After todays attack on effective “left-wing” politics of blanket transfers and the idea that we need government to save the day, I thought I should come out with a post in favour of other general government action. So lets looks at progressive taxes.
It is common for economists to attack progressive taxation as it can be seen as:
- Unfair, given that some people who work have to get income have to pay a greater proportion of there income to the state (even more than a greater amount!)
- Unfair, because we may believe that most of the spending benefits people on lower incomes,
- Inefficient, given that we are taxing our “most productive” citizens at a higher marginal rate, reducing their labour supply.
- Or inefficient, because if the tax is passed on to the business, we are taxing highly skilled industries more than unskilled industries, which is a distortion.
However, there are reasons why society may want a progressive tax system, and when it would dominate other tax systems:
- Society may believe that it is fair for those who are “endowed with luck” to pay a greater amount of tax – even proportionally so (often diminishing marginal utility is used for this – but that is a “cardinal” sin (ignore my economics pun)),
- People on high incomes may benefit disproportionately from government spending – who benefits more from investment in a road, those on high incomes (which are partially a function of domestic infrastructure) or those on low incomes
- Ramsey pricing: Demand for skilled labour may be more price “inelastic” – implying that, for a target level of government spending, we can minimise “dead-weight loss” from the taxes that raise revenue by placing more of them on skilled labour.
- People value the idea that poor people are being helped out, however any individual income they provide may not help people very much. Furthermore, if we are in a situation where everyone else is giving income to the poor, this person does not need to and so won’t – as a result there is a prisoner’s dilemma. People want society (including them) to provide for the poor, but have an incentive to pike out themselves, leading to a worse outcome for everyone. In this case a progressive tax can help to circumvent the prisoners dilemma.
As a result, if you hear anyone say that the argument for a flat tax system is obvious,and progressive taxes are a historical mistake – ignore them 😛