There Are No Fair Taxes
There Are No Fair Taxes
If you are using the concept of fairness as a basis for arguing the pros and cons of any specific type of tax, perhaps your arguments are more rhetorical than rational. There are no fair taxes.
All types of taxes are inherently unfair
The issue being discussed here is the distribution of the tax burden. The issue of the total amount of taxes collected by the government is a completely separate issue. Try not to get taken in by any rhetoric which confuses these two issues. For the purpose of this discussion, you can think of a fixed level of government revenue from taxes. When somebody’s taxes go down, then somebody else's taxes go up. If we decrease the tax burden for one group of people, then some other group(s) will see an increase in their tax burden.
Taxes can be progressive, regressive, or proportional
Progressive taxes place more of the tax burden on those with a higher ability to pay (higher income or higher wealth). People who get taxed more due to progressive taxes claim that it is unfair that they have to pay a higher percentage to the government than others. It’s their money; they earned it.
Regressive taxes place more of the tax burden on those with less ability to pay. People who get taxed more due to regressive taxes claim that it is unfair that they have to pay a higher percentage to the government than others. It’s their money, too; and they need it to survive.
Proportional taxes take the same percentage from everybody regardless of ability to pay. But proportional taxes are actually regressive taxes in the sense that they place more of a financial burden on those with less discretionary income. Proportional taxes are regressive taxes masquerading as “equitable” taxes. Flat taxes are proportional taxes which are regressive. Despite the rhetoric, flat taxes are only “fair” taxes in the sense that regressive taxes are "fair". Even if flat tax rates require a minimum income requirement before taxes are owed, those just above the minimum will have a higher tax burden than those far above the minimum.
Even progressive taxes can be viewed as being regressive, if the degree of progression in tax rates is less than the percentage change in the ability to pay.
Some groups of people may see some types of taxes as "fair", while other groups see different types of taxes as "fair". There are no taxes which can be viewed as "fair" to all.
If all types of taxes are unfair, which type should be used?
~Attributed to Oliver Wendell Holmes in a 1904 speech
The answer depends on what kind of society we wish to have. Even if we could reach a consensus on which taxes are more “fair” than others (and we can’t), then what happens if we create negative consequences in our society for no other reason than a sense of fairness in our methods? For example, if we as a society have the ability to prevent people from starving to death, should we let them starve if it means that saving them would be “unfair” to those with the ability to pay a little more in taxes? Should we take money out of the hands of those who need that money to survive and would spend it – thus increasing consumer demand and jobs – simply because it would be “unfair” to increase the tax burden on those who have a higher ability to pay? What if our adherence to “fairness” might cause a recession or worse? On the other hand, should we place such a high tax burden on those with a higher ability to pay that we end up taking away incentives for work, entrepreneurship, and investment?
Simply put, no single type of tax is consistent with a stable economy, economic growth, economic freedom, advances in technology, increases in the standard of living, and the opportunity for everybody to live the “American Dream”. If we depend too much on one type of tax, placing the burden on the same groups of people, then people who feel oppressed by the “system” will eventually rise up, putting at risk the survival of our system of government.
As a result of these considerations, Americans are subject to a mixture of various types of taxes, not just ones which place most of the tax burden on the same groups of people. Everybody pays taxes. The pain of the tax bite is spread around. This doesn’t mean that we have an optimal distribution of the tax burden. Far from it – we can always do better. It just means that we don’t have to rely on a single type of tax.
When we add all of these types of taxes together, the result is that taxes in the United States tend to be progressive, but perhaps not as progressive as some people may think.
In this image, each of the first four bars represents the rate of taxes paid by each of the first four quintiles (20%); the first four bars together represent 80% of all taxpayers. The first six bars represent 98% of all taxpayers. The last bar represents the top 2% of income earners.
~Adam Smith, The Wealth of Nations, Book 5, Chapter II, Part II, Article I, p. 911.
Some additional points to consider:
- Stated (or nominal) tax rates and marginal tax rates are NOT the same thing as effective tax rates. The effective rate is the rate that is actually paid. The rhetoric may say that corporations pay 35% in federal taxes, but NO corporation pays that much. Some very profitable corporations have an effective tax rate that is less than zero. For all types of progressive taxes, the effective rate is always lower than the marginal rate.
- The same income is subject to various types of taxes. It makes little sense to single out one type of tax, and then criticize it because it represents “double taxation”. They all do.
- Each type of tax represents a decrease in the ability for someone to engage in certain types of “socially desirable” economic activities. It makes little sense to single out one type of tax, and then criticize it for its potentially negative consequences, unless the consequences of alternative types of taxes are also taken into consideration.
- When taxes decrease the ability to engage in certain types of activities, they provide incentives for other types of activities. People and businesses often look for uses of money which will decrease their tax bills – invest profits in things which can be written off as pretax expenses, for example.
For this analysis, I treated the amount of government revenue from taxes as a separate issue – which it is – in order to focus on the distribution of taxes rather than the total amount of taxes. The truth is that different types of taxes actually CREATE changes in total government revenue.
For example, lower tax rates on corporations will allow corporations to keep more of their revenue, and this additional money will be used, in the aggregate, for a variety of things. Lower tax rates on rich individuals will result in additional disposable income which will be used, in the aggregate, for a number of things. In the aggregate, a percentage of the additional after-tax income resulting from lower tax rates will involve benefits for the overall economy; but only a percentage. Lower tax rates for lower-income individuals will result in additional disposable income which largely will be used, in the aggregate, for things which WILL benefit the overall economy. This is because lower-income people are much more likely to spend their disposable income in the domestic economy, increasing demand.
It makes little sense to advocate for lower tax rates for corporations and rich individuals on the basis that they will invest a portion of the extra cash in the economy, unless you also take into consideration that the alternative – lower taxes on low-income individuals – will result in a higher percentage of the money going back into the economy. This can create a broader tax base, increasing government revenue while decreasing government expenditures on social programs.
Talking about “fairness” can confuse the issue.
A version of this essay is included as a chapter in the book Common Misconceptions of Economic Policy by Jerry Wyant. You can purchase this book in paperback form from Amazon and other online book distributors. The list price is $12.99 (only $9.99 using discount code TA9GTK7E when ordering, depending on the distribution channel). Or if you prefer, you can download a digital version on your device (Kindle, Nook, etc.) for $4.99.
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