$22,600, Dick would pay a tax of $3,700 and Tom would receive a refund of $7,100. Dick thought for a moment, and then said, “I’ve got an idea. 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. 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. Without such a system, South Africa’s income inequality would be significantly higher than its current level. A progressive tax is a tax in which the tax rate increases as the taxable amount increases. 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 work was done for a total cost of $30,000. Third, the merit of the clear income theory is somewhat undermined with respect to hard workers. Acknowledgements The essay, The Inequity of the Progressive Income Tax, has been thoroughly vetted.No fewer than 17 scholars from the fields of economics, law, political and social science, and philosophy, have read and commented on the piece. Where did you get such a crazy idea?” he asked. or physical attributes (appearance, dexterity, possession of senses, etc.). The theory focuses on income as property, and analogizes the protections of government to an insurance company that insures property against loss. The results show that government spending, and social spending in particular – through direct and in-kind transfers – are strongly progressive. 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. Assume also that all of the persons in this society work exactly the same number of hours and at exactly the same intensity, resulting in incomes that correlate closely with aptitudes. Progressivity is measured through the Kakwani index (Kakwani, 1977). The analysis above may be interpreted to suggest that even greater fiscal redistribution is required. Deciding how much money should be appropriated for this pool and how it should be spent is almost always a subject of contentious debate. Morris Fiorina is a senior fellow at the Hoover Institution and the Wendt Family Professor of Political Science at Stanford University. The Labor Party cares no more about the inequity than the Coalition. Since there is no perfectly equitable tax system, the goal must be to design the least inequitable system. Theirs were the only houses on the street. They subtract a larger percentage of income from the poor than from the rich. II. 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. All these services can be regarded as in-kind transfers. “Why not? Understanding the primary determinants of income and the implications of each for tax policy are essential to designing the most equitable tax system. Figure 2 illustrates how the poorest households comparatively receive much more benefit from health spending than their share of market income. In a country as unequal as South Africa, it is critical to deter… Professional athletes, musicians, singers, and other performers can enhance their innate aptitudes substantially through extensive practice, and a great many are renowned for having done so. Thus, greater work effort can produce higher income whether the person is paid by the hour or earns a salary. The inde… The argument for progressive taxation on fairness grounds has three main strains. Together these items account for 43% of total government spending and 85% of social spending in the budget. progressive taxation, that is, how much can the income tax reduce ine-quality? 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. Earned income is determined by a mix of the three factors described above, and the relative contribution of each varies by individual. If such a thing were possible, it is certain that the more highly valued aptitudes — those that would produce higher incomes — would be bid up to amounts in excess of the per-capita cost of government. out are tied to the aggregate amount paid into the system by each beneficiary, This article explores these questions by reporting on work by an international group of researchers (Inchauste et al. 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. 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. They do not include According to economist Roger A. Arnold, … These reports are arguably misleading. The attempt to ascertain a mathematical scale of progression, so as to avoid a charge of arbitrariness, is foredoomed to failure.12. 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). The practical reason was simply the futility of taxing that portion of a person’s income that was needed for survival. On conceptual grounds alone, sacrifice theory appears to be a very weak foundation for tax policy. wherewithal. 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. Fourth, even if the protection argument had merit, it would, at best, argue for a proportionate rather than a progressive tax. Blum and Kalven touched obliquely on this concept when they noted: Another approach [to the benefits theory] is more ingenious. literature to describe financial wherewithal; and 3) “ability,” which, like faculty, is used to describe either capacity to earn or financial 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). Corporate tax (about 21% of tax revenue) is the largest category excluded from the analysis. office of the European Union. Again, our parable is instructive: Assume that Harry’s boss is a construction foreman who works 40 hours a week at $37.50 per hour, thus earning $75,000 per year (which is the entirety of the family income). to establish whether government spending and taxation separately and together are ameliorating or worsening the degree of inequality that would otherwise exist between individuals. Policy Research Working Paper 7194. Only “clear income” — defined as income above the level of subsistence — should be taxed. finances government services per se. Establishing a graduated rate scale and setting the top marginal rate on that scale are inherently arbitrary tasks. Or perhaps Harry has an obsession with saving enough money to send his two children to the best private secondary schools and universities. [4] 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. Under the current progressive tax system, Harry’s after-tax income will be $63,275 (after $11,725 in tax, which assumes that, since Harry’s labor income is 50 percent of his total family income, the tax attributable to him is 50 percent of the $23,450 tax paid by the family). Pretoria: National Treasury. Tax Inequity . 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). Each of these systems will be examined as part of the analysis of progressive taxation. Scottish economist J.R. McCullough condemned this arbitrariness in the strongest of terms: The moment you abandon . Under that formula, Tom would owe $3,000, I would owe $9,000, and Harry would owe $18,000. In fact, in comparing the marginal-utility curves of Tom, Dick, and Harry Class, there are any number of reasons why Harry’s marginal utility curve might decline less steeply than Tom’s and Dick’s. What do you propose instead?” asked Harry. Income inequality has reached its highest level since the U.S. Census Bureau began tracking the measure more than 50 years ago, according to recent data. Figure 1 illustrates how the poorest households comparatively receive much more benefit from spending on education than their share of market income. But it has to be understood as capacity; aptitude does not produce income until it is combined with individual effort. This is essentially what Harry proposed to his brothers as the fairest way of dividing the costs of their street improvements. Data from the 2016 Census show that income inequality grew quite significantly over the decade from 2005 to 2015, and that the supposedly most progressive part of our overall tax … be through direct spending programs. 