A Productive Tax Policy

“A worker’s appetite works for him, For his hunger urges him on.” – Proverbs 16:26

A few days ago we touched on the issue of US tax policies which appear, in my view, to be rigged to keep the wealthy intact while extracting as much effort and productivity as possible out of the lower and middle classes that dare aspire to rise in station. This spurred some interesting discussion.

In an attempt to defend progressive taxation, a reader noted that the progressive tax does not punish people for making an extra dollar. That is, for the additional dollar earned you are never taxed more than a dollar. But this is not the issue. Progressive taxes will not cause people to turn down a raise – but it will cause people to turn down additional work (additional productive opportunities) – thereby reducing economic activity. I’ve known plenty of people (myself included) who have turned down additional work because the marginal benefit was so depleted by progressive taxation as to be of negligible value. I’ve known highly productive people who chose to go to part-time hours instead of paying the high marginal tax rates. In the name of some presumed “justice” (or judgmentalism) progressive taxation lowers productivity, thereby harming the economy.

The whole thing got me to thinking about the nature of the most productive tax policy. Not necessarily the most just or most fair tax policy, but the one that will cause the most productivity. For reasons that I will lay out here, I would argue that the most productive income tax policy is regressive in nature, not progressive. Note, I am not arguing that I prefer regressive taxation – there are motivations other than productivity, like justice and fairness – but from a purely productivity standpoint, I’ll argue that regressive taxation is a more effective income tax policy.

The argument boils down to marginal benefit from marginal productivity. For a person to work an extra hour, he has to judge that the benefit he will receive from working the extra hour is worth more than having the hour free from work to rest, spend time with his family, or pursue recreation.

With the early hours of productivity, people are working to satisfy their basic needs – food, clothing, and shelter. Once these are covered, hopefully they turn to planning for the future (savings and retirement). After this, people will then move to nicer food, clothing, and shelter, followed by entertainment and various types of luxury. Everybody may well have a different order, and we should all get to decide for ourselves what is important to us.

The list itself points to the marginal benefit of marginal work. If you decide you don’t want to work an extra hour, you must figure out where you are on the list. If you’ve only covered food and clothing, chances are you will suck it up and work the hours needed to provide shelter. However, if you’re already out past entertainment and on into luxury, it’s very easy to walk away and not work any harder.

Thus, the first hour worked would appear to be the one with the most marginal benefit to the laborer, with later hours being less beneficial. (Note, we’ve tacitly assumed that each hour is equally productive. Obviously this won’t hold. Per hour productivity probably increases for a while and then decreases afterward.)

Now, if we want to talk about a taxation system that improves productivity, we must encourage people to be more productive – meaning choosing to work more hours. Because the marginal benefit of extra hours worked decreases as hours accrue, the tax rate must drop in accordance to encourage continued work.

You could probably tax people pretty heavily in their early work hours, their basic needs will spur them on. However, heavy taxation beyond the point of a certain productivity will result in people simply refusing to do any more – preferring free time to hard work for minimal gain. For those who are fantastically productive, encouraging them to work even more hours (when they have no more needs and very few wants) requires allowing them to keep most if not all of their productivity – very low or zero tax rate.

The reason productivity matters is that productivity is economy. Increasing aggregate economic activity will continually lower the necessary rate of taxation, feeding even more productive impetus. (As a side note, I read an economics article a few years back making exactly the same argument with regards to regressive taxation – though it was not the source of this post.)

Now, I will not argue that a regressive tax is good, fair, or just. But, it will be more productive than a progressive tax. It’s certainly OK for people to argue for progressive taxation on other grounds. We have to have to be comfortable with the notion that our preferred policies are not better in every possible way-shape-or-form for them to still be preferred. Most liberals have recognized this and argue for progressive taxation based on “justice” – an argument easily refuted, but one that will have to wait. (Note that progressive taxation is a hallmark of the Communist Manifesto, giving clear indication of its origins.)

I prefer a flat tax. As a Christian, I note that it is the only model of taxation I find in the Bible for man-made governments. (See Josephs’ 20% flat tax on Egyptian farmers in Genesis 47.) It’s also the manner in which God procures resources for “His house” – a 10% flat tax (the tithe). None of these indicates that such a taxation system is the most productive – but the most fair.

To lay a heavier burden on the poor because they can be exploited by their basic human needs is unfair, unjust, unacceptable – so I do not support regressive taxation. Similarly, to apply a progressive tax based on which people “can afford to pay” for various social programs is to raise oneself above the role of an equal and into the role of a judge. This too is an unjust and unfair position for a man to place himself in regards to his fellow man.  So then, if we are to have income taxation, it would seem a flat tax is the only rational and fair answer.

I sure I haven’t covered every facet of the argument though, and suspect the comments will bear that out.

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