The Inequity of the Progressive Income Tax

8/7/2019 The Inequity of the Progressive Income Tax

1/28

The Inequity of the Progressive Income TaxBy Kip Hagopian

Class Wars: A Parable

Once upon a time in the land of America, there lived triplet brothers named Tom, Dick,and Harry Class. They were 45 years old, had virtually the same aptitude (skill), andwere raised in the same home. Each was married and had two children. All three wereemployed as carpenters making $25 per hour, working 50 weeks a year.

While they were virtually identical in most respects, they had somewhat differentpreferences and values. For example, Tom, who worked 20 hours a week, had adifferent work ethic from his brothers, Dick and Harry, who each worked 60 hours perweek. Neither Toms nor Dicks wives worked, while Harrys wife worked 40 hours perweek as an office manager making $50,000 per year (the same hourly rate as her

husband). Tom and Dick spent all of their income, and were relying on social security totake care of them when they retired. Harry and his wife, on the other hand, saved mostof her after-tax income over many years, gradually accumulating $300,000. Theyinvested this money in bonds and real estate that produced $25,000 a year in interestand rental income. This was the income of each family:

Family=====================================

Tom Dick HarryWork hours per Week: 20 60 100

Annual WagesHusband: $25,000 $75,000 $ 75,000Wife: 0 0 50,000

Investment Income: 0 0 25,000Total Income: $25,000 $75,000 $150,000

Despite their different priorities, the Class families were close; so much so that when anew housing tract was developed in their community, they each bought an equally-priced home on the same private street. Theirs were the only houses on the street.One day the brothers decided to pool their funds for the purpose of improving theirstreet. Concerned about crime and safety, and desirous of a more attractive setting for

their homes, the three families decided to: install a gate at the streets entrance to deterburglars; add lighting for safety and additional security; repave the streets surface torepair damage; and install landscaping to beautify the approach to their homes. Thework was done for a total cost of $30,000.

The brothers were quite happy with the outcome and felt the $30,000 was a worthyexpenditure given the benefits provided each family. But when it came time to divide upthe bill, the problems began.

1


2/28

Harry thought it would be simple to divide the bill. Since the benefits to each family wereequal, each brother should pay one-third, or $10,000. But Tom and Dick objected. Whyshould we pay the same as you? they said. You make much more money than we do.Harry was puzzled. Why is that relevant? he asked. My family makes more moneythan yours does because my wife and I work long hours and we earn extra money on

our savings. Why should we be penalized for working and saving? Harry looked at Tomand said, Im no smarter or more talented than you are. If you and your wife workedharder and saved more, you would make as much as my family does. To which Tomreplied, I dont work more because I value my leisure time more than I value money.And I dont save because I prefer the gratification of consumption today more than I willwhen Im too old to enjoy it. Tom was adamant. How could Harry, who was clearlyrich, ask him to pay the same amount, when it was obviously harder for him to do so?

Dick thought for a moment, and then said, Ive got an idea. Our aggregate income is$250,000, and $30,000 is 12 percent of that amount. Why dont we each pay a flat 12percent of our income? Under that formula, Tom would owe $3,000, I would owe

$9,000, and Harry would owe $18,000. Since I make three times as much as Tom, Iwould pay three times as much. Harry, who makes twice as much as me and six timesas much as Tom would pay two times as much as me and six times as much as Tom."

No, said Tom. No? Dick and Harry responded in unison. Why not? What do youpropose instead? asked Harry. Tom was ready with his answer. Paying the samepercentage of our income is not fair. Instead, Harry, you must pay $23,450; Dick, youmust pay $6,550; and I will pay nothing. This is the only fair division. Dick wassurprised at how completely arbitrary this proposal was. He was also surprised at howdisproportionate it was, but since his suggested share was significantly less than underhis own proposal, he didnt object. Harry, however, was stunned. You call that fair?! Imake only two times as much as Dick, but you want me to pay three-and-a-half times asmuch as he does. I make six times as much as you but you expect me to pay almost 80percent of the total cost while you pay nothing. And this is despite the fact that each ofus is receiving the exact same benefits. Where did you get such a crazy idea? heasked. From no less an authority than the federal government, said Tom as he pulledout a gray booklet. Its all right here in the IRS tax tables. Under the current tax code,here is what each of us paid in income taxes last year:

Family=====================================Tom Dick Harry Total

Income $25,000 $75,000 $150,000 $250,000Taxes Paid1 0 6,550 23,450 30,000Effective tax rate 0% 8.7% 15.6% 12%

1 The tax figures were calculated by The Shapiro Group, a Los Angeles tax accounting firm. The marginalrates and brackets are those applicable for the 2010 tax year. These figures are for illustration purposesonly. They do not include the effect of certain tax credits (which some would consider transfer payments)that exist in the law. If these credits were included, Harry would pay a tax of $22,600, Dick would pay atax of $3,700 and Tom would receive a refundof $7,100.

2


3/28

By an amazing coincidence, our total taxes paid were exactly equal to the $30,000expended on our street improvements. This is the progressive income tax system allU.S. taxpayers live under, and I dont see why the Class families should be different. Infact, I believe all future pooling of funds should be divided in this way. Im in, saidDick. So, by a vote of two to one, the cost of the street improvements was divided as

follows: Tom Dick Harry Total

Dollars $0 $6,550 $23,450 $30,000Percentage 0% 21.8% 78.2% 100%

Also by a vote of two to one, all future pooling of funds was to be divided up the sameway.

Like all parables, the story of the Class brothers is designed to illustrate a moralprinciple. In this tale, Harry is required to pay a disproportionate amount of the cost and

value of the benefits he derives from his mini-society, simply because his family worksharder than the families of the societys other members. The moral question is: Is Harrybeing treated fairly? If not, how should this affect our thinking about progressivetaxation?

* * * * * * * * *In the United States, the payment of taxes is effectively a pooling of money by thenations citizens to fund the services of government. This pooling is putatively voluntarysince it is indirectly authorized by voters. The services of government include, but arenot limited to: the national defense, infrastructure, the judicial court system, police andfire protection (delivered at the federal, state and local levels), education (delivered at

the state and local level), the general administration of government, and support for trulyneedy citizens. Deciding how much money should be appropriated for this pool and howit should be spent is almost always a subject of contentious debate. The same is truewhen deciding how taxes should be apportioned. As to the latter, the debate inevitablydevolves into an argument over fairness and economic efficiency.

The primary source of federal tax revenues (excluding Social Security and Medicarelevies) is a progressive tax on the earned income of individuals. 2 This essay will makethe case that the progressive income tax is plainly inequitable. It will also review thealternatives to progression in an effort to identify the most equitable (or leastinequitable) tax system.

Factors that determine income

2 There are several other types of taxes levied on individuals by federal, state and city governments,including taxes on capital gains, dividends, estates, sales and property. These tax systems are outsidethe scope of this essay.

3


4/28


5/28

done so. A classic example is Hall-of-Famer Jerry Rice, who is generally recognized asthe best wide receiver in NFL history. He was one of the highest paid players in profootball for twenty years, an achievement largely credited to his intense practice andworkout regimen. Perhaps the most effective way of enhancing aptitude is throughincreased study in school. Whether it is grade school, high school, vocational school or

college, for any particular tier of aptitude, those who study the most almost always getthe best grades, matriculate to the best colleges, and secure the best jobs.

Choice of occupation. Choice of occupation is also important in determining income.Had Bill Gates decided to finish Harvard and become a high school math teacher, healmost certainly would have been successful, but he would not have become a multi-billionaire.

