Issue Analysis: Higher Taxes on the Wealthy

Proposition: People with a relatively high income should pay an even greater percentage of their income as taxes than they do currently in order to help the government with its financial problems.

Predicted Effects:

1. Incentives: In a market economy, the way that consumers get producers to produce what they want to consume is by rewarding producers monetarily for serving them well. They do so by using their money to buy the products that they deem are the most advantageous to buy at that moment, thereby rewarding the producers of those products with monetary income. Any proportional income tax, and especially a progressive income tax, takes more money away from those producers who are able to amass a greater monetary income by serving the consumers. Thus, the monetary incentive that contributes a great deal towards spurring the producers to serve the consumers in the best and most economical way is consequently weakened by the income tax, to a greater or lesser extent depending on the level of the tax. Any increase in the level of taxation on a certain group, in this case those with the highest incomes who, leaving aside for the moment the possibility of gains through coercion which must be dealt with separately, are the ones who are serving the consumers in the best way, will reduce the monetary incentive to produce of members of this group. As with most variables in economics, the level of monetary incentives works on the margins of decisions. It is not the case that producers before a certain tax level will have the incentive to produce, and will suddenly lose this incentive once the rate exceeds this level. Rather, with lesser monetary incentives, producers may be inclined to take fewer risks than before because the potential reward is diminished while the losses remain the same. They may also be slightly less dedicated to their businesses’ success, may choose to work fewer hours, to forgo education that they would have undertaken before because of the diminished reward for increasing their skills, to place a bit higher value on non-monetary rewards for themselves at the expense of serving the consumers for monetary rewards, etc… Thus, from the point of view of pure consumer’s satisfaction as demonstrated on the market, a higher income tax on the wealthy will be negative due to its reducing of the monetary incentives the consumers can offer producers.  

2. Change of Plans: Any tax, always a transfer of wealth from private producers to the government, involves an appropriation of money that would have been spent according to the plan of the taxed person that is now spent according to the plan of the government. Unless he would have voluntarily donated the equivalent sum of money to the government anyway (highly unlikely), the taxed person would have allocated it to the consumption, investment, and charitable ventures that he saw fit, instead of the government taking the money and allocating it to the purposes that they see fit.

3. Effect on capital formation: Along with the change of plans for the resources taxed comes the possibility of an effect on the societal savings rate, and hence on capital formation. Private individuals in a market economy can use their wealth to either consume in the present or to invest in the hopes of making a return in the future. Investment for purely monetary considerations involves attempting to seek out and employ resources to advance the production processes that are anticipated to be the ones that will produce the most value for the consumers, because doing so will result in the highest monetary returns on the investment. The more resources that are saved and invested, in other words, the more resources that are not immediately consumed, the more time-consuming/complicated, but also the more value-productive, production processes can be employed, and with them, the more consumer goods can eventually be produced. This is the importance of capital for material civilization, outlined in tip #27. When it comes to government, they can certainly consume resources, but we cannot talk about government ‘investment’ in the same sense as we do private investment. Governments don’t tend to try to make the highest monetary returns on their ‘investments’ of taxpayer money (unless they are administering sovereign wealth funds or pension funds), indeed, many of what could be called ‘investments’ such as roads are ‘free’ for the citizens once the taxes have been paid. With such activities, as outlined in tip #5, the government cannot employ the full processes of economic calculation used by the profit-seeking private businessman or investor. It is highly likely that some of what governments tend to refer to as ‘investments’ such as roads and schools would in fact be made by private investors if government stepped out of the way, but as it is, it is impossible to know exactly which of government’s ‘investments’ would have been made by profit-seeking businessmen on the free-market, and it is almost guaranteed that a great number of government ‘investments’ would never have been made by a profit-seeking businessman in search of the highest return on the market. Thus, when government ‘invests’ in such things, it is not permissible to treat this as the same phenomenon as private investment. 

