It’s obvious: “A graduated income tax rate is unfair to the successful high-income earners.”
As usual, let’s take a look what this claim might mean. You and I may have different notions of fairness, in which case, this claim would mean different things to us. We may have different measures of “high-income” and “graduated”, but our idea fairness may be the same. Unless we specify the usage of these three terms, we can’t even agree to disagree; we haven’t agreed, yet, to the topic of discussion. Fairness, especially, is a challenging notion. The common sense notion that if a rule or principle or dogma applies equally to all people within it’s domain of application says nothing about whether any specific rule structure, statutory regime, form of government, form of punishment, or, really, anything at all is fair. Yet, “That’s not fair!” is probably the most common complaint made by students, criminals, children, parents, employees or almost any group of people subject to rules of some kind.
Philosophers, politicians, legal theorists, economists, nearly reflective person, has discussed this notion for thousands of years, although it has ascended to near the acme of moral concerns only since, but not including, the Renaissance. Our idea of fairness, whatever it may be, didn’t become a major criterion of legislation until the ideas of a Social Contract and of Government Legitimacy being rooted in the Consent of the Governed (vs. “might makes right” and “divine right of kings, for example). Five hundred years ago, the idea that property may belong only to one class, the nobility, was considered fair. I do not intend to plunge into this thicket of thorny debates and prickly commentary in this post; ultimately, fairness is not the rabbit we’re hunting. And, this post isn’t about proposing specific rate structures or income levels as “high”, “middle-class”, “low” or “poverty”. Indeed, on a daily basis, we don’t concern ourselves with fairness or whether the poverty level of income maxes out at $35,000/year, $50,000/year or $25,000/year for a family of four, we know it’s in that range, and, when it’s our income, we know we’re poor. Likewise (mutatis mutandis), we know a high income when we see one or when we have one. Whether it’s $250,000/year or $350,000/year doesn’t matter for our purpose in this post.
However, the value of your dollars does matter; each dollar you earn is worth less than the previous dollar you earned. For the provider(s) for a family of four earning $30,000, the next (marginal) $1,000 earned or received has an entirely different significance than the next $1,000 earned has for the provider(s) of a family of four who earns $250,000. I hope this statement is beyond obvious; I hope it’s trivial. But, you never know. Not only is the level of household income material to this discussion, the number of people who contribute to it is as well. If husband and wife must work to earn $35,000, they must incur additional (marginal) costs of childcare, transportation and clothing (exceptions are rare). Likewise, if husband and wife earn $250,000, combined, they incur similar additional (marginal) costs. Nevertheless, these remarks apply to comparisons between single-earner households as well as between two-earner households. The contrasts are simply amplified when we compare two-earner households to single-earner households.
Not every dollar is worth the same to every person. In general, it should be obvious that the first dollar you earned is worth more to you than the 200,000th dollar you earned in a given year, say. First, the dollars we spend on food, shelter, clothing, utilities and transportation are more valuable to us than the dollars we spend in movies, theme parks, restaurants, jewelry stores, golf stores or boat yards. If you need one car, one dwelling, $100/wk. of food, 10 complete outfits, and lights on in your dwelling, you buy the car, dwelling, food, clothing, and electricity you need before you buy your fine china, eat at restaurant, go to Disney World or buy your girlfriend diamond earrings, for example.
Second, some dollars are worth more to us than others according to whether they’re spent on the first item in a category, the second item in the same category or the next item in that category. If you need two cars, you won’t buy a third until your choice is between that third car and some other inessential item, say, a trip Europe or an original painting.
Third, the last dollars you spend on a given item even are worth less than the first dollars you spent on it. Before you buy original works of art, you will buy prints and posters, then, if you have more income, you’ll buy numbered lithographs. The underlying principle is that you will buy goods only if they’re marginal value equals their marginal cost to you. My schedule of costs and values may differ from your, but, the principles that some goods are necessary and some are discretionary and that the first good of one kind Is more valuable to you than the second, third, fourth, or… are the same for both of us.
These principles are not the same as utility, or choice, theory because choice theory doesn’t distinguish between necessary purchases and discretionary purchases. This distinction between essential and inessential goods is crucial to understanding why a graduated tax rate schedule is fair and why the economy as a whole benefits from them. These principles are why taxing your 50,001st or 250,001st dollar at a higher rate than your 50,000th or 250,000th dollar is fair. They are also why reducing taxes to lower income taxpayers is more effective economic stimulus policy than reducing taxes to high-income taxpayers. Low-income taxpayers spend all of their tax savings immediately, thereby, stimulating demand immediately. Middle-income taxpayers spend most of their tax savings immediately, and high-income taxpayers spend very little, if any at all, of theirs immediately. The velocity of money exchanged among the poor is far greater than the velocity of money exchanged among the wealthy and the economic multiplier effect of tax cuts for the poor is much greater than the multiplier effect of tax cuts for the wealthy.