Some would argue that the element of luck should be on this list. Here we are talkingabout the pecuniary kind of luck rather than the luck that comes from circumstances ofbirth (aptitude, as defined). This may include financial windfalls (such as inheritance or

winning a lottery); random events that result in a person earning more income than hisor her aptitude or work effort would normally provide; or being born into a family ofwealth or privilege. In the case of inheritance, which is taxed under a different systemand consequently is outside the scope of this essay, the contribution to aggregatepersonal income appears to be quite small. Based on IRS data from 2008, inheritanceincome in that year was less than 3 percent of the combined total of earned andinherited income. There is no way of measuring the impact of random events, but inAmericas largely meritocratic system it is unlikely such events have much influence onaggregate incomes in the long term. As to starting life in a position of wealth andprivilege, luck of this kind also appears to be of minor significance. To wit: If the criterionfor being considered part of the privileged class was household income as low as$200,000 per year, less than 4% of households would meet the standard. And inanother cut at the data, President Obama has stated repeatedly that individuals whomake more than $200,000 and families whose income exceeds $250,000 add up to only2.5 percent of taxpayers.

In the aggregate the benefits of pecuniary luck would appear to be much lessremunerative than the greatest luck of all: being born with a highly valued aptitude andcompetent, caring parents. In any event, whether income is derived from the luck thatcomes from circumstances of birth (aptitude, as defined), or luck of another kind, itshould be treated the same way for tax purposes. Accordingly, it is of little consequenceto the thesis of this essay. This will become clear later in the discussion of the benefitsprinciple.

Excluding the pecuniary-luck factor, total income is determined by a mix of the threefactors listed above, and the relative contribution of each varies by individual. Under-standing the primary determinants of income and the implications of each for tax policyis essential to designing the most equitable tax system. Surprisingly, the literaturecontains only infrequent and oblique references to this crucial aspect of tax theory.

5


6/28

Alternative income tax systems

There is a consensus among economists and tax theorists that the best tax system isone that strikes the optimum balance between economic efficiency and equity. An

efficient tax system is one that does the least to distort the allocation of resources in theeconomy, thus maximizing overall production. Accordingly, taxes that might alterconsumer or investor behavior should be eschewed. As to equity, there is virtuallyunanimous agreement among scholars that the tax system should be fair.Unfortunately, there is great disagreement as to which system best meets this criterion.

There are basically four systems of income taxation described in the literature:

A per-capita, or head tax, which would require each person to pay his or her per-capitashare of the costs of government. (Technically a per-capita tax is not an income tax, butit is almost universally accepted as the most economically efficient tax system.)

A proportionate or flat tax, which would tax each dollar of income at a single rate.Embodied in virtually all proportionate tax proposals is a substantial broadening of thetax base through the elimination of most tax deductions, credits, and preferences, whichhas the benefit of simplifying the tax code and substantially reducing the cost ofcompliance. The purest form of this system is a single-rate tax levied on all earnedincome from the first dollar, but different variations on this theme have been proposed.

A degressive tax, which is a proportionate tax only on income above a certain thresholdor exemption.The exemption makes the system progressive, but typically much less sothan a system of graduated rates.

A progressive tax, which taxes incremental income at higher marginal rates as incomerises, resulting in an increase in taxes as a percentage of income as income increases.

Each of these systems will be examined as part of the analysis of progressive taxation.

The progressive income tax: A debate for the ages

Progression has been in use somewhere in the world for more than two thousand years.And it is safe to say the debate on its merits goes back just as far. At present, the

substantial majority of nations employ some form of progressive taxation.

The first time a federal income tax was imposed in the United States was in 1861 as ameans of financing the Civil War. The tax rates were decreased after the war and theincome tax was allowed to expire in 1872. The concept of an income tax was legallyquite controversial. So when a new income tax was levied in 1894, it was challenged inthe courts, and in 1895 was found to be unconstitutional. It was not until 1913, with the

6


7/28

ratification of the 16th Amendment to the Constitution, that the first constitutionallysanctioned income tax was enacted (which, incidentally, was progressive).

Throughout history, many arguments have been advanced both for and against theprogressive income tax. One of the most comprehensive examinations of the subject in

the 20th century was a book published in 1953 and reissued in 1963, entitled, TheUneasy Case for Progressive Taxation, by Professors Walter J. Blum and Harry Kalvenof the University of Chicago Law School. This book is an exhaustive review of the priorliterature on this topic, interspersed with the authors own analyses and critiques of thearguments presented. In their words, the book is, an effort to explore what might becalled the intellectual case for progression.4 Another particularly useful source ofinformation and analysis was a book-length article published in 1908 in the AmericanEconomic Association Quarterly, Progressive Taxation in Theory and Practice, by thenoted economist and tax historian, Edwin R.A. Seligman.5

The Case for Progression

According to Blum and Kalven, the most rigorous analysis of progression came onlyafter the idea had become a political reality . . . whatever the reasons, it is clear that thepolitical history affords little insight into the merits of the principle of progression.6The arguments in supportof progression tend to fall into three main categories:7

economic efficiency, fairness, and reduction of income inequality.

Economic efficiency. The argument is that progressive taxation increases workerproductivity, yielding greater economic efficiency and higher GDP.8 The study of theimpact of tax policy on economic efficiency and growth has for centuries been a fertile

ground for economists, who have produced numerous analyses on the topic withoutreaching clear consensus. Since the focus of this essay is on the issue of tax equity, theeconomic efficiency arguments will not be examined beyond noting that logic and theweight of empirical evidence appear to favor less progression rather than more.

4 Edward Blum and Harry Kalven, The Uneasy Case of Progressive Taxation (University of ChicagoPress, 1953).5 Edwin R.A. Seligman, Progressive Taxation in Theory and Practice (Princeton University Press, 1908).6 Blum and Kalven, 14.7 Some advocates of progression argue that a progressive income tax is needed to offset the putativelyregressive nature of the payroll taxes that fund Social Security and Medicare. The conflation of theserevenue streams is ill-conceived, inasmuch as each has a different purpose. Income taxes are used to

fund a broad range of government services as described above, while payroll levies are collected for theexpress purpose of providing income supplements and medical care during retirement. More specifically,Social Security levies are a form of forced savings, and Medicare levies are effectively prepaid medicalinsurance premiums. Neither of them finances government services per se. Since Social Securitybenefits, when paid out, are directly tied to the aggregate amount of money paid into the system by eachbeneficiary, the system is no worse than proportionate. In the case of Medicare, the amount paid into thesystem is proportionate to income while the benefits (paid health care) are essentially the same for eachbeneficiary; consequently, the system is redistributive, not regressive.8 The basic argument is that most people work to maintain a certain standard of living, thus highermarginal tax rates will require them to work more (produce more) in order to achieve their goal.

7


8/28

Fairness. The argument for progressive taxation on fairness grounds has three mainstrains.

The benefits principle. Taxes are payments made in return for government

services and protections. People with higher incomes have disproportionatelymore to lose; therefore, they should pay disproportionately more for theprotections afforded them by government;

Sacrifice theory and the marginal utility of money.Taxes are a burden onsociety that should be shared in an equitable manner. Burden is defined as thesacrifice made by the individual when he or she pays taxes. Since the marginalutility of a dollar declines as income rises, higher-income people should payenough more in taxes to equalize their sacrifice relative to the sacrifice of lower-income peers.

Ability to pay. A fair tax system is one in which those with the greatest ability topay should pay the most.

Reducing Income Inequality. In this view, inequality is a social injustice that should beremedied or mitigated by a progressive tax system. It is often proffered as an argumentfor fairness, but since proponents havent united around a specific principle of fairnessin its support, it will be considered separately.

We will now examine each of the three fairness arguments in detail, then turn to thequestion of income inequality.

Fairness

The benefits principle

The benefits principle of taxation holds that the government provides benefits to itscitizens that should be paid for in taxes by each beneficiary in accordance with thevalue he or she receives from government services. As a basic foundation for taxation,the benefits principle also called give and take or quid pro quo has probablyreceived more examination and comment than any other. As we will see, the statementof the principle payment of taxes in return for benefits lends itself to widely varying

interpretations.

