Thursday, July 11, 2013

What is the case for progressive taxation?

I am aware of two general arguments.

The first relies on inter-personal utility comparisons and goes like this: The marginal utility of a dollar is much higher for poor people than rich people, so in a utilitarian spirit, we can justify taking more marginal dollars away from the rich and giving them to lower income people.

Note that

(1) interpersonal utility comparisons are at best tricky and more likely impossible. We cannot rule out the case that the Sultan of Brunei gets more utility from another dollar than a slum dweller in Mumbai, and that in a utilitarian spirit, we should tax the slum dweller and give it to the Sultan!

(2) This is a case for redistribution, not for progressive taxes just to fund government generally.

(3) There is no reason for the argument to apply only inside national borders. Under the assumption of uniform diminishing marginal utility of money, we should be taxing poor Americans and giving it to the slum dwellers of Mumbai (or if we really have a utils machine, perhaps to the Sultan of Brunei).

The second argument is Rawlsian, and it goes like this: If we got together to set the rules of the game, without knowing what our socio-economic positions would be when the game was played (i.e. behind the veil of ignorance), we would all agree that rich people should be taxed at a higher rate and the money be redistributed to the poor.

Note that the same 3 notes above to argument #1 also apply equally here. We are taking uniform diminishing marginal utility of money as given, it's an argument for redistribution, not general funding, and, here even more than ever, it's a argument that should be applied globally.

Behind the veil, we don't know whether we'll be living in Norman Oklahoma, a slum in Mumbai or a palace in Brunei. The Rawlsian veil argues for higher taxes on most Americans with redistribution done on a global scale.

Now there's also the "you didn't build that" argument, but that seems more of a case that the rich should pay more taxes than the poor, which, certain extreme cases to the contrary notwithstanding, they generally do, and not a case for higher tax rates on the rich.

Are there other ways to make the case? Let me know in the comments


Warren said...

You have progressive taxation for the same reason you rob banks: That's where the money is.

Gordon CB said...

An argument I accept is that citizens should feel the burden of government equally. Hence, the rich, who experience a diminished utility from consumption, need to pay relatively more than the poor to make the felt burden equal. Of course, this argument only works if everyone actually pays some taxes!

David Prentiss said...

This may be the same argument as the "you didn't build that" argument. But since I've never heard that formalized I'll share this possibility:

Individuals with higher incomes have necessarily taken advantage of the protections (e.g. property rights) provided by the government to a greater extent than those with less income. Therefore, they should pay more to fund such protections.

Of course, this falls flat in a welfare state where the cost of providing welfare to low-income individuals might be greater than than the cost of protecting rights in general.

Note this makes no use of utility or subjective value. It claims that the assets implied by your high income cost more to protect than the assets implied by your low income.

Maybe this is not right or even original but, if true, would be a way to make the case.

Dustin said...

I don't think it's valid to dismiss redistribution simply because we could also redistribute to other countries. That would be like saying I shouldn't be buying food for my children because there are other children who have less than them. I don't think it's wrong to draw a line somewhere and say 'these people are mine and I will take care of them first'.

Aside from that, I think a possible case for progressive taxation or redistribution in general is to recognize that the 'system' isn't perfect. The nature of government is that the wealthy and powerful will inherently be able to bend it at least somewhat to their will. Since government is likely to inherently favor the rich, it may be justified to explicitly add some backflow. Not positive I buy it, but I think there's an argument there.

Norman said...

I think almost any argument for progressive taxes is actually going to be an argument for redistribution except one: a flat tax would either fail to raise sufficient revenue for the government's intended operations, or it would overly disincentivize low-income workers. You could fix the latter problem by adding a redistribution program, but that would end up equivalent to a progressive tax. So as Warren said above, that's where the money is.

Regarding other reasons for the progressiveness/redistribution, I can think of another argument. If you believe that very high incomes exist because of successful rent-seeking, rather than being associated with extremely high marginal product, you might want to discourage the rent-seeking activity by radically reducing the payoff. I don't endorse this plan, but I can see why people would favor it.

