Chad Perrin: SOB

11 February 2008

progressive and regressive taxes

Filed under: Cognition,Liberty — Tags: , , , , , , , — apotheon @ 12:54

I’m sure many of my readers have heard the terms “progressive tax” and “regressive tax”. I know I’ve run across them enough to suspect I’m not the only one that hears these terms used in vain.

Most people who use these terms don’t know what the hell they’re talking about.

In general, I tend to hear the terms “progressive” and “regressive” used by left-wingnuts in a pejorative fashion. “Regressive” is pejorative in the obvious, direct manner; “progressive” is pejorative in the “everything sucks except us” sense.

  1. Progressive tax gets used to refer to taxes that take more resources from the rich and fewer resources from the poor. The term is used in this fashion to promote a positive view of a given system of taxation, in much the same way that left-wingnuts refer to themselves as “progressive”, as though being a leftist is the only way one can be counted among the allies of “social” progress.
  2. Regressive tax gets used to refer to taxes that take more resources from the poor (as a percentage of the total resources of such people). The term is used in this fashion to promote a negative view of a given system of taxation.

These are not technically accurate uses of the terms. In truth:

  1. Progressive taxation is a system of taxation wherein the amount of levied tax grows with the taxed value.
  2. Regressive taxation, by obvious contrast, is a system of taxation wherein the amount of levied tax shrinks with the taxed value.

The other side of the coin of pejorative use of these terms is the definition of wealth. Wealth tends to get defined by left-wingnuts in whatever manner is most convenient for them at a given moment when trying to mount a rhetorical attack against some class of people. The economic definition of wealth, however, is the total value of resources available to a given entity, including real estate, property, and money.

Thus, by definition, an income tax that is strictly progressive is one that taxes income progressively — not wealth. A regressive transaction tax is one that, by definition, taxes transactions regressively — not consumption, and certainly not wealth.

A transaction tax will, within very limiting low-wealth constraints, tend to be measurably regressive as regards wealth — but that entire tendency pretty much evaporates at wealth levels that make subsistence a non-issue. There are effective minimum expenditure rates for subsistence, and as wealth increases the effect of these rates on total wealth approaches zero — it is only at the lowest levels of wealth that such subsistence expenditure rates can provide an effectively wealth-regressive taxation rate.

(Note that “transaction” or “transfer” taxes comprise a class of taxation that targets real estate title transfer, sales, gifts, inheritance, and other such property title transfers.)

Transaction taxes have a slightly stronger tendency toward a regressive relationship with income, but even this is a very limited relationship that applies only at the lowest levels. As with wealth, there is a “soft” ceiling on how much income growth is affected regressively by transaction tax levels — only below some sustainability line of income level can a transaction tax really be measurably regressive, because subsistence requirements do not grow with the level of income. Because “income” broadly encompasses wealth aggregation, and transaction taxes substantially encompass wealth expenditure, the tendency toward a regressive relationship to transaction taxes is somewhat stronger than in the relationship of such a tax with wealth; wealth in and of itself is measured as a snapshot, ignoring matters of income and expense. Thus, wealth itself is not as strongly tied to the tax in terms of determining progressivity or regressivity because there are many other factors involved.

In either case — wealth or income — however, other classes of expense tend to make up the lion’s share of allocation of resources above levels substantially dominated by subsistence requirements. This is why the whole notion of a transaction tax having a generally measurable regressive relationship with either income or wealth entirely falls apart beyond very limited, poverty-level scope. Furthermore, greater wealth (and, less directly, greater income) generally encourages more investment in income generating properties — which, in a non-broken system, would translate to greater transaction costs (and, thus, to greater susceptibility to the effects of a transaction tax). The end result might be that a middle class would be least susceptible to the effects of proportional transaction tax rates relative to total wealth and/or income. I might address this in more depth later, but I’ll give you a hint now as to why that is:

As income increases, savings rates tend to decrease, because the need for specific savings decreases.

A proportional tax is a tax that is neither progressive nor regressive with regard to its targeted value. This would, in essence, involve nothing more complicated than coming up with a single percentage and applying it evenly across the board.