Historically, the use of the benefits principle to advocate progression relied on theprotection theory of benefits, which asserts that the governments primary function isthe protection of property. The theory focuses on income as property, and analogizesthe protections of government to an insurance company that insures property againstloss. Those who cite protection theory as an argument for progression assert thatindividuals with higher incomes should pay a disproportionatelygreater share of the

8


9/28

cost of government than lower-income individuals because the higher-income groupwould have disproportionately more to lose if the protections of government werewithdrawn. Implicit in this interpretation of the principle is not just that the value ofbenefits received from the government increases as income increases, but that itincreases more rapidlythan the rise in income.

When examined closely, the protection theory interpretation of the benefits principlefalls short in five different ways.

First, the basic premise of the protection theory is flawed. Government protectionsextend to much more than property. The Founding Fathers made clear their vision forAmerica in the Declaration of Independence when they spoke of the unalienable rightsof all Americans to life, liberty and the pursuit of happiness. There is no basis forbelieving that a low-income persons life is worth more or less to an individual(ascontrasted with an insurance actuary, an economist, or a jury assessing damages in awrongful death case) than the life of a high-income person. The same is true for liberty

and the pursuit of happiness. The American military and other protective agencies andinstitutions of government exist to protect and preserve these rights for all Americansequally, regardless of how rich or poor they are.

Second, no persuasive support could be found in the literature for the claim that higher-income people derive a disproportionatelygreater value from government protection ofproperty than lower-income people. Some progression advocates have argued thatgovernment exists in large part to protect rich people from poor people, while poorpeople need no such protection. Thus, the value of the rich persons protection isdisproportionately greater than that afforded the poor. Perhaps this was true centuriesago in some feudal nations, but it is not now, and never has been generally true in theUnited States. Another argument is that insurance is priced according to value inaddition to risk. While this notion has conceptual merit, it does not follow that propertyowned by high-income people is at greater risk than property owned by low-incomepeople. In fact, the rich are more likely to engage in self protection (e.g., protectivewalls, security systems, guards, etc.), which would result in reduced, not greater, risk.Seligman, Blum and Kalven, and other scholars examined the property protectionarguments for progression and dismissed them as either untenably weak or meritless.In fact Seligman went so far as to argue that the value of government protection is lessto a rich man than a poor man:

Far from being the fact that the value of protection increases faster thanproperty, the reverse is trueFrom the standpoint of benefits conferred, whowould have the hardihood to say that the poor man does not value the

protection afforded to his life and property just as highly as the rich man?Hence if protection or benefit is to be the sole test of taxation, the scaleshould be graduated downward, instead of upward; for neither the protectionnor the benefits grow in proportion to the property or income.9

9 Seligman,154.

9


10/28

Third, this interpretation of the benefits principle overlooks the principle of marginalutility. If, as virtually all economists agree, the marginal utility of a dollar of incomedeclines as income increases, then people would place a lower value on protecting theirincome as it rises. To accept protection theory as an argument for progression, onewould have to assert that each additional dollar of income earned is worth more than

the previous dollar of income, which is nonsensical.

Fourth,even if the protection argument had merit, it would, at best, argue for aproportionate rather than a progressive tax. To argue otherwise requires a belief thatthe price of property insurance increases faster than the value of the property (in thiscase, income), which is observably untrue. If the insurance analogy were applied, thosewith two times as much income or property would pay two times as much tax, whichwould be proportionate, not progressive. Its no accident that historically almost allexponents of benefit theory employed it to support proportion as against progression. 10

Fifth, the analogy to an insurance company is specious. The costs of the military and

police and fire departments are not equivalent to property and casualty insurance, inwhich the policy is priced in accordance with the value of the property insured. There isno material difference in the cost of protecting persons with high incomes or high-valueproperty than that of persons with low incomes or low-value property. (In fact, the costmight be less, since persons with high income tend to reside in low crime areas).Accordingly, there would be no difference in the cost of these protections based onproperty value. Thus, under the protection theory, the fairest tax system would morelogically be per capita.

An alternative interpretation of the benefits principle leads to the exact opposite of whatthe more-to-lose advocates propose. In his book Principles of Political Economy,political economist, John Stuart Mill, argued contrarily (and similarly to Seligman) that itis lower-income people who should pay the greatest share of the cost of government.His rationale was as follows:

If we wanted to estimate the degrees of benefit which different personsderive from the protection of government we should have to consider whowould suffer most if that protection were withdrawn: to which question ifany answer could be made, it must be that those would suffer most whowere the weakest in mind or body If there were any justice, thereforethose to whom the protection of government is the most indispensable,ought to pay the greatest share of its price11

Of course, such a tax would be highly regressive, which would not only be politicallyunthinkable but (as will be shown later) would be inequitable as well. It is likely that Millwas being more provocative than serious in advancing this interpretation of the benefitsprinciple, inasmuch as he ultimately became an advocate of sacrifice theory, using it to

10 Blum and Kalven, 38.11 John Stuart Mill (1885) Principles of Political Economy(London: Longmans, Green and Co), 485.

10


11/28

support degression. But this interpretation, while lacking in merit with respect to equity,is arguably no less reasonable than the one advocating progression.

A third interpretation of the benefits principle, and one that appears clearly to have moresubstance and more scholarly support than the first two, is that government benefits

redound roughly equally to all people regardless of their income. More specifically, andas noted in the last argument against protection theory, the value of benefits relating tolife, liberty and the pursuit of happiness, including the protection of property, isessentially the same for all citizens. Thus, each person should share the costs ofgovernment equally, in which case the fairest tax would be per capita. This is essentiallywhat Harry proposed to his brothers as the fairest way of dividing the costs of theirstreet improvements.

There is yet another interpretation of the benefits principle that appears clearly to besuperior to the others, because it comes closest to placing a true value on the benefitsof government. This interpretation posits that the ultimate benefit of government is the

overall well-being each person derives from its services.

The Class Wars parable imagined a society in which all of the members had the sameaptitude. But in the broader society, aptitudes are distributed widely and unequally. Thischanges the picture substantially, as we can see by means of a simple thoughtexperiment: Assume the societys population has a normal (bell curve) distribution ofaptitudes. Assume also that all of the persons in this society work exactly the samenumber of hours and at exactly the same intensity, resulting in incomes that correlateclosely with aptitudes (assume luck is not a factor). In this hypothetical situation, andwithin each occupation, incomes would vary across a distribution curve almost identicalto the aptitude curve. Accordingly, persons with more highly valued aptitudes wouldearn more income than their lower-aptitude counterparts, and thus derive greater valuefrom government. It follows, therefore, that, all things being equal, higher-aptitudepeople should pay more in taxes than lower-aptitude peoplenot because they havemore to lose (or to protect), but because they receive greater value from theirgovernment. Blum and Kalven touched obliquely on this concept when they noted:

Another approach [to the benefits theory] is more ingenious. It is founded ona double assumption: first, that the well-being of men, while not caused bythe government, is dependent upon it in that government is a necessarycondition for its existence; second, that the only aspect of well-being which ismeasurable is wealth or income and that it is therefore appropriate to takeeither of these as an index of the benefits flowing from government. 12

Perhaps this ingenious approach should be attributed to Adam Smith who, in hisseminal book, Wealth of Nations, declared:

the subjects of every state ought to contribute toward the support ofgovernment, as nearly as possible in proportion to their respective abilities,

12Blum and Kalven (1953), 37.

11


12/28

that is, in proportion to the revenue which they respectively enjoy under theprotection of the state.13

Both Smiths statement and the approach described by Blum and Kalven, are entirelyconsonant with the greater-value interpretation of the benefits principle.14

The greater-value interpretation of the benefits principle is at odds with the cost-sharingconcept described above (which suggests a per-capita tax), inasmuch as it argues thathigher-income people should pay a higher price for their benefits because they havereceived greater value from their government, largely because of a more highly valuedaptitude (which is a gift at birth) or some other good fortune. The merit of this notion canbe inferred by imagining that aptitudes could be purchased on the open market. If sucha thing were possible, it is certain that the more highly valued aptitudes those thatwould produce higher incomes would be bid up to amounts in excess of the per-capita cost of government.