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. It also appears that consumption inequality has barely changed in recent years. To accept protection theory as an argument for progression, one would have to assert that each additional dollar of income earned is worth more than the previous dollar of income, which is nonsensical. 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). 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. They were 45 years old, had virtually the same aptitude (skill), and were raised in the same home. 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. (Technically a per-capita tax is not an income tax, but it is almost universally accepted as the most economically efficient tax system.). Sweden, often cited as the most progressive tax regime in the OECD, maintains a top statutory income tax … Tax policy can play a major role in making the post-tax income distribution less unequal. . 5 Edwin R.A. Seligman, Progressive Taxation in Theory and Practice (Princeton University Press, 1908). While they were almost identical in most respects, they had somewhat different preferences and values. The primary source of federal tax revenues (excluding Social Security and Medicare taxes) is a progressive tax on the earned income of individuals.2  This essay will make the case that the progressive income tax is plainly inequitable. 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 … “You make much more money than we do.” Harry was puzzled. 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 in the broader society, aptitudes are distributed widely and unequally. Your gift helps advance ideas that promote a free society. [2] Other data sources are the 2008 National Income Dynamics Study (NIDS) and some administrative data. Conceptual issues about how to measure progressivity are investigated. . As we will see, the statement of the principle — payment of taxes in return for benefits — lends itself to widely varying interpretations. The results indicate, first, that direct taxes (personal income tax plus payroll taxes) are progressive, since the richer income groups pay a proportionally higher share of total direct tax collections than their share of market income. 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. 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 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. Empty homes should automatically be taxed at a higher rate. Many of those who favor income redistribution assert that inequality foments dissension. 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. A highly progressive tax on consumption effectively closes all the loopholes since the income that evaded income tax is taxed as consumption. . If they had, they almost certainly would have realized that taxing such income progressively is inequitable. But the funding for such programs should If the word means the financial wherewithal with which to pay taxes progressively, the basic concept lacks an underlying principle of fairness to support it. 25 J. R. McCullough, A Treatise on the Principles and Practical Influence of Taxation, or the Funding Fomenting dissension. The deepest resentment will most likely be among those whose tax rates differ solely because of their work effort. “Why is that relevant?” he asked. Secretary General of the All-Africa Students Union Peter Kwasi Kodjie has charged African governments to formulate progressive policies aimed at reducing the tax burdens on women. Either way, ability could as easily dictate proportion as it could progression. This comment facility is intended for considered commentaries to stimulate substantive debate. 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. Political irresponsibility. The exemption makes the system progressive, but typically much less so than a system of graduated rates. Health spending is strongly progressive. This is a very large change. Fairness. Income tax and government . The first time a federal income tax was imposed in the United States was in 1861 as a means of financing the Civil War. It will also review the alternatives to progression in an effort to identify the most equitable (or least inequitable) tax system. venture capital and private equity firm. The greater-value interpretation of the benefits principle stands as a rejection of a per-capita tax system and as a compelling case for either a proportionate or a degressive system. Together these comprise about 64.5% of general government tax revenue in 2010/11. This essay is an abridged version of a Others argue that insurance is priced according to risk as well as value, implying that high-value property is at greater risk of loss. In 2009, the U.S. Gini was .468, while the average Gini for the 27 European Union nations was .304, a ratio of 1.54:1. Thus, a proportionate or degressive tax as proposed, would favor lower-income persons at the expense of higher-income persons. But as federal taxes became more progressive starting in the 1980s, the gap between before-tax and after-tax income inequality widened. 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. 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. Progression has been in use somewhere in the world for more than two thousand years. Secretary-General of the All-Africa Students Union, Peter Kwasi Kodjie, has charged African governments to formulate progressive policies aimed at reducing the tax … As noted above, it also includes work effort applied to strengthening one’s skills. 7 Some advocates of progression argue that a progressive income tax is needed to On the other hand, fuel taxes and VAT are slightly progressive. 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. Dan Throop Smith papers, Arch GA 81.17. Since I make three times as much as Tom, I would pay three times as much. . This book is an exhaustive review of the prior literature on this topic, interspersed with the authors’ own analyses and critiques of the arguments presented. 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. Or it may be acquired from lessons learned from parents and other life experiences. Reducing Income Inequality. It was not possible to incorporate differences in the quality of health and education services across the country. It follows, therefore, that, all things being equal, higher-aptitude people should pay more in taxes than lower-aptitude people — not because they have more to lose (or to protect), but because they receive greater value from their government. What is the equity principle that justifies this taking? This book assembles nine research papers on tax progressivity and its relationship to income inequality, written by leading public finance economists. 