83rd International Atlantic Economic Conference

March 22 - 25, 2017 | Berlin, Germany

Degressivity and the trigonometry of taxation

Friday, 24 March 2017: 15:10
James Chen, J.D. , College of Law, Michigan State University, East Lansing, MI
In addition to raising revenue for financing public goods and services, a system of taxation should also serve as a tool for redistributing income, wealth, or both.  The case for redistribution rests upon economic efficiency as well as moarality and aesthetics.  Chief among these reasons is the proposition that income or wealth has declining marginal value.  Furthermore, even if redistribution achieved no economic objectives whatsoever, a redistributive mechanism should not introduce economic distortions in its own right.

Traditional tax structures include Ramsey taxation, which levies taxes inversely proportional to individual elasticities of demand.  Ramsey taxes maximize public revenue with minimal economic distortion.  The redistributive impact of Ramsey taxation, however, is almost certainly regressive.

Flat tax rates blunt, to a limited extent, the regressive impact of Ramsey taxation.  They also avoid the economic distortions associated with progressive tax structures. Flat rates, however, are unlikely to achieve significant amounts of redistribution.

Progressive tax rates, by levying the proportionately heaviest taxes upon the wealthiest or highest-income individuals, achieve the greatest degree of redistribution. But they distort the private economy by imposing disincentives on work, innovation, or entrepreneurship.  Progressive taxation also distorts political economy by creating pressure for tax expenditures and ensuring that these nontransparent forms of public finance deliver normatively "upside-down" benefits to the wealthiest taxpayers.

Progressive tax structures therefore cut in both directions.  They achieve redistributive goals, at considerable cost, through the distortion of private economic activity.  But the very presence of progressive rates invites ever greater resort to tax expenditures, rather than direct governmental spending.  Lobbying for such preferences poisons the political economy of taxation.

In principle, it should be possible to achieve some balance between flat and progressive taxation through an income tax system containing exactly two rates: A large zero bracket, plus a single bracket imposing a positive tax rate on all income above the chosen threshold for taxation. Such a system may be characterized as a modified flat tax, subject to a generous "zero bracket" achieved through a compulsory standard deduction that replaces the battery of itemized deductions typically claimed by the wealthiest taxpayers. Alternatively, such a system may be described as a special case of progressive taxation, with exactly two brackets: zero, plus a positive rate on all income beyond the zero bracket.

By any name, such "degressive" taxation creates mild progressivity at lower income levels and taxes higher incomes at a flat rate.