(Available on request from the authors.). . Sacrifice theory is perhaps the most historically prominent and persistent argument in favor of progressive taxation. This suggests that the most notable economic inequality in the world is that between Americans and the citizens of all other countries. Accordingly, there would be no difference in the cost of these protections based on property value. 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. Fundamentally it is essential to attain better outcomes in terms of the initial distribution of wages, salaries and capital income (market income). In the United States, the payment of taxes is effectively a “pooling of money” by the nation’s citizens to fund the services of government. The measure falls between zero and one, where the former describes perfect equality and the latter is perfect inequality. In percentage terms, it remains today at roughly the pre-1980 value. If they did, what would be the logic of a tax based on proportionate sacrifice rather than one based on shared cost or value received? Interestingly, the per capita gdp in the U.S. in 2008 was $47,400, while the average per-capita gdp in the eu nations in that year was $32,900, a similar ratio of 1.44:1. 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. The argument is that progressive taxation increases worker productivity, yielding greater economic efficiency and higher aggregate incomes. A Labour government should replace council tax with a progressive property tax, payable by owners, not tenants. Did Harry’s brothers pay their fair share? But on close examination, it seems clearly without merit as a rationale for a fair tax system. This article appeared in The Washington Times on April 12, 2011. Perhaps the main benefit of a progressive tax system is that it helps reduce income inequality. The purest form of this system is a single-rate tax levied on all earned income from the first dollar, but different variations on this theme have been proposed. Figure 1 illustrates how the poorest households comparatively receive much more benefit from spending on education than their share of market income. 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. Or perhaps Harry has an obsession with saving enough money to send his two children to the best private secondary schools and universities. Thus, for these workers, work effort has its own marginal-utility curve that is essentially the same as the marginal-utility curve for income. Political irresponsibility. 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. Many of those who favor income redistribution assert that inequality foments dissension. “Paying the same percentage of our income is not fair. A lower average tax rate offset the equalizing effect of increased tax progressivity, leaving the effect of federal taxes on income inequality little changed. The same is true when deciding how taxes should be apportioned. This was quickly met with lawsuits and a ruling that it violated current law. Another disadvantage of progressive taxation is the inherit inequity in the system. Income, Poverty, and Health Insurance Coverage in the United States: A Treatise on the Principles and Practical Influence of Taxation, or the Funding National Treasury (2014). 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… One of the inherent characteristics of the U.S. system of government (and that of all Western nations) is the tension that exists between the political system (majoritarian) and the economic system (free enterprise). In The Wealth of Nations (Book V, chapter 2) he set down four general canons: Although they need to be reinterpreted from time to time, these principles retain remarkable relevance. Establishing a graduated rate scale and setting the top marginal rate on that scale are inherently arbitrary tasks. Since the benefits to each family were equal, each brother should pay one-third, or about $10,000. The inde… In a previous post, we discussed how raising tax progressivity can be expansionary. When the importance of work effort is considered, the inequity of progression becomes clear. . But as federal taxes became more progressive starting in the 1990s, the gap between before-tax and after-tax income inequality widened. The Distributional Impact of Fiscal Policy in South Africa. A highly progressive tax on consumption effectively closes all the loopholes since the income that evaded income tax is taxed as consumption. 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. 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. By Richard W. Rahn. In the United States, inequality has deepened in the past half century, especially since the … The most distinctive and technical arguments advanced in its behalf are the weakest. In the view of British economist Arthur Pigou and others, there is no way to prove this is true: All that the law of diminishing utility asserts is that the last ₤1 of a ₤1000 income carries less satisfaction than the last ₤1 of a ₤100 income does. The attempt to ascertain a mathematical scale of progression, so as to avoid a charge of arbitrariness, is foredoomed to failure.12. This comment facility is intended for considered commentaries to stimulate substantive debate. Tax Inequity . This is essentially what Harry proposed to his brothers as the fairest way of dividing the costs of their street improvements. Accordingly, figures from the period before1993 are not directly comparable with the period from 1993 to the present. Only applicable to highly mobile, demanded individuals who are able to shift increases in taxes on Throughout history, many arguments have been advanced both for and against the progressive income tax. 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. First, some have argued that the benefit derived from economic well-being (as measured by income) should be considered separately from the benefits derived from government protection of life, liberty, and property. South Africa has evidently made limited progress in reducing income inequality since the end of apartheid. Harry, who makes twice as much as me and six times as much as Tom would pay two times as much as me and six times as much as Tom.”, “No,” said Tom. Under a progressive tax system, workers whose work effort is above the median in their aptitude tier will pay higher average taxes per hour than those below the median. For the population as a whole, a tax is progressive if the combined share of the tax paid, for example, by the poorest 10% of the population is lower than their share of the aggregate income while the tax share of the richer income groups (e.g. Together these comprise about 64.5% of general government tax revenue in 2010/11. Other studies yield different result. 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. Because of this, the crucial implications of the distinction between income derived from aptitude and income derived from work effort have been left out of the debate. Consequently, the value of using money income to measure either standard of living or inequality is quite limited. While they were almost identical in most respects, they had somewhat different preferences and values. Pretoria: National Treasury. With time preference heterogeneity, the effective labor force, balanced growth, and income inequality are endogenously determined, and these interact with each other. This is a very large change. Press Release – Aotearoa NZ Association of Social Workers. 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. To comment one must be registered and logged in. From this datum it cannot be inferred that, in order to secure equal sacrifice . Deciding how much money should be appropriated for this pool and how it should be spent is almost always a subject of contentious debate. When examined carefully, the “protection theory” interpretation of the benefits principle falls short in five different ways. The economic principle of marginal utility on which sacrifice theory depends is sound. The spending was apportioned to individuals on the basis of household survey data, using educational enrolment and utilization of health services. A progressive tax is a tax in which the tax rate increases as the taxable amount increases. 