More specifically, and as noted in the preceding paragraph, the value of benefits relating to life, liberty, and the pursuit of happiness, including the protection of property, is essentially the same for all citizens. These figures are for illustration purposes only. 4 Edward Blum and Harry Kalven, The Uneasy Case of Progressive Taxation (University of Chicago Press, 1953. Progressive taxes are often designed to collect a greater proportion of income from the rich relative to the poor, thus reducing the inequality of disposable income compared to taxable 4 The empirical micro literature on developing countries has long pointed out the unreliability of in- Empty homes should automatically be taxed at a higher rate. In the end satisfaction in the sense of happiness defies quantification. Second, a proportionate tax would only be fair if all income were derived from aptitude, when in fact a substantial portion of income is derived from work effort. Consequently, the value of using money income to measure either standard of living or inequality is quite limited. “By an amazing coincidence, our total taxes paid were exactly equal to the $30,000 expended on our street improvements. The tax rates were decreased after the war and the income tax was allowed to expire in 1872. that exist in the law. 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 … Ironically, a progressive income tax can even have the extraordinary effect of increasing rather than reducing income differences. Income taxes are In 2017, the City of Seattle passed an income tax on households with total income above $250,000 for individuals or $500,000 for married couples. It should be noted that the figures for gdp per capita and median income understate America’s advantage because the median age of America’s population (about 36.8 years) is about four years lower than the average of the median ages in Western Europe and almost eight years younger than Japan. Sacrifice theory and the marginal Taken together, the mix of progressive direct taxes and slightly regressive indirect taxes generates a mildly progressive tax system. Implicit in this interpretation of the principle is not just that the value of benefits received from the government increases as income increases, but that it increases more rapidly than the rise in income. Lustig N & Higgins S. 2013. A tax on immense wealth would put a check on the concentration of wealth at the top, as Senators Bernie Sanders, I-Vermont, and Elizabeth Warren, D-Massachusetts, have proposed. 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. This regressiveness of indirect taxes at the lower end of the income distribution is largely a result of the impact of excise taxes on alcohol and tobacco; the analysis indicates that people earning a lower income spend a larger proportion of their disposable income on these products than richer people. Both of these interpretations have been discussed in the literature. 16 Gini coefficients cited herein come from The CIA World Fact Book 2010, the Census Bureau report on Income, Poverty, and Health Insurance Coverage in the United States: 2009 and other U.S. government publications, and Eurostat, the official statistical Economic efficiency. There is no perfectly fair tax system. While the title of Blum and Kalven’s book appears to indicate that the authors’ analysis led them to become uneasy proponents of progression, the reality is more nuanced (and more uneasy). Consequently, a tax system will be regarded as progressive by this index if the actual post-tax income profile strictly Lorenz dominates the hypothetical post-tax income profile. Third, this interpretation of the benefits principle overlooks the principle of marginal utility. The costs of the military and police and fire departments are not equivalent to property and casualty insurance, in which the policy is priced in accordance with the value of the property insured. The first time a federal income tax was imposed in the United States was in 1861 as a means of financing the Civil War. 5 Edwin R.A. Seligman, Progressive Taxation in Theory and Practice (Princeton University Press, 1908). It was assumed that the actual benefit received from health and education is equal to the amount spent per capita (see Inchauste et al. 1 The tax figures were calculated by The Shapiro Group, a Los Angeles tax To put this into perspective, imagine you are interviewing for a job.  Other data sources are the 2008 National Income Dynamics Study (NIDS) and some administrative data. The provisions of the United States Internal Revenue Code regarding income taxes and estate taxes have undergone significant changes under both Republican and Democratic administrations and Congresses since 1964. Most scholars who supported a proportionate tax system concluded that taxing only clear income was both practical and fair to both the individual and the state. The argument for progressive taxation on fairness grounds has three main strains. 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. This measure indicates that inequality declined 1.8 percent during the last 16 years (1993 to 2009) from a Gini of .395 to a Gini of .388. The point is that strong economic performance can coexist with higher levels of income inequality (and vice versa). System (The Lawbook Exchange Ltd., 2007), 143-145. They invested this money in bonds and real estate that produced $25,000 a year in interest and rental income. The U.S economy performed well in absolute and relative terms over the 25-year period from 1983 to 2008. But how much more should higher-income people pay? 2015) who studied these questions using the Commitment to Equity methodology developed by Lustig (Lustig & Higgins 2013). “It’s all right here in the irs tax tables. A progressive tax doesn't hurt the wealthy as much because, even after the tax, they can afford the basics. These effects are then compared with those of 12 middle-income countries, using the same methodology.  