On Tax Fairness (1 of 2)

October 20, 2011

First of two parts; for release Oct. 26 (482 words)

by Cecil Bohanon, Ph.D.

If Ms. Jones has 100 times the income of Mr. Smith how much more tax liability should Ms. Jones incur? Fifty times? One hundred times? One hundred and fifty times? Is there some ratio consistent with so-called “social” justice?

Public-choice economists ask a somewhat different question. What are the implications of alternative tax structures for public spending?

Consider a proportional tax on income that that gives no exemptions or deductions or credits, and that allows the legislature to manipulate only one component — the tax rate assessed on income. Under such a simple (and presumably constitutionally restrained) federal tax structure, a one-percent increase in the rate would raise around $84 billion a year in new federal revenue. [1]

It would also impose a $20,000 increase in tax liability on Ms. Jones who earns $2 million a year, and a $200 increase in tax liability on Mr. Smith who earns $20,000. If the powers-that-be in Washington want to increase spending by $84 billion a year to finance a new war or a national system of high-speed rail or whatever, Mr. Smith and Ms. Jones and all of us would know exactly where we stand.

If the same funds are to be raised under the current deduction-filled graduated income-tax structure, there are literally an infinite number of ways to parse up the new tax liability among various taxpayers.

Add in the possibility of deficit finance — which entails unspecified tax increases in future periods — and it becomes rather obvious that part of our fiscal problem traces to an uncertain tax system. Put another way: the very weak link between spending and taxation leads to excessive spending. Add to that fact that a large fraction of income earners pay no federal tax and any tax-based restraint on public spending fades into political oblivion. J.R. McCulloch opined in 1833 that:

“The moment you abandon the cardinal principle of exacting from all individuals the same proportion of their income . . . you are at sea without rudder and compass, and there is no amount of injustice and folly you may not commit.” [2]

A flat tax, so constitutionally constrained, establishes clearly how much each of us pays for public services and makes sure that all of us have a skin in the game.

But isn’t a flat tax unfair? Under a 10-percent flat income tax, Ms. Jones, who earns $2 million a year, pays $200,000 a year in taxes. Mr. Smith, who earns $20,000 a year, pays $2,000. To many this seems quite fair to Mr. Smith: after all a 100:1 price difference for the same bundle of public services (roads, defense, etc) is far in excess of what the rich pay for first-class airfares compared to coach fare paid by their less well off counterparts. And if a 100:1 ratio of public-sector liability for a 100:1 income difference fails the test of “social” justice, what ratio passes?

(Tomorrow: “Designing a ‘Fair’ Tax)

Cecil Bohanon, Ph.D., an adjunct scholar of the Indiana Policy Review Foundation, is a professor of economics at Ball State University. © Copyright Cecil Bohanon; distributed with permission to member newspapers; all rights reserved.

[1] These estimates are from 2008 IRS data found at: http://www.taxfoundation.org/news/show/250.html#Data

In 2008, the flat-tax rate that would in a static analysis raise the same amount of federal revenue as actually raised would be 12.24 percent.

[2] From F. A. Hayek “Constitution of Liberty,” Chicago, University of Chicago Press, 1960.  p.308.


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