Why Raising Tax Revenue is Hard
Reuters blogger Felix Salmon contends that our tax system encourages income inequality because it generates more revenue for the treasury.
[W]hen you have a progressive tax system, especially when there are surcharges on people making seven-figure incomes, you also have a system where for any given level of national income, the greater the inequality, the greater the government’s tax revenues. And indeed federal revenues have been rising faster than median wages for decades now, thanks to the rich getting ever richer.
Given the government’s insatiable appetite for cash, it’s only natural that it would prefer to tax plutocrats, spending some of that money on poorer Americans, rather than move to a world where poorer Americans earn more (but still don’t pay that much in taxes), and the plutocrats earn less, depriving the national fisc of untold billions in revenue.
The government’s interests, then, are naturally aligned with those of the plutocrats — and when that happens, the chances of change naturally drop to zero.
Kevin Drum looks at the numbers, though, and contends this is nonsense.
Here’s why: although the top 1% (the four richest groups in the chart) has a lot of income, the 60-80th percentile has about the same amount. That’s because although their incomes are a lot lower, there are a lot more of them. So what happens if that group loses, say, 10% of its income and it goes instead to the very tippy-top earners? Answer: total revenue to the government goes up about 1%. The same is roughly true for the other income groups as well.
In other words, the federal government doesn’t have much of an incentive to maintain lots of income inequality. Not much fiscal incentive anyway. For the most part, the political incentives swamp the fiscal ones, and unfortunately they aren’t very closely balanced. Pursue policies that raise middle class wages, and the effect is so diffuse and so slow that hardly anyone notices. Pursue policies that benefit the rich and you get immediately showered with oceans of campaign contributions. That’s mostly what motivates our political economy, I think, not tiny changes in the total tax take based on changes in income inequality.
A blogger at The Economist argues that the problem is income taxes themselves.
So if Congress needs all that money, then why doesn’t it adopt a VAT, or something similar? Mr Salmon’s logic would seem to suggest that it’s because the rich understand that a government dependent on them for revenue will continue to enrich them. As such, the rich will actually fight to prevent a less progressive tax system. I’m not sure this is borne out by experience.
Instead, I think that there are serious political difficulties in raising taxes broadly to fund social insurance programmes in a highly unequal society, because the social insurance is perceived as redistributing income over the population, rather than across time. Broad-based tax systems are how most European countries finance their social safety nets; nearly all of the redistributive effect of government programmes results from spending rather than tax policies.
There are all kinds of historical reasons for this, but one key thing to note is that pre-tax inequality in Europe is far lower than in America. Social insurance is much more about redistribution of resources over time than across the population. You pay taxes understanding that you’ll rely on services, be they health care, unemployment benefits, or pensions, at some point in the future. In America, by contrast, the rich will pay far more than they’ll ever demand from the government, while the poor will receive more than they’ll pay in (though Social Security is a bit of an outlier here).
The end result is a society which is reluctant to tax itself, since much of the voting public perceives government taxation and spending as giveaways to the non-taxpaying poor.
This is also, incidentally, a core issue in the current health care reform debate.