All this is to make the point that when government takes away resources from private individuals, especially wealthy private individuals who have proved empirically in present-day North America to save and invest a significant portion of their resources, it will result in a reduction of private investment that may or may not be replaced by government ‘investments’, which are not the same thing anyway. There is another way for government to use its money, and that is as transfer payments. They take money from one group of people via taxes and give it to another group of people via subsidies or welfare benefits. In reality, governments use the resources of taxpayers to transfer it both to other wealthy individuals such as favoured corporations, banks, or wealthy officials, and to poorer individuals for ‘social’ reasons such as welfare recipients and those that benefit the most from ‘free’ or subsidized services such as schooling or healthcare. I will assume for the moment that transfers to wealthy individuals is not what supporters of progressive taxation have in mind, so I will consider the case for downward transfer payments alone. Whatever can be said for egalitarian transfers of wealth from richer to poorer individuals, its positive effects on capital accumulation is not one of them. This is because empirically, the wealthy, in the modern world at least, tend to save and invest a greater proportion of their income than poorer people. I say empirically because the opposite scenario is conceivable and has happened historically, a possible example being in Bourbon France comparing the relatively thrifty habits of the poor peasants with the profligate spending of the wealthy aristocrats. Current conditions are different though, we typically hear complaints about the rich who supposedly make vast, ‘under taxed’, and ‘unearned’ incomes through their investment activities, while hearing of the poorer people who supposedly are forced to live ‘month to month’. With these empirical conditions, in addition to the undermining of monetary incentives to engage in production and with it, the attractiveness of investing in productive processes, as outlined in effect #1, taxing the rich is in effect taxing those that save and invest for profit the most for the benefit of those that don’t tend to save and invest for profit as much, namely, the government and poorer people. This will have the effect of lowering the amount of capital available for production and hence lowering the long-term general material standard of living of the members of the world market society.

4. More Egalitarian Income Distribution: The stated purpose of progressive income taxation and increasing taxes only on the wealthy is to forcefully affect a more equal distribution of income among the citizens of the nation-state in question. To the extent that the taxes are actually used as downward transfer payments or to fund subsidies of goods which benefit poorer members of the country more than the richer ones, a higher level of taxation on the wealthy can indeed lead to a more ‘equal’ distribution of wealth. These uses of the taxes are a big ‘if’ though. When they are used, for instance, to bail out reckless banks or fund a bloated military and their associated industrial complex, they might not have this egalitarian effect, or at least in a greatly reduced form. Since in no political system are proposals for tax increases earmarked to precise spending activities, it is very difficult to say what the government will be using the additional taxes to be gleaned from the wealthy for.

5. General Principle: A general principle that could be associated with the proposition being considered is the following: In a democratic political system, voters are entitled to vote based on politicians’ spending promises but they are not required to bear the burden of taxation required to fulfil those promises, having the possibility open to vote that another group should pay for it. Thus, citizens can vote for certain government services, but then vote that their expenses should be defrayed by someone else, usually richer people. It is easy to see why this principle would affect the functionality of a democratic constitution. One rationale for democracy was that rather than having an authoritarian ruling elite determine both how much to take in taxes and what to spend it on, the taxed people themselves would be represented in the making of both decisions, thus supposedly serving as a check on over-taxation and very wasteful expenditure. The institution of progressive income taxation in particular though renders this check ineffectual. With it, for one unacquainted with economics as most voters are, it seems as if one can have one’s cake and eat it too, they may receive the government service and force someone else that is richer than them to pay for it. If one is ignorant of the weakening of the monetary incentive to produce for the consumers and its importance, as well as the effect on capital accumulation and its importance, it presumably seems to many people to be a great deal to vote for ever more government services and to have ‘the rich’ pay for them. The likely result of such a principle gaining hold will be a large increase in government expenditures and an escalating tax burden which the citizenry probably did not consider the actual usefulness of carefully enough.

6. Combination of Progressive Income Taxation and Inflation: Another effect arises when progressive income taxation is combined with monetary inflation, something that almost always holds in the modern political world. In a progressive income tax system, different brackets of money incomes are taxed at different percentage rates, higher rates for higher money incomes. Monetary inflation is when the supply of money in use in a society increases. Presently, most currencies are national, paper, fiat currencies whose supply can be increased via the activities of fractional reserve banks and their coordinator, the central bank of a nation state. The central bank is a political institution; its chairman is typically appointed by the executive branch of government. The exact process of expanding the money supply in a central bank-dominated fiat money regime is a bit complicated, but suffice it to say that the central bank can see to it that the money supply is expanded whenever its directors see fit. Other relevant variables equal, such as societal demand to hold real purchasing power, general productivity, and societal distribution of resources, a threefold expansion in the money supply could result in a threefold increase in the general ‘price level’ (the money prices of all exchangeable goods in the economy). This means that after the inflation, the same money income will only be capable of buying roughly a third of what it could previously. The implications for progressive income taxation are clear. A higher money income is necessary to maintain the same material standard of living after the inflation. Someone who maintains the same material standard of living will therefore be forced into a higher income bracket, and thus will have to pay a higher percentage of their income as tax. If the tax rate is raised on those considered ‘wealthy’ at one point in time, those considered ‘average’ may have to pay those rates in the future due to inflation. Let us say those making more than $150 000 are considered wealthy at one point in time, and those making around $60 000 are considered average. After a threefold increase in the money supply and its corresponding effects on the price level, the people with an average material standard of living could very well end up in the ‘wealthy’ bracket. Through this method, the government can use a combination of inflation and progressive income taxation to subtly raise tax rates across the board, without any talk of increasing taxes.              