VAT revenue constitutes about a quarter of government’s total tax revenue, compared to about 3.5% for excise taxes and 5.2% for the fuel levy. For example, U.S. gdp shrunk 2.6 percent in 2009, substantially less than the 4.1 percent contraction experienced in the Euro area. It makes no difference whether the income is derived from aptitude (as defined), financial windfalls, random events, or privilege. And it is safe to say the debate on its merits goes back just as far. Several advanced economies have top income tax rates well above the current U.S. rate. “Transfers” include social security, welfare, etc. A 2005 study conducted by the Bureau of Labor Statistics found that in 2001 (the most recent year for which data are available) the Gini coefficient for consumption was .280,18 indicating that inequality with respect to this measure of U.S. living standards is relatively modest. Some would argue that South Africa should tax the rich even more, or target government spending to the poor even better. is ill-conceived, inasmuch as each has a different purpose. It is in the face of this difficulty that, even waiving all other objections, the whole elaborate analysis of progression in terms of sacrifice and utility doctrine finally collapses.13. Taxation does not reduce inequality. Those who cite protection theory as an argument for progression assert that individuals with higher incomes should pay a disproportionately greater share of the cost of government than lower-income individuals because the higher-income group would have disproportionately more to lose if the protections of government were withdrawn. Presentation. If, as virtually all economists agree, the marginal utility of a dollar of income declines as income increases, then people would place a lower value on protecting their income as it rises. Embodied in virtually all proportionate tax proposals is a substantial broadening of the tax base through the elimination of most tax deductions, credits, and preferences, which has the benefit of simplifying the tax code and reducing the cost of compliance. Throughout history, many arguments have been advanced both for and against the progressive income tax. used to fund a broad range of government services as described above, while Growth, inequality, and progressive tax. Thus, Tom’s and Dick’s marginal-utility curves may have steeper downward slopes than Harry’s, even though Harry earns much more income. For the scenario where targeting is not possible, the budget allocation for free basic services is divided amongst the entire population that receive municipal services and the distribution of the transfer is then compared to market income. philosophy, Vol. specifically, Social Security levies are a form of forced savings, and Medicare While this notion has conceptual merit, it does not follow that property owned by high-income people is at greater risk than property owned by low-income people. $22,600, Dick would pay a tax of $3,700 and Tom would receive a refund of $7,100. 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 “rough” carpenter who spends nights and weekends developing the skills necessary to qualify as a more highly valued “finish” carpenter will move up the wage scale by doing so. Does it mean (as some suggest) the financial wherewithal with which to pay taxes — which might come from either assets or income? office of the European Union. I make only two times as much as Dick, but you want me to pay three-and-a-half times as much as he does. Kip Hagopian was a co-founder of Brentwood Associates, a California-based In their words, the book is, “an effort to explore what might be called the intellectual case for progression.”4 Another particularly useful source of information and analysis was a book-length article published in 1908 in the American Economic Association Quarterly, “Progressive Taxation in Theory and Practice,” by the noted economist and tax historian, Edwin R.A. Seligman.5, According to Blum and Kalven, “the most rigorous analysis of progression came only after the idea had become a political reality . The most distinctive and technical arguments advanced in its behalf are the weakest. An ITEP report earlier this year outlines multiple progressive revenue-raising options—including implementing a wealth tax on the top 0.1 percent—to help alleviate inequality and restore fairness in a tax code that benefits the country’s wealthiest families and corporations. 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 in this country. . . Inequity of the paying of taxes Commentary. Inchauste G, Lustig N, Maboshe M, Purfield C & Woolard I. (In fact, the cost might be less, since persons with high income tend to reside in low-crime areas.) The exemption makes the system progressive, but typically much less so than a system of graduated rates. Secretary-General of the All-Africa Students Union, Peter Kwasi Kodjie, has charged African governments to formulate progressive policies aimed at reducing the tax … 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. There are basically four systems of income taxation described in the literature: A per-capita, or “head” tax, which would require each person to pay his or her per-capita share of the costs of government. In this view, inequality is a social injustice that can be remedied or mitigated by a progressive tax system. What do you propose instead?” asked Harry. South Africa’s Gini coefficient using market income is estimated to be around 0.77. In the event, their uneasy case for progression would have become an easy case for its rejection. Cohen-Stuart with debunking the notion that there is a universal marginal-utility curve that dictates progression. On the other hand, fuel taxes and VAT are slightly progressive. A classic example is Hall-of-Famer Jerry Rice, who is generally recognized as the best wide receiver in nfl history. And even that argument left them “uneasy.”. But while federal taxes have become more progressive, they also began shrinking in 2001 relative to before-tax income, thanks to tax cuts during the George W. Bush and Barack Obama administrations. Inchauste G, Lustig N, Maboshe M, Purfield C & Woolard I. Tom was ready with his answer. 