August 23rd, 2005
There has been a recent movement towards a “fair tax” initiative. Though there are different variations of how this is to be implemented what is typically said is that there will be a constant consumption tax attached to most goods. The value of this tax is typically a number that is less that the marginal tax rate that individual’s face. While I question why they got to the numbers they are using I am going to ignore that and provide a general argument showing the strengths of Progressive taxation from an economic standpoint. Such a system has several advantages over a flat consumption tax. Progressive taxation system can better avoid taxing the basics necessary for survival. Through a Progressive taxation the government is also able to reward behavior that benefits society. The barriers to trade that are present among high income earners with a higher rate of taxation are less then that of a low income earner. Progressive taxation may also allow the pursuit of equality in an efficient way.
Under a flat tax goods can be considered a necessity or a luxury. There are goods that can be considered both. Electricity and food are both necessities when consumed in moderation. When the cost of the item of food increases, such as the case with caviar, food then becomes a luxury. Electricity is also considered to be a necessity, however as use increases it starts to be used to power luxuries and can no longer be considered a necessity. Housing and clothing are also both goods that can be considered both luxuries and necessities. Under a consumption tax these goods would prove difficult to tax as it is unclear when they become luxuries. A family of five would require a larger, and by extension, a more expensive house then a family of three. How would you account for these differences? A progressive income tax makes this really easy; account for the necessities and the number of children by allowing deductions for these situations. The flat tax, which many people claim would be simpler, would not solve this problem without being excessively complicated.
Progressive taxation allows people to write-offs part of their taxes when they do things that benefit society. While this can be done through other institutions and other processes it is much less complicated to have it done through one process allowing a more cost effective delivery of the subsidy. People may be better able to understand what incentives are available if they are mostly done through one institution. This helps reduce the cost and allow people to take advantage of the incentive available increasing the overall incentive for people to help make society better off.
Another major advantage of progressive taxation is that there are fewer losses due trade as a high income earner is usually more specialized and will keep trading as apposed to doing things for ones self. Higher income earners typically aren’t going to attempt tasks such as renovations or cutting their grass themselves. Because of the financial situation they will hire someone to do it for them. It would take a very high tax rate to get these people to do these things themselves. People working at a lower income job are more likely to venture into areas that they are not specialized if the tax rates get higher. As a result when the tax rate for a low income earner is lower there will be specialization gains while the losses due to specialization in the high income earners will be less because the high income earner will be more likely to stay specialized even with higher taxes. It is important to keep in mind that a progressive tax rate still has the other disincentives that any tax has and there are still long term consequences to excessive taxation.
Another advantage of progressive taxation is that it may provide a way to pursue equality in an efficient way. Especially when a nation has low or reasonable taxes small increases in the tax rate for higher income earners may be a better policy for pursuing equality then other methods typically used. Instead of developing regulatory policies that get equality but at a high cost to growth, such as excessive wage controls, it may be better to accept some inequality in wages while having a more efficient regulatory system and combine this with progressive taxation to make the system more equal at a lower cost. This is a way that the government can work to maximize growth with respect to equality and vise versa. The advantage of maximizing equality and growth is that no one is being made worse of unnecessarily.
The benefits that are attributed to a flat consumption tax may not be as large as what is claimed. Various assumptions are made with respect to the cost of tax fraud, administration, and other costs under such a system. These costs may be higher then estimated. The loss of control over the design of the tax system, and the ability to tax demographics at a different rate may make it so that the government is less able to respond to future issues. Because of this and the various benefits that a progressive tax system offers to society it may be better to either leave the system as it is or make the necessary reforms while keeping a similar progressive structure.
source:
http://possiblylogical.com/blog/Author: me
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