Tax Breaks for the Rich

Here, I demand tax breaks for the rich.*

[ *Based on: “Tax Breaks for the Rich,” pp. 241-9 in Ethics, Left and Right: The Moral Issues that Divide Us, ed. Bob Fischer (Oxford University Press, 2019). This was my part in a debate about tax policy with Bruno Verbeek. ]

1. Background

Let’s suppose (as most people mistakenly believe) that we need government, and it has to collect taxes. In that case, how should the tax burden be distributed?

The current distribution in the U.S. is highly progressive: the higher your income, the higher a percentage of it that you have to pay in taxes. Many (leftist) people still insist that the rich aren’t paying “their fair share”.

Here is a graph showing the tax distribution:

This is old data from 2016, which I don’t feel like updating. The population is divided into 5 groups (quintiles) by income. The bars (and the left axis) show the net federal taxes paid by each group — that’s the average dollar amount of taxes that members of each quintile pay, minus the money value of benefits the government pays to them. For the bottom 3 quintiles, the net tax is negative (the government gives them more money than they give it). The 4th quintile is barely paying in, and almost everything is being paid by the top quintile. The line shows each group’s net tax rate (their net tax divided by their market income).

More recent data, I believe, are less extreme but qualitatively similar. Is all this fair?

2. Three Theories of Fair Tax Distribution

2.1. Ability to Pay

Perhaps taxes should be proportioned to one’s ability to pay. Since the rich can afford to pay more they should pay more.

This idea on its face begs the question. It doesn’t give an independent reason why the rich should pay more; it is pretty much just a restatement of the claim that the rich should pay more.

Perhaps the idea might be this: it would be unjust to demand that anyone pay more than they could reasonably afford to pay. And that amount is higher for rich people than poor people. Fair enough. But this just supports having a cap on total taxes at whatever level we judge the most that someone could reasonably afford, where this cap would go up with income. Subject to the cap, though, everyone would pay a fixed amount.

The current system is like this: Five friends go out for dinner. Say they have some expenses that are common to the group (e.g., a shared appetizer) plus some items ordered by and for specific individuals. At the end of the meal, someone suggests that one of the friends, the one with the most money, should be forced to pay for everyone, even though he doesn’t want to. In fact, he should be forced to pay extra in order to give kickbacks to three of the diners. This would not be accepted as a “fair division of the bill.”

2.2. Received Benefits

Perhaps people should be taxed in proportion to the benefits they get from the government. Everyone receives protection against violence and property crime. But rich people have more property; hence, the government’s protection against property crime is worth more to them. Hence, they should pay more.

Notice that this would support assigning the rich a higher absolute dollar amount in taxes, but not a higher percentage. It would at most support a fixed percentage tax, not the progressive tax system that we have. (In fact, since protection of property is only part of what the state does for us, only a portion of one’s taxes should scale with income, so taxes should be less than proportional to income overall.) This rationale certainly doesn’t make sense of a large portion of society having net negative taxes.

But this rationale isn’t very intuitive anyway. In the dinner example above, no one would suggest that everyone needs to pay in proportion to how much they enjoyed the meal. Intuitively, a fair division would be like this: Everyone pays for the items that he himself ordered, plus 1/5 of the common items.

2.3. Costs Incurred

Per the above example, common sense intuitions suggest that a fair division of the cost of some group project would be proportional to costs incurred by each individual. In the taxation case, it would seem a fair division of the tax burden would assign to each taxpayer an equal portion of the costs of all public goods, plus the cost that that taxpayer individually imposed on the state for the services that taxpayer consumed.

This, again, fails to support progressive taxation. As a first approximation, it suggests that the poor and the wealthy should pay equal absolute dollar amounts. In fact, it is plausible that the poor actually cost the government more money than the rich. This is party due to higher crime rates in poor neighborhoods, partly due to the rich voluntarily consuming less government services (e.g., by sending their kids to private schools), and partly due to the government running special programs just for the poor (welfare, food stamps). So if anything, it seems that a purely fair distribution of tax burdens would assign higher absolute dollar amounts to the poor than to the rich.

Caveat: To take account of sec. 2.1 above, perhaps this could be capped by the most that each person could reasonably afford.

3. What Is Best for Society?

Now let’s leave aside fairness and talk about what maximizes utility.

3.1. Diminishing Marginal Utility

Rich people get less benefit from a dollar than poor people do. So taking money from the rich would, prima facie, cause less harm to the rich people than taking an equivalent amount from the poor. That’s an argument for progressive taxation. However, there are other factors to take account of …

3.2. Incentives

We also have to take account of the incentive effect: high marginal tax rates decrease the incentive for productive activity. Most productive activities come with some cost or risk. So there are going to be some people for whom it is just barely worth it to engage in some productive activity (e.g., saving & investing money, getting more job training, starting a business, …). If the tax rate goes up, it becomes just barely not worth it to do those activities. So the higher the marginal tax rate goes, the less productive activity there is.

Wealthy people are the ones most likely to do highly productive activities, so progressive taxation discourages the most potentially productive people.

3.3. Investment Rates

Empirically, the rate of savings & investment increases with income: poor people save & invest very little, while rich people save & invest a lot. So a dollar taken from a rich person reduces total investment by a lot more than a dollar taken from a poor person. (Indeed, the latter has about zero effect on investment.)

But saving & investment is the key to economic growth. So progressive taxation is a big drag on economic growth. Reducing the growth rate has exponentially increasing costs over time — e.g. if you lower the growth rate by 1 percentage point a year for a century, then by the end, you’re looking at a vast total cost.

This factor probably dominates in the utility calculations. That’s why progressive taxation is overall bad for society. It basically diverts investment dollars into immediate consumption.

4. Conclusion

We voters like using our political power to steal from the rich because we’re greedy. That is why the rich are paying vastly more than their fair share of taxes, and vastly more than the socially optimal amount. But we refuse to admit this because we’re self-centered.

We like scapegoating the rich out of ressentiment, because we don’t like to admit that those people are doing a lot more than we are. We hate the rich, not because they don’t deserve their wealth, but because we secretly suspect that they do.

It’s time that the poor and the middle class start paying their fair share.