It’s obvious: “A graduated tax rate structure redistributes wealth.”

It’s obvious:  “ A graduated tax rate structure redistributes wealth.”

This “obvious” claim is accurate.  But, it’s irrelevant.  Every tax structure redistributes wealth and income.  Flat tax rates such as sales taxes, excise taxes, capital gains taxes, taxes on dividends, road tolls, building permits, real estate taxes and any other tax rate based on a single percentage of value or income redistributes income.  The issue of concern in this post is to whom is income or wealth distributed by which tax structure?  A secondary concern is how this redistribution actually happens.

Consider two cases:  the case of the extremely wealthy and the case of the working poor.  In the case of a flat tax, assume, for simplicity, a flat rate of 20% of income, where no deductions are allowed.  How does this flat tax redistribute income?  Let’s see how the incomes and wealth of the extremely wealthy and the working poor are affected by it.

Suppose Tom is the head of a family with four members.  Tom earns $50,000 per year.  In this flat tax structure, he pays $10,000/year in taxes, leaving $40,000 for living expenses and savings for him and his family.  We know that $40,000/year is barely enough to provide the basics:  food, shelter, clothing and transportation.  In many cities, transportation constitutes the bus or subway and many hours of transportation each week.  This person has no capacity to save or “invest”.  Therefore, he has no ability to accumulate wealth.  In the end, he no ability to accumulate enough wealth to generate economic rent income on which he and his family can live or, when he and his wife retire or grow to old and infirm to work, they will have to rely on the state to support them for the remainder of their lives.

Now, suppose Jim is the head of a family of four with an annual income of $1,000,000.  His after-tax income is $800,000.  Somehow, this amount seems more than sufficient to provide food, clothing, shelter and transportation.  The transportation is probably not a bus ride.  If he spends $300,000/year to provide the basics plus a cruise or two, a vacation and college educations for his children, then he saves, say, $500,000/year.  After 30 years of saving and investing $500,000 at an annual compounded return of 9%, his accumulated wealth would be about $6.6 million.  After annual inflation of 2%, this would amount to about $5.7 million in current dollars.

This difference reflects an outcome of a simple mathematical calculation based on the assumption that a dollar today is worth more than a dollar tomorrow, especially on a risk-adjusted basis.  The reasons for Jim’s superior income are irrelevant for this discussion.  The point is that economic principles describe a world in which, if left alone, the rich get richer and the poor stay poor.

The rich maintain, of course, that they’ve earned their wealth.  That claim has some merit when made by the first generation of wealth accumulators.  It has no merit when made by the second generation or subsequent generations, even when they’ve worked hard to increase their inherited wealth.  Those folks can simply collect rents and live well.  Or, at the least, they were born with material advantages over those people who were born poor.  The descendants of the wealthy are lucky.  Why should they be rewarded for that?


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Filed under Economics, Policy

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