Progressive tax

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A progressive tax is a tax where the tax rate increases as the taxable base amount increases.[1][2][3][4][5] The term "progressive" refers to the way the tax rate progresses from low to high, with the result that the average tax rate is less than the highest marginal tax rate.[6][7] The term can be applied to individual taxes or to a tax system as a whole; a year, multi-year, or lifetime. Progressive taxes are imposed in an attempt to reduce the tax incidence of people with a lower ability-to-pay, as such taxes shift the incidence increasingly to those with a higher ability-to-pay. The opposite of a progressive tax is a regressive tax, where the relative tax rate or burden decreases as an individual's ability to pay increases.[5]

The term is frequently applied in reference to personal income taxes, where people with more income pay a higher percentage of that income in tax than do those with less income. It can also apply to adjustment of the tax base by using tax exemptions, tax credits, or selective taxation that creates progressive distribution effects. For example, a wealth or property tax,[8] a sales tax on luxury goods, or the exemption of taxes on basic necessities, may be described as having progressive effects as it increases the tax burden of higher income families and reduces it on lower income families.[9][10][11]

Progressive taxation is often suggested as a way to mitigate the societal ills associated with higher income inequality,[12] as the tax structure increases equality,[13] but economists disagree on the tax policy's economic and long term effects.[14][15][16] Progressive taxation has also been positively associated with happiness, the subjective well-being of nations and citizen's satisfaction with public goods, such as education and transportation.[17][18]

History[edit]

In the early days of the Roman Republic, public taxes consisted of modest assessments on owned wealth and property. The tax rate under normal circumstances was 1% and sometimes would climb as high as 3% in situations such as war. These modest taxes were levied against land, homes and other real estate, slaves, animals, personal items and monetary wealth. The more you had in property, the more tax you paid. Taxes were collected from individuals.

By 167 BC, Rome no longer needed to levy a tax against its citizens in Rome or anywhere in Italy, due to riches found in the provinces they had conquered [19]

In 14th-century England, a progressive tax was applied. [20]

In the United States,the first progressive income tax was established by the Revenue Act of 1862, which was signed into law by President Abraham Lincoln and repealed the flat tax, which was short-lived Revenue Act of 1861.

Measuring progressivity[edit]

Indices such as the Suits index,[8] Gini coefficient, Theil index, Atkinson index, and Robin Hood index have been created for the progressivity of taxation, using measures derived from income distribution and wealth distribution.[21]

Marginal and effective tax rates[edit]

The rate of tax can be expressed in two different ways; the marginal rate expressed as the rate on each additional unit of income or expenditure (or last dollar spent) and the effective (average) rate expressed as the total tax paid divided by total income or expenditure. In most progressive tax systems, both rates will rise as amount subject to taxation rises, though there may be ranges where the marginal rate will be constant. With a system of negative income tax, refundable tax credits, or income-tested welfare benefits, it is possible for marginal rates to fall as the amount subject to taxation rises.

Inflation and tax brackets[edit]

Many tax laws are not accurately indexed to inflation. Either they ignore inflation completely, or they are indexed to the Consumer Price Index (CPI), which tends to understate real inflation. In a progressive tax system, failure to index the brackets to inflation will eventually result in effective tax increases (if inflation is sustained), as inflation in wages will increase individual income and move individuals into higher tax brackets with higher percentage rate. This phenomenon is known as bracket creep and can cause fiscal drag.

Economic effects[edit]

Income equality[edit]

Progressive taxation reduces income inequality.[13] This is especially true if taxation is used to fund progressive government spending such as transfer payments and social safety nets.[12] However, the effect may be muted if the higher rates cause increased tax evasion.[13][22] When income inequality is low, aggregate demand will be relatively high, because more people who want ordinary consumer goods and services will be able to afford them, while the labor force will not be as relatively monopolized by the wealthy.[23][24] High levels of income inequality can have negative effects on long term economic growth, employment, and class conflict.[25][26] Progressive taxation is often suggested as a way to mitigate the societal ills associated with higher income inequality.[12] The difference between the Gini index for an income distribution before taxation and the Gini index after taxation is an indicator for the effects of such taxation.[27]

There is debate between politicians and economists over the role of tax policy in mitigating or exacerbating wealth inequality and the effects on economic growth. For example, economists Thomas Piketty and Emmanuel Saez wrote that decreased progressiveness in U.S. tax policy in the post World War II era has increased income inequality by enabling the wealthy greater access to capital,[14] Conversely, a report published by the OECD in 2008 presented empirical research showing a negative relationship between the progressivity of taxes and economic growth.[15] Describing the research, economist William McBride stated that progressivity can undermine investment, risk-taking, entrepreneurship, and productivity because high-income earners tend to do much of the saving, investing, risk-taking, and high-productivity labor.[28][29] Professor Robert H. Frank states that tax cuts for the wealthy are largely spent on positional goods such as larger houses and more expensive cars, which could have been used to pay for things like improving public education and conducting medical research,[30] and suggests progressive taxation as an instrument for attacking positional externalities.[31]

