I’ve recently had a great deal of discussions on the topic of taxation. This article won’t be making any policy prescriptions. Rather, I’ll simply try to outline the problems that come with certain common methods of taxation.
As a society, we have collectively agreed on taxation as a policy in order to provide common services. US Supreme Court justice Oliver Wendell Holmes Jr. famously said: “Taxes are what we pay for civilized society”. There is perhaps some philosophical discussion to be had on the morality of taxation, however, I currently possess neither the expertise nor the desire to have it. I will take the morality of taxation as an axiom and argue from there. If you disagree with this, none of the following will hold.
Taxation can be split into two categories: progressive & regressive. The core concept is simple: if taxes scale with an individual’s income, they are progressive. If they don’t, we consider them regressive. From this view, we can make some categorizations: the income tax, as set up in most modern industrialized nations, is a form of progressive taxation. We ask on the wealthier individuals to pay a higher tax rate than those in the bottom echelons. An example of a country with a regressive tax system would be Russia: individuals pay 13.5% of their earnings in taxes, no matter their income.
However, one important caveat needs to be understood here. No tax system is truly “progressive” or “regressive”. Although it’s tempting to call flat tax rates such as the one in Russia regressive, this is a simplistic view. Yes, a flat tax-rate does not scale with income. But since a tax rate is measured in percentage of total income, a wealthier individual will end up paying a greater overall amount compared to someone who earns less. Of course, a millionaire will have less trouble paying 13.5% of his income compared to someone making minimum wage, but even this regressive system has a somewhat progressive element in it.
In contrast, we can examine the so-called progressive tax systems and realize that they have regressive elements within them. Most progressive income taxes work by having multiple tax brackets, each with its own marginal tax rate. The amount of an individual’s income that falls within one of these brackets is taxed according to the corresponding marginal tax rate. This poses two problems. The marginal system is in effect a step function, with income falling within the same bracket being taxed at the same rate. Thus, within the confines of a single bracket, a progressive income tax is regressive. Furthermore, a millionaire will still pay the lowest tax rate on the first section of his income which falls into the lowest tax bracket. This too displays a regressive characteristic, as we can safely say that a millionaire will have an easier time affording this tax compared to someone whose entire income falls within this tax bracket. Of course, there is a good reason for this: a tax-bracket system without marginal rates would in effect, disincentivize individual’s from making income that would put them into a higher bracket. The point remains, even our progressive systems aren’t fully progressive.
We can also imagine a system more regressive than the flat-tax rate. Imagine a simple flat tax, where any individual, whether they are a minimum wage worker or a high-income earner, would pay the same flat tax amount, let’s say 5000$. In this case, the pure dollar amount would be constant for the entire population. Obviously, this would be a disastrous system for lower income individuals and for society at large. There is the obvious question of what happens to people who make less than 5000$ a year, or people who make slightly more but now have the majority of their income lost to taxes. We could amend this by introducing tax exceptions for lower-income earners, but we would then be left with the problem that this system fails to raise enough money for a functional society. If our only goal is to try to design the most regressive tax system, we could go even further. Imagine a system with a decreasing income tax. Low income individuals would be asked to pay a greater amount than higher earners. This system would now approach the limits of what it would mean to truly be regressive.
One important pitfall to avoid in this discussion is the continuum fallacy. Simply because there is no true “progressive” or “regressive” taxation does not mean that all systems are equal. Some systems are more progressive than others. With this out of the way, we can examine some examples of regressive tax policies in society and determine whether they are effective and/or just.
One commonly cited example of a regressive tax is the sales tax. The argument goes as follows: lower income individuals spend, on average, a higher portion of their incomes purchasing goods and services compared to high income individuals. As such, lower income individuals will end up paying a greater portion of their incomes in sales taxes. This is a widely recognized problem, and society addresses it in multiple ways. Firstly, many implementations of sales taxes will have exemptions for basic necessities such as food. In addition, some systems will give additional tax breaks to lower income individuals in-order to counter act the sales tax.
Regressive taxation does have its uses. Take the “sin” tax for instance. This is a tax imposed on gambling, tobacco, alcohol, and other activities that society deems “sinful”. Since lower income individuals, on-average, spend a higher portion of their incomes on such goods, this is a classic example of a regressive taxation. The justification for this is that lower income individuals are far more likely to suffer from the negative consequences associated with these goods. The government decides that it is within their prerogative to curb this. I want to emphasize that I am not here to debate the morality of such sin taxes. In fact, I am partially sympathetic to arguments against such forms of taxation. But one thing is certain: the regressive nature of these taxes is not a bug, it’s a feature. But these methods do suffer from one key problem: democracy. High taxes on such goods are likely to be unpopular with the population. It can take only one opportunistic politician in-order to overturn these taxes.
The carbon tax can also be viewed as a sin tax but is more traditionally known as a Pigovian tax. If implemented naively, it is also a form of regressive taxation. Lower income individuals will suffer more from a carbon tax compared to individuals with higher incomes. These issues can be amended by spending the extra tax income on social welfare programs targeted at lower income individuals. However, much like with sin taxes, carbon taxes are likely to lose popularity among the population once individuals start paying them.
Although not strictly a tax, fines issued by the government are often regressive in nature. A higher income individual will more easily be able to afford a parking fine compared to a lower income one. Unlike the previous examples, there is no valid justification for this. The stated purpose of fines is to disincentivize certain behaviors. However, why should we disincentivize illegal parking or speeding more for lower income individuals than for higher income ones. I do not believe there is any good indication that the prevalence of such behaviors scales inversely with income. It seems that a more effective method would be to scale fines with income, but this is, for many reasons, is impractical.
Tariffs and quotas on products can also be viewed as forms of regressive taxation, for much the same reasons as the sales tax. In Canada, our system of supply management for dairy products is an example of this. Lower income individuals spend more on milk and dairy products and in effect, are asked to subsidize the dairy industry. I do not wish to open the can of worms that inevitably comes with the questions of whether certain industries should be subsidized. This is a discussion for another time. If we collectively agree do this, fair enough. However, let’s tackle this goal with a superior method that isn’t regressive: actual subsidies.
Unlike tariffs and quotas, subsidies can be funded using income taxes, and as such, are more progressive in nature. If dairy is truly an industry we deem worthy of protection, let’s collectively protect it in a manner that doesn’t ask the poor to chip in more. If we deem some behaviors undesirable and wish to punish them, let’s punish them in a manner that doesn’t disproportionately impact the poor. If we wish to reduce carbon output, let’s not ask the poor to suffer more as a result of it. For many issues though, I understand that we can’t always have our pick. I would prefer a green energy subsidy over a carbon tax, but I would still choose a carbon tax over doing nothing at all. Most importantly, let’s at least address these concerns ahead of time and alleviate the risk of certain actors with misaligned intentions using this as fuel for their future rhetoric.