The issue of tax is a difficult one because equally important principles pull in different directions. A tax system should be fair and progressive; that is, it should not be more burdensome for poorer people. It should take the most from those who have the most to spare. Yet you also want a tax system that raises sufficient revenue by encouraging (or at least, not discouraging) the productivity that creates the money to be taxed.
Following the fair-tax view means taxing disposable income at a much higher rate than the income that barely covers food and housing. That suggests a steeply progressive income tax, starting at zero for people making less than poverty-level income and rising gradually to something like 40 percent for the richest two percent of people or so. (If the tax cuts passed under President Bush expire, the top marginal rate will be close to 40%.)
But the competing view warns that higher marginal tax rates discourage businesses from making job-creating investments. I’m more likely to make an investment if I get to keep 90 percent of the profits than if I only get to keep 60 percent. In a high-tax environment I might decide it’s not worth it to put that capital at risk. You could complain that this argument caters to people’s greed, but that complaint does no good in practice. If we care about raising enough revenue for a social-welfare-oriented government, we have to make sure we’re not discouraging the very wealth creation that makes such a government possible.
You can believe (as I do) that right-wingers exaggerate higher taxes’ discouraging effect on productivity, and still appreciate that higher marginal tax rates affect incentives. If I get to keep more from making an investment, I am more likely to make that investment. It would seem naïve and wishful-thinking to argue that marginal taxes can be raised toward 100% without reducing wealth-producing incentives.
But this logic creates a problem for the fair-tax view. If higher marginal taxes discourage productivity, resulting in less wealth for everyone, we should perhaps not only enact a flat tax, but a downright regressive tax code, perhaps by taxing earned income (above a poverty threshhold) at a flat rate while taxing capital gains and dividends less or not at all. Encourage people to get richer by making it a tax liability to remain poor. This is the extreme case, of course. It’s very unlikely to happen, although the very conservative people who dominate the Republican Party would gladly move us in that direction.
For example, a state may decide to attract a large company to set up shop there by offering a lower tax rate. If the state fails to do so, the company may take its business – and its jobs – to another state. The logic of this argument leads to the elimination of tax altogether. States can keep competing for business by lowering taxes until there are no taxes left. Indeed, states could even pay companies to come to them.
But since governments still need revenue, they will have to raise it by taxing people who lack the political clout to resist it. It’s harder for a working-class family to move to a lower-tax state. Nor can they very well avoid the sales taxes that conservatives prefer over progressive marginal taxes on income and assets. The advantage of taxing poorer people is that it’s harder for them to avoid the taxes. So even though you’re taxing people who don’t have much money, you’re still taxing enough people to make revenues significant in the aggregate.
If you believe, as many appear to, that our government spends far too much on social welfare programs, you could resolve this dilemma by cutting taxes across the board, leaving just enough revenue for things even the hardest-nosed conservatives agree government must do. If you believe, as I do, that social welfare policy should err on the side of generosity lest we engender a society of fantastic wealth for the few amid grinding poverty for the many, we have to find another kind of balance. In the next post, if I can find the energy, I will explore ways of doing that.
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