Two Cheers for Regressive Taxes
David Leonhardt had an excellent article the other day on the long-run need for more tax revenue than can be generated merely be allowing for the expiration of the Bush tax cuts. He makes mention of something called Wagner’s Law, which is related to what I was talking about here, and that basically states that as society gets wealthier it demands more and more of the sort of services that need to be provided by the government. That means that over time as the economy grows the share of the economy that becomes tax revenue goes up. This not only meets public demand for more public services, but provided the tax rate doesn’t go up too rapidly, people’s after-tax income is still rising so private consumption goes up along with public services. And as he observed “the problem can’t be solved just by taxing the rich” largely because there aren’t that many very rich people.
The moral of the story, I would say, is that the left will need to embrace some revenue enhancements that are not-so-progressive in their distributional impact. I think that means, in the first instance, taxes on behavior that’s undesirable—carbon taxes, alcohol taxes, congestion pricing, market pricing of parking, etc. (obviously some of this stuff would be for local government rather than the federal government)—and in the second instance the dread VAT.
But why would progressives want to embrace non-progressive revenue sources? Well, fortunately Lane Kenworthy did an excellent post on this a year ago that contains graphs I can steal. The first chart shows that if you look around the one at what it is countries do to mitigate income inequality, nobody is substantially equalizing things through the tax system, but many countries are substantially equalizing things on the spending side:
Not that progressive taxation is a bad thing, or meaningless in the contribution it makes, but clearly insofar as direct public policy interventions (as opposed to things like wider distribution of educational attainment) are going to reduce inequality, it needs to be done on the spending side. Now this raises the question how do you get the spending side to do more? Is it by “means testing” existing programs and creating new small-bore “targeted” programs aimed at the neediest? Well, not really:
The most important thing is to just have lots of tax revenue. Public expenditures are pretty progressive in their impact everywhere, and the difference between a very progressive and a not-so-progressive system is mostly that the more progressive ones are bigger. So while liberals have no reason to give in to conservative demands to make the existing revenue scheme less progressive—by adopting a flat tax, say, or replacing the income tax with a consumption tax—there’s very good reason to basically be looking for revenue by any means necessary. If it’s easier, politically, to get some center-right politicians on board for new consumption taxes than for higher income taxes, then it’s incumbent on progressives to walk through that door and take the revenue. At the moment, of course, that’s not an open door so there’s really no need to worry about it either way. But this is the kind of choice you can imagine progressive politicians and/or activists facing at some future point, and I think it’s important to start building understanding of the structure of the choice.
45 Responses to “Two Cheers for Regressive Taxes”
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February 27th, 2009 at 3:55 pm
Why not something like a modest financial transaction tax? Dean Baker estimates that “a tax of 0.02 percent on the purchase or sale of a future contract or a tax of 0.25 percent on the purchase or sale of a share of stock” could raise $150 billion a year. That’s not enough to close the deficit, but assuming the amount stayed relatively stable, it’d be a big step in the right direction.
Even if these are unthinkable right now, why not see how much paring back farm subsidies and the mortgage interest deduction for everyone would raise? I wonder how many hundreds of billions that eliminating the deduction entirely would raise.
Also, can’t consumption taxes be progressive? Robert Frank of Cornell has written a bunch of columns for The New York Times claiming just that and singing the praises of these kinds of taxes.
February 27th, 2009 at 4:03 pm
Question: given increased/ing inequality in terms of wealth and income, why would regressive taxation yield more revenue than progressive taxation? As opposed to just increased taxation generally?
February 27th, 2009 at 4:05 pm
The reason Europe can afford to have the tax regime and the spending regime shown in the chart at the same time is that they spend way less money on the military than we do. We need more progressive taxes. Why? You know whose assets are so valuable we need multi-billion dollar aircraft carriers and advanced weapons systems to defend them? The RICH PEOPLE! I assure you, people who don’t like us so much don’t have an issue with America because of my apartment full of used books and doggie toys. It’s all about the $$$.
February 27th, 2009 at 4:12 pm
There are basically three claims to this argument:
(1) The easiest way to reduce inequality is through high levels government transfer payments
(2) Higher levels of transfer payments need to be funded through higher overall levels of taxation
(3) Higher overall levels of taxation can only be accomplished with the addition of regressive taxes.
(1) and (2) are basically correct, but (3) isn’t. This is especially the case where the pre-tax distribution of income is highly unequal, like it is in the U.S.
