Tax and Regulatory Equity in the Realm of Economics

I will argue that income taxes do not lack equity because they don’t tax high-income earners enough (though they could be seen as inequitable by making high-income earners shoulder most of the federal tax burden). State and federal regulatory policy however, is unjust and inequitable, harming poor and low-income families more than high-income families. The regulatory burden restricts economic freedom for both consumers and producers, but those with low-incomes are hurt most.

Social democrats often claim the federal tax code is inequitable because tax rates are not high enough for high-income earners. Equity in this resolution means treating people fairly, so if the tax code is unfair, debaters on the negative could claim economic freedom for those with high incomes should be further limited by higher tax rates, to improve social equity.

A problem with this tax claim is shown in recently released IRS data, reported by Investors Business Daily (1/12/2014):

What the IRS numbers show is that … by 2012 the top 1% of income earners accounted for 38% of all federal income taxes. 

That’s up from 33.2% in 2001, well before the “unfair” Bush tax cuts took effect, and far above the 29.5% average from 1986 to 2000. …

In 2001, for example, the top 1% accounted for 17.4% of all income reported to the IRS. In 2009, their share was slightly lower at 17.2%. Over those same years, share of income taxes paid by this group went from 33% to 36%. 

At the other end of the spectrum, the bottom half of all taxpayers was responsible for just 2.78% of federal income taxes in 2012, which is down from 4.9% in 2001. (IBD source.)

Social democrats argue that the wealthy benefited more than low- and middle-income families as stock market values increased. This is not surprising since wealthy people tend to invest more in stocks.

Since the wealthy now have higher incomes and more wealth, the argument goes, they could afford to pay more in taxes. This tax revenue would allow the federal government to reduce the deficit or spend more for welfare, education, health care, immigration and dozens or hundreds of other federal spending programs that, advocates claim, help lower-income people.

Note that this argument assumes state and federal programs actually help low- and middle-income families. This is discussed in more detail in Social Services for those living in poverty, an 8-page study guide (pdf), where I argue that mutual aid and self-help societies, along with churches and charities were far more effective in helping low income families before the New Deal programs of the 1930s. The history of Mutual Aid and Friendly Societies are discussed in more detail in Tom Palmer’s After the Welfare State (pdf here), in Section II: “The History of the Welfare State and What it Displaced”:

Section II: The History of the Welfare State and What It Displaced 

Bismarck’s Legacy . . . . . . . . . . . 33,   By Tom G. Palmer 

The Evolution of Mutual Aid . . . . . 55,    By David Green 

Mutual Aid for Social Welfare: The Case of American Fraternal Societies . . . . . . 67,  By David Beito

Tax Efficiency and Tax Equity
Critics argue that higher tax rates might actually reduce tax revenue over time as high-income people look for new ways to legally minimize their taxes. The French government’s “super-tax” on the rich led to wealthy people moving themselves and their wealth out of France.

Historically, as tax rates have been reduced, the wealthy pay a higher percentage of total taxes. This may seem surprising at first. With lower tax rates, high earners take more of their compensation as income rather than non-taxable benefits. For example, a small business owner facing high business or personal taxes may buy a Mercedes as a business car, writing off the expense against profits. With a lower tax rate the business owner might prefer a Ford and take the difference in purchase or lease cost as income. High income earners are often more flexible in how they are compensated.

For opposing views on federal tax policy, consider this Americans for Tax Fairness page which argues taxes on the wealthy should be higher and includes this “key fact”: The largest contributor to increasing income inequality has been changes in income from capital gains and dividends.


Compare this claim with the Tax Foundation discussion, “Inflation Can Cause an Infinite Effective Tax Rate on Capital Gains“:

The United States’ federal top capital gains tax rate is now 23.8 percent due to two tax increases at the start of 2013.[1] This is problematic, because the capital gains tax creates a bias against savings, slows economic growth, and places a double-tax on corporate profits. Although these problems with the capital gains tax are well known, there is a more subtle issue with the tax that makes it even worse for taxpayers than these conventional concerns suggest. 