Empirical Questions:

The following effects are qualitative, not quantitative, effects. Knowing the magnitude of effect #1 (reducing monetary incentives to produce), effect #3 (reducing societal savings rate), and effect #4 (more egalitarian wealth distribution) would help make valuation of these effects easier.

Unfortunately, it is unlikely that such magnitudes could be determined in a satisfactory manner. This is because so much will depend on the unique personalities, choices, and responses of the taxed people and the taxing government, thus making any ascertaining of magnitude useful more for historical purposes than for current policy decisions. Also, even putting aside this problem, it would be almost impossible to isolate taxation policy as an isolated variable affecting some measure like overall material standard of living, savings rate, or societal income distribution. This is because so many other variables would be affecting the same measures, and laboratory experiments to isolate variables are generally unavailable to the student of human societies. Finally, when considering the effects of higher income tax rates on the wealthy empirically, the relevant consideration is not the official rate itself, but the amount in taxation that the government actually collects from these wealthy citizens. It is well known that the tax code is full of loopholes and deductions, and the wealthy are typically the ones most equipped to take advantage of them. This complication makes empirical research on the magnitude of the effects of higher income taxation even more difficult.       

My Valuational Cost/Benefit List for higher taxes on the wealthy:

Costs: #1, #2 (given the current state of most governments’ budgetary activities), #3, #5, #6.

Benefits: #4.

Valuational Comments:

#1: As a consumer, I like it more if producers are rewarded more for serving me and my fellow consumers in a high quality and economical fashion, it heightens my material standard of living and those of my fellows, and this is something I value highly.

#2: I qualify putting this effect as a cost by saying ‘given the current state of most governments’ budgetary activities’ because there are some occasions where I think the government’s resource plans should take priority over the resource plans of the individual producers. I think that law and order, as well as some goods with public goods characteristics and externalities, can be usefully provided or interfered with by the government, despite the inherent disadvantages of government economic activities. But, as outlined in tip #17, we should not consider government versus non-government, but rather levels of government when considering taxation policy. In my view, most governments are already too large and doing many unnecessary and even harmful things, and still would be even if they eliminated their deficits through spending cuts alone, thus adding more taxation revenue to the government coffers is not called for. Thus, given conditions, I label this effect as a cost, because I think individuals could use the money more effectively than governments can, though if by some miracle government shrank tremendously and genuinely needed revenue to fulfil some of the functions I think it should, I might label this effect a benefit.   

#3: Being a fan of material progress, I would be happier if government did not intervene with policies that tend to result in less savings and capital accumulation.

#4: Despite all of the negative repercussions of pursuing egalitarian policies, egalitarian outcomes, considering them apart from these repercussions as we are here, I would generally consider to be positive occurrences. I suspect that, other things equal, the same material progress would make more people happier the more equally it benefited members of society. I do not, however, place too great an importance on the egalitarian ideal, and I generally tend to prefer policies that help enlarge the material goods pie quicker than those which seek to slice the existing pie more equally, at the expense of its rate of enlargement.

#5: This principle, as stated above, will tend to lead to larger government expenditures and less careful consideration by the voters of their merits. I suspect this was an important factor in the growth of government to its current extent, which I consider excessive, and will lead to further expansion in the future. As such, it is a cost of the policy, and a serious one at that.

#6: The same reasoning applies as for effect #5, the trick of combining inflation and progressive taxation probably allows a greater expansion of government spending then otherwise, thus I consider it a cost.

Overall: I think that the costs of raising tax rates on the wealthy far outweigh the benefits. Essentially, the possibility of a more egalitarian distribution of wealth is exchanged for effects that will undermine further material progress and lead to the growth of government to excessive, and thus harmful, levels. I am not willing to pursue an egalitarian ideal despite all its negative repercussions, thus I must reject this policy.

Invalid Arguments:

1. ‘Country X or Historical Period X features/featured a higher income tax rate on the wealthy and they have grown economically faster than Country Y or Historical Period Y. Therefore, a higher income tax rate on the wealthy clearly leads to higher growth, as well as leading to a ‘fairer’ distribution of wealth.’

This argument displays unjustified overconfidence in the pure empiricist method for analyzing this policy, thus violating tip #1. It forgets that correlation does not equal causation and blithely disregards all of the difficulties of applying the empirical method to this question, as I outlined above in the ‘Empirical Questions’ section.

2. ‘Tax rates must be raised in order to provide (insert favourite government services here). Since taxes must be raised anyway, doing so only on the wealthy is the least damaging way to do this.’

