Recently the stars have aligned in such a way that we have the Panama Papers telling us about wealthy Americans avoiding taxes by hiding money in offshore accounts, and at the same time we have politicians talking about cutting taxes on the wealthy.
Of course it will be a tax cut for everyone, they say, but the wealthy will make out like the bandits some of them apparently are. The argument in their favor is that the wealthy pay most of the taxes and that’s not fair. Unsaid is that the wealthy have most of the money and that may be unfair, too.
The unasked—or at least unanswered—question is, why do we ask the wealthy to pay so much in taxes? It is not because “that’s where the money is,” as Willie Sutton said when asked why he robbed banks. It is because it is fair. And it is fair because of an economic concept called “marginal utility,” which holds that the importance of each additional item diminishes as it is added to the total of the other items.
Huh? Well, consider a hungry person who wants a hamburger very badly. He is suddenly presented with an opportunity to have as many hamburgers as he wants, and believe me, that first hamburger is mighty important. The second one is important, too, but not quite as much as the first, and the third is still less important, as is the fourth, the fifth, and on and on ad nauseum, so to speak.
So with money. Consider a five-dollar bill lying on a sidewalk. A poor person will pick it up, but a rich person might pick it up. This means that money has two values—the face value, five bucks, say, and a psychological value, which essentially can be expressed as, “the less of it you have, the more important it is.”
It also might be more accurately expressed as a percentage of income; the higher the percent of income the five bucks is, the more valuable it is to the person. For this reason, tax rates increase as income increases. This is called progressive taxation.
Progressive taxation is an attempt to make the sacrifice (some might say pain) of paying taxes the same for everyone, to equalize the contribution in terms of the psychological value of the dollar for rich and poor alike.
Everyone, rich and poor, pays the same percentage on, say, the first $30,000 of taxable income. Everyone, rich or poor, pays the same increased percentage on their taxable income between $30,000 and $50,000. The higher the brackets of income, the higher the percent of taxation so that the less “important” each additional dollar is, the more highly it is taxed.
There is also an argument that high taxes on the wealthy lead to decreased investment and a slowing of the economy. Maybe, maybe not. Consider that from 1944 to 1963 the top marginal tax rate was over 90 percent on that portion of a person’s income over $200,000.
Adjusted for inflation, $200,000 in 1944 would be $2,609,023 in today’s dollars, while $200,000 in 1963 would be $1,500,614. (Data from the Tax Foundation; “History of Income Tax Rates.”) As high as that rate was, it coincided with a time when America enjoyed the greatest economic growth in the history of the nation.
Is this kind of taxation fair? Well, theoretically it is, but then, like a dollar, fairness also has two values, the theoretical and the psychological.
Jim Elliott is a former chairman of the Montana Democratic Party and a former state senator from Trout Creek.