Certain types of people like to ask the question “Why is a progressive tax fair?”
The inevitable answer given is “marginal utility!” The theory is that if a rich person and a poor person both have to pay an extra 50 spacebucks (or whatever currency is used in your realm) in taxes, it doesn’t reduce the rich person’s quality of life as much as it does the poor person’s. Therefore, it’s fair for rich people to have a higher tax rate.
I don’t much like this argument. For one thing, an opponent could twist it around and argue that a rich person should receive more charity money than a poor person, because it takes more money to improve the rich person’s quality of life.
And it seems to be jumping right to what I might call higher-order fairness, without laying the groundwork of first-order fairness.
In short, I would say that a ______ tax is fair because pretty much all taxes are fair. (At least for small values of “fair”.)
To keep it simple, I’m limiting the post to consideration of an annual income tax. Here’s a quick review of how such tax systems usually work.
The government takes some predetermined percentage of the first spacebuck you earn in a given year, and a (possibly different) percentage of the second spacebuck, and so on. As you earn each spacebuck, its tax rate is locked in. It will not change based on how many spacebucks you earn after it.
At any given time, the projected tax rate of the next spacebuck you would earn is called the marginal rate.
I would argue that, basically, a tax system is (first-order) fair provided:
- The rules are the same for everyone
- The marginal rate is never less than 0%, or more than 100%
The marginal rate condition really just means that the tax system is not totally stupid. More on that later.
Types of income tax systems
A progressive tax is, very generally speaking, one in which which the marginal rate goes up over the course of a year’s earnings. With a flat tax, it stays the same.
Most actual progressive tax systems satisfy both the rules are the same for everyone condition, and the marginal rate condition. So, a progressive tax is (potentially) fair.
There’s a point I want to address. There are rules of the form “the 5001st through 6000th spacebucks you earn shall be taxed at 35%”. Such a rule would be irrelevant for a person who earned less than SB5000. But that doesn’t mean the rules are different for that person. The rule still exists, even if it was not applicable this time. (Maybe it will be applicable next year.)
A flat tax is also fair. It satisfies the criteria.
A flat tax is often considered to be “regressive”, but what about a truly regressive tax, in which the marginal rate actually goes down as you earn more spacebucks? Rich people would be taxed at a lower total percentage than poor people. But, nevertheless, a truly regressive tax still meets the criteria, so it’s fair.
What about the most regressive tax possible, a constant tax? I.e., everyone pays, say, SB500 per year in tax, regardless of income? Well, even a constant tax is fair, though it does not technically meet my definition of an “annual income tax”.
If your marginal rate is below 0%, it means that earning one more spacebuck would cause your after-tax earnings to go up by more than one spacebuck. That (I assert) is unfair. Mainly, it’s unfair to the other taxpayers, who will one way or another have to fund the treasury’s gift to you.
If your marginal rate is above 100%, it means that earning one more spacebuck would cause your after-tax earnings to go down. That’s unfair — you should never be paid negative spacebucks for your work.
(Sadly, here in reality, there are plenty of situations in which your effective marginal rate can go above 100%. It happens because income tax is not the only thing based on your income. For example, earning one more spacebuck might cause your income to cross some arbitrary threshold that makes your daughter ineligible for a certain college scholarship, costing your family thousands of spacebucks.)
“The same for everyone”
There’s potentially a lot of nuance hidden in the requirement that “the rules are the same for everyone”.
A rule like “the tax rate is higher for people with brown eyes” would be unfair. But a rule like “the tax rate is higher for people who wear brown shoes” is not necessarily unfair.
The difference is that your eye color is an intrinsic part of you, while your shoe color is not. There’s plenty of room for argument as to which attributes are and are not intrinsic. Incidentally, note that the whole concept of an income tax is based on the premise that your income is not an intrinsic part of you.
An interesting question is whether it can be fair to tax people at different rates based on their age. Everyone ages in a similar fashion, so it is potentially fair: The same rules will ultimately apply to everyone. A fair tax could tax young people at a higher rate than old people, or vice versa.
One problem is that it’s tricky to ever change such a tax system without causing significant unfairness. Switching from a young-high/old-low system to a young-low/old-high system is unfair to the age group that aged into the “old” category right around the time that rules were changed.
Fair tax versus good tax
Having no tax at all would be fair, but whether a tax system is fair has little to do with whether it is good. A good tax would most importantly pay the nation’s bills. It might also be designed to do other things, such as promote desirable economic conditions, incentivize desirable behavior, and hopefully have some amount of higher-order fairness.
What higher-order fairness means is always going to be a subject of contentious political debate. There’s no way to calculate it mathematically. This is where many people sense that a well-tuned progressive tax is more fair than a flat tax, reasoning about the effect on quality of life. Nothing wrong with that, but not everyone is going to find it to be a convincing argument.
A good tax need not have perfect first-order fairness. Sometimes an unfair tax is used deliberately as a way of partially compensating the victims of some other unfairness.
For example, in some countries, legally blind people get an extra tax deduction. This may be defended as being compensation for a blind person’s likely-higher cost of living. By my definitions, that’s an unfair tax. Whether you are legally blind is an intrinsic part of you, not a part of your chosen lifestyle. So, this rule is not the same for everyone.
The extent to which such compensation is acceptable is, of course, highly contentious. Overcompensating would be bad, but well-tuned compensation is at least defensible.