Those that make this kind of argument tend to frame it in a way that assumes that the option is either between government services or no government services, rather than there being many different levels of government activity possible, thus going against tip #17. This is so unless the author of this argument truly believes and can reasonably argue that every service the government provides is absolutely justified and could not be done well enough with fewer resources. I alluded to this when I made my qualification for putting effect #2 as a cost, where if government shrunk to less gargantuan levels I might buy this argument and think that more taxation to fund useful government services is justified. In current conditions though, this is highly unlikely. Most taxpayers think that the government is wasting at least some of their money with services that they deem unnecessary or that are provided at excessive costs, they just also believe that certain services are worth having and could even use some extra funding. Unfortunately, what usually happens is that the politicians reach a ‘compromise’ where one party gets money to spend on its pet projects (the US Republicans and military spending for example) while another party gets money to spend on their pet projects (the US Democrats and ‘social’ spending for example). These kinds of ‘compromises’ usually just escalate the amount of unnecessary government spending. As such, claiming that higher taxes on the wealthy are ‘necessary’ to provide certain favoured services (unless of course one has heavy socialist leanings and thinks that government should provide a large amount of services, but that is another debate) is in most cases not true. Rather, re-purposing some of the money currently spent on services that the political observer deems unnecessary towards services deemed more worthwhile would in most cases suffice.

3. ‘Whatever utilitarian arguments you present against raising tax rates on the wealthy are of no avail. Such a policy is the only one that accords with justice and thus must be implemented regardless.’

This argument violates tip #19 by begging the question: what standard of justice does this policy accord with, and why should we accept that standard of justice? Justice simply cannot be separated from human well-being, taken broadly and over the long-term, or else why on earth would anyone want to follow-it? Thus, utilitarian arguments are necessary to even establish a standard of justice, and hence utilitarian considerations cannot be dismissed from a policy analysis in the name of justice. Longer-term, rule-based utilitarian arguments can, and perhaps often should, overrule shorter-term, more ad hoc utilitarian arguments as argued in tip #13, but there must still be a utilitarian element, a reference to some human’s or humans’ well-being, in any policy argument.

      

4. ‘Since rich people benefit more from government services than poor people do (more assets to protect, greater use of roads, etc…), it is only fair that they pay a greater percentage of their income as tax.’

One of the great weaknesses of government provision of economic goods and services is that payment is often not linked to service, funding is collected separately in a taxation process that refers very little to the actual government services consumed by individuals. This makes determining an individual citizen’s ‘fair share’ to be paid for government services received virtually impossible. That being said, if such an endeavour were possible, it would probably show that the people who pay the most taxes are actually paying far more than their ‘fair share’ for services received for several reasons. Firstly, governments tend to engage a lot in transfer payments, using taxpayer money to increase the incomes of other groups of people. The purpose is clearly redistributive, if not, it would be absurd, as government would just take money in taxes and pay it all right back as a transfer payment to the same individual. Secondly, the proclaimed purpose for most government provision of services is to make that service more ‘accessible’ to those with lower incomes, usually by giving the service away for free or charging a reduced rate made possible through subsidies. Without government provision of these services, they would be exchanged for their market prices, generally allowing the richer people to purchase more goods and services than poorer people. As such, the taxpaying rich of a world where government provision is relatively more important would tend to be able to obtain more goods and services in a world where the free-market is relatively more important, with the possible exception of the provision of law and order. Thus, it is precisely in a more free-market world that the rich would generally be better off, thus it is counter-intuitive to argue that these same people generally benefit more from government services than others.  This reasoning of course does not apply to the rich who owe a large part of their fortune to governmental transfer payments and special privileges, but as we mentioned earlier, to insist that groups that receive transfer payments or special privileges should pay more taxes is absurd, why not just stop the transfer payments and privileges altogether and accomplish the same result with much less effort and confusion?       

        

5. ‘Any plan to balance the government’s budget must be ‘balanced’, that is, it should involve a combination of tax increases and spending cuts.’

This argument appeals to the fetish of moderation for moderation’s sake, thus violating tip #22. There is nothing inherently good about ‘moderation’ or ‘balance’, it is only such if a cogent argument for why a ‘moderate’ policy would be better than an ‘extreme’ policy can be made. The implicit argument contained in this statement, as it is made by supporters of tax increases, is that achieving a balanced budget through spending cuts alone would starve the government for resources that it could use more effectively than private individuals. As was the case with invalid argument #3, to make this argument would require that the observer believes and can offer a reasoned explanation for why the government could not possibly function with less resources than it currently has. This would be a long process and one not typically engaged in by those seeking to demagogically increase the appeal of their policies by simply calling them ‘balanced’ and their opponents’ ‘extreme’.