23 Mark Robyn and Gerald Prante, “Summary of Latest Federal Income Tax Data,” Fiscal Fact 249 (Tax Foundation, October 6, 2010), http://www.taxfoundation.org/ news/show/250.html, 24 Roberton Williams, “Who pays no income tax?,” Tax Notes (June 29, 2009), available at http://www.taxpolicycenter.org/UploadedPDF /1001289_who_pays.pdf. Seligman, Blum and Kalven, and others have examined the property protection arguments for progression and dismissed them as either untenably weak or without merit. SEDLAC (Socioeconomic Database for Latin America and the Caribbean), CEDLAS at the Universidad de La Plata and World Bank. Income tax and government . The foreman’s hourly rate is commensurate with his aptitude as a manager, while Harry’s $25 per-hour rate is commensurate with his aptitude as a carpenter. Former President Barack Obama called it “the defining issue of our time,” and Nobel laureate Joseph Stiglitz has claimed inequality diminishes young voters’ belief in markets and eventually leads to weaker growth [PDF]. The larger the value, the more progressive the tax is. A lower average tax rate offset the equalizing effect of increased tax progressivity, leaving the effect of federal taxes on income inequality little changed. (Technically a per-capita tax is not an income tax, but it is almost universally accepted as the most economically efficient tax system.). For example, Tom, who worked 20 hours a week, had a different work ethic from his brothers, Dick and Harry, who each worked 60 hours per week. This changes the picture substantially, as we can see by means of a simple thought experiment: Assume the society’s population has a normal (bell curve) distribution of aptitudes. But the funding for such programs should some instances grievously so. The measure falls between zero and one, where the former describes perfect equality and the latter is perfect inequality. © 2020 by the Board of Trustees of Leland Stanford Junior University. If you and your wife worked harder and saved more you would make as much as my family does.” To which Tom replied, “I don’t work more because I value my leisure time more than I value money. In percentage terms, it remains today at roughly the pre-1980 value. “It’s all right here in the irs tax tables. The notion that taxes are simply a burden that must be tolerated rather than a payment for benefits raises the question: Why would the citizens of a democracy vote to impose taxes on themselves if they did not expect benefits in return? Policy Research Working Paper 7194. While they were almost identical in most respects, they had somewhat different preferences and values. In the study, government spending mainly includes cash transfers and certain in-kind transfers (spending on basic services as well as on education and health). Sweden, often cited as the most progressive tax regime in the OECD, maintains a top statutory income tax … The relevance of tax progressivity measures to policymaking depends on whether they help assess the extent to which taxation leads to social welfare gains or losses. A Labour government should replace council tax with a progressive property tax, payable by owners, not tenants. These may be valid assertions, and further research is important to determine the consequences of such policies on outcomes such as growth, unemployment, poverty and economic efficiency. Consequently, the value of using money income to measure either standard of living or inequality is quite limited. In other words, the rich in South Africa bear relatively more of the tax burden than the poor and the government redirects these resources more towards the poorest in society. Stated this way there is no “general” welfare; there is only the welfare of the two groups and the wealthy receive no counter-balancing benefits for their surrender of income or wealth.21, As contrasted with the benefits principle and sacrifice theory, each of which relies on conceptions that purport to enhance equity, income redistribution is simply a coercive transfer of wealth from one group to another without an equity principle to support it. On conceptual grounds alone, sacrifice theory appears to be a very weak foundation for tax policy. On the other hand, fuel taxes and VAT are slightly progressive. taxation must be progressive. By making progressive changes to the tax system now, the Liberals can raise much-needed revenues while fulfilling the commitment in the throne speech to find new ways of taxing extreme inequality. Only applicable to highly mobile, demanded individuals who are able to shift increases in taxes on A progressive tax doesn't hurt the wealthy as much because, even after the tax, they can afford the basics. Like all parables, the story of the Class brothers is designed to illustrate a moral principle. 