But how much more should higher-income people pay? The major fallacy in the use ofthe benefits principle as an argument for progression is the implicit premise that thevalue of government benefits increases more rapidly than income. Under the greater-value theory, since income a proxy for well-being is what each individual receivesfrom the economic system, income is a reasonable measure of the value eachindividual receives from government. It is reasonable to conclude, therefore, that thefairest tax system is one in which each person pays tax in proportion to his or herincome. It makes no difference whether the income is derived from aptitude (asdefined), financial windfalls, random events, or privilege. In all of these cases, the taxshould be levied in proportion to the value of the benefits received. Thus, a person whoearns 10 times as much income as another would pay 10 times as much tax, whilesomeone making 100 times as much would be taxed 100 times as much.

A new and important contribution to the debate over fairness emerged in the mid-19thcentury when proponents of proportionate taxation realized there were both practicaland theoretical reasons for exempting a portion of income from taxation. The practicalreason was simply the futility of taxing that portion of a persons income that wasneeded for survival. To do so would be self-defeating, since the hardship imposedwould deprive the state of production. The intellectual basis for the exemption, from thepoint of view of the state, emanated from the notion that income needed for subsistenceconstituted an expense of production, while income above this amount was surplus or

13Adam Smith (1776) Wealth of Nations, Part IV, Ch. 2, Part 2.14 To be fair, it should be noted that elsewhere in his book, Smith said: It is not very unreasonable thatthe rich should contribute to the public expense, not only in proportion to their revenue, but somethingmore than in proportion. Thus, Smith declared his support for a proportionate tax in one breath and inthe next, advocated (albeit weakly) progression. However, Seligman, who was both an economist and astudent of tax policy history, averred that this latter statement was a mere incidental remark by Smith,declaring that: A careful consideration of the general trend of his ideasmust convince us that AdamSmith held in the main to the benefit theory and proportional taxation. As evidence, Seligman quotesSmith as saying, the expense of government to the individuals of a great nation is like the expense ofmanagement of a great estate, who are all obliged to contribute in proportion to their respective interestsin the estate. (Seligman, 164-165.)

12


13/28

clear income, i.e., net of production costs (an insight attributed to the economist DavidRicardo). From the point of view of the taxed, government benefits only have real valueafter the taxpayer earns a surplus of income over what is needed for subsistence. Mostscholars who supported a proportionate tax system concluded that taxing only clearincome was both practical and fair to both the individual and the state. This

enhancement to the benefits principle, which introduced a mild degree of progression bycomparison to a pure proportionate tax (a tax from the first dollar of income), becameknown as a degressive tax. It is important to note that, among the proponents of thedegressive tax, there was clear consensus that the income exempt from tax should beset no higher than the level of subsistence. To do otherwise would be arbitrary and inthe opinion of many, inequitable.

The greater-value interpretation of the benefits principle stands as a rejection of a per-capita tax system and as a compelling case for either a proportionate or a degressivesystem.

Sacrifice theory and the marginal utility of money

Sacrifice theory is perhaps the most historically prominent and persistent argument infavor of progressive taxation. Stated simply, the theory posits that the fairest tax is onethat extracts from each taxpayer an equal or proportionate sacrifice.The theory rejectsthe quid-pro-quo notion that taxes are remitted in return for government benefits andinstead treats taxes simply as a burden that must be shared in the most equitable way.Sacrifice theory is dependent upon the economic principle that holds there is amarginal-utility curve for money to the effect that the more money one earns, the lessutility (or satisfaction) will be derived from the last dollar earned. Thus, if you plot a chartin which the vertical axis is units of marginal utility a person gets from money, and thehorizontal axis is the amount of money the person earns, the curve will eventually havea downward slope. A downward slope indicates, for example, that an incremental$1,000 has greater utility to a person earning $10,000 a year than it has to someoneearning $100,000.

The economic principle of marginal utility on which sacrifice theory depends is sound.However, there are several difficulties with the sacrifice theory itself that render ituntenable as an argument for progression.

First, the basic premise of sacrifice theory is conceptually flawed. The notion that taxesare simply a burden that must be tolerated rather than a payment for benefits raises thequestion: Why would the citizens of a democracy vote to impose taxes on themselves ifthey did not expect benefits in return? And if the government does provide benefits(which of course it does), why would the payment of taxes be considered a sacrificerather than a fair payment for value received? Did the Class brothers not receivebenefits from their street improvements? If they did, what would be the logic of a taxbased on proportionate sacrifice rather than one based on shared cost or valuereceived? On conceptual grounds alone, sacrifice theory appears to be a very weakfoundation for tax policy.

13


14/28

Second, the validity of the theory depends on more than just the existence of adownward sloping marginal-utility curve. For progression to be justified under a theoryof equal sacrifice, the curve must not only decline, but decline more rapidly than incomerises. In the view of British economist Arthur Pigou and others, there is no way to prove

this is true:

All that the law of diminishing utility asserts is that the last 1 of a 1000income carries less satisfaction than the last 1 of a 100 income does.From this datum it cannot be inferred that, in order to secure equal sacrifice .. . taxation must be progressive. In order to prove that the principle of equalsacrifice necessarily involves progression we should need to know that thelast 10 of a 1000 income carries less satisfaction than the last 1 of a100 income; and this the law of diminishing utility does not assert.15

Seligman credits the Dutch economist A.J. Cohen-Stuart with debunking the

notion that there is a universal marginal-utility curve that dictates progression.

In amost ingenious workCohen-Stuart shows that the whole elaboratesystem of computation is erroneous, and that progressive taxation is by nomeans a logically necessary conclusion from the assumed premises of adecrease in final utility. It is perfectly possible, in other words, to constructtables [curves] which lead not to progression, but to proportion and even toregression.16

Third, the sacrifice argument for progression is dependent upon the additionalassumption that the marginal-utility curves of all persons are essentially the same.While it is well accepted that marginal-utility curves will eventually slope downward, it isby no means true that all curves have the same slope. In fact, in comparing themarginal-utility curves of Tom, Dick, and Harry Class, there are any number of reasonswhy Harrys marginal utility curve might decline less steeply than Toms and Dicks.Imagine, for example, that Harry has a learning-disabled son who needs costly specialeducation, or that Harrys wife has an illness that requires expensive medication notcovered by insurance. Or perhaps Harry has an obsession with saving enough moneyto send his two children to the best private secondary schools and universities. Nowconsider Toms and Dicks situation: Knowing that Harry is the most industrious of thebrothers and was unlikely to need their help, Harrys parents made it clear that whenthey died they would leave all of their rather significant estate to the less industriousbrothers, leaving nothing to Harry. In this event, Toms and Dicks marginal-utility curvesare affected by their knowledge that they dont need as much income to secure theirfuture. Thus, Toms and Dicks marginal-utility curves may have steeper downwardslopes than Harrys, even though Harry earns much more income. Seligman calls thisthe very core objection to sacrifice theory:

15 Arthur C. Pigou,A Study in Public Finance (Toronto: Macmillan, 1951), 85-86.16 Seligman, 219.

14


15/28

The imposition of equal sacrifices on all taxpayers must always remain anideal impossible of actual realization. Sacrifice denotes something psychical;something psychological. . . . Two men may have the same income, whichthey may value at very different rates. The one may be a bachelor, the othera man with a large family dependent upon him; the one may be well, the

other ill; . . . the one may earn his income, the other may receive it as a gift. .. . The attempt to ascertain a mathematical scale of progression, so as toavoid a charge of arbitrariness, is foredoomed to failure.17

This inability to prove the sameness of the marginal-utility curves of different peopletroubled Blum and Kalven to the point that they dismissed sacrifice theory as a theoryon which to base a fair tax system:

The error lies in trying to translate money, which can be measured in definiteunits, into corresponding units of satisfaction or well-being. In the endsatisfaction in the sense of happiness defies quantification. Utility is a

meaningful concept; units of utility are not. It is in the face of this difficultythat, even waiving all other objections, the whole elaborate analysis ofprogression in terms of sacrifice and utility doctrine finally collapses.18

If there is no accurate way to draw any individuals marginal-utility curve, there is noway to compare the curves of different persons. The only things that can be stated withconfidence are that all persons have marginal-utility curves that are ultimatelydownward sloping and that the slopes of individual curves are determined by manyfactors in addition to income. And even if, as a general proposition, the curves aresimilar (as intuition would suggest), there are sufficient variations in them that sacrificetheory could not be applied without resulting in the inequitable treatment of anunacceptably large portion of the population.

