Who said taxes are fair?
IF YOU live in a developed country your taxes will probably increase. Politicians won't necessarily tell you this. They would rather pretend that someone else will pay for our profligacy. In America, Republicans claim they can cut spending enough that taxes won’t need to increase. But if they are to balance the budget over the long run, they will have to make drastic cuts to services and entitlements: large enough to rattle an armchair libertarian. Across the aisle, Democrats often say we can close the gap if the “rich pay their fair share”. That is also unrealistic because there are not that many rich people and you can only tax them so much. This raises an interesting question: what is your “fair share"? Politicians seem to say if you’re part of my base your fair share is zero. But let’s first acknowledge that probably everyone will have to pay something and then indulge the normative question: who should pay what if the goal is fairness? To me, fairness would suggest taxing behaviour that poses a negative externality to everyone else. Pollution is the obvious example. Fairness can also mean not taxing things you want to encourage, like working and saving, which bolster long-term growth. Instead you’d tax consumption. Perhaps fairness should involving paying for the services you consume. For example, people in wealthy suburbs pay higher taxes in exchange for better public schools. From that perspective not much is fair about entitlements. In America, each generation is getting a smaller return on their Social Security taxes than the previous generation. The opposite is true of Medicare, which gets progressively more generous and expensive. Eugene Steuerle and Stephanie Rennane of the Urban Institute found that a 66-year-old couple, who earned the average wage, paid about $110,000 in Medicare taxes over their working life, but can expect $343,000-worth of benefits. Soon-to-be retirees have paid their payroll taxes their entire careers with the promise of income and health care in retirement (though what that includes has changed). Is reneging on that promise fair? Of course those promises were made without the consent of future taxpayers, who are stuck with the bill. And how do you take care of the most vulnerable? Some people can simply not afford to pay for decent schools, health care, and dignified retirement; they must be subsidized. When it comes to taxing high earners more, I am not sure what fairness has got to do with it. According to the Tax Foundation in 2008 the top 5% of earners earned 34.7% of the nation's adjusted gross income, but paid approximately 58.7% percent of federal individual income taxes. Is that not their fair share? Defenders of progressive taxation usually make a utilitarian argument. If you earn $250,000 parting with $20,000 is not as big a deal as it would be if you earned $25,000. In economics we’d say high earners receive a smaller benefit from an extra unit of consumption (assuming they spend more than poor people). So parting with some of your disposable income is less painful.Perhaps fairness also requires that the tax code account for the higher cost of living in some areas. The income cut-off for tax increases floated by President Obama is $250,000. That sum buys you a lot more in Fargo than it does in Manhattan. Most high earners live in expensive areas. They command such high salaries, in part, to offset their high cost of living. So if by fairness we mean targeting a certain benefit from consumption, it seems federal taxes need to account for geographic disparities. University of Michigan economist David Albouy found that workers in high-cost cities pay up to 27% more in federal taxes than workers with similar skills in low tax cities. Is that fair? Unless the government has taken the view that living in Texas is a normal good and California is a luxury good. Perhaps income taxes are actually consumption taxes in disguise.