Is progressive taxation harmful to wealthy and low income people

Published: Last Edited:

This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.

In 1848 Karl Marx and Friedrich Engels frankly proposed "a heavy progressive or graduated income tax" as one of the  measures by which, after the first stage of the revolution, "the proletariat will use its political supremacy to wrest, by degrees, all capital from the bourgeois, to centralize all instruments of production in the hands of the state.

Abstract- The idea of progressive income tax is widely accepted in economic societies. The aim of this paper is to demonstrate that despite common belief, progressive taxation is harmful both for those who pay high taxes, the ones that own most of the wealth or try to obtain it, and those who pay low taxes such as low income employees. After presenting irrational cases of progressive taxation, it concludes that progressive taxes curb progress and punish efficiency, innovation, creativity, and economic growth.

Introduction- Governments have charged taxes to cover their expenses since the ancient times. Nowadays, almost every citizen contributes a percentage of his or her earnings in taxes to cover public spending on security, justice, education, health, and all the other areas to which resources must be allocated for the normal carrying out of public affairs [1] . Among the main responsibilities of a government is to provide an environment conducive to economic growth and opportunity. This can be achieved byhaving in place a tax system that rewards - or at least does not unduly discourage - productive behavior:

"Above this race of man stands an immense and tutelary power, which takes upon itself alone to secure their gratifications and to watch over their fate. That power is absolute, minute, regular, provident and mild. It would be like the authority of a parent if, like that authority, its object was to prepare men for manhood; but it seeks, on the contrary, to keep them in perpetual childhood; it is well content that the people should rejoice, provided they think of nothing but rejoicing. For their happiness such a government willingly labors, but it chooses to be the sole agent and the only arbiter of that happiness; it provides for their security, foresees and supplies their necessities, facilitates their pleasures, manages their principal concerns, directs their industry, regulates the descent of property, and subdivides their inheritances; what remains, but to spare them all care of thinking and all the trouble of living?" [2] (p. 318)

Is tax equity possible? Or is it just anything, the person in power says it is? To believe in equity one must first believe that objective principles of moral truth exist and are shared in the community [3] . Whether we are rich or poor, we are obliged to treat each other respectfully, because our sociable nature requires this of us. In short, in our essentials we are more alike than we are different. If this is the case why shouldn't we then be treated alike?

The state must be extremely careful in drawing up and enacting tax legislation. Taxes should be simple, fair, and no distortional; they should not burden individuals, corporations, and businesses in different ways. It should be borne in mind that all members of a society are taxpayers and that taxation affects everyone's behaviors, real income and wages; the design of an optimal tax policy affects all members of a society.

Though not normally discussed in moral terms, economic growth should be viewed as an ethical obligation of any government since failure of compiling a good policy to achieve that goal deprives people of opportunity and creates barriers among the most efficient members of society. Due to lack of knowledge regardingan individual's abilities, needs or preferences, the trade-off between equity and efficiency plays an essential role when drawing an optimal tax policy. Given its high policy influence, taxation has always been a topic of discussion and research.

Defining the Problem- There is a widespread belief among tax consultants and academics as well as the media and the general public, that direct taxes should be progressive. In other words, the more a person has or earns, the more he or she should pay in tax as a percentage of overall income. [4] 

There is no just or progressive tax rates scale [5] . The injustice inherent in the conception of progressive taxation can be demonstrated through a simple example. In a proportional tax system with a particular rate of 25%, a subject whose taxable income is $1,000 will pay $250 in tax, while another whose taxable income is $10,000, will pay $2,500. Both individuals will thus have 75% of their profit left to invest in their business or to spend as they like. On the other hand, if the tax is progressive and the higher rate is 35%, the individual whose taxable income is $10,000 will pay $3,500 in tax and will have only 65% left to invest. So, the higher the taxable income is, the higher the deductive tax and the lower the remaining income will be.

