Sales tax is, in most cases, a proportional or flat tax. For example, in Massachusetts, the sales tax rate is 6.25% on taxable transactions. It does not matter if you purchase a $5 item such as a hockey puck or a $25,000 item such as a car; the rate is the same, and the tax increases in proportion to the price.
In the United States, the Federal income tax is called progressive. The term seems to indicate that it is a positive thing, but the word progressive means that the tax rates progress, or move higher, as income increases. For example, in 2012, single taxpayer incomes up to $8,700 are taxed at 10%, while incomes above $388,350 are taxed at 35%. Here’s the complete table:
US Federal income tax rates for 2012
| Tax rate | Single filers | Married filing jointly | Married filing separately | Head of household |
| 10% | Up to $8,700 | Up to $17,400 | Up to $8,700 | Up to $12,400 |
| 15% | $8,701 – $35,350 | $17,401 – $70,700 | $8,701- $35,350 | $12,401 – $47,350 |
| 25% | $35,351 – $85,650 | $70,701 – $142,700 | $35,351 – $71,350 | $47,351 – $122,300 |
| 28% | $85,651 – $178,650 | $142,701 – $217,450 | $71,351 – $108,725 | $122,301 – $198,050 |
| 33% | $178,651 – $388,350 | $217,451 – $388,350 | $108,726 – $194,175 | $198,051 – $388,350 |
| 35% | $388,351 or more | $388,351 or more | $194,176 or more | $388,351 or more |
A common myth of the progressive tax system is that you can lose money by moving in to a higher tax bracket. In fact, only the income that falls into a bracket is taxed at that rate. For example, a single filer with income of $50,000 would have the first $8,700 taxed at 10%, the next $26,650 taxed at 15%, and then the rest taxed at 25%.
One can argue both for and against progressive taxation.
Progressive taxation is a form of income redistribution – a way to make higher earners pay a larger share of the tax burden, to fund government programs that benefit lower earners, or in cases such as the earned income credit to give money directly to lower earners. There are those who argue that this is morally correct, and there are those who argue that it is unfair. Both arguments are valid – progressive taxation is both morally correct, and unfair, at the same time. The tricky part is maintaining a reasonable balance so that the unfairness does not exceed the moral correctness by too much. Tipping too far in one direction, the less fortunate live in misery and squalor, their life expectancies far lower than they should be. Tipping too far in the other, the higher earners are taxed to the point where it can be considered robbery and they will rebel.
From a purely pragmatic point of view, there are both benefits and risks to progressive taxation. Progressive taxation tries to raise the outcome for the less fortunate without causing too much pain for everyone else. Living in a smaller mansion is a lot less painful than a low income person not being able to afford food or heat. If the government were to adopt a proportional tax system, low earners would be crushed by the tax increase. There is no question that the progressive tax system we have raises the standard of living of the lower earners a great deal, and also allows the government to enact some useful social programs that they would not be able to afford otherwise.
One risk of progressive taxation is obvious to anyone who has played the game “Sim City”: when taxes increase too much, revenue actually begins to decline. There are many ways to structure businesses or income to shield them from taxes, and the incentive to do so increases as taxes increase. More importantly, the world is a smaller place than it has ever been, meaning it is more globally connected than ever. Those with enough money can live anywhere they want in the world, so when their taxes are increased enough, they can pick up their money and leave. Many famous inventors, entrepreneurs, artists, and musicians have become “tax exiles”, emigrating to a country with a more reasonable tax structure to protect their wealth from what they consider to be confiscation by excessive taxation. A similar effect occurs with business taxes, especially in today’s global market. Many businesses can locate almost anywhere in the world with little difficulty. Hauser’s Law was created from long study of the US economy and states that the government can only collect approximately 19.5% of the US GDP*; attempting to raise rates higher does not increase revenues. Again, this is much like the Sim City tax rate problem.
* GDP (Gross Domestic Product) is the estimated market value of all goods and services produced within a given time, usually a year. Some calculate it by saying it’s the amount of income everyone (including businesses) earned in a year. Others use a formula such as GDP = private consumption + gross investment + government spending + exports – imports.
There is also a psychological factor – the perception of injustice. There have been studies done which attempt to test the effects of various economic models. One interesting method is called the “Ultimatum Game” (more info at Ultimatum_game on Wikipedia). Two players are shown a sum of money to divide. One player gets to decide how the money is divided, and the other chooses to either accept this offer, or reject it, leaving both players with nothing. Players who offer less than 20% often find that the other player rejects the offer, leaving both with nothing. This isn’t a logical choice, since something is better than nothing, and says a lot about human nature and our sense of justice. The players rejecting low offers feel it is worth receiving nothing to punish the player who offered them an unjust share, and they don’t act in their own best interest. This must be a consideration for imbalance in either direction of the tax system. The rich can leave a country, or hide their income, or just give up, but the poor can end up feeling they have nothing to lose and thus become violent and attempt to seize wealth by force. There’s also the legend of Robin Hood to consider. Robin Hood was a thief and highway robber, but he was a hero to the poor, who were oppressed by excessive taxation.
Those who consider all taxes bad, no matter how small and inconsequential, are heartless and selfish. Those who consider all taxes good, no matter how burdensome and unfair, are just as heartless and selfish. They just have a different perspective.
To summarize:
- Progressive taxation means that higher income people pay a higher rate of taxes than lower income people.
- Some level of progressive taxation is needed to run a compassionate government, with a decent standard of living for everyone.
- Maintaining a reasonable balance is critical to the proper functioning of the tax system.
- It is also necessary to balance the morality of income redistribution with the unfairness of it.
- Increasing taxes too much on lower earners will push them into misery and squalor.
- Increasing taxes too much on higher earners will not increase revenues, and can even decrease them.
Those who say, “The rich can always pay more!” are just as wrong and harmful as those who say, “Who cares about the poor?”