Regressive taxes and redistribution

Imagine a society of 100 people run by a rapacious dictator and his henchmen. This dictator has an income of 1000 and his four henchmen an income of 500. The other 95 people have an income of 10. And imagine too that the dictator has rigged the tax system so that he and his cronies pay 10% of their income in tax whilst the other 95 pay 20%.
Is this society just or equal?
Most of us would say not. Most of us, that is, except Fraser Nelson. He says:

The richest 1% of this country pay 23% of all income tax collected in 2008-09. The richest 5% pay 42% of the tax. These ratios should warm the heart of the most ardent redistributionist.

They shouldn’t. Think of the equivalent figures in my example. The richest 1% of earners - the dictator - pays 20.4% of all tax. The top 5% pays 61.2% of all tax.
But these ratios, and this society, would not “warm the heart” of any redistributionist.
My example shows that if inequality is high enough, even a regressive tax system will involve the rich paying a large share of tax.
What’s more, if inequality rises, so too will these ratios. If our dictator and his cronies rob the poor of half their income and divide it among themselves, the share of total taxes paid by the top 1% will rise from 20.4% to 24.7%, whilst the share paid by the top 5% will rise to 78.5%. By Fraser’s reckoning, our society has become more redistributionist. Which it has - but in precisely the opposite direction that Fraser would think.
So, the share of taxes paid by the rich tells us nothing about whether society is equal or the tax system progressive. To believe they do is to commit a plain logical error.
Stephen Pollard describes Fraser’s post as “incredibly important.” It is, because it shows just how badly the right can misunderstand what redistribution means.

Comments

[Dan]

Even more hilariously, it's cited as a case of "the Laffer curve in action". Utterly bizarre.

[Jock]

Chris, thank you for that simple explanation of something I had seen quoted ad nauseam and never actually sat down to work out simply. Of course I'm not an income tax person (Single Taxer for me) but still an important argument to wheel out! And thanks for the link.

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If your dictator and his cronies "rob the poor of half their income", is that not a tax that the poor are paying to their rulers?

In which case, you have demonstrated that a more regressive tax system will have a more regressive effect. I doubt Fraser would be surprised.

[Chris Clark]

Yes, but...

Your example is that of a "fixed pie-variable slices" economy - which ours is not. As Fraser points out in that post: "When he reduced the top rate to 40% [Nigel Lawson] unleashed wealth creation and the government profited by taking a smaller slice of a much bigger pie."

Now, I'm all for a bit of Lefty-Righty argy-bargy, but you misrepresent Fraser's views here. He clearly sets out (rightly or wrongly) the model of a society where the wealth of the top 5% is created with none of the imposition on the 95% that is present in yur model (other than in their resultant inequality).

Questions:
1) Is there a direct trade-off between wealth creation and inequality?
2) If there is, how on earth could we measure where the equilibrium should lie?
3) Why are you so keen on seeing society as a closed shop when talking about income distribution, but consider it an open shop when discussing population distribution?

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On reflection, whether or not Fraser understands “what redistribution means”, I don’t even understand what Chris means by it in this post.

Example: take the first model society and change it so that everyone now has a before tax income of 10. There is now no income inequality at all, but everyone is going to suffer lower public spending, lower after tax income (due to tax increases for most people), or both.

Fraser would probably disapprove of this change, but I believe Chris would be pleased, as the changed society is more equal.

Indeed, it would remain equal if everyone’s before tax income were cut to 5, or 1, or even 0.

Is this what redistribution means?

Or does it mean taking money from the rich to give to the poor? In which case, the richer the rich are, the more money can be taken from them.

[anotherplanet]

Yes. And when the top 1% take ALL of the nation's pre-tax income they will be paying 100% of any income tax, poor dears.

[BenP]

The 5% are rich due to the labour of the 95%, it's certainly not due to their innovation of financial bonds or 'risk' taking now is it.

Redistribute the wealth i.e. reclaim the surplus extracted from workers, we all pay tax on our share and have plenty to pay for the services we all use.

For those with short memories the only thing Lawson unleashed was a housing bubble and inflation.

[Sean Hunter]

This is an idiotic argument. The fact that your straw man society is brutally inequitable does not prove anything in the real world, where the ratios are nowhere near that.

[ortega]

But there is another point. What has in fact happened is that by reducing the high income taxes the total amount of income taxes has been increased. So the question is: you tax to increase the money available to the state or your aim is to punish people because they are rich?

[Andreas Paterson]

I think Chris' main argument is basically that the fact that the rich pay a very big proportion of tax is a sign of an uneven distribution of wealth.

If we do a bit of jiggery pokery with the numbers..

Total wealth = 1000 + 2000 + 950 = 3950
Total Tax = 100 + 200 + 190 = 490

In an equal society each citizen has an pre tax income of 39.5 an after tax income of 31.6. The total tax revenue is 790 meaning that your average citizen is nearly 4 times richer under this regime.

In my view it's not necessarily about punishing the rich, it's reversing the tendency for wealth to accumulate. Asset ownership tends to act as a natural distribution from the poor to the rich.

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I think you are assuming here what has to be proven.

The poorest people in an inegalitarian society must be poorer than the poorest people in a more egalitarian society of the same average wealth, but there is no particular reason why a massive effort of redistribution must leave total wealth unchanged.

So if you are really concerned about the welfare of the poorest, you should seek to make them richer, whether your efforts make things better or worse for the rich.

Frasers claim was that a reduction in the top tax rate produced an increase in the tax money raised, by reducing the deadweight cost of the tax system. If that claim is true, then the government would be left with more money buy votes, sorry, help the poor. He also thought that would be something that supporters of redistrubution would be keen on.

So if Frasers claim were proved to be correct, would you support the policy?

[Mark]

Wealth tends to accumulate with the rich because of the regressive nature of inflation. Inflation steals money from the poor and places it under control of the rich, an effect which must be countered by progressive taxation.

End deficit spending, which is in fact a tax on the poor, and the problem of inequality ceases to belong to government.

[fred zen]

why do I have to share the planet with people who are so stupid? You idiots are just playing with words. It is also dishonestly presented by setting up the rich as dictators who rob other people. Good god, are you incapable of honest discussion! Do you think that anyone without your prejudices is going to be taken in for a second by this propagandistic nonsense.

REdistribution occurs when some people pay for the benefits obtained by others. The nonsense on this page depends on ignoring that transfer of benefits and focuses on tax rates. It doesn't matter what the tax rates are. If someone gets more benefits from government than what they pay in taxes then they have had somebody else's money redistributed to them, even if they pay a high tax rate. If someone else pays a low rate but pay in taxes more than the benefit they receive from government then their money has been taken from them for someone else's benefit.

[Erik]

Whoa whoa whoa. The problem with your whole example is that it doesn't say where the taxes end up. What is IMPLIED, to make your argument stronger, is that the taxes go to the government, run by this evil dictator and his cronies. However, if you put those tax incomes into a welfare system, suddenly yes, the poor are paying 10%, but the wealth will be redistributed to them, either in direct transfers amounting to more than the 10% they paid, or in common goods that the five rich people value much less than what they paid for them. The ONLY way the poor people will be worse off is if the taxes are redistributed all to the wealthy, which never happens in the real world, and your example tries to imply does.