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The Inequity of the Progressive Income Tax

By Kip HagopianClass Wars: A Parable

Once upon a time in the land of America, there lived triplet brothers named Tom, Dick,and Harry Class. They were 45 years old, had virtually the same aptitude (skill), andwere raised in the same home. Each was married and had two children. All three wereemployed as carpenters making $25 per hour, working 50 weeks a year.While they were virtually identical in most respects, they had somewhat differentpreferences and values. For example, Tom, who worked 20 hours a week, had adifferent work ethic from his brothers, Dick and Harry, who each worked 60 hours per week. Neither Tom’s nor Dick’s wives worked, while Harry’s wife worked 40 hours per week as an office manager making $50,000 per year (the same hourly rate as her husband). Tom and Dick spent all of their income, and were relying on social security totake care of them when they retired. Harry and his wife, on the other hand, saved mostof her after-tax income over many years, gradually accumulating $300,000. Theyinvested this money in bonds and real estate that produced $25,000 a year in interestand rental income. This was the income of each family:Family

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Tom Dick HarryWork hours per Week: 20 60 100Annual WagesHusband:$25,000$75,000 $ 75,000Wife: 0 0 50,000Investment Income: 0 0 25,000Total Income:$25,000$75,000 $150,000Despite their different priorities, the Class families were close; so much so that when anew housing tract was developed in their community, they each bought an equally-priced home on the same private street. Theirs were the only houses on the street.One day the brothers decided to pool their funds for the purpose of improving their street. Concerned about crime and safety, and desirous of a more attractive setting for their homes, the three families decided to: install a gate at the street’s entrance to deter burglars; add lighting for safety and additional security; repave the street’s surface torepair damage; and install landscaping to beautify the approach to their homes. Thework was done for a total cost of $30,000.The brothers were quite happy with the outcome and felt the $30,000 was a worthyexpenditure given the benefits provided each family. But when it came time to divide upthe bill, the problems began.

Harry thought it would be simple to divide the bill. Since the benefits to each family wereequal, each brother should pay one-third, or $10,000. But Tom and Dick objected. “Whyshould we pay the same as you?” they said. “You make much more money than we do.”Harry was puzzled. “Why is that relevant?” he asked. “My family makes more moneythan yours does because my wife and I work long hours and we earn extra money onour savings. Why should we be penalized for working and saving?” Harry looked at Tomand said, “I’m no smarter or more talented than you are. If you and your wife workedharder and saved more, you would make as much as my family does.” To which Tomreplied, “I don’t work more because I value my leisure time more than I value money.And I don’t save because I prefer the gratification of consumption today more than I willwhen I’m too old to enjoy it.” Tom was adamant. How could Harry, who was clearly“rich,” ask him to pay the same amount, when it was obviously harder for him to do so?Dick thought for a moment, and then said, “I’ve got an idea. Our aggregate income is$250,000, and $30,000 is 12 percent of that amount. Why don’t we each pay a flat 12percent of our income? Under that formula, Tom would owe $3,000, I would owe$9,000, and Harry would owe $18,000. Since I make three times as much as Tom, Iwould pay three times as much. Harry, who makes twice as much as me and six timesas much as Tom would pay two times as much as me and six times as much as Tom."“No,” said Tom. “No?” Dick and Harry responded in unison. “Why not? What do youpropose instead?” asked Harry. Tom was ready with his answer. “Paying the samepercentage of our income is not fair. Instead, Harry, you must pay $23,450; Dick, youmust pay $6,550; and I will pay nothing. This is the only fair division.” Dick wassurprised at how completely arbitrary this proposal was. He was also surprised at howdisproportionate it was, but since his suggested share was significantly less than under his own proposal, he didn’t object. Harry, however, was stunned. “You call that fair?! Imake only two times as much as Dick, but you want me to pay three-and-a-half times asmuch as he does. I make six times as much as you but you expect me to pay almost 80percent of the total cost while you pay nothing. And this is despite the fact that each of us is receiving the exact same benefits. Where did you get such a crazy idea?” heasked. “From no less an authority than the federal government,” said Tom as he pulledout a gray booklet. “It’s all right here in the IRS tax tables. Under the current tax code,here is what each of us paid in income taxes last year:”Family

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Tom Dick Harry TotalIncome$25,000$75,000$150,000 $250,000Taxes Paid

0 6,550 23,450 30,000Effective tax rate 0% 8.7% 15.6% 12%

The tax figures were calculated by The Shapiro Group, a Los Angeles tax accounting firm. The marginalrates and brackets are those applicable for the 2010 tax year. These figures are for illustration purposesonly. They do not include the effect of certain tax credits (which some would consider transfer payments)that exist in the law. If these credits were included, Harry would pay a tax of $22,600, Dick would pay atax of $3,700 and Tom would receive a

refund

of $7,100.

“By an amazing coincidence, our total taxes paid were exactly equal to the $30,000expended on our street improvements. This is the progressive income tax system allU.S. taxpayers live under, and I don’t see why the Class families should be different. Infact, I believe all future pooling of funds should be divided in this way.” “I’m in,” saidDick. So, by a vote of two to one, the cost of the street improvements was divided asfollows: Tom Dick Harry TotalDollars $0$6,550$23,450 $30,000Percentage 0% 21.8% 78.2% 100%Also by a vote of two to one, all future pooling of funds was to be divided up the sameway.Like all parables, the story of the Class brothers is designed to illustrate a moralprinciple. In this tale, Harry is required to pay a disproportionate amount of the cost andvalue of the benefits he derives from his “mini-society,” simply because his family worksharder than the families of the society’s other members. The moral question is: Is Harrybeing treated fairly? If not, how should this affect our thinking about progressivetaxation?

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In the United States, the payment of taxes is effectively a “pooling of money” by thenation’s citizens to fund the services of government. This pooling is putatively voluntarysince it is indirectly authorized by voters. The services of government include, but arenot limited to: the national defense, infrastructure, the judicial court system, police andfire protection (delivered at the federal, state and local levels), education (delivered atthe state and local level), the general administration of government, and support for trulyneedy citizens. Deciding how much money should be appropriated for this pool and howit should be spent is almost always a subject of contentious debate. The same is truewhen deciding how taxes should be apportioned. As to the latter, the debate inevitablydevolves into an argument over fairness and economic efficiency.The primary source of federal tax revenues (excluding Social Security and Medicarelevies) is a progressive tax on the earned income of individuals.

This essay will makethe case that the progressive income tax is plainly inequitable. It will also review thealternatives to progression in an effort to identify the most equitable (or least

equitable) tax system.

Factors that determine income

There are several other types of taxes levied on individuals by federal, state and city governments,including taxes on capital gains, dividends, estates, sales and property. These tax systems are outsidethe scope of this essay.