Friday, 23 October 2015

The Road Gets Steeper: On the Alleged Unfairness of Progressive Income Tax

     I've been having a lengthy and frustrating argument with a friend who seems to hold the position that progressive income tax is unfair. He seems to think it is punitive to impose a higher tax rate on someone just because they happen to earn more than someone else. And he's not alone in using words like "punitive"; lots of people are wrong along with him.

     Simply put, progressive income tax is where the marginal tax rate rises as income rises; as your income rises, you are taxed a progressively higher percentage. Simple enough, and simpler still if you just ignore the word "marginal", which is a common mistake, but turns an otherwise sensible policy into a horrifying injustice.
     Consider: You earn 10,000 quatloos, and are in the 10% tax bracket, so you pay 1000 quatloos in tax. But next year, you earn 10,100 quatloos, and that puts you into the 15% bracket, so perversely you end up paying 1515 quatloos, effectively losing money by earning more. That definitely would be punitive, because there's an actual disincentive to earn the extra quatloo.
     That's how many people think progressive income tax works, so they naturally find it objectionable. But that's what you get for ignoring the word "marginal". The way progressive taxation really works is that you only pay the higher rate on the income above what you earned in the lower bracket. So you pay 10% on the first 10,000 quatloos, and then when you earn an additional ("marginal", for the margin or gap between what you earned and the previous bracket) 100 quatloos, you pay 15% on the additional income, or 15 quatloos. So your total tax bill is now 1015 quatloos, not 1515. There is no point at which earning an extra quatloo costs you more than one quatloo in taxes; earning an extra quatloo always means taking home more money. Hence, it's not actually punitive; you're never actually worse off for having earned more, at least so far as taxes are concerned.

     I think my friend understands this much, but he still insists that it's unfair to make the rich pay a higher percentage of their income in taxes. I must confess I've really been having a hard time understanding this reasoning. It might come from an inappropriate emphasis on the word "equal", which doesn't necessarily mean "fair". After all, a straight head tax of $1000 per person per year would be equal in dollar terms, but impossibly burdensome on the poorest, and imperceptibly so on the richest. Obviously fairness does not demand arithmetic equality; why should we assume it would require equal percentage rates?
     But that seems to be the core of the objection: progressive income tax treats the rich and the poor differently. And I want to argue that it doesn't, at least, not in a discriminatory way.
     Think of it this way. You are moving along a road. Every meter you travel horizontally is a dollar in your pocket. Every vertical meter you ascend is a dollar in taxes. At first, the road is level, or even slopes gently downward (if you're receiving social assistance from the government, perhaps). But as you move farther along, it gradually begins to slope upward. After a hundred kilometers or so, you're heading up quite a noticeable grade, and in another thousand kilometres, it gets steeper yet. But it never becomes quite vertical; it's always possible to travel another meter horizontally, although you may need to climb more than a meter vertically to do so.
     Now, as you strain your way up the steepest part of the slope, you may cast a longing glance backwards at those lucky people ambling easily along the gentler rise behind you, and lament how unfair it is that they have an easier time than you. But is in unfair? Are those people enjoying some benefit or advantage that is denied to you?
     Of course not. You've already travelled that stretch of road. You just travelled it much faster. Perhaps you had a bicycle, or a car, that let you cover those kilometers so quickly, while they're jogging, walking, or even crawling. There is no advantage they have over you that you haven't already enjoyed. You might legitimately complain that the road is too steep for you here, and you might even decide to emigrate to a different country where the roads are flatter, but you are in absolutely no position to complain about unfairness.

     And so, likewise, with progressive income tax. The very rich are not being penalized by higher taxes any more than you, having already travelled the gentle slopes, are being penalized by a steeper hill. They have already earned and used up their Basic Personal Exemption, and paid the same low tax rate as everybody else on the first few tens of thousands they earned this year. It's just that the tax rate, like the road, gets steeper the farther you travel along the income axis.

     It's important to emphasize that in this argument, I'm not claiming that we should implement progressive (or more steeply progressive) taxes because it would be fair to do so. Rather, I am here attempting to refute the specific objection that progressive taxes are unfair, which once you understand the math, is not just wrong but almost incomprehensibly wrong.

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