Educational attainment[edit]

Economist Gary Becker has described educational attainment as the root of economic mobility.[32] Progressive tax rates, while raising taxes on high income, have the goal and corresponding effect of reducing the burden on low income, improving income equality. Educational attainment is often conditional on cost and family income, which for the poor, reduces their opportunity for educational attainment.[33][34] Increases in income for the poor and economic equality reduces the inequality of educational attainment.[35][36] Tax policy can also include progressive features that provide tax incentives for education, such as tax credits and tax exemptions for scholarships and grants.[37][38]

A potentially adverse effect of progressive tax schedules is that they may reduce the incentives for educational attainment.[16][34][39] By reducing the after-tax income of highly educated workers, progressive taxes can reduce the incentives for citizens to attain education, thereby lowering the overall level of human capital in an economy.[16][34][39] However, this effect can be mitigated by an education subsidy funded by the progressive tax.[40] Theoretically, public support for government spending on higher education increases when taxation is progressive, especially when income distribution is unequal.[41]

Psychological effects[edit]

"Tax The Rich" banner at an IUSY campaign for a financial transaction tax.

Tax law professor Thomas D. Griffith, summarizing research on human happiness, has argued that because inequality in a society significantly affects happiness, a progressive tax structure which redistributes income would increase welfare and happiness in a society.[17] A 2011 social psychology study, using data from 54 countries, found that progressive taxation was positively associated with the subjective well-being, while overall tax rates and government spending were not. The authors added, "we found that the association between more-progressive taxation and higher levels of subjective well-being was mediated by citizens’ satisfaction with public goods, such as education and public transportation."[18]

Since progressive taxation reduces the income of high earners and is often used as a method to fund government social programs for low income earners, calls for increasing tax progressivity have sometimes been labeled as envy or class warfare,[31][42][43] while others may describe such actions as fair or a form of social justice.[43][44]

Law Professor Marjorie E. Kornhauser has theorized that much of the opposition to progressive taxation is caused by ignorance, cognitive bias, and inflammatory rhetoric, and would disappear if people better understood progressive taxation and how it benefits their self-interests.[45]

Examples[edit]

As of 2010, 68.8% of US Federal individual tax receipts including payroll taxes, were paid by the top 20% of taxpayers by income group. The top 1% paid 24.2% whereas the bottom 20% paid 0.4% due to deductions and the Earned income tax credit. With 2013 tax law changes, the top 1% will pay an even larger share.[46]

Most systems around the world contain progressive aspects. When taxable income falls within a particular tax bracket, the individual pays the listed percentage of tax on each dollar that falls within that monetary range. For example, a person in the U.S. who earned $10,000 US of taxable income (income after adjustments, deductions, and exemptions) would be liable for 10% of each dollar earned from the 1st dollar to the 7,550th dollar, and then for 15% of each dollar earned from the 7,551st dollar to the 10,000th dollar, for a total of $1,122.50.

In the United States, there are seven income tax brackets ranging from 10% to 39.6%. The US federal tax system also includes deductions for state and local taxes for lower income households which mitigates what are sometimes regressive taxes, particularly property taxes. Higher income households are subject to the Alternative Minimum Tax that limits deductions and sets a flat tax rate of 26% to 28% with the higher rate commencing at $175,000 in income. There are also deduction phaseouts starting at $112,500 for single filers. The net effect is increased progressivity that completely limits deductions for state and local taxes and certain other credits for individuals earning more than $306,300.[47]

New Zealand has the following income tax brackets (for the 2012–2013 financial year): 10.5% up to NZ$14,000; 17.5% from $14,001 to $48,000; 30% from $48,001 to $70,000; 33% over $70,001; and 45% when the employee does not complete a declaration form.[48] All values are in New Zealand dollars and exclude the earner levy.

Australia has the following progressive income tax rates (for the 2012–2013 financial year): 0% effective up to A$18,200; 19% from $18,201 to $37,000; 32.5% from $37,001 to $80,000; 37% from $80,001 to $180,000; and 45% for any amount over $180,000.[49]

Progressive taxation often must be considered as part of an overall system since tax codes have many interdependent variables. For example, when refundable tax credits and other tax incentives are included across the entire income spectrum, the United States has the most progressive income tax code among its peer nations; although its overall income tax rates are below the OECD average.[50][51]

See also[edit]

References[edit]

