peter Diamond on optimum design of commodity taxes led to the deeply significant two-part paper of 1971 generalising the results of Ramsey and Samuelson. Firstly, they showed that in a wide variety of circumstances there is no argument for distorting production. Distortion to consumption and labour supply decisions may be an unavoidable feature of the optimal tax policy, but there is no case for the economy to produce inefficiently. The undesirability of taxing transaction between firms that follows from this makes the case, for example, for collection through a value-added tax.  Secondly, they showed how Ramsey’s arguments for setting tax rates so as to discourage consumption of all commodities equally need to be adapted to incorporate the problem of income redistribution together with that of raising revenue when consumers are heterogeneous.

The problem of designing an optimal non-linear tax schedule for labour income raises conceptual challenges that required a breakthrough made by Mirrlees at around the same time.  How should formulation of the question capture taxpayer responses to the potentially highly irregular schedule under design?  Mirrlees showed how to pose it as an information question.  Governments can monitor only how much people do earn and not know how much they could earn unless they design taxes so that people’s decisions will voluntarily reveal it.  Whatever combination of work hours and after-tax income the government decides it wants someone to choose, it needs to make that combination more attractive to them than what such a person could get by posing as anyone of lower earnings capacity.  Tax design therefore has an incentive compatibility constraint which, under reasonable assumptions on preferences, can be represented as a constraint on the rate at which taxpayer well-being needs to increase with unknown earnings capacity in a suitably formulated optimum control problem. The Mirrleesian framework remains the accepted starting point for serious treatment of direct tax design and shapes much ongoing analysis. 

His original paper reported simulations based on particular preferences and ability distributions which suggested optimal schedules might be close to linear and at lower rates than he had anticipated. For a time he was led to question his prior belief in the case for graduation in marginal tax rates and the effectiveness of the income tax as a tool for reducing inequality but the later work of others restored his belief ‘that marginal rates of tax should … be greater than they were in these first calculations’ and graduated so that they ‘were highest in the middle of the range of incomes, and fell towards higher incomes and lower’. The ‘notorious’ result that the marginal tax rate on the topmost income should be zero — not a feature of his work, which assumed no known highest ability, but discovered by later authors extending his findings — was one that he regarded as ‘practically irrelevant’.

In later years he chaired the Mirrlees Review of the entire UK tax system convened by the Institute of Fiscal Studies.  It called for ‘a systematic conceptual approach that joins together our thinking across the whole range of taxes … rooted in economic theory that models the constraints people face and the way they behave when taxes change.’  It proposed, for example, better integration in direct taxation, better justification for departures from neutrality in indirect taxation and  replacement of ill-designed taxes on asset transfers with VAT on services yielded.  Its approach and findings have been widely cited as a model for reviews of this kind.

His modelling of the optimum income tax problem as one of informational asymmetry between government and taxpayers began a continuing engagement with informational economics over following years which eventually led to the award of the Nobel prize, jointly with William Vickrey, in 1996.  Just as his optimum tax work produced ideas of wide applicability to the analysis of adverse selection problems, so his work on moral hazard delivered findings of fundamental and far-reaching importance to a wide body of later work.  In many fields, economists find themselves analysing problems where a principal needs to set incentives so as to optimally motivate an agent despite the agent knowing more than the principal either about their type or their actions.  It is from Mirrlees’ investigation of such problems that much understanding of the general principles of contract theory has emerged.

His contributions have enriched and informed multiple fields of economics.  His specific investigations into tax and public policy changed the way that questions in those fields are discussed. His ability to simplify complex problems in ways which revealed their tractable essence deepened knowledge in widely different fields of microeconomics.  In practical terms his work yielded radical and relevant insights that left the whole discipline wiser and more able to see how things fit together.

His work was motivated throughout by a commitment to economic inquiry as a way of doing good in the world.  Besides his scholarly contribution to the improvement of public policy, his personal generosity is warmly spoken of by all those who knew him.

Richard Blundell and Ian Preston

University College London