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. it is inaccurate to call the levies regressive. Imagine, for example, that Harry has a learning-disabled son who needs costly special education, or that Harry’s wife has an illness that requires expensive medication not covered by insurance. It has been widely reported that income inequality in the U.S. has been rising for “decades,” and by implication, that the rise is ongoing. Letter: Progressive tax on ultra-rich is needed. When examined carefully, the “protection theory” interpretation of the benefits principle falls short in five different ways. 14 John Stuart Mill, Principles of Political Economy with some of their applications to social 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. The progressive taxation of income from work effort is inequitable, The progressive taxation of income from aptitude is inequitable, Progressive Taxation in Theory and Practice, Principles of Political Economy with some of their applications to social 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. 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). However, for final income – i.e. In this event, Tom’s and Dick’s marginal-utility curves are affected by their knowledge that they don’t need as much income to secure their future. Choice of occupation. 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). Work effort. This essay is an abridged version of a For such people the most effective remedy would The main source of data is StatsSA’s Income and Expenditure Survey (IES) 2010/2011. Statistics South Africa (2014). In the past decade, economists and policymakers have raised concerns over the economic and political implications of rising inequality, renewing debate over the role of government in redistributing wealth. “You make much more money than we do.” Harry was puzzled. Accordingly, persons with more highly valued aptitudes would earn more income than their lower-aptitude counterparts, and thus derive greater value from government. These people get more raises, larger bonuses, and more promotions than their peers. 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. 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. In this paper, we develop a heterogeneous‐agent, endogenous growth model of a unionized economy with distinct progressive tax schedules on labor and capital income. Aptitude.3 For the purposes of this essay, aptitude is broadly defined as the capacity to produce, or to earn income. Putting aside the measurement difficulties of such a scheme, if this alternative quid pro quo principle were applied, and the two tax rates were blended to reflect the different values of the benefits, the most equitable tax would be somewhere between per-capita and proportion. Tax progressivity determines the incidence of taxes across people with different incomes. paper which is available in its entirety and for comment at Tax policy is the mechanism through which market results are redistributed, affecting after-tax inequality. Figure 1 illustrates how the poorest households comparatively receive much more benefit from spending on education than their share of market income. Seligman calls this the “very core objection” to sacrifice theory: The imposition of “equal sacrifices” on all taxpayers must always remain an ideal impossible of actual realization. If there is no accurate way to draw any individual’s marginal-utility curve, there is no way to compare the curves of different persons. A degressive tax, which is a proportionate tax only on income above a certain threshold or exemption. be through direct spending programs. 2014. Once upon a time in the land of America, there lived triplet brothers named Tom, Dick, and Harry Class. A widely used measure of income inequality is the Gini index. 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. Instead, your tax liability is based on the marginal tax rates set by the IRS. One of the main goals of a progressive tax system is to charge taxes according to an individual's ability to pay, so that everyone pays his fair share. A next step is to determine the impact of these fiscal instruments (taxes and spending) on inequality by measuring the Gini coefficient before and after redistributive fiscal efforts. the effect of certain tax credits (which some would consider transfer payments) 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. This suggests that the most notable economic inequality in the world is that between Americans and the citizens of all other countries. In this case, the person earning £10,000 is paying 20% of their income in tax (total tax of £2,000) Seligman, Blum and Kalven, and others have examined the property protection arguments for progression and dismissed them as either untenably weak or without merit. At the conclusion of the book, they wrote: The case for progression, after a long critical look, thus turns out to be stubborn but uneasy. From 1967 to 2008 the Gini for money income rose from .397 to .468 (17.9 percent), about four-fifths of which occurred from 1967 to 1993. As to the latter, the debate inevitably devolves into an argument over fairness and economic efficiency. Progressive taxes are imposed in an attempt to reduce the tax incidence of … This involves comparing the income of different individuals in the population in terms of two measures: Market income is formally defined as the income a person receives from wages, salaries, capital, private transfers and contributory pensions before paying taxes – and not counting benefits from government spending. 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? When the importance of work effort is considered, the inequity of progression becomes clear. This was quickly met with lawsuits and a ruling that it violated current law. Instead, Harry, you pay $23,450; Dick, you pay $6,550; and I will pay nothing.”. They subtract a larger percentage of income from the poor than from the rich. The inde… Progressive tax systems attempt to reduce the "tax incidence" of people with a lower "ability-to-pay," as they shift the incidence increasingly to those with a … Since the focus of this essay is on the issue of tax equity, the economic efficiency arguments will not be discussed beyond noting that logic and the weight of empirical evidence appear to favor less progression rather than more.  