Personal Pedantic Political Peroration, the Progressive Taxation Effect

Oliver Wendell Holmes once said: ‘I like to pay taxes. With them I buy civilization.’

I think that’s a good way to frame this complex and emotionally charged topic.

How you are disposed to feel about taxation really depends on how you are disposed to feel about government. If you believe that government is a force for good then you probably are less opposed to paying taxes. If you believe that government is not a positive force in society then you probably resent every penny you pay.

I am, in theory, in the former camp. Tax= benefit. I say in theory because how much we benefit depends on how well we are governed, which is another blog…

The current fiscal situation in Alberta plays into the two major arguments against taxation.

  1. The tax system isn’t fair
  2. Governments can’t be trusted with our tax money

Alberta just came off a boom cycle. As quick as we busted, we were told to tighten our belts. That leaves me and many of my fellow Albertans scratching our heads and wondering, where did our tax dollars go? Personally, when I hit tough times I had income, and savings from that income, that I could fall back on. Why don’t we have anything put aside for a rainy day, Alberta?

We have two problems, income and fiscal management. Until an election is called I’m only going to tackle income.

Alberta has a flat tax. Ostensibly that seems fair. But it isn’t, and it deprives our government of valuable income.

Consider this flat tax scenario:

  • Government taxation exempts the first $100 from taxation and takes ten per cent from the rest.
  • Jane makes $110 a week. She pays $10 in taxes and has $100 left to feed, clothe and care for her family.
  • John makes $1100 a week. He pays $100 and has $1000 left to feed, clothe and care for his family.
  • The government collects $110 to provide public services for Jane and John.

A ten per cent tax imposes a significantly greater burden on Jane because it has a significantly greater impact on her ability to provide the basic necessities of life for her family. John has adequate money left to provide for his family, and even enough to save each month. Government has money to provide public services.

A flat tax is a REGRESSIVE tax because it places a greater burden on lower income earners.

That isn’t fair. Not in my books. No one should put their child to bed hungry. Ever. Every child should be able to afford education. Always.  If you don’t comprehend that from a moral point of view, I may at a later date discuss the dollar cost associated with poverty within society to help you quantify it.

Now consider a progressive taxation scenario, based on income; same Jane, same John:

  • Government taxation exempts the first $100 from taxation and takes ten per cent from earnings over $100 and under $200, and fifteen per cent on all earnings if the earner makes over $200.
  • Jane makes $110 a week. She pays $10 and has $100 left to feed, clothe and care for her family.
  • John makes $1100 a week. He pays $150 and has $850 left to feed, clothe and care for his family.
  • Government collects $160 government to provide public services for Jane and John.

Jane is a little better off and government is better off.  John, however, is worse off and might regret working those extra hours because it means that for every hour worked he now pays more.

A progressive tax system can act as a disincentive to earning. John may feel like the all effort he put into earning money was not worthwhile and he may choose to the minimum possible because it is hard to see how his tax dollars contribute to publicly provided services benefits from. We don’t want to dis-incentivize working.

What we want tax dollars to do is to provide a net gain to society.

There is a concept in economics called a ‘Pareto Improvement’. It occurs when resources are reallocated among members of a group so that the benefit, summed across members of that group, is greater than it was before the resource was reallocated.

Another useful economic concept is utility. Utility is measured in benefit derived. This helps explain why Jane’s money is not the same as John’s money. A dollar does not always have the same utility. The benefit Jane derives from her dollars is the ability to feed, clothe and educate her family – the ability to improve the quality of her life and the lives of her children. When those needs are met, and after that money is spent, things change. After John provides the same level of benefit to his family, his additional dollars start providing less utility. There is little gain in utility between a winter coat bought for $100 and a winter coat bought for $500. Both provide the same function. Function carries the most utility.

Marginal progressive taxes impose the higher tax ONLY on additional income earned. As income increases, each incremental increase is taxed at a higher rate. Only those who have reached the point where the utility of their income is decreasing, pay.

The two concepts of utility and pareto improvement are justifications for marginal progressive taxation.

Now consider a progressive marginal taxation scenario:

  • Government taxation exempts the first $100 from taxation, takes ten per cent from earnings over $100 and under $200, and fifteen per cent from income over $200.
  • Jane makes $110 a week. She pays $10 and has $100 left to feed, clothe and care for her family.
  • John makes $1100 a week. He pays $10 on his first income increment and $135 on his second income increment, for a total of $145, leaving him $955 left to feed, clothe and care for his family.
  • Government collects $155 government to provide public services for Jane and John.

Jane is better off than in the first scenario in two ways, she can personally provide for her family and she will have better access to public services to assist her in improving her quality of life. The government is only slightly less better off than in the second scenario but that loss in utility is offset by the benefit of avoiding dis-incentivizing John’s hard work.  John is less better off than under a flat tax, but better off than in the progressive tax. However in terms of society’s overall gain, John’s loss in utility is offset by the gain in utility for Jane. Additionally, he does derive some benefit from alleviating the poverty around him.

The sum of the utility in the third scenario is positive, and therefore a pareto improvement.

I vote for marginal progressive taxation.

 

 

 

 

 

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