25 J. R. McCullough, A Treatise on the Principles and Practical Influence of Taxation, or the Funding Fourth, even if the protection argument had merit, it would, at best, argue for a proportionate rather than a progressive tax. Figure 4 illustrates how the combined effect of taxation and government spending reduces South Africa’s Gini coefficient from 0.77 (for market income) to 0.59 (for ‘final’ income). In the case of Medicare, the Choice of occupation. There are weaknesses in the logic of this doctrine that make the fairness of a proportionate or degressive tax system less than perfect. The “Class Wars” parable imagined a society in which all of the members had the same aptitude. Surprisingly, the literature contains only infrequent and oblique references to this crucial aspect of tax theory. It is important to note that the U.S. income figures cited above come from the Census Bureau, which uses what it calls “money income” (income before taxes, excluding the value of non-cash benefits). Establishing a graduated rate scale and setting the top marginal rate on that scale are inherently arbitrary tasks. Tax policy is the mechanism through which market results are redistributed, affecting after-tax inequality. “My family makes more money than yours does because my wife and I work long hours and we earn extra money on our savings. A more comprehensive measure of income yields a very different picture. Several advanced economies have top income tax rates well above the current U.S. rate. There are at least five methodologies used for measuring income inequality. 3. levies are effectively prepaid medical insurance premiums. How could Harry, who was clearly “rich,” ask him to pay the same amount, when it was obviously harder for him to do so? “From no less an authority than the federal government,” said Tom as he pulled out a gray booklet. While it is well accepted that marginal-utility curves will eventually slope downward, it is by no means true that all curves have the same slope. And if the government does provide benefits (which of course it does), why would the payment of taxes be considered a sacrifice rather than a fair payment for value received? accounting firm. II (D. Appleton and Company, 1894), 99, 401. To do otherwise would be arbitrary and in the opinion of many, inequitable. There is no material difference in the cost of protecting persons with high incomes or high-value property than that of persons with low incomes or low-value property. Corporate tax (about 21% of tax revenue) is the largest category excluded from the analysis. The Census Bureau’s so-called “15th measure of income” adds to money income, transfer payments, insurance supplements, capital gains, Medicare, Medicaid, net imputed return on equity in owned homes, and subtracts taxes. They do not include This essay is an abridged version of a In either of these scenarios, taxing Harry at a higher marginal rate than Tom (as required by a progressive income tax) would be inconsonant with sacrifice theory, and by its own standard, inequitable. Both the IRS and California assess tax based on tax brackets, which are the divisions at which tax rates change in a progressive tax system. . Does it mean (as some suggest) the financial wherewithal with which to pay taxes — which might come from either assets or income? 7 Some advocates of progression argue that a progressive income tax is needed to Secondly, indirect taxes (VAT, excises on alcohol and tobacco and the fuel levy[3]) are slightly regressive, notably in the bottom half of the income distribution. The same is true for liberty and the pursuit of happiness. when all taxes (indirect and direct, excluding corporate taxes) as well as key categories of government spending are taken into account – the Gini coefficient is estimated to be around 0.59 – a reduction of 0.18 Gini points. The spending was apportioned to individuals on the basis of household survey data, using educational enrolment and utilization of health services. But the case for more economic equality, when examined directly, is itself perplexing. Now consider Tom’s and Dick’s situation: Knowing that Harry is the most industrious of the brothers and was unlikely to need their help, Harry’s parents made it clear that when they died they would leave all of their rather significant estate to the less industrious brothers, leaving nothing to Harry. Accordingly, there would be no difference in the cost of these protections based on property value. These transfers also have significant value: for the poorest 10% of South Africans, transfers are worth 10 times more than their market incomes. This was quickly met with lawsuits and a ruling that it violated current law. During this period, real compound annual gdp growth in the U.S. was 3.3 percent, substantially greater than the growth of its G-7 counterparts, which on a weighted-average basis (using either population or gdp), grew only 2.3 percent per year. Lastly, where the logic of the doctrine is flawed, in each case it errs on the side of taxing lower-income people less, regardless of the reason their income is lower. As we will see, the statement of the principle — payment of taxes in return for benefits — lends itself to widely varying interpretations. To be sure, inequality exists in the United