What could be more fair than a flat-rate income tax? All citizens would be taxed at the same rate—no special treatment for anyone. Such a system is progressive in that, the more one earns, the more tax they pay. And those who are unemployed would pay nothing until they are able to find work (unlike with sales or “value added” taxes).

Some flat-tax plans are even more progressive. Such plans exempt income below a specified level, allowing the very lowest income earners to avoid paying any tax at all.  Such an exemption increases the progressive nature of the system all the up the income scale too.  For example, with a 20 percent flat rate and a $20,000 exemption, someone making $20,000 per year would pay no tax, while someone making $40,000 would pay tax at a rate of 10 percent, those making $80,000…15 percent, $200,000…18 percent, $5 million…19.92 percent, and those bringing in $20 million per year would pay tax at a rate of 19.98 percent.  It’s progressive.

Is it progressive enough?  What are the considerations that need to be addressed in determining whether such a flat tax is fair to all citizens and prudent for the health and wellbeing of our economy and our society?  Here are a few.

Social Justice

One might ask why should we not simply let nature take its course—let freedom and the free enterprise system do what it does best. That is, reward those who work hard and those who, through their own initiative and ingenuity, realize the highest incomes. Our free enterprise system, because it rewards hard work and ingenuity, is the most efficient and productive economic system the world has ever devised.  We certainly wouldn’t want to compromise the economic system that has enabled the United States to become the most prosperous nation in history.

But of course, while free enterprise has been the primary engine that has produced American prosperity, it has not been an unfettered free enterprise.  It has not been the kind of laissez-faire economic system that operates on the principle of “survival of the fittest,” with utter indifference to those who do not succeed and prosper. There are two reasons why we do not subscribe to a simple laissez-faire economic system. One has to do with practical economics, as we will see momentarily. The other reason concerns American principles of social justice.

In his first draft of our Declaration of Independence, Thomas Jefferson described the principle “that all men are created equal” as a “sacred” truth.  (It was the impious Benjamin Franklin who urged the substitution of “self-evident” for “sacred.”)  It had not escaped Jefferson’s attention that, in fact, men possess quite a wide range of physicality, intellect, initiative, and moral aptitude.  He simply meant that, since all men are created by God, we are all equal in the possession of a common humanity, and that natural law, therefore, dictates that everyone is entitled to the same inherent rights.  The notion that we are all “equal in the possession of a common humanity” also suggests, just as Christianity and other religions teach us, that we have a responsibility to our fellow human beings—a duty to see to it that everyone is given an equitable chance to live freely and prosper.

This does not mean, of course, that everyone should be guaranteed an equal financial outcome. Rather, it prescribes that we have an obligation to see to it that everyone has as equitable a chance to get ahead, relative to other citizens, as can be practically ensured. Unbiased formulation of tax policy, therefore, demands that we consider the advantages that higher incomes and wealth provide in the quest for greater prosperity relative to lower incomes.

Though in his day taxes were based primary on property ownership, Thomas Jefferson believed that a progressive tax structure would best serve the cause of social justice.  In a 1785 letter to James Madison, Jefferson wrote:

Another means of silently lessening the inequality of property is to exempt all from taxation below a certain point, and to tax the higher portions or property in geometrical progression as they rise.

Wealth Begets Wealth

We’ve all heard the expression, “it takes money to make money.” Such colloquial sayings are very often over-simplifications, yet, like this one, they are also usually grounded in some truth. It isn’t always just harder work and greater initiative that enables some people to make more money than others. It is very often affected more by their position in life than by an intensity of labor.  There are a great number of factors that can help to establish one’s position in life—initiative, foresight, education, intellect, imagination, inheritance, familial or personal associations, appearance, and health, for example.  We have some control over many of these factors.  Others, we do not.

The most significant circumstance in determining our station in life is usually our immediate family, or lack thereof.  It is from our parent(s) that we learn what to expect in life.  This is why descendents will usually rise to roughly the very same socio-economic status as their parents—expectation, more than anything else.  If we are unfortunately born into poverty, or of slovenly or disabled or otherwise dysfunctional parents, it is up to us to expect and achieve more for ourselves.  But, while expectation is perhaps the most significant factor in determining one’s station in life, it is by no means the only factor.

Achieving an undergraduate or graduate degree, for example, is a result of not just desire, but of intellectual capability and an ability to navigate the economic demands of attending school. Sure, many people have been able to attain degrees on their own through loans and/or part-time employment, but many others have familial obligations that make such a scenario impossible (even if they may be brilliant).  In any case, there can be no doubt that excelling in college is facilitated by economic security.

Those young people who come from a family of substantial means also have the advantages of a safety net—a supportive family to fall back on in case of failure or setbacks, enabling greater risk taking and bolder ambitions.

There are also more direct ways in which having money enables us to more easily make additional money.  Those of us who have been in the work force long enough and have been successful enough to have accumulated substantial savings, or those of us who have inherited wealth, have an ability to generate “unearned” income in addition to our ordinary income—i.e. rents, royalties, interest, dividends, capital gains, etc. And the more we have, the more abundant and the more profitable such investment opportunities become.  Having assets also enables us to secure loans or to apply our own resources toward a business enterprise.