Fourth, for a substantial (but indeterminate) number of workers those who workbecause they need the money rather than because they enjoy the job the number ofhours they choose to work is determined by the marginal utility of the income they earnfrom that work. Thus, for these workers, work effort has its own marginal-utility curvethat is essentially the same as the marginal-utility curve for income. To illustrate: Harrysfamily chooses to work 100 hours a week, while Toms family chooses to work 20 hoursa week. Harry and his wife work these long hours because the marginal utility of theincome produced from the extra hours is greater than the marginal utility of leisure (upto that point). Conversely, Toms family has decided to work only 20 hours per weekbecause the additional utility of the income from the 21st hour is sufficiently low to himthat he chooses to forgo it in favor of leisure. In this entirely plausible scenario, themarginal utility of one extra dollar to Harry might be equal to the marginal utility of oneextra dollar to Tom. It is also plausible that the marginal utility of another dollar to Harryis even greaterthan it is to Tom, in which case, under its own logic, sacrifice theorywould call for taxing Harry less than Tom. In either of these scenarios, taxing Harry at a

17 Seligman, 222-223.18 Blum and Kalven, 63.

15


16/28

higher marginal rate than Tom (as required by a progressive income tax) would beinconsonant with sacrifice theory, and by its own standard, inequitable.

Fifth,the application of sacrifice theory would be plainly unfair to the people in a societywho work the hardest. Among people whose aptitudes are the same, the only way one

person can earn more than a peer is by working harder. But progression has theperverse effect of reducing average, after-taxhourly wage or salary rates as work effortincreases. Consider the Class brothers: While Toms average, after-taxhourly wagewas $25 (he paid no tax), Dicks was $22.82, and Harrys was only $21.10 (thisassumes the tax on Harrys $75,000 in labor income was $11,725 or 50 percent of thefamilys total tax of $23,450). To put this into perspective, imagine you are interviewingfor a job. When you ask what the job pays, your prospective employer says, Well thatdepends on how hard you work. You say, Good, because I am a hard worker. Towhich the employer responds, You dont understand. If you work 20 hours a week, I willpay you $25 per hour. But if your family works 100 hours a week and has income fromsavings, I will pay you about $21 per hour. The more hours you work, the less average

hourly wage I will pay you. John Stuart Mill gave full voice to this apparent injusticewhen he denounced progressive taxation as a penalty on those who worked harderand saved more than their neighbors and a mild form of robbery. 19

On the surface, sacrifice theory appears to be a respectable argument for progression.But on close examination, it seems clearly without merit as a rationale for a fair taxsystem. By far the most compelling condemnation of sacrifice theory is not theargument over the slopes of the marginal-utility curves, but the unfair penalty it wouldimpose on the hardest working and most productive people in society.

Ability to pay

The notion of ability to pay is most often identified with Karl Marx (from eachaccording to his ability, to each according to his needs), even though the basic conceptwas considered by scholars long before Marx was born. While the phrase says nothingabout progression, it has often been used to advocate it.

Ability-to-pay has been the subject of considerable debate on definitional groundsalone. For example, a review of the literature on tax theory does not turn up a generallyaccepted definition of the word ability. What does according to his ability reallymean? Does it mean (as some suggest) the financial wherewithalwith which to paytaxes which might come from either assets or income? Or does it mean the innate orlearned ability to earn income, which would equate to aptitude (as defined)? Both ofthese interpretations have been discussed in the literature. Either way, ability could aseasily dictate proportion as it could progression. If the word means the financialwherewithal with which to pay taxesprogressively, the basic concept lacks anunderlying principle of fairness to support it. (Proponents of this meaning of ability-to-pay often draw on sacrifice theory for intellectual support, but as shown above, the

19 John Stuart Mill, Principles of Political Economy with some of their applications to social philosophy,Vol. II(D. Appleton and Company, 1894), 99, 401.

16


17/28

application of sacrifice theory results in inequitable outcomes.) If the word ability meansthe innate or learned capacity to earn income, it is synonymous with aptitude, in whichcase, the greater-value interpretation of the benefits principle should be applied. Thiswould lead to proportionate taxation.

Reducing income inequality

One of the most persistent arguments in favor of progressive taxation is that it reducesincome inequality. Essentially, the argument is that inequality is a social injustice thatmust be remedied through policies that redistribute income. University of Chicagoeconomist Henry Simons based almost his entire support for progression on the issueof inequality:

The case for drastic progression in taxation must be rested on the caseagainst inequality on the ethical or aesthetic judgment that the prevailing

distribution of wealth and income reveals a degree (and/or kind) of inequalitywhich is distinctly evil or unlovely.20

To be sure, income inequality exists in the United States as it does to a greater or lesserextent in all other nations. But why should we care? If it is social justice we areconcerned about, what is the evidence that the American system is unjust?

There are at least five methodologies used for measuring income inequality. The mostcommonly used measure is the Gini coefficient, developed by the Italian statisticianCorrado Gini. The Gini coefficient is a method of measuring the statistical dispersion of(among other things) income, consumption, and wealth. The figure of merit for the Gini

coefficient for income inequality ranges from zero to 1.0, where zero equals totalequality (all persons have identical incomes) and 1.0 equals total inequality (one personhas all of the income). By this measure, the U.S. has higher income inequality thanalmost all other industrialized nations. In 2009, the U.S. Gini was .468, while theaverage Gini for the 27 European Union nations was .304, a ratio of 1.54:1.Interestingly, the per capita GDP in the US in 2008 was $47,400, while the average per-capita GDP in the EU nations in that year was $32,900, a similar ratio of 1.44:1. Thepoint is that strong economic performance can coexist with higher levels of incomeinequality (and vice versa).

It is important to note that the U.S. income figures cited above come from the Census

Bureau, which uses what it calls money income (income before taxes, excluding thevalue of non-cash benefits). Money income is the income definition most often usedwhen citing income inequality measures,21 even though this definition of income doesnot include many variables that might affect inequality and standard of living, such as

20 Blum and Kalven, 72.21 Gini coefficients cited herein come from The CIA World Fact Book 2010, the Census Bureau report onIncome,Poverty, and Health Insurance Coverage in the United States: 2009 and other U.S. governmentpublications, and Eurostat, the official statistical office of the European Union.

17


18/28

transfer payments, taxes, employer-provided fringe benefits (primarily retirementbenefits and health insurance, which can amount to as much as 30 percent of income 22),capital gains, dividends, imputed rent from owner-occupied housing, size of household,increases in the value of home equity and other investments, etc. Consequently, thevalue of using money income to measure either standard of living or inequality is quite

limited.

It has been widely reported that income inequality in the U.S. has been rising fordecades, and by implication, that the rise is ongoing. These reports are arguablymisleading. From 1967 to 2009 the Gini formoney income rose from .397 to .468 (17.9percent), about 80 percent of which (14.3 percentage points) occurred from 1967 to1993. Roughly one-third of this increase (4.8 percentage points) occurred between 1992and 1993 due primarily to a change in the way data was collected. This change inmethodology biased the Gini calculation upward. Accordingly, figures from the periodbefore 1993 are not directly comparable with the period from 1993 to the present.During the 16 years between 1993 and 2009, the Gini increased from .454 to .468 (3.1

percent), and from 2001 to 2009 there was virtually no change in income inequality asmeasured by the Gini coefficient.