February 27th, 2009 at 4:13 pm
I’ve actually seen OECD data showing that Sweden’s taxes are regressive, but that taxes and transfers together drop the Gini by about .12.
All those high-tax countries do it with the VAT, by the way.
February 27th, 2009 at 4:14 pm
The reason Europe can afford to have the tax regime and the spending regime shown in the chart at the same time is that they spend way less money on the military than we do
And rightly so. No country is going to attack the EU, or the US. There is no need for American troops anywhere in the world, except East Asia. Most of American wars have been a complete disaster since WWII.
Europeans are smart, we are dumb, or just too much in love with the military industrial complex.
February 27th, 2009 at 4:16 pm
Brian J,
Dean B’s “tobin tax” would be a horrendous idea. Speculation on relatively liquid products that are leverage restricted do not cause crisis and did not cause our current crisis. Speculation on assets that are infrequently traded and have essentially unrestricted leverage are a different story. These types of trades are what caused our current crisis and are what caused the dot com bubble as well. It was not the retail speculation in stock – it was the usage of internet stocks to buy real world companies and cash flows. Essentially, the stocks became like money and were used as money. The leverage came in from the float vs. the entire value of the company – when they would float 10% of a company and use the 90% remaining to purchase real world assets.
Matt, you need to understand the money creation process as described by Warren Mosler. Most arguments you make regarding taxation are based on the assumption there is some merit to having a balanced budget or even a surplus. Balanced budgets and surpluses are horrible for economies.
February 27th, 2009 at 4:24 pm
If you expect people’s after-tax income to rise, 100% of additional taxation has to come from the rich, since the rich capture 100% of US economic growth and have since the 70s.
February 27th, 2009 at 4:27 pm
“—there’s very good reason to basically be looking for revenue by any means necessary. If it’s easier, politically, to get some center-right politicians on board for new consumption taxes than for higher income taxes, then it’s incumbent on progressives to walk through that door and take the revenue. At the moment, of course, that’s not an open door so there’s really no need to worry about it either way. But this is the kind of choice you can imagine progressive politicians and/or activists facing at some future point,”
Possible, but not necessarily probable. Large shifts in economic policy tends to be monopartisan. More regressive taxes wouldn’t be popular with voters. US taxes arent’ very progressive at the moment.
A better argument would be that at some point it’ll be more problematic making the tax code even more progressive, and that that wouldn’t be the end of the world.
A better argument
February 27th, 2009 at 4:29 pm
“If you expect people’s after-tax income to rise, 100% of additional taxation has to come from the rich, since the rich capture 100% of US economic growth and have since the 70s.”
True, but in Matt’s future world where the left and center-right team up for one more round of hefty tax hikes, that might no longer be the case.
February 27th, 2009 at 4:30 pm
Put your Majic Ponies back in their stalls chilluns.
Taxing the 2% Uber Rich to death will simply not finance the vast Left Wing Society Matt visions for us all.
As you have been told all along the only way the ProgRev can be financed is by higher taxes and fees on the middle class.
The cap and trade fees are just such a tax.
Now Matt argues that da peeps done voted for all this when electing da ObaMessiah to lead us to Nirvana land and I don’t mean Seattle.
But that is a lie.
Da peeps heard Obama promise the land of milk and honey with no tax increase, indeed heard tax cuts, for the middle classes. And that is what da peeps expect.
The moment da peeps finally get it that there is no free lunch, that ObaLand offers them a lower standard of living with higher taxes and fees, that is the beginning of the end for Barry.
The Repubs are betting that happens in the next year and a half.
The Dems hope that the Stimulator will postpone that reckoning past November 2009.
Who really knows about that race? But the reckoning must come.
And by the way, when does Obama now promise the first division home from Iraq?
He has gone from one a month to some date past Nov 2009 for a much smaller partial withdrawal.
All of this is simply another lie from Obama, more of the samo samo.
The only difference between Bushit and Obama is who they are giving their ill gotten gains to; both are equally intent on fucking over the middle class.
February 27th, 2009 at 4:31 pm
The rich getting richer is a problem that appears to have cured itself over the last 5 months.
There won’t be a whole lot of super rich people for a decade or so, just as there weren’t after 1929. So, Obama’s spending plans are going to require squeezing hard families who make between $100k and $250k.
February 27th, 2009 at 4:43 pm
Dean,
The rich have already captured about 40 years of growth, so I am not too worried about them having a few down decades.
