Progressive taxes in a regressive world
Sep 24, 2010

Progressive taxes in a regressive world

Most western societies operate based on a progressive tax scheme. That is, schemes where the rich pay a relatively higher proportion of their incomes than poorer people do. As the debate surrounding the Bush tax cuts becomes a key campaign issue it is important to step back a bit and recall why we have progressive taxes at all.

The case for progressive taxes is actually quite multifaceted and dates back to at least Adam Smith, although it admittedly faces criticisms, however I would like to focus my comments here to noting the regressive nature of our world. There are many forces in our society that disproportionately advantage greater wealth and we can thus see progressive taxes as a means to balancing out these forces and aiming for a more equitable society. When one considers a flat tax (everyone pays the same proportion) it at first glance appears very equitable and fair however when one acknowledges the innate regressive forces of our society the need for a progressive balance to maintain a more equitable society become clear.

These regressive factors abound in many different ways. Firstly, the less wealth one has the higher the proportion of that wealth is spent on non-discretionary spending such as basic food, clothes and shelter and cannot be spent on wealth gaining activities like investing in a business. Poor people are often forced to rent compared to owning homes the latter of which over the long term has historically been one of the largest means by which the middle class grow wealth.  College education which is well understood to be on average a largely positive expectation adventure (one receives far more money from better jobs etc than one spends on the education). Since this path is often inaccessible or at least has many barriers to entry for poor people, money is regressive. Those who have less of it have proportionally less ability to acquire it through lowered means to participate in such positive expectation endeavors as college education. The list of examples goes on, but the general point is clear is that their are forces which perpetuate our wealth discrepancies and effectively keep the poor poor and the rich rich. It is important to acknowledge this cyclical nature to combat the rhetorical dogma often found in the right that allocates an undue proportion of responsibility for the poor's situations on them and not on the societal forces that trap them there.

The above comments really apply to comparing the genuinely poor (those who are forced to rent, spend most of their wealth on basics of food and living, are unlikely to go to college) and the middle class or perhaps upper middle class. It becomes far more extreme when one compares this to the genuinely rich such as the CEOs of corporations and the like. The ability to proportionally grow their wealth is enormous. Investment opportunities unavailable to the overwhelming majority of the population, ability to implement economies of scale, ability to infiltrate political processes to their benefit etc, are all examples of the regressive lack of opportunity having less wealth gives. This is why Goldman Sachs can profit every single day of the first quarter of this year while no upper middle class day trader could hope to do the same. In general as one increases along the wealth scale from the ability to invest in a small local business up to  running the worlds largest corporations the ability to proportionally increase wealth only goes up which explains why their is so much consolidation of industry into so few very large corporations.

Returning back to the lower 99% of people, even while our tax code is explicitly progressive, in actuality it is regressive in many ways. The reason is that it focuses on income opposed to wealth - for legitimate pragmatic reasons - however a lot of the sources of the wealth of rich do not come directly in the form of income. Thing such as benefits, pensions, company cars, and most importantly especially for the truly rich things like stock options, business ownership capital gains and the like all result in growth of the net wealth but without direct taxation in the top income brackets. As Obama noted in a recent MSNBC town hall event, the average tax rate of the top hedge fund managers was some 15%, less than their secretaries. The result is that even if one ignores the societal regressive forces, the actual nature of the tax code is regressive when considered to wealth not income.

One metric we can use for evaluating a progressive tax system is the direction of the rich-poor gap. If the gap between the rich and the poor grows and society polarizes, this is a strong indication that the tax system is insufficiently progressive and that natural regressive forces are dominating, and vice versa. Unfortunately, this is precisely what we have seen over the last 30 years where in metric after metric (such as proportion of the wealth held by top 1% or 5%, CEO to worker pay, stagnation of inflation adjusted minimum wage compared to increasing living costs, etc) the gap appears to be widening. Granted it is still suffering a major decline, but the poverty rate in the US hit 14.3% a couple weeks ago.

I should qualify that I have largely glossed the moral, economic and other arguments both for and against progressive taxes and don't mean to misrepresent their importance. However, I find the nature of these regressive forces in our world to be both important to acknowledge for their own sake and quite compelling as an argument for progressive taxes.

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