Progressive Taxes Could INCREASE Inequality

UPDATED 2015/01/28

Cathie Jo Martin and Alexander Hertel-Fernandez wrote an interesting article on Vox arguing that progressive taxation increases inequality.  It is a counter-intuitive argument, but their graph gives evidence for it:

OECD_Tax-RedistributionTheir theory is that progressive taxation leads to political and governance problems.  On the political side, elites resent progressive taxation and strive to subvert governance instead of unifying around increasing the efficiency of government.  Elites are natural leaders because of their tremendous economic and political resources and when a large fraction of the power of a nation feels that they are unfairly taxed, they can do a lot of damage.  In countries with less progressive taxes like Sweden and Denmark, you would never hear national political leaders like Mitt Romney complaining to wealthy donors that 47% of citizens “pay no income tax” and don’t take “personal responsibility…for their lives.”

The poorer half of Swedish society has greater capability to take personal responsibility for their lives because Sweden’s business class wants to invest more in the human capital of their labor force than America’s business class.  Because of greater support for the Swedish government to provide quality minimum standards in education, healthcare, and childcare to increase labor productivity, Swedes have more equal opportunities to get good jobs and that gives them more incentive to contribute to society.

Another political science theory says that voters make better, more informed decisions when they have to pay more taxes because voters hold governments more accountable for efficiently spending tax dollars when they all feel the burden of taxation.  One of the political problems for governments that get all their revenues from mineral wealth like Alaska or Saudi Arabia is that the masses don’t care as much about how badly the government works if they feel like they are getting something from the government for no sacrifice.  The government benefits in these nations are like manna from heaven that tend to stave off populist political reforms and revolutionary pressures.  Government without taxation is a recipe for citizens to put up with corrupt, inefficient governments that choke long-run economic growth.  Nations that tax all workers tend to be more democratic and less corrupt.  And because citizens trust efficient governments more than corrupt governments, they are happier for the government to expand its provision of  education, healthcare, and other services that increase human capital and increase productivity.  This is another illustration of how reducing inequality often increases efficiency.

So higher taxes on the poorer 47% of Americans could end up making them (and the median) better off by increasing the efficiency of our democracy and paying for greater investment in their human capital like Scandinavia does.  And it would make people like Mitt Romney happier to feel like they live in a nation with fairer taxes.

UPDATE: I did a TV interview on this topic for WLIO and I didn’t bother to get the video, but Branden Ferguson did a writeup about it that isn’t quite accurate.  I argued that greater government social spending is more correlated with equality than greater tax progressivity.  I showed one of the best works of research on progressivity of taxation from Monica Prasad and YingYing Deng, who calculated total tax burdens at different levels of the income distribution (gated):

progressive taxationPrasad and Deng also calculated the total progressivity of governement after spending is also included.  Unfortunately, they didn’t correlate the two measures into a scatterplot like in the graph at the top of this article (and I don’t have the time at the moment).  That would have been a more useful display of their data than two separate graphs.  If someone does this work, please leave me a note about it in the comments.

total progressivity

Posted in Development, Inequality, Medianism, Public Finance

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