Steve,
I do not think your claim matches with reality.
February 27th, 2009 at 4:55 pm
I’m not sure I like the general drift of this post. I Matt trying to be a caricature of a “tax and spend liberal” as defined by Rush Limbaugh? Each progressive program should stand or fall on its own merits. A general call for higher taxes and bigger government is not very useful.
Also, JT, I might be interested in your opinions if you could express them in a less jackass-y way.
February 27th, 2009 at 5:08 pm
“US taxes arent’ very progressive at the moment.”
According to these data from the non-partisan Congressional Budget Office, effective federal tax rates in America (taking into account payroll taxes as well) are highly progressive. In 2005, the lowest quintile of earners had an average effective federal tax rate of 4.3%, and the highest quintile had an average effective federal tax rate of 25.5% (the top 1% paid 31.2%).
February 27th, 2009 at 5:33 pm
I didn’t say federal taxes. State taxes are regressive.
February 27th, 2009 at 5:38 pm
The trouble some people on the left have is that they seem to want to punish the things they don’t like about America – suburbs, shopping, meat eating – more than they seem to want to preserve the things they like about America.
The only kind of environmentalism that has ever appealed to Americans is conservationism, not left-wing puritanism.
But you’re never going to convince me of the need for any new taxes save rolling back the Bush tax cuts.
February 27th, 2009 at 5:42 pm
“I didn’t say federal taxes.”
You said “US taxes”. “US” generally refers to federal.
“State taxes are regressive.”
Which state in particular are you referring to, or are you making this claim of state taxes in general? What are you basing this claim on?
February 27th, 2009 at 5:53 pm
Re: There won’t be a whole lot of super rich people for a decade or so, just as there weren’t after 1929.
There were indeed super-rich people in the 1930s. The Fords, the Rockefellers and the Vanderbilts were not eating at soup kitchens after all. (Nor were the Roosevelts). The Depression did however cause the wealthy to hide their riches from the public eye rather than flaunt them as they had in the past. and a case can be made WWII clipped the wings of the American upper class more than the Depression did.
February 27th, 2009 at 6:08 pm
JonF,
Higher income tax rates don’t target the super-rich anyway (i.e., the Gates and Buffetts who own big chunks of their own businesses); they target the salaried rich. The ranks of the salaried rich have gotten hammered. In recent years, the financial sector generated about 30% of U.S. corporate profits. I wouldn’t be surprised if it generated an even higher percentage of private sector compensation, since comp was often the biggest expense item at Wall Street firms. Hundreds of thousands of financial sector workers are now out of jobs, and most of those that are still working are making a lot less.
February 27th, 2009 at 6:32 pm
Just thinking out loud here, but I wonder if some “sin” taxes don’t have a progressive impact in non-economic ways. For example, it’s well known (right?) that poorer people are more likely to smoke. So to the extent that high cigarette taxes encourage people to quit or smoke less, it has a disproportionately positive effect on lower income people (who also may be more sensitive to the impact of the tax). This assumes, of course, that you see not smoking as positive.
This doesn’t make the tax progressive — and obviously doesn’t apply to carbon tax (rich people use more energy) — but maybe it’s some kind of silver lining.
February 27th, 2009 at 6:33 pm
One the better posts you have ever written, MY. You have finally interested me.
A Pareto political economy? Meaning not a Pareto optimum, but one based on Pareto’s Law of Elites. With regressive, Pigouvian, and consumption taxes, and after the top 19% of households adjust their consumption downward (they are able), you will pretty much lock in an wealthy/political/professional elite, secure and untouchable, inheritable forever.
Now it could be that social disruptions are caused by misguided attempts to change leadership, not within the elite, but say when the 3rd & 4th quintiles have opportunities beyond their abilities to responsibly manage. So with regressive taxes and social Keynesianism, you will not only bring the bottom two quintiles up but the 3rd & 4th quintiles down to meet them.
It’s like the medieval sumptuary laws, keeping the merchants and lawyers in their place, reminding them who is boss & always will be.
February 27th, 2009 at 6:41 pm
ut again, with government services/transfers at say 50% of the economy, essentially self-sustaining, both politically and economically, because politically supported and financed by the people who need and use those services & transfers…
the rich can speculate and gamble as they will without much damage, because they will always be messing with each other’s money…
…except for the war thing, which is where these heirarchical systems always tend to go. The rich get bored.