As such, if you want to avoid a wealth-regressive or income-regressive tax, but at the same time want to avoid punishing productivity, and simultaneously avoid the tremendous bookkeeping costs of trying to manage a true wealth tax, you could do much much worse than a proportional transaction tax. Obviating the regressive tendency of such a tax at the lowest level would require nothing more than an annual transaction tax discount card — much less paperwork and bureaucracy necessary than the current progressive income tax system requirements. Such a tax discount could simply eliminate any and all transaction taxes below a given income level, based on the previous year’s reported income.

. . . and whether you disagree with that or not, please don’t use the term “regressive” to refer to a transaction tax as though the very concepts were indivisible.

4 Comments

  1. That is an excellent point about the discussion of “progressive” and “regressive” taxation. In the essay I am writing, I discuss the idea of “wealth” as well, but after reading this, I think I need to slightly revise my wording since (for the time being), I am strictly discussing wealth generation, not wealth on hand.

    “This is why the whole notion of a transaction tax having a generally measurable regressive relationship with either income or wealth entirely falls apart beyond very limited, poverty-level scope.”

    This is the real nut of the problem in any discussion of economic policy, and is the central focus of much of the essay I have been working on. The bell curve of income distribution starts at “$0” and ends at $infinite. That’s not the issue. The distribution is pretty standard if you split it into 20% brackets and have the final 20% start around $150,000 per year. The problem is not that about 20% of the population falls into the bottom 20%. That’s normal, and there is nothing necessarily wrong with that. The problem is, what quality of life is possible for someone in that bottom 20%?

    The answer, as many people will tell you with anecdoctal evidence, is that you can live quite well even in the bottom 20%! In fact, you can live better in the USA’s bottom 20% than in the middle 20% in probably 75% of the world.

    If.

    If one makes extremely rational, good and well informed decisions, starting around age 14 – 16.

    And that is one heck of a big if. There’s another one, and it has to do with your parents. Sure, by age 14 – 16, someone as free will, and they can’t really blame their parents for everything. But if their parents failed to equip them with the tools they need to make those decisions properly (for whatever reason), those kids almost overwhelmingly make the wrong decisions, and end up with 3 TVs, 5 DVD players, $200 shoes and are stuggling to pay the heating bill.

    The liberals get mad whenever the conservatives suggest (or outright say it) that people’s decisions are the root of how they live. On the flip side, conservatives refuse to beleive that their are causes and conditions behind people’s poor decisions which are not always within their control, or they have been “set up for failure” by their parents. The simple fact of the matter is, a kid who grows up in a household where sound financial informtion is not provided, saving is not valued, and a “c’est la vie” attitude towards personal responsibility is not likely to make good use of their free will, no matter how much or how little of it they might have.

    Of course, I am certainly not advocating thought control, child confiscation by the government, or other means of coercing people into making the “right” decisions. But I do beleive that any sound economic policy will have at its core a strong educational component, particularly regarding personal money management, and must recognize that “free will” does not equate to “rational agent”.

    Of course, I’m giving a lot of the points of my essay away here, but that’s OK. Better to get it out & discussed & refined that to try just dropping a giant pile of garrbage off untested. :)

    J.Ja

    Comment by Justin James — 11 February 2008 @ 01:35

  2. Your point about the bottom 20% is something that really needs to be more widely understood — and it’s something I tend to incorporate into my own commentary in response to “welfare fixes everything” types. Enhancing the productivity of a society elevates the standard of living of everybody, not just the rich.

    A small part of the reason I lean in a libertarian direction is, simply put, the fact that I want to see standards of living increased as compared to what they were previously — not just to see some arbitrary standard of monetary favor increase in comparison with some other person. Economics is not a zero-sum game. Everyone can benefit at once: you don’t have to destroy one person to help another.