Under the federal tax code, the increase in an asset’s price is determined as the nominal amount (i.e., not adjusted for inflation). When an asset (often a stock) is sold above its purchase price, a gain is realized and is taxed. Any capital gain due to inflation is not accounted for, and the taxpayer is taxed on both their increase in income and on increases in prices economy-wide. As a result, the effective tax rate on the real (inflation indexed) capital gain has exceeded the statutory rate every year since 1950 and has averaged around 42 percent. 

In some instances, the practice of taxing the nominal gain can lead to an infinite effective rate on real capital gains when the increase in price is only due to inflation. In fact, if a taxpayer purchased an average stock in 1999, 2000, or 2007 and sold in 2013, they would be taxed entirely on inflation.

So, are changes in tax rates for dividends and capital gains the “largest contributor to increasing income inequality” or are capital gains taxes sometimes infinite because of past inflation?

For more on tax policy debates and economics see this “Taxation” entry in the The Concise Encyclopedia of Economics at Econlib.org.

Economists specializing in public finance have long enumerated four objectives of tax policy: simplicity, efficiency, fairness, and revenue sufficiency. While these objectives are widely accepted, they often conflict, and different economists have different views of the appropriate balance among them. 

More complaints about taxes, and about regulations
Social democrats also argue that sales and other taxes at the state level are regressive and therefore unfair. Lower-income people pay a higher percentage of their income for sales and property taxes (property taxes raise rents for lower-income people). But more important I would argue, are the dense regulations that lead to higher housing and rental costs, higher cable and cell phone rates, higher car insurance and health care insurance. The burden thousands of state and federal regulations make life harder on low-income families. Here is a November article from Reason “How San Francisco’s Progressive Policies Are Hurting the Poor: Left-wing regulations are increasing inequality, reducing affordable housing, and killing economic opportunities.” Here is a John Stossel article “The Cancer of Government Regulation: How occupational licensing laws hurt the poor.“

Social democrats have long advocated progressive income tax rates, so the rich will not only pay more in taxes (because they earn more), but higher tax rates (because even with higher tax rates, the wealthy will have more income after taxes). This is sometimes justified as causing “equal pain” to taxpayers. Another utilitarian justification of progressive tax rates is the claim that marginal income gives already high-earning people less pleasure (like eating the third piece of pie gives less pleasure than the first or second). So that marginal income could be taxed away away at higher rates, which would, in theory, allow lower-income people to pay lower rates and keep more of their income. So more poor would gain a first piece of pie while the rich would be giving up just their third or higher piece of pie. (More on pie, taxes, and regulation below.)

Another way to look at taxation is as payment for government services. From government roads to schools to courts, police and national defense, governments provide goods and services. To pay for these good and services, governments collect taxes. Since that passage of the Sixteenth Amendment to the Constitution, the federal government has been able to collect direct taxes on income. (Bill of Rights Institute post on 16th Amendment here.)

Back to state regulations and pie…
Regulatory policy also raises the price and restricts access to pie, according to this article in the Wall Street Journal, “Pennsylvania Pie Fight: State Cracks Down on Baked Goods: Inspector Nabs Homemade Desserts At St. Cecilia Church’s Lenten Fish Fry“:

Sold for $1 a slice, homemade pies have always been part of the Lenten fish-fry dinners at St. Cecilia’s, located in this tiny city near Pittsburgh. Similar dinners are held in church basements and other venues across the country this time of year.
After a state crackdown forbidding the sale of homemade pies, members of St. Cecilia Catholic Church in Rochester, Pa., proceeded with their annual Lenten fish fries anyway. The pie flap helped draw healthy crowds.

The problem is the pies are illegal in Pennsylvania. Under the state’s food-safety code, facilities that provide food at four or more events in a year require at least a temporary eating and drinking license, and food has to be prepared in a state-inspected kitchen. Many churches have six fish fries a year, on Fridays during Lent. St. Cecilia’s has always complied with having its kitchen licensed, so food made there is fine to serve. But homemade goods don’t make the cut. 

The disappearance of Mary Pratte’s coconut-cream pie, Louise Humbert’s raisin pie and Marge Murtha’s “farm apple” pie from the fish-fry fund-raisers sparked an uproar that spread far beyond the small parish.