Whether taxes are proportional or progressive, the person or company that earns more pays more. What is unfair, however, about progressive taxation is that it increases the percentage paid by higher earners. It is a way of punishing efficiency based on a distorted view of justice, fairness, and individuals' rights [6] . As such, it is just one of the many appeals of the communism epoch whose purpose was and still is to grab income, wealth and capital from capitalists in the name of "social justice", or contribution to the good of the community. [7] 

In practice, the term "social justice" has served as a pretext to confiscate wealth from its legal owners and redistribute it at the government's own judgment in the form of subsidies. Those governments that state that they have a right to do so disregard that legitimate income belongs to the person who earned it: the right of private property is innate in the very nature of man, so it is indubitable. If two of our neighbors want to take something that belongs to our property, could it be that the neighbors have this right? If not two, then how about a group of neighbors? The whole society?

Rights cannot be added up; two persons who form a group do not have more rights than a single person does. Therefore the obvious and indisputable conclusion is that I don't have the right to take your property without your consent, no matter how many people are in my group.

After all, taxation is a form of forced payment, nobody is asked if he consents to pay tax or not. However, the objection is neither against taxation as process nor against the distinction between high and low tax, but against the distinction between fair and unfair tax. The objection is against progressive tax. It is clearly unfair to require some people to pay more taxesthan others. If we believe that all people are created equal and that everyone is entitled to equal protection of the law, shouldn't everyone have to pay the same price for those rights and protections ? "Social justice," then, is no justice at all unless everyone is equal before the law. In free economic societies, where everyone has the opportunity to climb the social ladder through their own efforts, justice seems to be applied in different structure depending on the different scale position of people, not to society as a whole. This is what is meant by blind universal justice.

The progressive tax rates inevitably put pressure not to work overtime upon the taxpayer or to withdraw his capital from productive business. If the rates were set more reasonably, taxpayers would have less incentive to avoid paying.

" a very important social and economic question is also involved in high tax rates. That is the result taxation has upon national development. . . . If we had a tax whereby on the first working day the Government took 5 percent of your wages, on the second day 10 per- cent, on the third day 20 percent, on the fourth day 30 percent, on the fifth day 50 percent, and on the sixth day 60 per- cent, how many of you would continue to work on the last two days of the week?" [8] 

Just as there cannot be one justice for the rich and another for the poor, it is note fair to charge more money the entrepreneurs who have earned through hard work and inventiveness, risking their own capital, compared to some others who have done nothing to earn it. The social dynamics of the market economy allow today's poor to become tomorrow's rich. In a market economy everyone is at least free to try, and at least some will experience the true satisfaction of having succeeded in life on their own merits. This means undertaking projects and initiatives [9] , taking risks, and by means of all of one's intelligence and inventiveness to get ahead. Taking more money away especially from the earnings of the successful ones that begin an activity means to increase obstacles for further.

Wealth is only created through effort, savings, and personal dedication and it must be created every day. The healthiest and most rewarding approach for everyone is to create own wealth with means at their disposal. Wealth creation and capital investment occur only in the sectors of the economy that are capable of saving and investing. This is the only way to create more jobs and wealth, or develop a business.

Paradoxically, although the intention of progressive taxation is to benefit people with lower incomes through subsidies, the real effect is exactly the opposite (as explained below).

The more tax employers have to pay, the less capital they have to invest. Consequently, they are unable to create more jobs to meet increased demand from lower income groups that pay less tax and can consume more. It is a fallacy, then, to assume that progressive taxation puts more spending power in the hands of people with less funds . Even if it were true that progressive taxes help maintain jobs and purchasing power at a high level and so make lower-income groups more willing to spend, employers would still have to invest in order to meet this demand. Obviously, they cannot do so while a large percentage of their profits disappear in taxes.

In addition, progressive taxes distort the efficiency with which companies use economic resources thus discouragingextra work or risks.

Thus, the true result of low production and high demand is often to create threat of inflationary processes, and combined with progressive taxation this means that the impact of tax on the total price of products is increasing both in relative and in absolute terms.

Governments might have to make unfavorable decisions to cut public spending, in short, the capitalization rate of the economy that helps create wealth and has a multiplier effect on the economy. It is the engine of growth, resulting in benefits for the country as a whole and all its inhabitants. Increasing taxes in general and the top rates of tax in particular results in a reduction in the quantity of goods offered, and hence an increase in price due to the reduction in overall productivity resulting from the reallocation of resources.