Unfortunately, not all taxes and spending categories could be incorporated into the analysis. Figure 2 illustrates how the poorest households comparatively receive much more benefit from health spending than their share of market income. c) Regressive tax because poorer people spend a larger portion of their income on housing. Sacrifice theory is dependent upon the economic principle that holds there is a marginal-utility curve for money to the effect that the more money one earns, the less utility (or satisfaction) will be derived from the last dollar earned. http://harrisschool.uchicago.edu/faculty/ web-pages/Inequality60s.pdf. Not only are South Africa’s main fiscal instruments progressive overall, the degree and structure of progressiveness is such that these instruments achieve significant reductions in income inequality. For most people aptitude is the most significant determinant of income. Accordingly, figures from the period before1993 are not directly comparable with the period from 1993 to the present. © 2020 by the Board of Trustees of Leland Stanford Junior University. A tax decreases their ability to invest in stocks, add to retirement savings, or purchase luxury items. A more progressive tax system would reduce income inequality if nothing else changes. According to economist Roger A. Arnold, … Fundamentally it is essential to attain better outcomes in terms of the initial distribution of wages, salaries and capital income (market income). But the case for more economic equality, when examined directly, is itself perplexing. “Why should we pay the same as you?” they said. This Article examines trends in economic inequality and the role of the tax system in reducing it. . It will also review the alternatives to progression in an effort to identify the most equitable (or least inequitable) tax system. Article excerpt. Comments may be screened by an editor before they appear online. Most Western nations are experiencing the effects of this tension, which manifests itself in vigorous disputes over tax and welfare policies. It means that the more a person earns, the higher his average rate of tax will be. But the funding for such programs should Some progression advocates have argued that government exists in large part to protect rich people from poor people, while poor people need no such protection. I make six times as much as you but you expect me to pay almost 80 percent of the total cost while you pay nothing. For example, a review of the literature on tax theory does not turn up a generally accepted definition of the word “ability.” What does “according to his ability&rdqquo; really mean? Second, there is no persuasive support in the literature for the claim that higher-income people derive a disproportionately greater value from government protection of property than lower-income people. philosophy, Vol. In 2008, the top 1 percent of taxpayers in America earned about 20 percent of all personal income and paid roughly 38 percent of federal income taxes; the bottom fifty percent of taxpayers currently pay only 2.7 percent of income taxes,23 and it is estimated that 46.9 percent of workers paid no federal income tax for the 2009 calendar year.24 Inasmuch as only a minority of taxpayers is affected by rises in tax rates, there is a built-in incentive for the majority to act in its self-interest, which opens the door to inequitable treatment of the minority. Poverty Trends in South Africa: An Examination of Absolute Poverty between 2006 and 2011, Pretoria. come from a tax system that is equitable. . A negative value would indicate that the tax is regressive and therefore contributing to increased inequality. Fomenting dissension. The argument is that progressive taxation increases worker productivity, yielding greater economic efficiency and higher aggregate incomes. 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). World Bank Group: Poverty Global Practice Group & Macroeconomics and Fiscal Management Global Practice Group. But based on an examination of the various tax principles and theories described in the literature, together with a critical analysis of the arguments supporting and opposing progression, it’s possible to put forward a new doctrine of fairness. The social welfare implications of progressivity measures have yet to be explored adequately in the literature. . 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. The strongest arguments against progression are the rebuttals to the arguments for progression. As a basic foundation for taxation, the benefits principle — also called “give and take” or “quid pro quo” — has probably received more examination and comment than any other. 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. (Technically a per-capita tax is not an income tax, but it is almost universally accepted as the most economically efficient tax system.). South Africa’s levels of inequality are even greater than those in Brazil, another highly unequal country. In fact, the rich are more likely to engage in self-protection (e.g., build protective walls, install security systems, hire guards, etc. community of supporters in So, by a vote of two to one, the cost of the street improvements was divided as follows: Also by a vote of two to one, all future pooling of funds was to be divided up the same way. The moral question is: Is Harry being treated fairly? ONCE UPON a time in the land of America, there lived triplet brothers named Tom, Dick, and Harry Class. The study assesses how taxes and social spending programmes redistribute income to groups at different income levels. Since the benefits to each family were equal, each brother should pay one-third, or about $10,000. Perhaps the most effective way of enhancing aptitude is through increased study in school. To the editor. To do so would be self-defeating, since the hardship imposed would deprive the state of production. The economic principle of marginal utility on which sacrifice theory depends is sound. First, the basic premise of sacrifice theory is conceptually flawed. Baker Library Special Collections, Harvard Business School. 2015 for more detail). Under the current tax code, here is what each of us paid in income taxes last year:”1. In addition to America’s substantial superiority in gdp per capita (which is a measure of the performance of the economy without regard to how income is distributed), the U.S. has a much higher standard of living than virtually all of the most advanced European and Asian countries. This was the income of each family: Despite their different priorities, the Class families were close; so much so that when a new housing tract was developed in their community, they each bought an equal-priced home on the same private street. 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