States as it does to a greater or lesser extent in all other nations. In this entirely plausible scenario, the marginal utility of one extra dollar to Harry might be equal to the marginal utility of one extra dollar to Tom. In a country as unequal as South Africa, it is critical to deter… This indicates that more progressive income tax policies (e.g., higher income taxes on the wealthy and a higher earned-income tax credit) would reduce after-tax income inequality. Harry thought it would be simple to divide the bill. Had Bill Gates decided to finish Harvard and become a high school math teacher, he almost certainly would have been successful, but he would not have become a multi-billionaire. be through direct spending programs. Thus, if you plot a chart in which the vertical axis is units of marginal utility a person gets from money, and the horizontal axis is the amount of money the person earns, the curve will eventually have a downward slope. But it has to be understood as capacity; aptitude does not produce income until it is combined with individual effort. If the insurance analogy were applied, those with two times as much income or property would pay two times as much tax, which would be proportionate, not progressive. Work effort. The most equitable tax system is one based on the value of benefits received. . There is yet another interpretation of the benefits principle that is arguably superior to the others, because it comes closest to placing a true value on the benefits of government. Stated simply, the theory posits that the fairest tax is one that extracts from each taxpayer an equal or proportionate “sacrifice.” The theory rejects the quid-pro-quo notion that taxes are remitted in return for government benefits and instead treats taxes simply as a burden that must be shared in the most equitable way. These services include, but are not limited to: the national defense, infrastructure, the judicial court system, police and fire protection (delivered at the federal, state, and local levels), education (delivered at the state and local level), the general administration of government, and support for truly needy citizens. . In 2010, the U.S. grew 2.8 percent compared with only 1.8 percent growth forecast for the Euro area by the International Monetary Fund. The benefits principle of taxation holds that the government provides benefits to its citizens that should be paid for in taxes by each beneficiary in accordance with the value he or she receives from government services. This enhancement to the benefits principle, which introduced a mild degree of progression by comparison to a pure proportionate tax (a tax from the first dollar of income), became known as a “degressive” tax. Progressive taxation is a key component of effective fiscal policy. The biggest coronavirus relief package so far, March’s CARES Act, gave three times as much ($135 billion) in one tax break to millionaires than it spent on safety net programs ($42 billion). For instance, 61.3% of aggregate consumption expenditure comes from the richest 20% of South Africans, compared to 55.7% in Brazil (StatsSA 2014; SEDLAC). As to equity, there is virtually unanimous agreement among scholars that the tax system should be “fair.” Unfortunately, there is great disagreement as to which system best meets this criterion. The attempt to ascertain a mathematical scale of progression, so as to avoid a charge of arbitrariness, is foredoomed to failure.12. Since there is no perfectly equitable tax system, the goal must be to design the least inequitable system. The table also shows that 50% of the entire population – the poorest deciles 1 to 5 – do not earn enough to pay income tax (i.e. When you ask what the job pays, your prospective employer says, “Well that depends on how hard you work.” You say, “Good, because I am a hard worker.” To which the employer responds, “You don’t understand. Conversely, Tom’s family has decided to work only 20 hours per week because the additional utility of the income from the 21st hour is sufficiently low to him that he chooses to forgo it in favor of leisure. Money income is the income definition most often used when citing income inequality measures,16 even though this definition of income does not include many variables that might affect inequality and standard of living, such as transfer payments, taxes, employer-provided fringe benefits (primarily retirement benefits and health insurance, which can amount to as much as 30 percent of income17, capital gains, dividends, imputed rent from owner-occupied housing, size of household, increases in the value of home equity and other investments, etc. Progression has been in use somewhere in the world for more than two thousand years. *An earlier version of this piece incorrectly stated that Seligman was quoting Cohen-Stuart when he was in fact summarizing Cohen-Stuart’s arguments. Read preview. Fiscal redistribution alone is unlikely to achieve the desired reductions in inequality. society. Article excerpt. Taken together, the mix