As we know, resources are scarce, and the main purpose of economic policy is precisely the optimal allocation of resources to arrange a large number of human needs. Therefore, increasing the tax per unit of a product by diverting production factors, which are always in short supply, from areas preferred by consumers toward areas chosen by political authorities, inevitably leads to a misallocation of resources. Moreover, because wages depend on the prevailing capital structure, progressive taxes quickly become regressive to the extent that they slow down income and wages by reducing capitalization or investment. In fact, this simply increases the chances that marginal workers will remain unemployed.

Most taxes do not provide direct correlative paybacks. How do I measure the benefits to me of all the activities carried on by the government? How do I know that my neighbor and I receive the same benefits, especially if the benefits are paid differently over the course of a lifetime? How can we draw any satisfaction from paying our taxes when we cannot correlate our payment to some benefit except in the most general sense? If we look closer the problem is discouraging. On the other hand, when government spends more in subsidies than other public goods; (I didn't get the meaning of this sentence to correct further) or are benefits to the social arrangement, then the mass contribution should be collected equally. Individuals have little incentive to contribute voluntarily to such actions, since their individual contributions make little difference; some form of coercion is still required. Democracy tries to limit this coercion by requiring that at least a majority of people favor such enforced action to be reduced on above the freedom of minorities [10] .

Optimal Taxation- Lower the Rate, Broaden the Base

The phrase 'optimal taxation' imposes high demands on research. Has somebody solved what taxes should optimally be? Unfortunately, the answer is 'no'. Neither have the earlier contributions on theory done so nor will this essay be able to meet such a challenge. Since the time of Adam Smith, and even earlier, economists have thought and written about the effects of taxation. In doing so, they have frequently tried to describe what they regarded as desirable characteristics of tax systems. Smith (Wealth of Nations, 1776, Book 5, Ch. 2) listed "four maxims with regard to taxes in general':

(i) equality: that people's tax payments should be in proportion to their income;

(ii) certainty: that tax liabilities should be clear and certain, rather than arbitrary;

(iii) convenience of payment: that taxes should be collected at a time and in a manner that is convenient for the taxpayer; and

(iv) economy in collection: that taxes should not be expensive to collect, and should not discourage business

Optimality of taxes is always, at least to some extent, a question of values. We are a diverse culture with differing philosophical, moral, social, and religious views that influence our perspectives. We are economically diverse as well. Some methods of taxation are more burdensome for one group than for another. Taking into account the essentially negative nature of taxation and our pluralist society, it is difficult to settle on a taxing scheme that is broadly acceptable. Each person or homogenous group of persons feels it in their interest to let someone else pay the burden.

If one naturally would raise the question on: how would the ideal tax system be? Of course the answer should be to have the lowest possible tax rates on work income, saving, investment, risk-taking, and entrepreneurship. After all, these are the activities that generate income and wealth which affect the life of every person, and thus their behaviors with respect to creating a prosperous economy. Also the benchmark for the ideal tax system should be an equal rate such as the flat tax [11] . Because of free market competition, the environment would lead to economic growth. And since economic growth has numerous positive externalities there would be an increase in taxable income, and tax system would play a valuable role in moving society in the right direction. A progressive tax on saving and investment is particularly reverse since all economic theories - including Socialism and Marxism - agree that capital formation is the key to long-run growth and higher living standards. As is confirmed by two economists of the American Enterprise Institute:

"high rates of taxation on capital income...stand in marked contrast to the implications of optimal tax theory in the economics literature. Over the past three decades, numerous studies...have concluded that an optimal tax system in most cases will not include a tax on capital. ...A capital tax introduces a distortion into an economy, a distortion that explodes over time. Hence, even a small capital tax will not be optimal. When capital accumulation and economic growth suffer, it is not just high-income individuals that pay the price. ...workers are better off their wages are higher when the capital stock is higher, which makes workers more productive and feeds through to wages" [12] 

One interpretation can be made even by the hypothesis of the Laffer-Curve [13] which postulates the diminishing marginal returns applied to tax policy. In the recent years there seems to be a common of priorities for national economies to reduce the headline corporate tax [14] in order to increase competition for investment, and to grow the tax base in order to fill the need for tax revenues, and pay deficits. As the table below shows the: Global Average Corporate Tax Rates 2005-2010.