A more comprehensive measure of income yields a very different picture. The CensusBureaus so-called 15th measure of income adds to money income, transferpayments, insurance supplements, capital gains, Medicare, Medicaid, net imputedreturn on equity in owned homes, and subtracts taxes. This measure indicates thatinequality declined1.8 percent during the last 16 years (1993 to 2009) from a Gini of .395 to a Gini of .388.

In any event, the consensus view among economists is that the best measure of livingstandards

over the long termis consumption (determined not only by income but by

savings, home ownership, borrowing, barter, region of domicile, and other factors),suggesting that consumption inequality is the inequality that counts the most. A 2005study conducted by the Bureau of Labor Statistics found that in 2001 (the most recentyear for which data are available) the Gini coefficient for consumption was .280, 23

indicating that inequality with respect to this measure of U.S. living standards isrelatively modest. It also appears that consumption inequality has barely changed inrecent years. During the period 1986 to 2001, the consumption Gini went down slightly,from .283 to .280.24 Since the Gini for money income was virtually unchanged from 2001to 2009, it is quite possible that the Gini for consumption was also relatively flat duringthat period; in which case, consumption inequality has not increased for 23 years ormore. Further support for this latter surmise comes from a 2010 study which concludedthat in the 2000s overall consumption inequality shows little change.25

22 Bureau of Labor Statistics, Employer Costs for Employee Compensation: December 201023 David S. Johnson, Timothy Smeeding and Barbara Boyle Toney, Economic Inequality Through thePrisms of Income and Consumption Monthly Labor Review, (Bureau of Labor Statistics, April 2006),available athttp://www.bls.gov/opub/mlr/2005/04/art2full.pdf24 Johnson,et al., Economic Inequality.25 Bruce D. Meyer and James X. Sullivan (2010) Consumption and income inequality in the U.S. sincethe 1960s, working paper, available at http://harrisschool.uchicago.edu/faculty/web-

18
http://www.bls.gov/opub/mlr/2005/04/art2full.pdfhttp://www.bls.gov/opub/mlr/2005/04/art2full.pdfhttp://www.bls.gov/opub/mlr/2005/04/art2full.pdf


19/28

It is very likely that the demographic trends in the US over the last 25 years have hadsome impact on all of the inequality measures. The approximately 80 million baby-boomers, which are currently in their peak earning years, are affecting the high end ofthe scale. And during the 1982 to 2008 period in which baby boomers incomes were

rising, the US experienced a substantial influx of low-skilled immigrants which draggeddown incomes at the low end. The combination of these trends has almost certainlybiased inequality measures to the high side, so the fact that there has not been asignificant measured Gini increase in either income or consumption inequality during thelast 16-23 years is all the more impressive.

In addition to Americas substantial superiority in GDP per capita (which is a measure ofthe performance of the economy without regard to how income is distributed), the U.S.has a much higher standard of living than virtually all of the most advanced countries.According to the Luxembourg Income Study (which uses a very comprehensivemeasure of income) median disposable personal income in the US in 2002 was: 19.3

percent higher than Canada; 68 percent higher than Finland; 45 percent higher thanGermany; 59 percent higher than Italy; 31 percent higher than Norway (despite its vastoil and gas wealth); 73 percent higher than Sweden; and 31 percent higher than theUnited Kingdom. These figures do not take into account the various transfer paymentsand government subsidies provided by the U.S. and these other states. Since most ofthe European countries provide universal health care coverage it is possible thatgovernment largess in these states is, in the aggregate, higher than in the U.S. It isunlikely, however, that any difference, if it exists, would close the gap in the standard-of-living advantage enjoyed by the U.S. It should also be noted that the figures for GDPper capita and median income understate Americas economic performance advantagebecause the median age of Americas population (about 36.8 years) is about four yearslower than the average of the median ages in Western Europe and almost eight yearsyounger than Japan. Age (a proxy for experience) is one of the most significantcontributors to income. (Interestingly, it is also a significant contributor to incomeinequality.) In addition to higher median incomes, Americans have higher median networths, which add further to the standard of living differential.

There is no question that until the recent recession, the U.S. economy performed well inboth absolute and relative terms over the 25 year period from 1983 to 2008. During thisperiod, real compound annual GDP growth in the U.S. was 3.3 percent, substantiallygreater than the growth of its G-7 counterparts, which on a weighted-average basis(using either population or GDP), grew only 2.3 percent per year. Thus, the U.S.economy grew 43 percent faster per year than the non-U.S. G-7 countries. Moreover, inthe recent recession, the U.S. economy contracted less than the worlds other advancedeconomies. For example, U.S. GDP shrunk 2.6 percent in 2009, substantially less thanthe 4.1 percent contraction experienced in the Euro area. In 2010, the U.S. grew 2.8percent compared with only 1.8 percent growth forecast for the Euro area by theInternational Monetary Fund. Further evidence of the superior economic performance ofthe U.S. economy comes from a comparison of unemployment rates. The average

pages/Inequality60s.pdf

19


20/28

unemployment rate in the United States from 1982 to 2007 was 6.0 percent, comparedwith 9.0 percent in France, 8.3 percent in Germany and 7.7 percent in the UnitedKingdom. Thus, over this period, the unemployment rate in the most importantEuropean economies was 28 percent to 50 percent higher than that of the U.S.

Another common claim is that incomes in the U.S. have been stagnant for decades.But this claim is at odds with data from the Congressional Budget Office which uses ameasure of household income that, like the Luxembourg measure, is quitecomprehensive, taking into account transfer payments, health and retirement benefits,profits from retirement accounts, imputed interest on owner occupied homes,differences in household size, and taxes paid. Using this more meaningful definition ofincome, from 1983 to 2005 real median household income in the U.S. rose by 35percent, which can hardly be considered stagnant.

The presentation of these facts is not meant to suggest that income inequality causeshigher living standards or GDP growth. But it is clear that it can co-exist with both high

and low national living standards. Those who advocate redistribution of income ongrounds of social justice should consider that Americas standard of living is higher andhas grown faster than virtually all of the nations exhibiting lower measured inequality.This suggests that the most notable economic inequality in the world is that betweenAmericans and the citizens of all other countries.

Those who are most vocal about income inequality often point to the large increase inthe ranks of the super rich over the last few decades, which has contributed to the risein the percentage of income earned by the top one percent. America has more self-made billionaires per capita than any other country in the world. What is wrong withthat? Imagine what the U.S. and world economies would be like if Bill Gates had notstarted Microsoft; Steve Jobs had not created Apple; Larry Page and Sergey Brin hadnot launched Google; Fred Smith had not founded Federal Express; and Bob Noyce,Gordon Moore and Andy Grove had not begun Intel? These people, all multi-billionaires,created entire new industries. They and people like them, have been responsible forcreating tens of millions of jobs while increasing substantially Americas (and theworlds) productivity, competitiveness, and wealth.

The most compelling argument against the use of the progressive income tax toredistribute income is simply that it is inequitable and, arguably, an infringement of abasic right. Here is Thomas Jefferson, writing on the general welfare clause in theConstitution:

To take from one, because it is thought his own industryhas acquired toomuch, in order to spare to others whohave not exercised equal industryand skill, is to violate arbitrarily the first principle of association, to guaranteeto everyone a free exercise of his industry and the fruits acquired by it.26

26 US Department of Treasury (2009) Fact Sheet: Taxes. http://www.ustreas.gov/education/fact-sheets/taxes/ustax.shtml.

20


21/28

Similarly, Blum and Kalven, expounding on redistribution and the general welfare,noted that when the tax system is used to redistribute income,

. . . the welfare of one group in a society has been increased at the expenseof the welfare of a different group. Stated this way there is no general

welfare; there is only the welfare of the two groups and the wealthy receiveno counter-balancing benefits for their surrender of income or wealth.27

As contrasted with the benefits principle and sacrifice theory, each of which relies onconceptions that purport to enhance equity, income redistribution is simply a coercivetransfer of wealth from one group to another without an equity principle to support it.Note that $13,450 of Harrys income was distributed to Tom and Dick (this is thedifference between Harrys one-third share of the cost of the street improvements($10,000) and the $23,450 he was forced to pay).