of progressive direct taxes and slightly regressive indirect taxes generates a mildly progressive tax system. The point is that strong economic performance can coexist with higher levels of income inequality (and vice versa). At the same time, it establishes the affirmative case for a degressive system as being the least inequitable. The authors seem to be saying that the only argument for progression that could not be dismissed was the value they ascribed to reducing income inequality. paper which is available in its entirety and for comment at However, South Africa’s fiscal deficit and debt indicators signal that there is limited fiscal scope to spend more to achieve even greater redistribution. But as federal taxes became more progressive starting in the 1990s, the gap between before-tax and after-tax income inequality widened. The moral question is: Is Harry being treated fairly? The income tax has become much more progressive in the past 30 years, resulting in a situation in which a relatively small minority of taxpayers pay the bulk of the taxes… From the point of view of the taxed, government benefits only have real value when the taxpayer earns a surplus of income over what is needed for subsistence. It is important to note that, among the proponents of the degressive tax, there was clear consensus that the income exempt from tax should be set no higher than the level of subsistence. As illustrated in row 10 of table 1, the wealthiest 10% of individuals earn about 63.7% of total market income, but they pay 86.9% of total personal income tax. http://harrisschool.uchicago.edu/faculty/ web-pages/Inequality60s.pdf. But when it came time to divide up the bill, the problems began. . . Income, Poverty, and Health Insurance Coverage in the United States: A Treatise on the Principles and Practical Influence of Taxation, or the Funding Woolard et al 2015 Fiscal policy progressivity FINAL4.pdf. Did the Class brothers not receive benefits from their street improvements? A widely used measure of income inequality is the Gini index. I focus on the economy’s BGP along which labor hours are stationary, while output, consumption, and physical capital all grow at a common constant rate denoted as ψ = (1 − τ 1 m *) (1 − β) Y * K * − δ − ρ 1, where an asterisk denotes the BGP value of a … Accordingly, figures from the period before1993 are not directly comparable with the period from 1993 to the present. He was also surprised at how disproportionate it was, but since his suggested share was significantly less than under his own proposal, he didn’t object. Aptitude is measured from low to high in accordance with the monetary value placed on it in the marketplace. On the whole, the evidence from 2010 shows that the fiscal system in South Africa is progressive overall: the tax system is mildly progressive and government spending is highly progressive. The opinions expressed on this website are those of the authors and do not necessarily reflect the opinions of the Hoover Institution or Stanford University. Using this more meaningful definition of income, from 1983 to 2005 real median household income in the U.S. rose by 35 percent, which can hardly be considered “stagnant.”. In order to prove that the principle of equal sacrifice necessarily involves progression we should need to know that the last ₤10 of a ₤1000 income carries less satisfaction than the last ₤1 of a ₤100 income; and this the law of diminishing utility does not assert.10, Seligman credits the Dutch economist A.J. The most commonly used measure is the “Gini coefficient,” developed by the Italian statistician Corrado Gini. Once upon a time in the land of America, there lived triplet brothers named Tom, Dick, and Harry Class. The more hours you work, the less average hourly wage I will pay you.” John Stuart Mill gave full voice to this apparent injustice when he denounced progressive taxation as “a penalty on those who worked harder and saved more than their neighbors” and a “mild form of robbery.”14. An efficient tax system is one that does the least to distort the allocation of resources in the economy, thus maximizing overall production. By far the most compelling condemnation of sacrifice theory is not the argument over the slopes of the marginal-utility curves, but the unfair penalty it would impose on the hardest working and most productive people in society. With sluggish economic growth, the National Treasury (2014) expects this trajectory to only worsen. 