9/08/2005

Are Progressive Taxes a Good Thing?

The standard wisdom of American politics is that the poor, who have so much less income to work with, should therefore pay proportionally less than others of greater means, i.e. the rich and the middle class. This would seem to be an act of benevolence toward the poor, since they are benefiting from government activity largely thanks to the tax payments of others.

More recently, between the policies of Bill Clinton, the 1996 Republican Congress, and the Bush tax cuts (via adjustments to the lowest tax bracket and the Earned Income Tax Credit), well over a third of American families no longer pay Federal income tax of any kind. These are generally from the poorer end of the population; therefore, the poor are clearly being helped by our tax policy.

But are people really helped by being removed from the tax rolls? Or are they actually being set up for a terrible betrayal by government?

Many have argued at length about the pernicious economic effects of high marginal rates, arguing that a broad tax base would be better for everyone. I would like to examine another side of the argument. Let us consider the Federal government as a rational actor.

Now, at some level the government's policies are constrained by the need to increase tax revenue—perhaps even to maximize revenue. Therefore, the government will more readily pursue policies that will generate more taxes than those generating fewer, let alone those policies decreasing tax revenues. (That this theory only works if our congressmen understand basic economics is, of course, its gaping flaw. But regardless.)

In our present fiscal situation, wealthy people and corporations pay high Federal income taxes, and poorer people pay no income taxes at all or very few. Therefore, it makes sense for our rational actor, the Federal Government, to make laws that give preference to the rich and corporations over the poor, since tax revenues respond much more quickly when the rich get richer than when the poor get less poor. Such additional revenues can naturally be used to succor the same poor that the government has just victimized, making the poor indebted to the government and to the particular elected officials of each district.

Example:

Let's say that millionaires pay 50% average taxes. People making $10,000 a year or less pay nothing. Suppose that a given area has one family who owns a fire-extinguisher company with a gross income of $1,000,000, and 100 family making $10,000. As is, total taxes equal half a million dollars ($500,000).

Some politicians then get a brilliant idea. They pass a law mandating that each family must keep one fire extinguisher in their kitchen, garage, and master bedroom. This law is advanced in the name of public safety: "After all, if it saves just one life…" Fire extinguishers are expensive and require continual maintenance, so each family must now pay $1,000 to the fire-extinguisher company. So now the rich family makes a total of $1,100,000 gross per year, while everyone else is left with $9,000. Tax revenues increase to $550,000 yearly. The rich family's after-tax income also increases $50,000.

Now, government has an extra $50,000 to play with. After spending just half of it (if the town is lucky) on pet projects, the politicians notice that many people are running short on money, and use the remailing $25,000 to fund a government entitlement for the absolute worst off. Say that 50 families receive $500 each.

In short, the rich become richer, the poor become poorer, and government wins both because they get more money to fritter away and because 50 families are now dependent on government's generosity. That the government got them into the situation in the first place will be quickly forgotten.

Is this such an unlikely scenario? Who is it, indeed, that benefits from artificially high argicultural prices, and who is it that must pay them? Who is it that benefits from the horrid patchwork of telecom laws, and who is it that must pay high prices because of them? To my regret, I could go on all day.

Now is this due entirely to the Federal government's skewed cost/benefit situation caused by the "progressive" tax code? I doubt it. But I suspect that if the tax base were indeed broadened so that nearly all families pay a share, no matter how small, we may find that the government suddenly cares much more about the welfare of the poor.

5 comments:

Ezra said...

A few problems:

a) government is not a rational actor. You say, for instance, that they may want to help out the rich because it makes them more money. That's totally irreconcilable then with Bush's two tax cuts, which were slanted towards the rich and massively cut government revenues. Your problem here is that the government doesn't act on policy, the president does. What the bureaucracy might want tends to have little influence there because the pres has different motivations than the gov.

2) The rational choice would not be corporate subsidies, it'd be higher rates on the rich. The Clinton years proved that modestly high brackets don't retard growth. if the govworked as you say, it'd be raising taxes, not lowering them and finding backdoor ways to eke out extra revenue.

3) The rich get giveaways because politicans are rational actors who need campaign money. Your case works much better in favor of campaign finance reform (in its clean election incarnation) than higher tax rates for the poor.

Mike Maller said...

Another problem... from a slightly different tack:

How much money does this rational actor want? Your argument seems to be that, one way or another, the Federal government will find more tax revenue. If it is a matter of buying the government's attention/affection, there is no way that the poor could compete with the rich.

For instance: in your hypothetical, to even match the starting tax payment of the rich family, the 100 other families would have to sacrifice half their income... and half of a paltry sum is downright unlivable. The problem is that this is a simple hypothetical, in a closed system. Even if the numbers didn't work out so nice, it is only logical to realize that the rich could still out-spend the poor.

Back to your example, consider that the poor are already being taxed... albeit indirectly. The government passes the law requiring people to buy fire extinguishers. The government is requiring these people to make a payment, just not to the IRS. All that levying a tax on the poor in that hypothetical would do would be to make it a direct tax.

However, what do the poor get from the direct taxation? They're out $1000 dollars either way, and there's no reason for more of the money to benefit them giving it to the IRS than to be giving it to the IRS through the Fire Extinguisher Company. At least when they give it to the company, however, they're guaranteed to get a fire extinguisher or three.

Government cannot be allowed to behave toward the people in a "what have you done for me lately" manner. Majority rule, minority rights. Not a majority of cash.

Mastiff said...

You have a point Ezra; except tht it is far more difficult to openly raise taxes than it is to monkey around with obscure regulations that nobody has heard of.

(As far as I know, the Clinton tax increases were followed by a mild recession. It was only after he cut the Capital Gains tax that the stock market took off.)

But yes, rational actor theory only goes too far. On the other hand, it does add another factor to the balance scale which must be taken into account, which will have to have some impact on the final decision.

Kevin said...

But still the best way to increase working revenue is to cut internal government operating waste, estimated at about 20% by CAGW (admittedly optimistic, so say half that... still a few hundred billion). The inability to do that haunts the reputation of the democrats (deserved or not) and is a major disappointment of the current administration. Some big buckos there! And I won't even start to talk about pork from both parties.

Anonymous said...

RE: Ezra's comment about cutting taxes -- in fact, tax revenues went up after the tax cut, as the economy rebounded and more people were making more money. High taxation levels are actually a major drain on the economy of a country, as illustrated by the sorry state that most socialist, highly taxed European countries' economies are in (helped along by rediculous labor laws, etc.).