Another possible reason is that people see income inequality as a negative externality in itself. Some inequality is necessary to encourage effort or spur growth, but since the individual's effect on inequality is not borne by the individual markets will naturally produce too much inequality. Progressive taxes then become Pigouvian taxes, and the objective is to arrive at the optimal level of inequality. Again, not saying I buy this argument, but I don't think it depends on utilitarianism or Rawls.

michael said...

would it make sense to look at the log of income, rather than the linear income?

When I get a raise, it's given as a percent on what I had before. When I choose to get a higher quality consumer item, the distribution of options appears to follow a log distribution (options becoming more spread out as quality increases).

I would say that the marginal utility of an extra dollar for a sultan is undoubtedly less than that for a beggar, but an extra 1% or 5% means about the same to each.

At least I observe this to be true as my income increases, my willingness to spend small amounts on trifles increases. Or that could just be age.

How does a "flat tax" look if applied to logarithmic income? Am I overthinking this?

Anonymous said...

It's the cheapest way to prevent a raid against the rich.

Dirty Davey said...

As a baseline for interpersonal utility comparisons, consider Maslow. Not all needs are equal, and the slum dweller has difficulty with needs at the levels of physiology and safety that the sultan does not. If you accept the hierarchy of needs, then it makes sense to conclude that a dollar used to alleviate a more basic need is providing more utility than that dollar used to alleviate a secondary need.

Max said...

To 1)
You miss that there is also a categorization or priorization of certain needs that probaly ALL humans have. The needs for survival come first, meaning:
- housing
- food

This is why utility here has also to include those catagories for supporters of progressive taxation.

Even if it means that in an objective sense it is unjust. I think even Ayn Rand conceded once that military defense is most of the time for those people that have to lose something. The poor don't need or want it, thats why drug lords have a militia.

Anonymous said...

Also, if everyone feels the same way! That is, there is no such thing as subjective utility!

Jim Oliver said...

I have often read arguments that we should have progressive taxation to keep the rich from getting too powerful and oppressing the rest of us. It would be like a law preventing one from owning a nuclear bomb.

Anonymous said...

Price discrimination. Rich people have a higher surplus from a stable, public goods-providing, law and order-providing government. If you live near subsistence, your surplus is relatively low, and the alternative (no government) may not be that much worse (or better). Progressive taxation extracts the greater surplus in a similar way as price discrimination. I'm not sure if this is a fair justification, or a justification at all, but it is an explanation for why it exists.

A Rawlsian tax on luck and rent-seeking. Many people are enriched by providing mutually beneficial exchanges in a market economy. But many other people are just lucky or got their gains via rent-seeking. Progressive taxation might be a "throw the baby out with the bath water" approach to addressing the latter.

I didn't say either justification is necessarily perfect (they're not), but they're better than many of the typical justifications for progressive taxation.

Les Cargill said...

I thought the argument for progressive taxation was that monetary velocity would be higher, not that utility goes up. Those are related but not quite equivalent. Higher monetary velocity that is not hyperinflation is generally considered to be a public good, SFAIK.

Pelsmin said...

The question is not whether our tax system has redistributive elements. Our tax system is primarily about redistribution. Consider this: if you asked the top 25% of earners to pay for 100% of essential shared services for everyone -- the courts, the military, highways, etc. -- and nothing else, their taxes would go down. The majority of taxes paid go towards redistribution of wealth through programs like welfare, social security (be honest!), food stamps.

Anonymous said...

The whole point is that if the government is so weak that it can barely buy a pair of shoe laces then there will be prosperity and freedom. Mises was right. Government is the negation of freedom. For a while the Constitution served as protection but with a "living" Constitution it has ceased to exist and people should study Argentina for ways to survive and thrive in a runaway State.

Anonymous said...

The whole point is that if the government is so weak that it can barely buy a pair of shoe laces then there will be prosperity and freedom. Mises was right. Government is the negation of freedom. For a while the Constitution served as protection but with a "living" Constitution it has ceased to exist and people should study Argentina for ways to survive and thrive in a runaway State.

jj said...

The rich want the government to spend more on public goods than the poor do. Therefore, they must pay more.

As an example, a poor person with only $10 wouldn't be willing to contribute any more than, say, $9 for policing. But a millionaire wants a lot more policing than that.

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