  1. ^ Webster (4b): increasing in rate as the base increases (a progressive tax)
  2. ^ American Heritage (6). Increasing in rate as the taxable amount increases.
  3. ^ Britannica Concise Encyclopedia: Tax levied at a rate that increases as the quantity subject to taxation increases.
  4. ^ Princeton University WordNet: (n) progressive tax (any tax in which the rate increases as the amount subject to taxation increases)
  5. ^ a b Sommerfeld, Ray M., Silvia A. Madeo, Kenneth E. Anderson, Betty R. Jackson (1992), Concepts of Taxation, Dryden Press: Fort Worth, TX
  6. ^ Hyman, David M. (1990) Public Finance: A Contemporary Application of Theory to Policy, 3rd, Dryden Press: Chicago, IL
  7. ^ James, Simon (1998) A Dictionary of Taxation, Edgar Elgar Publishing Limited: Northampton, MA
  8. ^ a b Suits, Daniel B. (September 1977). "Measurement of Tax Progressivity". American Economic Review 67 (4): 747–752. Retrieved 28 January 2014. 
  9. ^ Internal Revenue Service: The luxury tax is a progressive tax – it takes more from the wealthy than from the poor.
  10. ^ Luxury tax – Britannica Online Encyclopedia: Excise levy on goods or services considered to be luxuries rather than necessities. Modern examples are taxes on jewelry and perfume. Luxury taxes may be levied with the intent of taxing the rich...
  11. ^ Clothing Exemptions and Sales Tax Regressivity, By Jeffrey M. Schaefer, The American Economic Review, Vol. 59, No. 4, Part 1 (Sep., 1969), pp. 596–599
  12. ^ a b c Pickett, Kate; Wilkinson, Richard (April 26, 2011). The Spirit Level: Why Greater Equality Makes Societies Stronger. Bloomsbury Press. ISBN 978-1608193417. 
  13. ^ a b c Moyes, P. A note on minimally progressive taxation and absolute income inequality Social Choice and Welfare, Volume 5, Numbers 2-3 (1988), 227–234, DOI: 10.1007/BF00735763. Accessed: 19 May 2012.
  14. ^ a b Piketty, Thomas, and Emmanuel Saez. INCOME INEQUALITY IN THE UNITED STATES, 1913–1998. Tech. 1st ed. Vol. CXVIII. Quarterly Journal of Economics, 2003. Print.
  15. ^ a b Arnold, Jens (14 Oct 2008). "Do Tax Structures Affect Aggregate Economic Growth? Empirical Evidence From A Panel of OECD Countries". OECD. Retrieved 2 Jan 2014. 
  16. ^ a b c Becker, Gary S.; Murphy, Kevin M. (May 2007). "The Upside of Income Inequality". The America. Retrieved Jan 8, 2014. 
  17. ^ a b Griffith, Thomas D. (2004). "Progressive Taxation And Happiness". Boston Law Review. Retrieved March 17, 2014. 
  18. ^ a b Shigehiro Oishi, Ulrich Schimmack, and Ed Diener,. Progressive Taxation and the Subjective Well-Being of Nations. Psychological Science 23(1) 86–92. (Published online before print December 8, 2011).
  19. ^ Roman Taxes. Unrv.com. Retrieved on 2014-04-12.
  20. ^ A History of Taxation. Tax World (2006-06-14). Retrieved on 2014-04-12.
  21. ^ Philip B. Coulter: Measuring Inequality, 1989, ISBN 0-8133-7726-9 (This book describes about 50 different inequality measures.)
  22. ^ Duncan, Denvil, Klara Sabirianova Peter (October 2012). "Unequal Inequalities: Do Progressive Taxes Reduce Income Inequality?". Institute for the Study of Labor. 
  23. ^ The Economics of Welfare| Arthur Cecil Pigou
  24. ^ Andrew Berg and Jonathan D. Ostry, 2011, "Inequality and Unsustainable Growth: Two Sides of the Same Coin?" IMF Staff Discussion Note SDN/11/08, International Monetary Fund
  25. ^ Alesina, Alberto; Dani Rodrick (May 1994). "Distributive Politics and Economic Growth". Quarterly Journal of Economics 109 (2): 465–90. doi:10.2307/2118470. Retrieved 17 October 2013. 
  26. ^ Castells-Quintana, David; Vicente Royuela (2012). "Unemployment and long-run economic growth: The role of income inequality and urbanisation". Investigaciones Regionales 12 (24): 153–173. Retrieved 17 October 2013. 
  27. ^ Shlomo Yitzhaki (1998). "More than a Dozen Alternative Ways of Spelling Gini". Economic Inequality 8: 13–30. 
  28. ^ McBride, William (December 18, 2012). "What Is the Evidence on Taxes and Growth?". Tax Foundation. Retrieved January 2, 2014. 
  29. ^ McBride, William (February 20, 2013). "Comments on Who Pays? A Distributional Analysis of the Tax Systems in All 50 States". Tax Foundation. Retrieved January 2, 2014. 
  30. ^ Frank, Robert H. "Positional Externalities Cause Large and Preventable Welfare Losses". American Economic Association. Retrieved March 17, 2014. 