Source: KPMG International, July 2010

Whether such move is a manoeuvre or is aims to make it just (make what just? I didn't get that), the fact is that the multinational corporations, or their overseas shareholders, are given alleviation in the tax legislature. Governments are implementing these tax reforms to encourage new investments in all sectors and be competitive internationally; on the other side driven by the need to increase the base tax (I didn't understand the point of this last sentence).

Government public choices are merely equivalent to the private decisions. If these choices were rational or feasible, we would have less need for a democracy to figure out choices in a nonviolent manner. Nevertheless the conflict between the equality and economic efficiency is inescapable [15] . One dollar transferred from the rich individual to the poorer individual will result in a less than a dollar, because of administrative costs, changes in attitudes, changes in savings and investment behaviors.

The pursuit of progressivity is loaded with costs and risks that mean it must always be aligned to the other principles. The pursuit of progressivity adequately aligned to the pretending for equity and efficiency, is nothing more than the recreation of a society that is going to be richer and efficient in the broadest sense of pursuit- word. At last the equal tax handling of different levels of earnings, would guide to both efficiency and equity gains by taxing those everyone equally, whether they have equal earnings or not, and removing tax-induced distortions. Of course the last feature mentioned above is difficult to be proven, because parts of the societal organism are totally dependent on each other. Equity is the service that individuals make known as a preference, and like all services, it should be treated with priority. The final claim that progressivity must at least be considered derives from the demand for equity.

Equity is not only a legitimate field of inquiry for economists, but also a necessary implementation for any would-be policymaker who must balance the benefits and costs of various public actions. Public finance without consideration of equity is like a body without a soul. The presence of hard choices does not mean the absence of workable choices. Suppose a person finds $50. He or she could, perhaps, think of a million good ways to spend the money, he or she could also finds a trillion ways to waste the money. In sum, despite many sources of complexity, equity principles are the first standard against which policy is assessed and judged. Our democratic world cannot be otherwise. Certainly, much bad policy today derives from nothing more than an inadequate consideration of the demand for equal justice. And the tension between vertical and individual equity will always remain. Taxes are the instrument upon which a reforming social democracy will rely. Political parties should demonstrate strong interest in a tax system as a result of the desirable relationship between a government and its people. Taxes should exemplify trust and consent, and thus make a positive contribution to the strength and stability of society.

The moral benefit of growth- The relation between income and happiness was predicted more than 200 years ago by Adam Smith in "The Wealth of Nations". He notices that in the progressive state, while the society is advancing to further acquisitions, the condition of the great body of the people seems to be the happiest and the most comfortable; while it is in the stationary period, people are in a miserably declining state [16] .

There is direct evidence that lower taxes and smaller government intervention increase happiness. The well known phrase of A. Smith "laissez faire" advocates that it should be no concern of the state. The relationship between happiness and government intervention is published by research of a Swiss University:

"Our results show that life satisfaction decreases with higher government spending. ... It is alleviated by government effectiveness - but only in countries where the state sector is already small. satisfaction decreases with government's active involvement in the economy. ...the data on life satisfaction are from the third and fourth waves of the World Values Survey... The evidence quite clearly supports the public choice view that excessive government involvement is detrimental to individual's quality of life. ... We therefore conclude with a rather simple policy implication: governments interested in maximizing the life satisfaction of their voters should, regardless of their ideology, limit their direct interventions in the economy to allow voters a high degree of personal freedom." [17] 

Economic growth also supports other benefits with regards to people, as peace, tolerance and better behaviors. The Economist writes:

"Growing prosperity, history suggests makes people more tolerant, more willing to settle disputes peacefully, more inclined to favor democracy. Stagnation and economic decline are associated with intolerance, ethnic strife and dictatorship. ...If people are becoming better off relative to their own past standard of living, they will care less about where they stand in relation to others. If they are not growing better off relative to their own past standard of living, they will care more about their placing in relation to others-and the result is frustration, intolerance and social friction. Growth, in short, has moral as well as material benefits. " [18] 

Economic growth is not an elixir, it does not solve all problems, but a more prosperous economy certainly makes many problems easier to deal with. Tax systems help promote growth by encouraging governments to shift toward optimal tax policy. To be sure, tax competitions between different economies influence their economic performances. The powerful forces of economic liberalization, the balance of the political pressures and the expansion size and power of government, unquestionably have been in favor of re-examination of each economy tax system. In other words, the modern period of globalization and competition are of assistance to the optimal system of taxes, probably not making the world a better place but of course keeping the world from moving in the wrong direction.

The right way to reduce tax evasion- In Europe, the underground economy accounts for more than 16 percent [19] of economic output. In some countries, such as Greece and Italy, more than one-fourth of economic activity takes place underground. The biggest reason for the existence of the shadow economy, not surprisingly, is tax burden:

"In almost all studies it has been found out, that the tax and social security contribution burdens are one of the main causes for the existence of the shadow economy. ...Empirical results of the influence of the tax burden on the shadow economy ...all found statistically significant evidence for the influence of taxation on the shadow economy". [20] 

The lower the tax rate, the lower the incentive to use either legal or illegal means to hide money. In other words, when tax rates are low, people are willing to report more income to the government. Similarly, lower tax rates and better tax systems have reduced the underground economy. In Russia the 13 percent flat tax, for instance, has dramatically enhanced fulfillment [21] . Tax fulfillment also may be morally questionable if government is acting irresponsibly and impose a high tax system. Thus, tax evasion might reduce the tax revenues and therefore the size of government as cited below:

" ...there seems to be a certain consensus that tax evasion is rather allowed when taxes are unfair, the government acts inappropriately or the government is not legitimated." [22] 

And another writer asks:

"What if you live under a corrupt government, where a large portion of tax revenue goes to corrupt politicians and their friends and family? ...What if you are in a high tax bracket and the government takes more than 90 percent of your marginal income... If the government uses the tax system as a means of redistributing income rather than as a means of financing legitimate government functions, are you justified in evading taxes? [23] 

Ethical Considerations- When applying progressive taxes, the state assumes that the people or companies with higher incomes should contribute more as a matter of "social justice." What should be borne in mind, however, is that this income is the private property of those that have earned it. To assume otherwise is to criminalize success and, of course, if we treat successful people as criminals, they will either behave as such (through tax avoidance) or go elsewhere (leading to a brain drain).

On the other hand, if we implement a system that encourages people to enter the market and compete in the belief that honest hard work is of the highest ethical value, then these people are much more likely to operate within the framework of the law. In this sense, civil society and the state exist to serve the individual, and not the other way around. It is only if the individual fails to live up to these high expectations that the state should intervene, through the administration of justice, to ensure that the law is enforced.

In other words, people should be free to pursue their own individual goals. The state should not interfere with progressive burdens. Rather, it should allow for expressions of true solidarity, which can never be imposed, where each person is free to decide how to be generous towards others. It is not the state's role to decide how much tax different citizens should pay to remedy the needs of the poor; it is citizens themselves who can and should do so freely out of charity towards their neighbors. Many of humanity's great works have been financed with private capital. All over the world, countless people have donated part of their private fortunes to set up projects, foundations, schools, universities, research institutes, museums, etc., thereby improving the quality of life of others. And in general, these improvements have been achieved more cheaply and efficiently than if they had been paid for with public money. [24] 

However, it is the duty of the state to assist the neediest, but not through confiscation of taxpayers' profits, but with real money obtained through a fair and strict fiscal policy.

In conclusion, progressive taxation is a malevolence that must be eradicated if countries are to grow and prosper. Eliminating progressive taxation is also a way to protect individual liberties. Fortunately, the trend of the developed world seems to now be moving in that direction. It is the moral duty of current and future generations to take advantage of opportunity, to innovate, and to progress.