    Comment by apotheon — 11 February 2008 @ 06:38

  3. “… I want to see standards of living increased as compared to what they were previously — not just to see some arbitrary standard of monetary favor increase in comparison with some other person. Economics is not a zero-sum game. Everyone can benefit at once: you don’t have to destroy one person to help another.”

    I am in FULL agreement with this slightly truncated statement. The problem is, “how do we make sure that children have a great opportunity for success, regardless of their parents?” When we can come up with a good answer to that, I will probably be fully in favor of the libertarian position and the theory of free market economics. I don’t mind a few wolves roaming around flocks of well informed, rational agents. I object to a few wolves roaming around a flock where most of the sheep are ignorant of “financial hygeine”, unwilling to practice what little they know, and make major financial decisions by essentially shooting from the hip. The damage to the overall economy when the “sheep” willingly allow themselves to be financially victimized and then require bailouts in one form or another every 10 years is insane. Even worse, a major portion of the economic willpower and strength is tied up in taking advantage of these suckers instead of generating real economic activity that adds values. It is really difficult to grow the economy when much of the economic activity taking place is building houses for people who cannot afford them unless they get a sub-prime mortgage AND sell their current home at inflated prices to someone else with a sub-prime mortgage. Or to rephrase it, I do not consider an economy based on the loaning and reloaning of money to be particularly sound. And that is precisely what we have, since consumer spending is 2/3rds of the economic activity, and the average household has a negative saving rate.

    Then again, the US government does exactly the same thing. A file cabinet full of IOU’s indeed.

    J.Ja

    Comment by Justin James — 12 February 2008 @ 10:32

  4. The problem is, “how do we make sure that children have a great opportunity for success, regardless of their parents?” When we can come up with a good answer to that, I will probably be fully in favor of the libertarian position and the theory of free market economics.

    We don’t. Sad but true. All the wishful thinking in the world doesn’t change the fact that economies are simply too complex to control everything, and the moment you start trying to control everything you start screwing things up. The best we can do is try to ensure there’s a framework in place for prosecuting provable misconduct.

    When you start meddling in things like that too much — such as by appropriating money from large numbers of people to try to fund “public” education — what you end up doing is screwing up the inherent incentives in the market, hampering overall productivity, slowing advancement, and so on. The end results is that you actually do damage to more children’s chances of success than you help. It’s a net loss.

    Free markets aren’t just about improving economic efficiency. They’re more about not screwing up economic efficiency in the pursuit of improving it. A free market approach to economics is about avoiding policies that amount to burning the village to save it — which is what interventionist policies really do. Every time someone tries to manipulate economics by redistributing income, treating it all as a zero-sum game, that person screws with incentives and productivity, stealing resources from the “engine” of the economy.

    Furthermore . . . any project like “public” education creates inherent conflicts of interest, and we end up with problems like the current “public” education system’s relentless tendency to suck the curiosity out of otherwise eager students, to impart inaccurate knowledge, and to completely fail in its supposed primary aim (presumably to help people learn how to learn, how to think critically, how to communicate, and — first and foremost — how to be reasonable, responsible, free-thinking adults).

    I don’t mind a few wolves roaming around flocks of well informed, rational agents. I object to a few wolves roaming around a flock where most of the sheep are ignorant of “financial hygeine”, unwilling to practice what little they know, and make major financial decisions by essentially shooting from the hip.

    This is exactly what’s wrong with an interventionist economic policy. I don’t understand why you’re listing this as a support for your statement that you disagree with libertarian free market policy.

    It is really difficult to grow the economy when much of the economic activity taking place is building houses for people who cannot afford them unless they get a sub-prime mortgage AND sell their current home at inflated prices to someone else with a sub-prime mortgage.

    This is a problem created by economic interventionist policy. The sub-prime mortgage crisis was created by the manner in which the government (via the Federal Reserve banking system) props up the shell game loaning institutions play with money. To explain in some kind of useful depth, I’d have to spend quite a few words on it, but in short I’ll try to summarize:

    1. Foo loans to Bar on an extremely short schedule, and accepts an extremely small interest rate on the loan. There are 300 million examples of Foo.

