Dr. Bails is Executive Director of the Public Interest Institute at Iowa Wesleyan College in Mt. Pleasant, Iowa.
How should the tax burden be distributed? How much should one group or individual pay relative to some other group or individual? Both of these questions are usually answered by some vague reference to “fairness” and “equity.”
In common usage, equity in taxation implies that high-income individuals should pay more than middle-income individuals, and low-income individuals should pay the least. More formally, the issue of equitably distributing the tax burden among taxpayers has generally been resolved by applying the concept of the “ability-to-pay” principle of taxation. A shorthand statement of this principle would be “treat equals equally and unequals unequally.”
The issue of levying higher taxes on those with higher incomes is frequently cited as a justification for a progressive or graduated tax structure. Under such a structure, the more income an individual earns, the larger the tax bite out of any additional income. For example, if an individual earns $30,000, the first $10,000 might be taxed at a rate of 10 percent, the second $10,000 at a tax rate of 15 percent, and the third $10,000 at a tax rate of 25 percent. Thus, a person who earns $30,000 will pay a total tax of $5,000.
Although it is true that progressive taxes satisfy the higher tax requirement for those with higher incomes, there are fundamental problems with this position. The requirement of higher taxes on higher incomes is also satisfied under a flat-rate tax where a single tax rate is applied to all income. In the case of the individual who earns $30,000, the last $1 earned would be taxed at exactly the same tax rate as the first dollar earned. If the single tax rate were set at 10 percent, the total tax bill would equal $3,000. For a person who earns only $20,000, the tax bill would equal $2,000. The principle of treating unequals unequally requires only that those with higher incomes pay higher taxes, a condition that is satisfied under a flat-rate tax. It does not require that they face a higher tax rate. Those who justify progressive taxation by relying on the ability-to-pay principle demonstrate a complete lack of understanding of this principle.
Advocates of progressive taxation argue that individuals with larger incomes have more resources with which to pay taxes; thus, they place a lower value on the additional dollars that they earn (or that would be paid in taxes) than do lower-income individuals. If this argument is correct, levying a higher tax rate on those with higher incomes has some intuitive appeal.
However, the validity of this position rests critically upon two questionable assumptions: (1) the value of additional income to those who earn it must decline, (2) it must decline more rapidly as income increases. The value of the income earned by individuals is reflected in the goods and services they purchase. Thus, if the lower-value argument is true, it would suggest that, for example, the additional income required to purchase a color television is less important than the lower income required to purchase a radio. Similarly, the purchase of an automobile for transportation is not as important as being able to purchase a bus ticket for travel. In a more general sense, this position argues that all individuals, if asked to choose, would prefer fewer goods and services to more. An examination of real-world behavior certainly seems to suggest the opposite. We generally observe that individuals place some value on obtaining more goods and services and earning more income.
Further, there is no objective method for determining whether or not one individual derives more or less value from an additional dollar of income over any other individual. Those who justify progressive taxation on the grounds that some (higher income) individuals place a lower value on the goods and services that could be purchased with this income are implicitly assuming that the preferences of all individuals are identical. They assume that all of us, if left to make our own decisions, would make exactly the same choices.
In light of the tremendous diversity among individuals, this is a curious assumption indeed. Individuals differ with respect to the type of entertainment and social activities they enjoy, the goods and services they consume, the company they prefer, and virtually all other matters. Why then should they have exactly the same preferences with respect to how much income they choose to earn? Who among us is willing to argue that a person who chooses to work longer hours contributes less to society than a person who chooses to work less and create art with the additional leisure time? Is art more valuable than making an automobile? Is practicing medicine less valuable than driving a race car? Those who advocate progressive taxation are in reality arguing that the value of all goods and services is identical for all individuals and are, in essence, arguing, that all professions are equally valuable.
This complete disregard for individual initiative and free choice, under the guise of equity, is puzzling. It focuses completely on the end result and never on the process which generated this result. Those who would advocate redistributive policies, such as progressive taxation, ignore totally the process by which income is earned. There is at least some reason to believe that the majority of those with higher incomes have earned this position because they are providing a good or service that the rest of us value highly. Who among us would claim that the millions of dollars earned by Bill Gates, the founder of Microsoft, by Garth Brooks, the country singer, or by Sam Walton, the founder of Wal-Mart, should be confiscated under the guise of fairness? Did not these individuals earn their high incomes fairly through the voluntary purchase of their services by the rest of us? Those who favor a progressive tax structure are suggesting that the process by which these and other successful individuals earn their incomes matters not at all.
Another curious aspect of tax policy in the United States is that a majority of individuals are allowed to impose tax rates upon a select minority. This type of policy would surely be deemed unacceptable in all other policy arenas. Indeed, in many other endeavors, the United States goes to great lengths to protect minorities from majority oppression. The principle of treating equals equally is so important that it has been written into the U.S. Constitution as the Equal Protection Clause of the Fourteenth Amendment. It is time to apply this principle to taxation.
There is something perverse about arguing, in the name of equity, that the efforts of a minority of high-income individuals are less worthy than those of lower- and middle-income individuals. It is far more appealing to believe that all individuals should stand equally before the tax law and be subject to the same statutory rate of taxation on their efforts.