One clear inequity of redistribution is that, while it may have some effect in reducing

inequality of income (there is some dispute about this), in a way, it has the oppositeeffect on inequality of wealth. On this issue, Blum and Kalven remarked:

The income tax can do nothing to mitigate existing inequalities in wealth,and, moreover, it retards the accumulation of new fortunes. The progressiveincome tax alone, no matter how steep the progression, tends to preserveand magnify the advantages of inherited wealth.28

Thus, redistribution hurts many of the people it is designed to help.

The perniciousness of redistribution is even better illustrated by the recognition that, formost people, income is largely determined by aptitude, and inequality of aptitude (asdefined) is unalterable except through work effort. Thus, other than redistribution, themost effective way income inequality can be reduced between persons with differentaptitudes is through a differential in work effort. Ironically, however, a progressiveincome tax can have the extraordinary effect of increasing rather than decreasingincome differences. Again, our parable is instructive: Assume that Harrys boss is aconstruction foreman who works 40 hours a week at $37.50 per hour, thus earning$75,000 per year (which is the entirety of the family income). The foremans hourly rateis commensurate with his aptitude as a manager, while Harrys $25 per-hour rate iscommensurate with his aptitude as a carpenter. They both make $75,000 per year, butHarry does it working 60 hours per week and his boss does it working 40 hours perweek. Under the current progressive tax system, Harrys after-tax income will be$63,275 (after $11,725 in tax, which assumes that, since Harrys labor income is 50percent of his total family income, the tax attributable to him is 50 percent of the$23,450 tax paid by the family). His boss will take home $68,450 (after $6,550 in tax).Thus, a disproportionate amount of Harrys income has been taken from him andredistributed, simply because his family worked harder.

27 Blum and Kalven, 75.28 Blum and Kalven, xviii.

21


22/28

As noted by Blum and Kalven, and illustrated by our parable, redistributionrequires that money be taken from some and given to (or not taken from) others.What is the equity principle that justifies this taking? Redistribution has been

justified by some as a means of rectifying social injustice in the economic system.

But proponents of this view have not provided a convincing argument that suchinjustice even exists.29

There is no persuasive evidence that reducing income inequality will increase economicwell-being for the majority of people; in fact, Americas superior median standard ofliving relative to the other advanced economies is evidence to the contrary.

The case against progression

The strongest arguments againstprogression are the rebuttals to the arguments for

progression. To wit: The pro-progression interpretation of the benefits principle is invalidbecause it depends on the untenable assumption that the value of government benefitsincreases more rapidly than the rise in income;on the surface, sacrifice theory is arespectable argument for progression, but on closer examination, it is clear that itsapplication produces an inequitable outcome (this is most obviously so when applied toincome derived from greater work effort); the ability-to-pay argument lacks an equityprinciple (other than sacrifice theory) on which to base a fair tax system; andredistributing income through a progressive tax system is inequitable.

These rebuttals to the arguments for progression should be sufficient to settle the caseagainst it. But there are other important reasons to reject progressive taxation.

Political irresponsibility. In 2008, the top 1 percent of taxpayers in America earnedabout 20 percent of all personal income and paid roughly 38 percent of federalincome taxes; the bottom 50 percent of taxpayers currently pay only 2.7 percent ofincome taxes,30 and it is estimated that 46.9 percent of workers paid no federalincome tax for the 2009 calendar year.31 Inasmuch as only a minority of taxpayersis affected by rises in tax rates, there is a built-in incentive for the majority to act inits self-interest, which opens the door to inequitable treatment of the minority.

Arbitrariness. Establishing a graduated rate scale and setting the top marginal rate onthat scale are inherently arbitrary tasks. Scottish economist J.R. McCullough,

condemned this arbitrariness in the strongest of terms:

29 To be sure, there are people in America that are needy or disadvantaged, in some instances, grievouslyso. For such people the most effective remedy would be through direct spending programs. But thefunding for such programs should come from a tax system that is equitable.30 Mark Robyn and Gerald Prante, Summary of Latest Federal Income Tax Data, Fiscal Fact249 (TaxFoundation, October 6, 2010) available at http://www.taxfoundation.org/news/show/250.html.31 Roberton Williams, Who pays no income tax? Tax Notes (June 29, 2009), available athttp://www.taxpolicycenter.org/Uploaded PDF/1001289_who pay.pdf.

22
http://www.taxpolicycenter.org/Uploaded%20PDF/1001289_who%20pay.pdfhttp://www.taxpolicycenter.org/Uploaded%20PDF/1001289_who%20pay.pdf


23/28

The moment you abandon . . . the cardinal principle of exacting from allindividuals the same proportion of their income or their property, you are atsea without rudder or compass, and there is no amount of injustice or follyyou may not commit.32

The progressive tax system rests on a very slippery slope, making the term fairshare so subjective as to be an invitation to abuse. Did Harrys brothers pay theirfair share?

Fomenting dissension. One of the inherent characteristics of the U.S. system ofgovernment (and that of all Western nations) is the tension that exists between thepolitical system (majoritarian) and the economic system (free enterprise). Most Westernnations are experiencing the effects of this tension, which manifests itself in vigorousdisputes over tax and welfare policies. Many of those who favor income redistributionassert that inequality foments dissension. Whether this is true or not, dissension is justas likely to be caused by tax laws that are deemed unfair by those being taxed. By its

nature, a system that taxes people progressively without the support of an acceptedequity-based principle may breed resentment, particularly when so many pay notax atall. The deepest resentment will most likely be among those whose tax rates differsolely because of their work effort.

A new doctrine of fairness?

There is no perfectly fair tax system. But based on an examination of the various taxprinciples and theories described in the literature, together with a critical analysis of thearguments supporting and opposing progression, it is possible to put forward a new

doctrine of fairness. It is based on five principles:

The most equitable tax system is one based on the value of benefits received. Income is the most equitable (or least inequitable) measure of the value of

benefits; thus taxes should be levied in proportion to income. Well-being is theultimate benefit of government and income is a reasonable proxy for well-being.Whether income is derived from aptitude (as defined), a financial windfall, arandom event or privilege, it is fair (or less unfair) that it be taxed in proportion tovalue received. This principle serves as a rejection of a per-capita tax systemand establishes the affirmative case for proportion.

Only clear income defined as income above the level of subsistence should be taxed. From the point of view of the state, an individuals earnedincome up to the level of subsistence is effectively the governments cost ofproduction and should not be taxed. From the point of view of the taxed,

32 J. R. McCullough,A Treatise on the Principles and Practical Influence of Taxation, or the FundingSystem (The Lawbook Exchange Ltd., 2007), 143-145.

23


24/28

government benefits only have real value after the taxpayer earns a surplus ofincome over what is needed for subsistence.

The progressive taxation of income from work effort is inequitable. Income isderived primarily from a combination of aptitude and work effort. All things being

equal, people with high-value aptitudes earn more than those with low-valueaptitudes. Each tier of aptitude (whether there be 100 or 10,000 such tiers)comprises a mini-society in which differentials in income between the membersare derived almost solely from work effort. Under a progressive tax system,workers whose work effort is above the median in their aptitude-tier will payhigher average tax rates than those below the median. As a result, at any onepoint in time, an unacceptably large percentage of the total work force will earnless average, after-tax income per hour than their peers, simply because theyworked harder. This is inequitable on its face.

The progressive taxation of income from aptitude is inequitable. Whereas the

most equitable tax system is one based on the value of benefits received fromgovernment; and whereas the value of government benefits does notincreasemore rapidly than income, there is no equitable basis for taxing incomeprogressively. Thus, even if it were assumed that income was derived solely fromaptitude, progression would be unfair.

Implicit in this fairness doctrine is that taxation in excess of a proportionate share of thevalue of benefits (defined as clear income) is an inequitable confiscation of property.