2014. And crucially, a progressive federal income tax was enacted by Constitutional amendment, overcoming the opposition of not only the steel lobby and the establishment press, but a … Harry and his wife work these long hours because the marginal utility of the income produced from the extra hours is greater than the marginal utility of leisure (up to that point). Accordingly, persons with more highly valued aptitudes would earn more income than their lower-aptitude counterparts, and thus derive greater value from government. Each of these systems will be examined as part of the analysis of progressive taxation. A second interpretation of the benefits principle, and one that appears clearly to have more substance and more scholarly support, is that government benefits redound roughly equally to all people regardless of their income. In this view, inequality is a social injustice that can be remedied or mitigated by a progressive tax system. This is the progressive income tax system all U.S. taxpayers live under, and I don’t see why the Class families should be different. Analysis: Ireland is one of the few developed countries that has seen high income growth and falling inequality in the last 30 years. Age (a proxy for experience) is one of the most significant contributors to income and is also, therefore, one of the most significant contributors to income inequality. The fact that VAT is not regressive can be explained by the zero rating of basic food items, as the poor tend to spend a greater percentage of their income on VAT-free items (and similarly for the VAT exemption of public transport). The graph above shows the impact of Federal Government’s tax and transfer policy on each fifth of the population and on the top 1 percent. One day the brothers decided to pool their funds for the purpose of improving their street. The only things that can be stated with confidence are that all persons have marginal-utility curves that are ultimately downward sloping and that the slopes of individual curves are determined by many factors in addition to income. Support for this latter surmise comes from a 2010 study which concluded that “in the 2000s overall consumption inequality shows little change.”20. Inequity of the paying of taxes Commentary. South Africa’s levels of inequality are even greater than those in Brazil, another highly unequal country. increases pre-tax inequality Increases in taxes (or progressivity) causes individuals to shift the tax burden onto their employers thus increasing pre-tax inequality. Note that $13,450 of Harry’s income was “distributed” to Tom and Dick. This would lead to proportionate taxation. The figure of merit for the Gini coefficient ranges from zero to 1.0, where zero equals total equality (all persons have identical incomes) and 1.0 equals total inequality (one person has all of the income). The study of the impact of tax policy on economic efficiency and growth has for centuries been a fertile ground for economists, who have produced numerous analyses on the topic without reaching clear consensus. The Gini coefficient is a method of measuring the statistical dispersion of (among other things) income, consumption, and wealth. The Aotearoa New Zealand Association of Social Workers (ANZASW) supports calls for more progressive taxation policies to be adopted by government in order to address the high levels of social and economic inequity … The American military and other protective agencies and institutions of government exist to protect and preserve these rights for all Americans equally, regardless of how rich or poor they are. Income inequality is when one segment of the population controls a much larger share of the economy's wealth than another. It was assumed that the actual benefit received from health and education is equal to the amount spent per capita (see Inchauste et al. Without such a system, South Africa’s income inequality would be significantly higher than its current level. After adopting the progressive income … Moreover, in the recent recession, the U.S. economy contracted less than the world’s other advanced economies. Ironically, a progressive income tax can even have the extraordinary effect of increasing rather than reducing income differences. 2015) who studied these questions using the Commitment to Equity methodology developed by Lustig (Lustig & Higgins 2013). And I don’t save because I prefer the gratification of consumption today more than I will when I’m too old to enjoy it.” Tom was adamant. This change in methodology biased the Gini calculation upward. First, who bears more of the burden of taxation and who benefits relatively more from the various forms of social spending – the poor, those in the middle or the rich? They were 45 years old, had virtually the same aptitude (skill), and were raised in the same home. Utility is a meaningful concept; units of utility are not. To wit: The pro-progression interpretation of the benefits principle is invalid because it depends on the untenable assumption that the value of government benefits increases more rapidly than the rise in income; on the surface, sacrifice theory is a respectable argument for progression, but on closer examination, it is clear that its application produces an inequitable outcome (this is most obviously so when applied to income derived from greater work effort); the ability-to-pay argument lacks an equity principle (other than sacrifice theory) on which to base a fair tax system; and redistributing income through a progressive tax system is inequitable. 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