    2. Bar loans back to a smaller subset of Foo at an extremely long rate of return, at much longer loan periods, using money from the 300 million Foo who loaned to Bar in the first place, with a much higher interest rate. There are considerably fewer than 300 million examples of Bar.

    3. Bar profits from the differential in interest rates, as long as the subset of Foo doesn’t start defaulting on its loans, and as long as the total set of Foo keeps renewing the loans it made to Bar. If there’s a bad enough mismatch between how the two work out — defaulting on loans and calling in loans — Bar has to default.

    4. But wait! There’s more! Bar doesn’t have to worry about that, so much, because it can always do the equivalent of “selling” the loans it has out to the subset of Foo for a smaller profit — but enough of one so it never has to default on a loan! The “buyer” is Baz, which is willing to buy the remainder of a loan at less than the total remaining value with interest rate.

    5. Because most of what Bar has received so far in payment is interest, though, this means that Bar squeaks by with a slight profit overall — and Baz now “owns” a loan at a cost of less than the value of the loan. This allows Baz the ability to give the beleaguered Foo a discount on settling the loan, making it seem like a great deal after that financial collapse that led to loan default (I use the term “default” loosely here), while still providing Baz an overall profit.

    6. This is all just peachy, until such time as more parties are calling in loans than can be covered. Then, everything comes crashing down — because all of Bar is playing the same damned shell game.

    The problem is that this behavior all seems perfectly safe and profitable as long as you’re the only person playing this dangerous shell game with loan funds — or as long as you’re part of a reasonably small subset. When everyone is doing it, though, all that’s required for a bona-fide financial crisis to occur is for a minor miscalculation in likely rates of default and loan term enforcement to screw things up on a wide scale. Suddenly, all those buyers stop buying, because part of what makes it all profitable is the ability to shuffle the properties paid for with loans around and resell them. When too many of Foo are in default already, and (more to the point) are way too high a credit risk to take a chance on a loan, there’s no market for even recouping further losses — let alone make a profit.

    Here’s where government intervention comes in:

    The government provides an illusory safety net. As long as the Federal Reserve and Congress provide bailouts and try to manipulate markets to “create” money when “needed”, this kind of behavior by Bar and Baz is enabled. In short, when you subsidize failure, you get more of it.

    Part of the problem is not just bailouts and Federal Reserve interest rate manipulations, though. There’s also the very institution of the corporation itself — something that could not exist without government intervention in the economy. The corporation serves as an insulating device, protecting decision-makers substantially from the consequences of their own choices. What happens when a lending institution’s CEO screws up so badly a bank goes out of business? He or she loses his or her job. What would happen if it was his/her own money being loaned out according to his/her policies? He/she wouldn’t just lose his/her job — (s)he’d lose his/her money. Since that doesn’t happen, though, it’s “okay” for him/her to take those chances — because, most of the time, they pay off and make him/her look like a hero to stockholders.

    Even stockholders are insulated somewhat. They “diversify portfolios” to protect themselves against such eventualities as losing everything when all eggs are in one basket and the person carrying the basket (the CEO) drops it. This allows them to tolerate greater risk in individual investments by spreading that risk out in a manner that statistically reduces the damage of failures, providing greater safety in profit-making schemes overall — until the first major statistical anomaly. Then, we get the sub-prime mortgage crisis (or a similar problem), and everyone loses his or her shirt. This illusion of safety is created by the individually insulating function of corporate law, where nobody has to cover the entire financial burden of a loss to a lending institution — it’s shared, diffused across many stockholders, and cushioned, as long as a disaster is localized.

    So . . . between bailouts and Federal Reserve manipulations on one hand, and the insulating properties of corporate law on the other hand, people are encouraged to behave economically in a manner that actually leads to failures like the sub-prime mortgage crisis. If you want to fix the problem, get government out of economic management.

    If you decide you want to do that, you’ve just become a free market libertarian, at least in matters of the economy.

    (note: I’ve grossly oversimplified a lot of this, of course.)

    Comment by apotheon — 13 February 2008 @ 08:22

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