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10 Mar 2004 23:30:33 Daniel H.

Subject: Econ_Policy    
On Progressive Taxation and the Worthy Rich

Progressive Taxation and the Worthy Rich.

Let's start with the the fundamental rationale for progressive taxation: that it burdens those most able to bear it. Moreover, even from the viewpoint of personal liberty, progressive taxation (even high marginal rates) are justified by the reality that the "rich" are only rich because they have a society to operate in. That without this society (and the economy it maintains), the rich would not be rich. Therefore, the distribution of income is a social choice, and society can choose to reallocate market outcomes without fear of treading on fundamental personal liberties.

Yet there are individuals who's contributions are so valued that society (by which I mean a large number of other indiviuals) are quite happy to see them rewarded materially. For example, many a Los Angeles Laker's fan may be quite willing to see Shaquille ONeil richly compensated, for he brings great pleasure to their lifes.

Combine these facts: that while progressive taxation offends no rights, there are groups within society may want to richly reward some individuals. To solve this contradiction, consider the following tax policy:

a strongly progressive tax structure, with transferable tax credits that citizens can reallocate to high-income individuals.
Here's how it could work:
Part 1 All incomes greater then $300,000 should be taxed at a 50% marginal tax rate (only 1% of tax payers earn more then $300,000/year). That is, once a taxpayer hits $300,000, half of every extra dollar (over this $300,000 figure) goes to the government. In contrast, the current top marginal tax rate is about 35%. Using the income table below, this would yield yield about $100 billion dollars in increased revenue.
Part 2 Every taxpayer is granted a $500 transferable tax credit.
This tax credit can be used to reduce the marginal tax rate from 50% to 35%. In other words, it is of no use to tax payers earning less than $300,000/year.
Part 3 Each taxpayer can dispose of this credit in one of three ways:
  1. Not use the credit. This means that the richest 1% will pay (in aggregate) $500 more in taxes, money that the government can use for social programs, debt reduction, national security, whatever.
  2. Give the credit to the rich as a class. This means that the richest 1% will pay $500 less in taxes (distributed proportional to their income).
  3. Distribute the credit to specific individuals, or to specific groups of individuals
This is the essential notion: give individuals greater choice over the social structure of income.

There are numerous tweaks. For example:

  1. One could give credits to "charities for the rich" -- non-profits that would redistribute the credits to the deserving wealthy (say, all the members of the local professional baseball team).
  2. Transfer would be anonymous, so as to prevent market in credits. Think of these credits as votes in the worthiness of a rich individual's contributions. As with any vote, they should not be subject to sale. It would be a crime to sell or buy a credit!
  3. The credit doesn't have to be given to one individual -- a taxpayer could give $250 to Shaquille ONeil, $25 to David Letterman, $25 to Bill Gates, and discard the remaining $200 (the government will collect this $200 in taxes-on-the-rich).
  4. If a rich taxpayer recieves more credits than he needs, they revert back to the granting tax payers, who can then give them to someone else. This "more then he needs" occurs when all his income is being taxed at the population-average marginal rate. Thus, the rich will never escape their taxes. At best, they'll just be treated the same as everyone else (at the margin).
In summation,
in juxtaposion to of the oft-heard conservative chestnut:
"If social spending is so important, then let individual charity fund it"
we posit
"If encouraging entrepenurial vigor is so important, then let the individual taxpayer fund it."


High marginal tax rates, on upper income individuals, are ethically neutral
The essential microeconomic argument for differences in income is based on marginal value. That the market, assuming away distortions, will reward productive assets (such as a man's work) at their marginal value.

If this is true, then imposing an income tax, especially a progressive one, will distort labor choices. Workers will labor for fewer hours (since they are recieving less take home pay). This leads to a loss in production (sometimes referred to as a deadweight loss) that exceeds the compensation the worker would require. Which leaves society poorer. And if it's the richest taxpayers, who presumably are the most productive (elsewise why would they be so rich), than this deadweight loss will be even larger.

Yet we observe income taxes anyways. Perhaps the deadweight loss isn't too bad (do people really increase their work hours as their pay increases?) Or perhaps the advantages of government programs exceeds the loss in production. Or perhaps the advantages of income redistribution to poorer citizens (perhaps via government subsidy of necessary goods) is so much appreciated, that it exeeds the pain felt by those with plenty when they lose a chunk of income.

Granting that an income tax can lead to an increase in aggregate social welfare, there still is a question of individual justice. Is it fair that a productive individual should be penalized for their hard & efficient work? Isn't that theft?

In some limited sense, perhaps. But why should the worker have sole claim to what he produces within a large economy? After all, place this self-same hard & efficient worker on a desert island, and then see what he can make. That is, the marginal product of a worker is due both to his effort/talent, and the wherewithal provided by the society/economy he works within. Therefore, the worker has no more claim to this bonus than society at large.

Hence, the division of the products of labor, between society (that provides the context) and the individual worker (who works with what society offers) is ethically neutral. The free-market (at its purest) would give the worker his entire earnings. Imposing an income tax merely reflects a different, but ethically still neutral, division of this output.

Do the rich really deserve all their lucre?
While mean yearly income (across all taxpayers) is about $49,000, about 1% of the population earn more than $300,000/year. This top 1% recieves as much income as the lower 50%.
Are these folks really that productive? Or are they essentially lucky, perhaps in honest ways (they have skills that society needs). In any case, it's not like they've suffered for this wealth. So why not tax them at a higher rate. After all, they'll still be quite well off, even after the high tax rate.

A few 2001 income distribution facts
Income class# of tax returns
AGI (billions $)Mean AGI
(removing richer),
thousand $
(cutoff in k$)
All128.8$6241 trillion49 n.a.

Top 1%1.3 1094 841 292
Top 5%6.4 1996 311 (176) 128
Top 10%12.9 2690 208 (107) 93
Top 25%32.2 4071 127 (64) 56
Top 50%64.4 5379 84 (40) 29
Bottom 50%64.4 861 (13) 0 to 29
  • For a nicely turned summary of the US distribution of wealth, check out this story on AlterNet
  • Subtracting the income below $300k from the richest 1%, and multiplying the remainder by .15 (the difference between the current max 35% rate and the proposed 50% rate) yields about $100 billion dollars in increased revenue.

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