As we enter the election year, it’s no doubt that we will hear countless policy suggestions, some we agree with, some we don’t; some better than others. It is important to understand some of these proposals so we can best judge the policy for what it is, independent of what team or side it’s coming from.
“It’s worth it to explain the flat tax for what it is: a regressive policy that would only serve to further hurt the poor while enriching the wealthy.”
One issue that comes up fairly often is the idea of reforming our current (admittedly complicated) progressive tax system for a flat tax. For those not familiar, a flat tax would subject all Americans and incomes to the same singular tax rate (as opposed to the current progressive tax system where higher amounts of income are taxed at ever increasing amounts, known as ‘tax brackets’).
While it appears we may not have a presidential candidate running on this reform in 2020 as we did with Libertarian presidential candidate Gary Johnson in 2016, it’s worth it to explain the flat tax for what it is: a regressive policy that would only serve to further hurt the poor while enriching the wealthy. It would, unquestionably, drastically increase the wealth and income inequality under which the United States is suffering from.
(An aside: many news sources have correctly pointed out that many high income earners and corporations now pay little to nothing in income taxes, exasperated by Trump’s tax reforms. While a flat tax would be an improvement to this situation, that says more about the state of our current broken system than it does the merits of a flat tax system.)
It’s easy to understand why a flat tax seems both rational and fair: treating every dollar as equal is certainly the most fair policy. One step further, on the surface it seems immoral that just because you make more money, you should be forced to pay a higher tax rate. But both of these ‘logical’ assumptions ignore a basic economic principle: the law of diminishing marginal utility and how it applies to income.
The law of diminishing marginal utility can be demonstrated with any resource. Put simply, the first unit of any item is more valuable than the next. Using a very basic example, let’s look at a $2 slice of pizza. For the hungry, that first $2 slice is delicious, and every part of is savored. The second slice, for most, is still very good, and worth every penny spent. By the time you get to your fifth or sixth slice, extraordinary appetites aside, you’re less likely to part with your $2 because that next slice isn’t bringing the value to you that the first did.
Bad example — there’s no such thing as too much pizza.
Let’s move to the example of dollars. I’m going to say something here that, at first, won’t make a lot of sense, but I promise if you follow along, it’s an economic truth founded in good science and logic.
Not every dollar has the same economic value to the individual.
That’s the dumbest thing I’ve ever heard. One dollar equals one dollar, every time.
True enough, but your first dollar is worth more, to you, than your tenth dollar.
Don’t believe me?
Drop a $100 bill between a CEO and a homeless person and let’s bet on who comes away with it first. The CEO is not going to risk injury or, depending on his professional obligations, the time it takes to acquire that $100 bill.
Because the economic utility of that $100 is astronomically higher for someone who’s destitute than it is for someone with $10M in their checking account.
Let’s put it another way most of us have probably experienced.
I, like millions of others of Americans, buy silly things. Not often, and with varying degrees of silliness, but I have plenty of things I don’t need. I recently spent $130 on a signed copy of Noam Chomsky’s Requiem for the American Dream — likely my favorite nonfiction by who I and many others believe is the greatest living intellectual of our generation.
I have also had moments in my life where I spent over half of my current net worth on a McDonald’s value meal. (Of all the things I miss about my college days, I miss that the least.)
When I have $10 to my name, $7.50 represents a huge chunk of my wealth and my economic buying power. When I am not struggling, I can justify spending $130 on a piece of glorified anarcho syndicalist propaganda.
I needed that $7.50 to survive. It was worth everything to me. When my situation changed, a $130 frivolous purchase was easily tolerated.
So it is, your first dollar is your most valuable. And, like any resource, as dollars are accumulated, each dollar holds less of a value than the last.
Mathematically speaking, this is very easy: finding a dollar when you have $10 to your name increases your net worth by 10%. Finding a dollar when you have, say, $5000 in your accounts increases your net worth by just 0.02%. Their relative values are vastly different.
It is this law that a flat tax ignores, to the great detriment of the working class and poor. Your first $30,000 barely affords you existence in America; the last $30,000 of a $300K salary will change your situation far less.
It is for that reason that taxing your first dollars at the same rate as your last dollars makes no economic sense. It is for that reason that taking the same percentage from a struggling families budget to just survive as you do a millionaires yacht fund is immoral.
But that’s not fair to the millionaire: he’s being treated differently than the working family. Aren’t progressives about equality?
We are, and, believe it or not, both cases are being treated equally under a progressive tax rate. The struggling worker and the millionaire are actually taxed the exact same: the millionaire pays the same low tax rate on his first $30K as the low wage worker. He pays a higher tax only on the income that exceeds that tax bracket. And if the working man gets a raise, he too will be subjected to a higher tax rate in that next bracket.
But remember, just because you slip into a higher tax bracket, that doesn’t mean all of your income is taxed at that higher rate: only the dollars made above that threshold are subject to that higher rate.
An example: currently the first tax bracket in the United States is 10%, on income from $0 up to $9875. The next is 12%, up to $40,125. Bob makes $9875. Jacob makes just a dollar more, $9876. That means Bob pays $987.50 (10% of $9875) and Jacob pays $1185.12 (12% of $9876), right?
Bob does indeed pay $987.50, but Jacob, making a dollar more, actually pays almost exactly the same — $987.62 — because his first $9875 is taxed at 10% too. He only pays 12% on income over that amount, which in this case, is $0.12 on that last dollar.
Which makes sense — it would be unfair for Jacob to have made more money, but taken less home by “slipping into the next tax bracket”, a fallacy often repeated by those that don’t understand the progressive tax system.
The takeaway from that is that both Bob and Jacob are being treated equally, as both are being taxed at the same rate for each identical dollar.
This is why progressive taxation is the standard for all major economies, with only a few countries using a flat tax (Estonia, Lithuania, Russia).
So the next time you hear someone advocating for a flat tax, now you know that they are either coming from a place of economic ignorance, or know the economics are are wilfully trying to enact a policy that would benefit them at the expense of the poor.