The Folly of Progressive Taxation

[mencken]

The most sensible argument I have seen for progressive taxation is the idea that the wealthy have a lower marginal utility for money, and thus there is lower loss of productivity by taxing it to pay for government projects. This betrays a fundamental ignorance of what the wealthy actually do with their money.

Contrary to the image of Scrooge McDuck putting all his earnings in his vault, wealthy people are far more likely to invest their non-consumption money than simply sit on it. This money then either goes directly into production, or in poor economic times goes into the bank. The latter option increases bank reserves which facilitates lower interest rates and consequently greater production. While some of the investment decisions will fail to correctly predict future demand, those that are successful are rewarded monetarily, which has the net effect of encouraging those that are more adept at predicting future demand. Thus, the marginal income of those in high brackets is not wasted, but goes toward increasing supply of future goods that people are likely to consume. Moreover labor costs will presumably factor in to one of the uses for that invested income, so wage-earners will have the capacity to consume those goods in the future. There would be little sense in an project that is too costly for eventual mass consumption, so those projects that eventually materialize in an affordable product are likely to be rewarded with a loan.

Now consider what happens when this income is taxed. Temporarily ignoring the use of borrowing to finance many of the government's activities (and the corresponding crowding out effect), this money will be used to either make transfer payments or finance projects. Transfer payments may temporarily increase the present consumption of the poor, but since this money would otherwise have gone toward investment, the process has the net effect of decreasing their future consumption in favor of present consumption. This encourages subsistence of the lower class at the expense of a material increase in their standard of living.

If this taxed income is used to pay for a government project, there is a possibility that it will be used to fix potholes and other productive expenses of government. This is a generous assumption, as it is far more likely that, with little incentive to guard the bottom line, it will be used on some wasteful expense for some politically advantageous community. Nevertheless, the government faces no incentive to deliver a profitable venture, nor any means to determine what is a profitable venture. The project, whether productive or frivolous, will be above market rate and hire more people than necessary. This is essentially a transfer payment of a different form, except that it also redirects labor away from potentially lucrative projects in the private sector in favor of project that will deliver far less future value. Once again, the net effect is the same, but amplified.

Granted, as mentioned earlier, there are some necessary government expenditures. However, the dichotomy for financing this is not consumption versus income but present consumption versus future consumption. Taxing the latter would be more deleterious toward real economic growth.

[PJ]

Why do you have a red avatar?

One of the most common argument this fails to address is the idea that many of the rich gain their wealth through exploitative methods.

Regardless of whether or not the wealthy sit on their money or invest it, they are not obligated to, so some are going to choose not to invest. Even if they are spending their money, I hardly see how building a beach house in the Bahamas (for example) is going to benefit the economy. Not all forms of investment are going to benefit the public good. Based on your endorsement of Gary Johnson and past posts I've seen from you, I'm going to assume that you find most government endeavors to be wasteful, which is where I have a philosophical disagreement. Government funding for a public healthcare system is going to have more direct benefits than investment by the rich. The only way I see the wealth of the rich actually benefitting society directly is through philanthropy, and even then, it's evident that private charity is not an effective method of solving issues such as poverty on its own.

[🐒Gods of Prosperity🔱🐲💸]

It's a good point you make about the value of investment that is ignored by the "fleece the rich" crowd.   But consumption (and, where they are able, investment) by poor and middle income folks also funds and enables investments by businesses and the wealthy. 

Low taxes, yes.   But the taxes that exist should be progressive, simply because the more wealthy are more able to pay a large portion of their income without hardship.

[mencken]

Why do you have a red avatar?

See my screenname or signature.

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Yes, unfortunately many of the wealthy these days obtain their position through political connections and corporate welfare rather than by truly producing a good or service desired by the public. However, it would seem to be simpler to eliminate opportunities for such cronyism by reducing the scope of government, rather than giving public resources to certain people, then taking it away in the name of the public good.

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As I said ealier, this betrays a fundamental understanding of how the wealthy operate. Nobody gets rich to begin with by hiding their wealth under their mattress. Even hypothetically speaking, if we were to find a hermit with a six-figure income, it is difficult to argue that he is a great drain on society if he produces valuable work while choosing to live as a pauper.

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So I would think a progressive consumption tax would be more favorable, since building a lavish beach house is the example you identify as least economically productive?

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Those that have the greatest appeal are going to have the greatest return, and those without substantial demand are going to be punished at the marketplace. Thus, those investments that are least beneficial for the aggregate good will be "taxed" the highest.

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Not necessarily, although government projects are generally more costly than the equivalent private projects, given that the costs of the former are externalized. 

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Ignoring my substantial objections to a socialized healthcare system for the time being, the latter will certainly have more direct benefits per dollar spent than the former. Investors are much more likely to be scrupulous in ensuring their money is going to efficient use than involuntary taxpayers.

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It depends on how the philanthropy is used. Subsidizing complacency is certainly a societal dead weight. However, providing basic sustenance to the downtrodden while teaching skills that would enable eventual self-reliance would have a decent chance of being helpful, almost like an investment in human capital.

It's a good point you make about the value of investment that is ignored by the "fleece the rich" crowd.   But consumption (and, where they are able, investment) by poor and middle income folks also funds and enables investments by businesses and the wealthy. 

Low taxes, yes.   But the taxes that exist should be progressive, simply because the more wealthy are more able to pay a large portion of their income without hardship.

I acknowledge that present hardship is the one difficulty in advocating a system that rewards future growth rather than present consumption. This could be avoided by a consumption tax that exempts staple goods. My personal preferred option would be a single land tax, which would almost exclusively target those with a low marginal utility for wealth while at the same time encouraging investment rather than present consumption.

[Clark Kent]

I used to support a flat tax rate, until I realized that basic necessities take up a larger portion of low-income people's incomes, so it would actually be pretty regressive. I still support lower taxes, though.

[DC Al Fine]

I used to support a flat tax rate, until I realized that basic necessities take up a larger portion of low-income people's incomes, so it would actually be pretty regressive. I still support lower taxes, though.

Indeed. The old Canadian Alliance ran on a two bracket system. 0% until about $30k and then a flat tax after that. That's something I could live with.