Horse 1218 - In Defence of Progressive Taxation

I apologise in advance because this is primarily written for an American audience.

One of the questions which has been raging as a result of the US Debt Crisis is the underlying problem that collectively the American people do not pay enough in tax.

As I mentioned in Horse 1215 the US Govt collects about $2,300bn a year in taxation receipts; spends $225bn just on interest of previous debt, $2,108bn on "Mandatory" spending and a further $1397bn on "Discretionary" Spending. Even in the US Federal Government cut all "Discretionary" Spending to ZERO, there'd still be a shortfall of about $333bn.

There are several major problems with raising additional taxation:
- How do you design a system which is fair?
- How do you design a system which is efficient?
- Who should the burden of taxation fall on?

Quite a lot of people are in favour of switching to an entirely Consumption Tax based system. The problem with this is that the burden of payment of a Consumption Tax mainly falls on poorer people by virtue of the fact that they spend a higher proportion of their income.
I have also heard it suggested that a "Flat Tax" is the fairest system. Although this sounds reasonable at first, upon closer inspection, it doesn't really seem all that fair at all.

These then are the main reasons why I think a Progressive Taxation is "fairer".


1. Due to economies of scale, the larger an investment is the higher the likely return on that investment. Since governmental policy is largely shaped by either trying to attract investment or through forces to do with political donations, it follows that the wealthiest people in society also have the greatest degree in shaping governmental policy.

"Inequality impacts politics. Economic power tends to beget political power even in democratic and pluralistic societies. In the United States, this tends to work through campaign contributions and access to politicians that wealth and money tend to buy. This political channel implies another, potentially more powerful and distortionary link between inequality and a non-level playing field. It may also create pathways from inequality to instability, because both the economic and political implications of inequality can create various backlashes."
- Daron Acemoglu, The Economist 23rd Jan 2011
http://www.economist.com/economics/by-invitation/guest-contributions/economic_power_begets_political_power


2. People on lower incomes have a higher marginal propensity to consume. Their incomes are already more likely to be directed to private firms through retail spending. By giving people on lower incomes a concession, the economy is effectively permanently stimulated.

3. As incomes increase, the marginal utility of money decreases along with the marginal propensity to consume. Because the marginal utility of money decreases the actual burden of taxation is less as incomes increase.

To illustrate this, assume a Flat Tax of 10%.
Someone on Ÿ10,000 a year is always going to miss that next dollar than someone on Ÿ100,000 a year. Although the tax on Ÿ10,000 is only Ÿ1000, for the person on Ÿ10,000 that Ÿ1000 take is very much likely to eat into their quality of life, whereas for someone on Ÿ100,000 the take of Ÿ10,000 doesn't have anything like the same impact. Needless to say that someone on Ÿ1,000,000 if they have Ÿ100,000 taken out in tax they still won't feel it as much as either the persons on either Ÿ10,000 or Ÿ100,000 a year.
(Income in Economics equations is almost always shown as a Y to avoid confusion with I for Interest or the number 1. Ÿ is a good symbol for Income Monies).

As I said in Horse 1024:
"But we'd also have to assume that as people's income increases, then obviously they can spend more right? Well almost, but not quite. For as people's income does go up, although they might buy nicer things, their absolute capability of buying stuff stops at some point. No-one for instance can fill the car with petrol anymore than full. No-one can buy more groceries than they can fit in their house."
- Me, 13 Aug 2009 (Is it plagiarism if you quote yourself?)

4. If things like the Department of Defence are seen as a collective insurance system, then the stability of the economy should also be seen as a collective insurance system. People who benefit the most from the economy's stability, should therefore be liable for the greatest proportion of premium because they derive the greatest benefit from the stability of the economy.

https://www.cia.gov/library/publications/the-world-factbook/fields/2172.html

A Gini Co-Efficient of 45 would indicate that in the United States, has a very high degree of income inequality.
Although the calculation to work out what percentage of the population derives what proportion of incomes, it can be taken that:
- The top 20% earn 49.98% of all income
- The top 8% earn 28.50% of all income
- The top 3% earn 17.50% of all income
 Also:
- The bottom 80% earn 50.02% of all income

To design a "fair" taxation system would logically require that  the top 20% would pay 49.98% of all income taxes and that the bottom 80% would pay 50.02% of all income taxes, no? However, if you look though the actual statistics from the IRS, the top 20% only paid 25.80% percent of income taxes because of tax concessions for the rich whilst, the bottom 80% actually paid 74.20% percent of income taxes despite only earning 50.02% of income. How is that fair?

To address the three questions of fairness, efficiency and who the burden should actually fall on, since there is only one set of taxation codes rather than individual taxation codes for each individual (which would be undoubtedly more fair and make the burden fall where it should, but be less efficient), then that set of taxation codes needs to be more generalised.
To that end a Progressive Taxation system at least makes an attempt to address the above issues whereas a system based on either a Flat Tax or an entirely Consumption Tax based system do not.