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). The marginal rates and brackets are those applicable for the 2010 tax year. Scottish economist J.R. McCullough condemned this arbitrariness in the strongest of terms: The moment you abandon . For progression to be justified under a theory of equal sacrifice, the curve must not only decline, but decline more rapidly than income rises. There are weaknesses in the logic of this doctrine that make the fairness of a proportionate or degressive tax system less than perfect. 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. Policy Research Working Paper 7194. But progression has the perverse effect of reducing average, after-tax hourly wage or salary rates as work effort increases. taxation must be progressive. By its nature, a system that taxes people progressively without the support of an accepted equity-based principle may breed resentment, particularly when so many pay no tax at all. Note that $13,450 of Harry’s income was “distributed” to Tom and Dick. These reports are arguably misleading. CEQ Working Paper No. But it is clear that it can co-exist with both high and low national living standards. We will now examine each of the three fairness arguments in detail, then turn to the question of income inequality. Tax policy can play a major role in making the post-tax income distribution less unequal. There are at least five methodologies used for measuring income 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. Fomenting dissension. 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). Again this can be seen in our parable: Using a degressive tax system and assuming the subsistence level of income was $25,000, Tom would not have to pay any tax, even though he could easily pay his share of a proportionate tax simply by working three more hours per week. 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. Utility is a meaningful concept; units of utility are not. The study assesses how taxes and social spending programmes redistribute income to groups at different income levels. 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. Most types of education are strongly progressive, including preschool, primary and secondary education. According to economist Roger A. Arnold, … Cash transfers – especially the child support grant – are the most progressive of all spending programmes. This change in methodology biased the Gini calculation upward. Taken together, the mix of progressive direct taxes and slightly regressive indirect taxes generates a mildly progressive tax system. It makes no difference whether the income is derived from aptitude (as defined), financial windfalls, random events, or privilege. 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. Analysis: Ireland is one of the few developed countries that has seen high income growth and falling inequality in the last 30 years. 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. 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. Those who advocate redistribution of income on grounds of social justice should consider that America’s standard of living is higher and has grown faster than virtually all of the nations exhibiting lower measured inequality. And this is despite the fact that each of us is receiving the exact same benefits. 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. 22 To be sure, there are people in America who are needy or disadvantaged, in The poorest 40% of individuals receive 69% of all cash transfers. c) Regressive tax because poorer people spend a larger portion of their income on housing. But as federal taxes became more progressive starting in the 1980s, the gap between before-tax and after-tax income inequality widened. roads) could not be apportioned to different individuals or households and were excluded from the analysis. A tax decreases their ability to invest in stocks, add to retirement savings, or purchase luxury items. Blum and Kalven touched obliquely on this concept when they noted: Another approach [to the benefits theory] is more ingenious. 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. Corporate tax (about 21% of tax revenue) is the largest category excluded from the analysis. In order to make this determination one must ask two critical questions. The larger the value, the more progressive the tax is. By Brian Garst. The exception is tertiary education (in particular university education, but also other post-secondary training) which is only slightly progressive. There is no perfectly fair tax system.  For the scenario where free basic services are perfectly targeted to help the poor, progressivity is measured by dividing the total amount of the budget for basic services equally amongst the poor that actually receive municipal services and then comparing the distribution of allocations to market income. therefore, too limiting; 2) “faculty,” which, like aptitude connotes capacity to earn, but is also used in the This inability to prove the sameness of the marginal-utility curves of different people troubled Blum and Kalven to the point that they dismissed sacrifice theory as a theory on which to base a fair tax system: The error lies in trying to translate money, which can be measured in definite units, into corresponding units of satisfaction or well-being. For the purposes of this essay, the term “work effort” includes not only the number of hours worked, but also the intensity of the effort applied during those hours. Nevertheless, addressing the challenge of income inequality in a way that is consistent with fiscal sustainability will require higher quality – and more efficient – public services. or physical attributes (appearance, dexterity, possession of senses, etc.). 2 There are several other types of taxes levied by federal, state, and city South Africa has evidently made limited progress in reducing income inequality since the end of apartheid. 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 main source of data is StatsSA’s Income and Expenditure Survey (IES) 2010/2011. 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 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. 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. Aptitude may be derived from innate talents (cognitive, musical, artistic, athletic, etc.) An efficient tax system is one that does the least to distort the allocation of resources in the economy, thus maximizing overall production. specifically, Social Security levies are a form of forced savings, and Medicare (One must keep in mind that corporate taxes are not included in the analysis.). b) Progressive tax because the total tax on housing increases as the price of the house increases. . 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). Your gift helps advance ideas that promote a free society. progressive taxation, that is, how much can the income tax reduce ine-quality? 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. One of the most vexing questions for the framers of the Constitution was how to create a vigorous and independent executive without making him king. May 3, 2017. Taxation does not reduce inequality. (This is the difference between Harry’s one-third share of the cost of the street improvements ($10,000) and the $23,450 he was forced to pay.). While recent Census data show modest increases in median household income and average hourly wages—numbers anti-tax politicians and pundits have used to deny rising inequality—a deeper look at some of the latest numbers reveals a … If not, how should this affect our thinking about progressive taxation? These effects are then compared with those of 12 middle-income countries, using the same methodology. 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. 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