  31. ^ a b Frank, Robert H. (June 4, 5, 2003). "Are Positional Externalities Different from Other Externalities?". Brookings Institute. Retrieved March 17, 2014. 
  32. ^ Becker, Gary S. (October 15, 2013). "Becker Explores the Roots of Upward Mobility". The University of Chicago. Retrieved January 24, 2014. 
  33. ^ Campbell, Mary; Haveman, R., Sandefur, G., Wolfe, B. (2005). "11 Economic inequality and educational attainment across a generation". Focus 23 (3): 11–15. "we found that family income and wealth have positive and statistically significant links to attainment: children who grow up in families with higher income and greater wealth receive more schooling." 
  34. ^ a b c Mueller, Richard (May 2008). Access and Persistence of Students from Low ‐ Income Backgrounds in Canadian Post ‐ Secondary Education: A Review of the Literature. MESA Project. Educational Policy Institute. "students from low income backgrounds are more sensitive to changes in tuition and aid packages than their colleagues from higher income families, as are students attending community colleges compared to universities." 
  35. ^ Campbell, Mary; Haveman, R., Sandefur, G., Wolfe, B. (2005). "11 Economic inequality and educational attainment across a generation". Focus 23 (3): 11–15. "[Implications of increased economic inequality:] Average achievement goes up slightly, but so does the variability of achievement. Average years of schooling increase by less than 1 percent. Inequality, in contrast, increases substantially, by over 8 percent when all four measures of inequality are considered together. Moreover, a higher proportion of students do not complete high school or 11th grade." 
  36. ^ Checchi, Daniele (May 2001). Education, Inequality and Income Inequality. Distributional Analysis Research Programme Papers 52. Suntory and Toyota International Centres for Economics and Related Disciplines, LSE. "income inequality effectively reduces school enrollment, mainly at secondary level." 
  37. ^ "Growth in Means-Tested Programs and Tax Credits for Low-Income Households". Congressional Budget Office. February 11, 2013. Retrieved January 28, 2014. 
  38. ^ Rachel Johnson, James Nunns, Jeffrey Rohaly, Eric Toder, Roberton Williams (July 2011). "Why Some Tax Units Pay No Income Tax". Tax Policy Center. Retrieved January 28, 2014. 
  39. ^ a b Heckman, J., L. Lochner and C. Tabner, Tax Policy and Human Capital Formation, American Economic Review, 88, 293–297. Accessed: 31 July 2012.
  40. ^ Krueger, Dirk; Ludwig, Alexander (May 2013). "Optimal Progressive Labor Income Taxation and Education Subsidies When Education Decisions and Intergenerational Transfers Are Endogenous". American Economic Review 103 (3): 496–501. Retrieved 28 January 2014. 
  41. ^ Ansell, Ben (2010). From the Ballot to the Blackboard: The Redistributive Political Economy of Education. Cambridge University Press. p. 175. "Under conditions of high income inequality and tax progressivity, there will be even greater support for higher education spending even if most people do not receive it" 
  42. ^ Powell, Jim (October 17, 2012). "Class Warfare: The Mortal Enemy Of Economic Growth And Jobs". Forbes. Retrieved February 3, 2014. 
  43. ^ a b Kim, Susanna (Sep 19, 2011). "Warren Buffett Rule: Class Warfare or Tax Fairness?". ABC News. Retrieved February 3, 2014. 
  44. ^ Egypt constitution panel rejects article on progressive taxation, Ahram Online, 11 Nov 2013, retrieved February 3, 2014 
  45. ^ Kornhauser, Marjorie (9-1-2004). "Educating Ourselves Towards a Progressive (and Happier) Tax: A Commentary on Griffith's Progressive Taxation and Happiness". Boston College Law Review. Retrieved February 3, 2014. 
  46. ^ "The Distribution of Household Income and Federal Taxes, 2010". The US Congressional Budget Office (CBO). 2013-12-04. Retrieved 2014-01-28. 
  47. ^ 26 USC 55. Also see IRS Form 6251 (individuals) and Form 4626 (corporations).
  48. ^ "Income tax rates for individuals". ird.govt.nz. Inland Revenue Department (New Zealand). Retrieved 15 May 2013. 
  49. ^ "Individual income tax rates". ato.gov.au. Australian Taxation Office. Retrieved 15 May 2013. 
  50. ^ Growing Unequal?: Income Distribution and Poverty in OECD Countries, OECD Publishing, ISBN 978-92-64-04418-0, 2008, pp. 103, 104.
  51. ^ Crook, Clive (February 10, 2012). "U.S. Taxes Really Are Unusually Progressive". The Atlantic. Retrieved April 16, 2014. 

External links[edit]