Reply: On flat tax

Over at the Standard they are discussing the perceived inequity associated with a shift from a progressive income tax system to a flat income tax system.

This is an issue we have discussed before in this post. In the post we asked “what is the equality-efficiency trade-off” and “is the tax system the best way to redistribute income”.

The first question matters, because if we are reducing growth in the economy sufficiently by redistributing income it may be the case that lower tax cuts are parteo superior – which implies we could say they were better without having to make any assumptions (apart from the assumption that people prefer more). Even if the efficiency gains are not that strong it does imply that less than 78% of the population (the figure that the Standard states) will have a higher tax bill.

The second question matters as even if we are in a situation where a certain set of value-judgments implies that redistribution is optimal, there may be a better may to do it than through a progressive tax system.

Now even ignoring those two points we have the issue that “fairness” is a value-laden concept.

We can view the fairness argument by taking the Standards value judgment:

What’s fair about putting up tax on 78% of Kiwis to give a massive tax cuts to the few most wealthy?

And rewording it, such that:

Is it fair to make 22% of Kiwi’s shoulder a greater than proportional share of the provision of public services for everyone?

Note that the same amount of tax is being payed – so the lower taxes for 78% of the population are being paid for directly by another 22% – this isn’t necessarily fair.

Furthermore, calling this 22% of the population “wealthy” is just plain wrong – just because you have earned a high annual income does not mean you are wealthy.  E.g. Farmers have many low income years, but they certainly hold onto a lot of wealth.

Elasticity

Another point to remember is the “incidence of tax” issue, and the fact that a change in the tax system would lead to a change in wages.  If low skilled labour are those on low incomes, then firms will attempt to pay them their reservation wage.  If tax goes up on these workers, the firm still has to pay the reservation wage – and so gross wages rise to keep net wages constant.

In this case, the burden of the tax actually falls on the owner of capital, not on the employee, and so these people will not be made worse off by an increase in income taxes on the poor – the business owner will be.

One further issue is the level of spending – however, that is an issue I’m not going to discuss at present 🙂

  • Steve Pierson

    Re: ‘fairness’ and your rewording of my quote.

    We’re not talking about first principles here (although I’m happy to defend progressive tax on principle), we’ve got a status quo now and the question is what the effects of changing that existing system would be. We have a progressive tax system, if we changed it to a flat tax, we would put up tax for 78% of people.

  • “we’ve got a status quo now and the question is what the effects of changing that existing system would be”

    Status quo bias doesn’t tell us anything about fairness – unless we assume that moving in some direction from the status quo would be fair

    “although I’m happy to defend progressive tax on principle”

    I think that would be a more appropriate way to do it

    “We have a progressive tax system, if we changed it to a flat tax, we would put up tax for 78% of people”

    We have a progressive tax system, which implies that 22% of people are having to foot part of the tax burden for other people (if we were to say, assume that a proportional income tax was fair).

  • Kimble

    “We have a progressive tax system, if we changed it to a flat tax, we would put up tax for 78% of people”

    Why do you assume the current situation is fair? If it is fair then ANY move away from it would be unfair, and therefore shouldnt take place. This is the reasoning of an ultra-conservative. Are you an ultra-conservative?

  • CPW

    I wouldn’t have thought that the Standard would naturally be fans of the conservative philosophy that the status quo is inherently good :).

    I find the Standard analysis misleading on two fronts: the first is that a flat-tax system does not mean that there is no room for income threshold, or even a demogrant.

    The second is the 78% claim – yes, at one moment in time this might be true, but a lot more than 22% of people earn over 50,000 at some point in their life. And the more relevant unit is the household, and again more than 22% of people are part of a household with an income-earner earning over 50,000.

    Actually Matt, if we assume that people get equal rather than proportional access to public goods and services, it’s more like 30% of people who pay more than they get (anyone earning over $38,000). But public goods and services are allocated in a progressive manner wherever possible, so I think that is an understatement.

  • CPW

    Ha, I hadn’t even read Kimble’s comment when I posted mine.

  • “Actually Matt, if we assume that people get equal rather than proportional access to public goods and services, it’s more like 30% of people who pay more than they get”

    Agreed – I didn’t feel that I needed to bring that up to make my point initially though 🙂

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  • roger nome

    “Is it fair to make 22% of Kiwi’s shoulder a greater than proportional share of the provision of public services for everyone?”

    Fuck yes it is. Unless you beleive the ability of someone to buy a new BMW everery year is more important than giving children from poor households freedom from avoidable illness, and proper eductional opportunities.

    Fortunately most New Zealanders don’t think this way.

  • roger nome

    ” If low skilled labour are those on low incomes, then firms will attempt to pay them their reservation wage. If tax goes up on these workers, the firm still has to pay the reservation wage – and so gross wages rise to keep net wages constant.”

    I don’t see the rationality in that assumption. Low skilled workers usually face downward wage pressure from competition with the unemployed, and so are paid at, or close to the minimum wage.

  • CPW

    “Fortunately most New Zealanders don’t think this way.”

    Yeah, I’d say that roughly 78% think the current distribution is fair 🙂

  • “Fuck yes it is. Unless you beleive the ability of someone to buy a new BMW everery year is more important than giving children from poor households freedom from avoidable illness, and proper eductional opportunities.”

    But what happens if that is not the trade-off. I don’t think that many people in that top 22% go out and buy BMW’s (in fact given tax avoidance and the prevalence of trusts I think that there will be more BMW’s in the other category). Furthermore we aren’t talking about cutting services in this example at all – so talking about health and education is a straw-man.

    “I don’t see the rationality in that assumption. Low skilled workers usually face downward wage pressure from competition with the unemployed, and so are paid at, or close to the minimum wage.”

    Indeed, I was hoping someone would raise that point – because it is completely true. If there is a ceiling on prices, then as long as the ceiling is higher than the tax + the reservation wage the whole incidence will fall on the employee.

    However, in the current environment is there sufficient “competition from the unemployed”? If there is, then there is two things to remember:

    1) Trained staff are still worth more than fresh staff – people generally don’t stay on the minimum wage for long or they move (just look at the turnover at clothing stores!).

    2) The unemployment benefit also provides a reservation level – as a result, the higher the benefit, the more likely it is that some of the incidence will fall on employers.

  • Kimble

    ” Unless you beleive the ability of someone to buy a new BMW everery year is more important than giving children from poor households freedom from avoidable illness, and proper eductional opportunities.”

    Thats the problem you will always have with, Nome. Tax on one part of the population cannot be reduced ever, because if you do, orphans will die.

  • Kimble

    with Nome

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