For those who start with no assets, no higher education, and no “connected” acquaintances—especially those who lack exceptional intellect—accumulating enough savings for productive investment can be exceedingly difficult.  The lower one’s income, the greater portion of it is required for the very basic and essential costs of living, such as food, clothing, housing, utilities, transportation, and healthcare (if affordable at all).  Even maintaining a bank account for somebody with very little money requires service fees that those of us who have more money are not required to pay.

Today 20 percent of Americans hold 84 percent of our nation’s wealth and a mere 1 percent of Americans hold half of that—42 percent.  There can be little doubt that the advantages of wealth do not follow the same one to one correlation that is implied by the use of the same tax rate for all income levels.  The advantages of wealth are exponential.

Societal and Corporate Infrastructures

None of us live in a vacuum. We live in a complex and dynamic society—the American society that well affords us an opportunity to prosper. No one can become wealthy, or even make a living at all for that matter, alone. We are either an employee or an employer. Even a self-employed one-man-enterprise has to have customers, suppliers, utilities, roads, general police protection, as well as his own basic education. We all make our living, at least in part, in conjunction with the labor of others.

As Americans we have today’s opportunities to prosper in large part because of those Americans who came before us and built our nation’s governmental, physical, and economic infrastructures, and because of the institutions that maintain those things today.  In exchange for the economic opportunities made available to each of us as a result of public investments and our safe and orderly society’s greater infrastructure, each of us is obligated to financially support our nation at a level that is commensurate with the financial benefits that we come to realize within it.

As we consider the degree to which those who realize the largest incomes do so only in conjunction with the labor of others, we might also consider the practical limits to how much someone can actually earn.  The salaries of some corporate managers, for example, have become quite large in recent years.  There is nothing too troubling about that.  It is merely the result of supply and demand.  If several companies are vying for one of a just few exceptionally talented managers, it makes sense that they will have to pay at least as much as any other company is willing to pay. And given the enormity of the financial stakes involved in properly managing a multi-billion dollar corporation, offering a manager an enormous sum in salary and bonuses can be prudent. We have to ask ourselves, however, “can anyone really earn $50 million per year?” There are people who bring in that much, and rightfully so, if that’s what the market dictates.  But can anyone really work a thousand times harder and/or a thousand times smarter or be a thousand times more deserving than those people who make only $50,000 per year (the median income in the U.S.)?  No one attains a position in which they make $50 million per year as a result of merely good luck. Such individuals possess tremendous talent and they have worked very hard.  They have made a lot of the right decisions in their rise to such a position in life.  But however one has risen to a position of making $50 million per year, they can receive that much money only because the money has been generated by the labor of those below them in the corporation, and within the context of our society at large.

The wealthier we are, the more direct benefits we tend to realize from our nation’s assets and infrastructure too. Business owners and corporate shareholders enjoy the unlimited use of roads and waterways, the availability of a publicly educated work force, and our nation’s armed forces protecting American economic interests around the world.  While we all enjoy the benefits of these things, those of us who realize the largest incomes as a result of business enterprise tend to gain the most benefit from them.

Supply-side Economics

Doesn’t taxing the rich hurt the economy? “Supply-side” macroeconomic theory does indeed proclaim that citizens with the largest incomes are the driving force behind our nation’s economy. Many of them, after all, are the small business owners and the entrepreneurs who produce the majority of America’s jobs. The more they are taxed, advocates of the theory declare, the less money they have available to invest in their businesses, and therefore, the less productive the American economy becomes.

Actual supply-side economic theory is not quite so simple as that, but this is generally how it is presented by a great many politicians and political advocates.  What these advocates overlook, or willfully ignore, is that such business investment is not taxed at all.  In fact, higher marginal personal income tax rates can actually induce some business owners to invest more in their businesses, rather than taking the money out as personal income and paying the tax on it.

The Heritage Foundation and others who advocate lower taxes for the wealthy as justified by macroeconomic assumptions cite several occasions in history when the lowering of the top marginal income tax rates were following by periods of accelerated national economic growth.  As we often find when someone advocates for a particular faction of society, they leave out pertinent information that does not support their preferred conclusion.  In economics there are always a multitude of variables that must be taken into account in order to reach a more objective conclusion. Not only does the Heritage Foundation tend to disregard factors outside of the tax rate changes, they also leave out those tax cuts that were not followed by accelerated growth, the tax increases that were followed by accelerated growth, as well as the more comprehensive historic correlation between personal income tax rates and economic growth.

Recent history provides a pretty clear indication that lower tax rates alone are not a panacea to an ailing economy, and that raising taxes on upper incomes is much less harmful to the economy than some proclaim.  Two of the most prosperous decades of the twentieth century were the 1950s, when the top income tax rate was 91 percent, and the 1990s, which immediately preceded all of the many tax cuts enacted at the urging of the Bush and Obama administrations.  Because of the Bush and Obama tax cuts, the top marginal income tax rate today is lower than at any time since 1931 (except for the brief period from 1988 to 1992), and the overall tax burden of Americans as a percentage of the GDP over the last three years has been lower than any three year period since 1941 to 1943.  And yet, our economy continues to struggle to recover from the economic contraction that occurred from December 2007 through July 2009, the resulting banking crisis, and subsequent high unemployment.