Critique of the doctrine

There are weaknesses in the logic of this doctrine that make the fairness of aproportionate or degressive tax system less than perfect. First, some have argued thatthe benefit derived from economic well-being (as measured by income) should beconsidered separately from the benefits derived from government protection of life,liberty, and property. This alternative view has induced some scholars (John Stuart Mill,for one) to suggest that two types of tax should be imposed: a proportionate tax to payfor economic well-being and a per-capita tax to pay for the protection of life, liberty, andproperty. Putting aside the measurement difficulties of such a scheme, if this alternativequid pro quo principle were applied, and the two tax rates were blended to reflect thedifferent values of the benefits, the most equitable tax would be somewhere betweenper-capita and proportion. Thus, a proportionate or degressive tax as proposed, wouldfavor lower-income persons at the expense of higher-income persons.

Second, a proportionate tax would only be fair if all income were derived from aptitude,when in fact a substantial portion of income is derived from work effort. The inequity ofthis is demonstrated in the Class Wars parable, in which Harry paid more than a per-capita share of the cost of the street improvements despite the fact that his benefitswere exactly the same as his brothers. (Note that in this all-too-common circumstance,where both aptitudes and benefits are equal, even a proportionate or degressive tax is

24


25/28


26/28

into account the possibility that the people they represent could end up on the bottomrung of the social and economic ladder.

Given these assumptions, Rawls posits that the arbiters would prescribe two principlesof justice:

(a) Each person has the same indefeasible claim to a fully adequate schemeof equal basic liberties, which scheme is compatible with the same schemeof liberties for all; and

(b) Social and economic inequalities are to satisfy two conditions: first, theyare to be attached to offices and positions open to all under conditions of fairequality of opportunity; and second, they are to be to the greatest benefit ofthe least-advantaged members of society (the difference principle).

the first principle is prior to the second; also, in the second principle fair

equality of opportunity is prior to the difference principle. This priority meansthat in applying a principle (or checking it against test cases) we assume thatthe prior principles are fully satisfied.34

Rawls posits further that the parties in the original position would devise backgroundinstitutions which would strike a balance between basic rights and liberties on the onehand and equalities on the other. Rawls qualified the difference principle by stating that,there is no injustice in the greater benefits earned by a few, provided that thesituation of persons not so fortunate is thereby improved.35 This made clear Rawlssview that economic efficiency was a necessary part of maximizing economic equality.Thus, he deemed it perfectly acceptable for some in a society to have more economicgoods a larger slice of the pie as long as their success resulted in a large enoughexpansion of the pie to enhance the economic position of the least advantaged. Withthis as a qualification, Rawls argued that the organizers of a just society would pursuepolicies that maximize the economic outcomes for the least well off in society. He calledthis the maximin rule, which in its application would maximize the minimum.

On income taxes, Rawls opined that the needs of ajustsociety would best be served bya proportionate tax on consumption. But in an unjustsociety (one with excessiveinequality), steeply progressive income taxes might be justified.36 Unfortunately,Rawls did not specify the criteria for determining whether a society is unjust. So, left totheir own devices, some disciples of Rawls have asserted that the U.S. society is unjustand have used his theory to support a more progressive tax system. But this is a difficultcase to make inasmuch as the standard of living in the U.S. is significantly higher thanany other society extant or, for that matter, in all of history. Moreover, there isconsiderable evidence that the well-being of the least prosperous in the U.S. (thoseliving below the official poverty line) isagain, by comparison with other societies past

34 John Rawls (2001) Justice as Fairness: A Restatement. (Cambridge, Harvard University Press). 43-44. The original two principles were written inA Theory of Justice but were revised in this follow-up book.35 Rawls (2001).1536 Rawls (1971). 279

26


27/28

and presentalso greater, suggesting that the minimum is relatively high, if not fullymaximized.37 Part of the reason this is true, is that the federal government spends over$750 billion per year on safety net programs for the least well off.

Regardless of ones judgment of the justness of U.S. society, it is interesting to ponder

how Rawls would vote if, sitting behind the veil of ignorance he was presented with thefive principles of the fairness doctrine proposed herein. The maximin rule requiresmaking policy choices that produce the best economic outcomes for the leastadvantaged persons while striking the optimum balance between maintaining basicliberties and maximizing economic efficiency. If we accept that, all things being equal,persons with the lowest-value aptitudes are the least advantaged in society, then theonly way such persons can increase their standard of living and accumulate wealth is byworking harder. But the opportunity to do this would be substantially curtailed by theprogressive income tax.

So how would Rawls vote? Since his first principle of justice requires that each person

have an indefeasible claim to a fully adequate scheme of equal basic liberties, mighthe see that a progressive tax would, as Jefferson put it, violate arbitrarily the firstprinciple of association, to guarantee to everyone a free exercise of his industry and thefruits acquired by it. thus infringing on a basic liberty? And might he also see thatreducing a persons average, after-tax hourly rate of income for each additional hourworked, is a clear violation of his own difference principle, which calls for policies thatbenefit the least advantaged members of society? In the event, might Rawls have votedagainst the progressive income tax and embraced the fairness doctrine as proposed?

Summary and conclusion

The flaw in virtually all of the intellectual arguments on the issue of the progressiveincome tax (both pro and con), is a lack of appreciation for how income isdetermined. Because of this, the crucial implications of the distinction betweenincome derived from aptitude and income derived from work effort has been leftout of the debate. When the importance of work effort is considered, the inequity ofprogression becomes clear.

To recap: Sacrifice theory in large part foundered on the fact that, for a largeportion of the work force (primarily those with lower aptitudes), an individuals workeffort has its own marginal-utility curve which coincides closely with his or her

marginal-utility curve for income; thus, the sacrifice a tax might impose on Tom isnot necessarily greater than that imposed on Harry (and may even be less),despite the disparity in their incomes. In this circumstance, taxing Harry at a higherrate would be inequitable. The theory then collapsed entirely when it became clear

37 The reader is encouraged to review the works of Robert Rector of the Heritage Foundation andNicholas Eberstadt of the American Enterprise Institute, who have shown that Americans living below theofficial poverty line are, in absolute terms and by comparison to average citizens in other nations, moreprosperous than is commonly believed.

27


28/28

that Harrys average hourly after-tax income was being reduced onlybecause hisfamily worked more hours than his brothers. The recognition of the inequity thatprogression imposes on the hardest working and most productive persons insociety is the most important contribution of this essay and should be, by itself,sufficient to reject progression.

Of almost equal importance is the recognition of the vital role aptitude plays inderiving value from government. This led to the notion of a greater-valueprinciple, which established a compelling intellectual rationale for the rejection ofa per-capita tax.

Lastly, the explication making clear that government benefits do not rise morerapidly than income, established the affirmative case for a proportionate tax andmade the case against progression even more compelling.

While the title of Blum and Kalvens book appears to indicate that the authors analysis

led them to become uneasy proponents of progression, the reality is more nuanced(and more uneasy). At the conclusion of the book, they wrote:

The case for progression, after a long critical look, thus turns out to bestubborn but uneasy. The most distinctive and technical argumentsadvanced in its behalf are the weakest. It is hard to gain much comfortfrom the special arguments [in favor of progression], however intricatetheir formulations, constructed on the notions of benefit, sacrifice, ability to

pay, or economic stability. The case has stronger appeal whenprogressive taxation is viewed as a means of reducing economicinequalities. But the case for more economic equality, when examined

directly, is itself perplexing.

The authors seem to be saying that the only argument for progression that could not bedismissed was the value they ascribed to reducing income inequality. And even thatargument left them uneasy.

But it is clear from a careful reading of the book that Blum and Kalven did not appreciatethe implications of how income is determined, specifically the special nature of incomederived from work effort. If they had, they almost certainly would have realized thattaxing such income progressively is inequitable. In the event, their uneasy case forprogression would have become an easy case for its rejection.

April 1, 2011

Documents

The Inequity of the Progressive Income Tax