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. As a result, at any one point in time, an unacceptably large percentage of the total work force will earn less average, after-tax income per hour than their peers, simply because they worked harder. 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. 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. . www.kiphagopian.com. Donald Trump has unveiled a new tax plan. 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. 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. Accordingly, persons with more highly valued aptitudes would earn more income than their lower-aptitude counterparts, and thus derive greater value from government. In this case, the person earning £10,000 is paying 20% of their income in tax (total tax of £2,000) There is no question that until the recent recession, the U.S. economy performed well in both absolute and relative terms over the 25-year period from 1983 to 2008. property. This alternative view has induced some scholars (John Stuart Mill, for one) to suggest that two types of tax should be imposed: a proportionate tax to pay for economic well-being and a per-capita tax to pay for the protection of life, liberty, and property. The moral question is: Is Harry being treated fairly? The question for policymakers is how much the tax system should reduce inequality given those costs and social values about fairness. [3] 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. A proportionate or “flat” tax, which would tax each dollar of income at a single rate. d) Progressive tax because as income increases people tend to buy more expensive houses. Cohen-Stuart with debunking the notion that there is a universal marginal-utility curve that dictates progression. (Note that in this all-too-common circumstance, where both aptitudes and benefits are equal, even a proportionate or degressive tax is redistributive with respect to the hardest workers.) Here Seligman summarizes Cohen-Stuart: “It is perfectly possible . 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. 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. As to the latter, the debate inevitably devolves into an argument over fairness and economic efficiency. 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). Thus, a person who earns 10 times as much income as another would pay 10 times as much tax, while someone making 100 times as much would be taxed 100 times as much. Statistics South Africa (2014). . Several advanced economies have top income tax rates well above the current U.S. rate. If the word ability means the innate or learned capacity to earn income, it is synonymous with aptitude, in which case, the greater-value interpretation of the benefits principle should be applied. Fiscal redistribution alone is unlikely to achieve the desired reductions in inequality. It’s no accident that “historically almost all exponents of benefit theory employed it to support proportion as against progression.”8. In fact, since 1994 the Gini coefficient[1] has increased somewhat to 0.69 in 2011. 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. 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. 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… 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. The Gini coefficient is a method of measuring the statistical dispersion of (among other things) income, consumption, and wealth. Consequently, the value of using money income to measure either standard of living or inequality is quite limited. (In fact, the cost might be less, since persons with high income tend to reside in low-crime areas.) 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. They both make $75,000 per year, but Harry does it working 60 hours per week and his boss does it working 40 hours per week. 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). Or does it mean the innate or learned ability to earn income, which would equate to aptitude? Accordingly, figures from the period before1993 are not directly comparable with the period from 1993 to the present. 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 … Ability-to-pay has been the subject of considerable debate on definitional grounds alone. In this view, inequality is a social injustice that can be remedied or mitigated by a progressive tax system. Harry, however, was stunned. But it is clear from a careful reading of the book that Blum and Kalven did not appreciate the implications of how income is determined, specifically the special nature of income derived from work effort. Press Release – Aotearoa NZ Association of Social Workers. Income, Poverty, and Health Insurance Coverage in the United States: A Treatise on the Principles and Practical Influence of Taxation, or the Funding For most people aptitude is the most significant determinant of income. For the most part, it comes from circumstances of birth and is distributed unequally. 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? The arguments in support of progression tend to fall into three main categories:7  economic efficiency, fairness, and reduction of income inequality. “From no less an authority than the federal government,” said Tom as he pulled out a gray booklet. Thus, for these workers, work effort has its own marginal-utility curve that is essentially the same as the marginal-utility curve for income. Class Wars: A Parable . However, for final income – i.e. Tax policy is the mechanism through which market results are redistributed, affecting after-tax inequality. Lustig N & Higgins S. 2013. . The one may be a bachelor, the other a man with a large family dependent upon him; the one may be well, the other ill . The main source of data is StatsSA’s Income and Expenditure Survey (IES) 2010/2011. Historically, the use of the benefits principle to advocate progression relied on the “protection theory” of benefits, which asserts that the government’s primary function is the protection of property. Roughly three-tenths of this increase occurred between 1992 and 1993 due to a change in the way data were collected. In fact, I believe all future pooling of funds should be divided in this way.” “I’m in,” said Dick. Tom was ready with his answer. . 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. The Inequity of the Progressive Income Tax . Inequality in income after taxes and transfers, as measured by the Gini index, was about 25% lower than for income before taxes and transfers on average in the OECD area in the late 2000s.2 For the same period, poverty measured after taxes and transfers was 55% lower than before taxes and To argue otherwise requires a belief that the price of property insurance increases faster than the value of the property (in this case, income), which is observably untrue. Like all parables, the story of the Class brothers is designed to illustrate a moral principle. Article excerpt. 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