Income Inequality (15): Progressive Taxation

Yes, I know… another post (and a long one) on income inequality, something which isn’t even a human rights issue, strictly speaking. I repeat, the most important thing to me is the provision of basic necessities, not the unequal distribution of these necessities. The fact that someone is poor and homeless is a more important problem than the fact that some people earn more or have bigger houses. Human rights address the first problem, not the second. When human rights address the problem of inequality, it’s usually not income inequality but other types of inequality (unequal rights, discrimination, unequal representation or access to information etc.).

What’s the problem?

However, as I stated here, income inequality IS a problem. It can destroy the cohesiveness of a society when it surpasses certain limits. People lose their self-esteem when they see that they are relatively worse off (even though not necessarily poor), especially when their position in society isn’t completely their own fault, which is often the case. People’s income, even in supposedly meritocratic societies such as the U.S. and the U.K., depends heavily on their family and social environment, and not only on their own achievements. Income inequality therefore becomes a problem of justice, social justice. And it can also become a problem for democracy, in which case it becomes a human rights issue (democracy is a human right). On top of that, people tend to be healthier and to live longer in more egalitarian societies.

And finally, this paper shows that

increased income (or wealth) generally does not increase … happiness significantly, and to the extent that it does, relative income plays a greater role than absolute income. In light of this … redistribution, via a progressive income tax, will increase people’s utility (happiness) by improving their relative incomes.

What can we do?

So, there are many good reasons to reduce income inequality, or at least slow down the trend of increasing inequality. There are also many ways to do this. Progressive taxation, rather than regressive taxation or a flat tax, is one way, as stated in the quote (and here/here). Public social spending is another way, as are some measure to increase social mobility and reduce the correlation between parents’ income and that of their offspring (e.g. an inheritance tax). Better funding for education, and helping lower income people gain access to education (by way of vouchers or scholarships etc.) is also good policy.

In the current post, however, I want to focus on one aspect of policy, namely taxation. I want to defend progressive taxation against regressive or flat taxation, not because of reasons of economic efficiency – although these are important – but because it is a policy which can reduce income inequality.

What is progressive taxation?

Progressive taxation (an idea going back to Adam Smith if not before) means that those with a higher income pay a relatively larger share of their income on taxes, and that this share rises progressively when income levels rise. Earning more means paying more taxes, both in absolute terms (the amount of taxes paid) and in relative terms (the percentage of income paid on taxes). A concept often used to describe this is “increasing tax burden”, but that is misleading, as Ezra Klein has pointed out. A person paying more taxes both in absolute and relative terms, doesn’t necessarily carry a bigger burden:

A strong person carrying a 50 pound bag may feel less burdened than a weak person carrying a 20 pound bag.

Even if the 50 pound is larger compared to the body weight of the strong and healthy person than the 20 pound is to that of the weak and sick person. Klein again:

The average after-tax income of the average person in the middle income quintile is $52,100. That’s down from about $60,700 after an effective tax rate of 14.2%. In the top quintile, the after-tax income is $184,400, down from $248,400 after a 25.8% effective federal tax rate. The rich person certainly pays more, both in absolute terms and as a share of income. But is his burden greater than the middle-income taxpayer left with $52,100? It’s hard for me to see how.

A progressive tax system can also be defined by comparing it to the so-called flat tax. A flat tax usually means that everyone pays the same tax rate. As a result, rich people pay more taxes in absolute terms, but the same taxes as poor people in relative terms. Proponents of a flat tax system say that it stimulates economic growth because it takes away less money from the wealthy, who can then invest it in the economy. Such higher growth in turn leads to more revenue for the government, and hence more means to benefit the poor, for instance. A flat tax also leads to more revenue because lower tax rates for the rich means that they will be less inclined to cheat or avoid taxes, and because its simplicity eliminates loopholes and deductions.

However, these advantages, to the extent that they are real, don’t address the inherent injustice of the system.

How do you make taxation progressive?

The “progressivity” of taxes can be achieved in different ways:

  1. The most obvious way: a higher income means a higher tax rate.
  2. Rather than increasing the tax rate together with increases in the taxable amount (usually the wage or other types of income), one can also choose to increase the taxable amount for wealthier people while leaving the tax rate identical for everyone. Wealthier people would then have a larger “tax base”. For example, they may have less exemptions, deductions, tax credits etc., or they may have to pay taxes on luxury goods that only they can afford to buy. With one and the same tax rate for all, we still are able to introduce progressivity. This looks a bit like the flat tax.
  3. Or one can decide to have, like in the previous case, only one tax rate rather than rates rising with income levels, and exempt from taxes all income below $50,000 or something. This as well is a progressive tax, because people with higher incomes pay more taxes, both in an absolute and a relative sense.

Progressivity can not be achieved by moving the tax system away from income and towards sales taxes, VAT or consumption taxes. Such taxes are by definition regressive, because they impose a relatively higher burden on lower income taxpayers, who, after all, spend a larger proportion of their wealth and income on consumption, and therefore pay a greater share of their income on taxes.

Other options?

As mentioned above, progressive taxation is only one way to reduce income inequality, and perhaps not even the most useful one. Yglesias and Kenworthy have shown that it’s not the tax system as such but targeted government spending that equalizes things. The important thing is to have a tax system that generates enough revenue to spend on counter-inequality measures (such as education, benefits etc.). Whether this system is progressive or not is secondary. According to Kenworthy, countries with higher tax revenues but not necessarily more progressive tax systems achieve more inequality reduction.

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