Trickle-up Economics

Another name for supply-side economics, often used pejoratively, is “trickle-down economics.” Perhaps a more relevant and authentic dynamic in the function of an economy could be characterized as “trickle-up economics.” That is, an economic model that emphasizes the importance of demand.

The reality, of course, is that both supply and demand are essential elements of any economic system.  But we do well to realize that, without demand, all of the supply in the world cannot make an economy grow and prosper. The first and foremost ingredient in a healthy economy is demand—i.e., lots of people who are able and willing to buy goods and services.

At the urging of a member of his board of directors in 1913, Henry Ford raised the wages of his factory workers from an average of around $2.50 per day to $5.00 per day.  It was an unprecedented and bold gesture.  Other automakers accused him of being a “traitor to his class,” and said that he would “wreck the industry.”  The Wall Street Journal called it blatantly immoral, a misapplication of “Biblical principles” in a field where “they don’t belong.” The dramatic wage increase was intended as a humanitarian gesture as well as a rather clever advertising ploy, but the consequences of the wage increase benefited the Ford Motor Company, its directors and stockholders, and ultimately the nation, in a number of ways that were unanticipated.

Absenteeism at the factory dropped from 10 percent a day to less than one half of one percent, saving the company millions of dollars in productivity and training costs for new hires.  Ford workers suddenly became proud of their association with the company.  The most significant aspect of the five dollar wage, an aspect the importance of which would only later become apparent, was the fact that it created a whole new group of consumers for Ford products. By increasing the workers’ salaries, Ford had elevated them to the middle-class and thus enabled them to buy middle-class consumer goods, such as new cars.

Similarly, a smaller tax burden on the lower classes can afford them a better opportunity to become enabled to improve their circumstance and to ascend into the middle-class.  As the middle-class is enlarged, the infrastructure of the marketplace is enlarged, and ultimately the opportunities for free enterprise and prosperity for all citizens are enlarged.

Wouldn’t a Flat Tax Be Simpler?

Many flat-tax proponents over the years have held up a postcard and declared that their flat-tax proposal would mean that everyone could do their own tax return on a short form the size of the card they were holding.  It’s a ruse.

Internal Revenue Service statistics show that roughly 70 percent of Americans already file their tax returns on simple “short forms.”  Those who file the longer more complicated returns do so because it is a benefit to them and to our entire nation.

Tax law is an effective way to encourage certain behaviors. We want to encourage people to give to churches and to other charitable organizations, for example. Our society has also chosen to use the tax code to encourage marriage, home ownership, and energy conservation—all things that have been judged to be beneficial to our society. Our tax returns, therefore, necessarily have provisions for reducing our taxes when we respond to the greater public interest.

Business owners have to account for wages, payroll taxes, the cost of supplies and other expenses, depreciation, capital gains, etc.  Various sources of “unearned” income also need to be reported if they are to account for and/or treated differently.

There is little question that our current tax code is too complicated and too cumbersome.  It is so much so that it is a significant drain on productivity—an issue that certainly needs to be addressed.  But its complexity, of course, has nothing to do with tax rates.  Most anyone who is capable of earning an income should be able to read a tax table or calculate a percentage.  Those who suggest that we need a flat tax “because our current system is too complicated” are being dishonest.

Doesn’t a Progressive Income Tax Punish Some People By Taxing Them at Higher Rates Than Others?

There has been a lot of discussion lately about how proposals to increase taxes on upper incomes constitute “class warfare.”  We often hear the expression “soak the rich.”  These expressions are born of the idea that taxing higher incomes at a higher rate is to treat some people differently than others—to punish those of us who have worked the hardest and smartest and who have succeeded, through our own initiative, in realizing a plentiful income.  Such an idea misunderstands the principle of progressive taxation entirely.

Properly implemented, a progressive rate income tax treats everyone in exactly the same way.  It is income above specified levels that are taxed differently, not people. Everyone would pay tax at precisely the same rate on every level of income that they may bring in. So an individual who makes $50 million per year would pay tax at the very same rate on his first $50,000 in income as the man who only makes $50,000, even if he might pay tax at a higher rate on income above $50,000.  Everyone is taxed in the same way, with the same set of rates.

At whatever rates we may choose to collect the taxes needed to pay for our national defense, highways, waterways, national parks, Medicare, Medicaid, welfare, medical and other scientific research, space exploration, resource management, and the many other things undertaken by the federal government, it appears that the most fair and prudent method of doing so is through a progressive rate income tax. We can see that, while treating all citizens by the same standard of taxation, such a system is considerate of the plight of the poor, understanding of the exponential advantages of rising income levels, and beneficial to the whole of our economic system and everyone who prospers from it.