February 27th, 2009 at 7:00 pm
You are auditioning for Slate, aren’t you?
February 27th, 2009 at 7:16 pm
And it’s only coincidence that this lets you go ahead with all the micromanagerial social-engineering policies you favor anyhow.
February 27th, 2009 at 7:22 pm
As DTM says, the curve fit in the second chart is crappy. What it tells me is that although higher tax levels lead to lower inequality on average, there are a lot of outliers. Germany in particular is a big country and it combines nearly the largest reduction in the gini coefficient due to the transfers with low mid-range tax levels.
Australia manages much higher gini coefficient due to transfers with a modestly larger increase in spending.
Instead of drawing Matt’s conclusion (high taxes = low inequality) I would suggest looking hard at Australia. Australia and the US share a lot of cultural similarities, and they manage to use government to significantly reduce inequality without increasing the size of government too much. That seems like a package that can be sold in America.
February 27th, 2009 at 7:46 pm
Dave Weman,
I didn’t say federal taxes. State taxes are regressive
Please present your data showing that state taxes are regressive. Thanks.
February 27th, 2009 at 7:54 pm
According to these data from the non-partisan Congressional Budget Office, effective federal tax rates in America (taking into account payroll taxes as well) are highly progressive.
Not only that, but federal taxes have become significantly more progressive over the last three decades. The share of total federal taxes paid by the top 1% of households by income almost doubled between 1979 and 2005, from 15.4% to 27.6%, while the share paid by the lowest quintile fell from 2.1% to 0.8%.
February 27th, 2009 at 8:47 pm
It seems to me that there are several things that need to be addressed if, as a country, we want government to occupy a larger portion of the economy. The European states are able to reduce inequality through transfers, but it comes at a high price to growth. We need to reduce the tax burden on capital/investment for a supply side shock and at the same time impose the VAT or sales tax. The regressive nature of the VAT or sales tax can be corrected through tax credits for lower incomes. You need higher growth to reduce unemployment or we will just end up lowering our overall living standards. There is a plethora of research showing that taxes on capital are less efficient than taxes on consumption. That being the case, a cut in taxes on capital and a concomitant imposition of a VAT or sales tax should produce a higher growth rate which in turn should produce higher revenue for government. I am not advocating eliminating taxes on capital or income, but reducing them to relieve the growth inhibiting behavioral consequences.
Another thing that gets ignored in the inequality debate is the role of monetary inflation and political corruption. Living in Miami, maybe I have a better view of what causes inequality because I’m so close to Latin America, but it seems obvious that these two factors are correlated with inequality. There is academic research to back that up:
http://econpapers.repec.org/paper/cprceprdp/3470.htm
There are others as well, but I don’t have time to dig them up. There is also a correlation between gini coefficient and political corruption.
When I speak of inflation, I use the classic definition of an increase in money supply relative to demand. If one thinks about how inflation of money and credit is distributed, I think it becomes clear that inflation of the money supply is a signficant factor in producing inequality. When new money is created by the Fed or the banking system, it is the wealthy that benefit first from this new money. As it circulates through the system, the price of goods and/or assets rise. By the time it reaches the poor the purchasing power of the new money has diminished.
Over the last two decades we have seen three asset bubbles. Ask yourself who benefitted most from the internet bubble, the housing bubble and the commodity bubble. The wealthy who funded the venture capital firms who in turn funded the internet companies were obvious beneficiaries of the internet bubble. Poorer people were stuck buying the inflated stocks after they were floated on the market. In the housing bubble, the wealthy or relatively wealthy, already owned real estate which rose in price. In the commodity bubble, the poor got killed by high gasoline and food prices which had a relatively minor impact on the rich.
If we are to reduce inequality and fund higher levels of social spending we cannot do it without a higher growth rate. Merely adding new taxes, regardless of their efficiency, is not the answer. The answer is to find a balance between consumption taxes and capital and income taxes. Any real answer will also have to address the serial inflations of the Federal Reserve. While a gold standard has many drawbacks, it may be the only way to restrain the inflationary tendencies of a central bank. At a minimum, the Fed should have its mandate reduced to maintaining the purchasing power of the dollar and leave growth management to fiscal policy.
February 27th, 2009 at 8:57 pm
“Australia and the US share a lot of cultural similarities, and they manage to use government to significantly reduce inequality without increasing the size of government too much. That seems like a package that can be sold in America.”
A major reason for Australia’s relative lack of inequality, I suspect, is its immigration policy, which selects for highly-skilled (i.e., high earning potential) immigrants. Another reason is that Australia is extraordinarily rich in natural resources, particularly on a per-capita basis. Jobs in natural resources tend to pay well, and there are plenty of those kinds of jobs in Western Australia (there would be more if Australia’s government didn’t limit uranium mining so much).
February 27th, 2009 at 9:23 pm
Joe Calhoun:
I like the way you think.
February 27th, 2009 at 10:38 pm
The most likely vehicles for a VAT will be Social Security and health care. We could basically eliminate or greatly reduce the current payroll taxes and create a VAT that will keep Medicare, Social Security and the new universal health care plan solvent. But it doesn’t seem to me like Obama is going to do it.
February 28th, 2009 at 2:06 am
But that doesn’t reflect progressive taxation, that reflects the increasing income gains of the rich. The real statistic is that the marginal tax rate on the wealthiest one percent has fallen from 37 percent to 31 percent over the same time frame.
February 28th, 2009 at 4:51 am
“A major reason for Australia’s relative lack of inequality, I suspect, is its immigration policy, which selects for highly-skilled (i.e., high earning potential) immigrants. Another reason is that Australia is extraordinarily rich in natural resources, particularly on a per-capita basis. Jobs in natural resources tend to pay well, and there are plenty of those kinds of jobs in Western Australia (there would be more if Australia’s government didn’t limit uranium mining so much).”
Thinking about that second reason some more, I suspect it applies to American states with high levels of per-capita natural resources as well. I would bet that Wyoming and Alaska have lower income inequality than, say, New York. After writing that (honestly), I did a little googling and it turns out to be the case: as of 2006, Wyoming and Alaska had Gini coefficients of about .41 and .42, respectively, and New York had one of about .495.
February 28th, 2009 at 7:01 am
Does Matt really mean to say that we should tax the poor and middle class to fund the lifestyle of the wealthy?
IF you support regressive taxation, you’re not a Progressive. You’re a limousine liberal.
February 28th, 2009 at 9:47 am
Of course all these assumes reducing income inequality is desirable. I say it is not. Some people are rich and others are poor. So what. We need gardeners, hamburger flippers and street sweepers.
February 28th, 2009 at 11:19 am
Re: We need gardeners, hamburger flippers and street sweepers.
Great, so let’s have you volunteer, to flip burgers for a living.
February 28th, 2009 at 1:19 pm
But that doesn’t reflect progressive taxation, that reflects the increasing income gains of the rich.
Whatever it “reflects,” it’s a shift in the tax burden away from the poor and on to the rich.
And the effective tax rate has become more progressive too.
In 1979, the rate on the top quintile was a little over three times the rate on the bottom quintile. By 2005, the top quintile rate was almost six times the bottom quintile rate. There was similar increase in progressivity between the bottom quintile and the top 1%.
February 28th, 2009 at 1:39 pm
Actually, Mr. Kenworthy doesn’t seem to have included state and local taxes. They are considerable.
according to this site, total (the real total) taxes seem to make up 30-35% or so depending on the year over the last nine years…but averaging in the low-mid 30s.
February 28th, 2009 at 2:28 pm
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March 2nd, 2009 at 8:26 am
Thanks for getting progressives thinking about this. It’s been obvious for a long time that we need to raise taxes to 1) reduce the deficit and 2) fund the kind of government redistribution (whether it’s handouts or highways) that is necessary to maintain aggregate demand in a high-productivity society.
In the long run this will result in greater prosperity and growth–which will both accompany and pay for greater equality.
Unfortunately tax increases do tend to retard growth in the short term, so we’ve got a tough road ahead, after thirty years in which politicians have been buying votes with irresponsible tax cuts, and borrowing money to pay for them.
Progressives, wake up. Reagan really really was wrong: we need to raise taxes.
March 2nd, 2009 at 8:41 am
John V:
The site you link to seems to be seriously unreliable.
http://www.usgovernmentrevenue.com/#usgs302
Their source for state and local taxes (US Census) only gives numbers up to the 2005/6 tax year, but they give numbers out to the 2010. And much of the data for many years is unpopulated. Notably, for every year the government transfer number (Fed to state, for instance) is at zero–which strongly suggests double counting.
OECD data tells us that total US taxes have been about 28% of GDP for decades. Europe’s have been about 40%.