A Tax Taxonomy

(Photo: Hemera)

Dan Hamermesh’s much-discussed post about taxing capital gains brought to mind my own taxonomy of taxes, so to speak, from least to most progressive:

  1. Poll tax. Everyone pays the same amount. What could be fairer than this?!
    England tried it in the late 14th century, leading in 1381 to Wat Tyler‘s Rebellion. Six hundred years later, England tried it again, leading to the Poll Tax Riots.

  2. Sales tax. Goods are taxed at a flat rate (often 17 to 20 percent in Europe, and 5 to 8 percent in various American jurisdictions). Because the wealthy spend a smaller fraction of their income on taxable goods than do the poor, this tax is less progressive than a flat income tax.

  3. Flat income tax. Everyone pays the same fraction of his or her income. This tax was the core of Steve Forbes’s platform when he ran for president in 1996 and 2000.

  4. Progressive income tax. The usual system today: Higher incomes are taxed at a higher marginal rate. In the U.S., doubts about its constitutionality were settled by the Sixteenth Amendment to the Constitution.

  5. Flat wealth tax. Wealth (net worth) is taxed at a fixed rate. If income is the flow into net worth, then wealth is its accumulation, so inequalities in income produce significantly larger inequalities in wealth. Thus, a wealth tax is more progressive than an income tax (and a flat wealth tax is probably more progressive than most progressive income taxes).

  6. Progressive wealth tax. Larger wealth holdings are taxed at a higher rate. Switzerland and France use a progressive wealth tax as part of their tax codes. This link analyzes, with lots of data, the effect of a Swiss-style progressive wealth tax (the data are from the 1980s and 1990s, so all the dollar amounts seem low to us today).

This taxonomy helps me decide how angry to be at various public costs. Even if your sense of justice differs greatly from mine, the taxonomy still can help you decide where to aim your political fire.

Here are examples:

  • Social Security taxes. It’s a flat income tax until an annual income of $110,100 (in 2012), with a rate of 12.4 percent (including the employee and employer contributions). Above $110,1000 the marginal rate is zero. Thus, it’s an anti-progressive income tax, falling on the taxonomy between a flat income tax and a poll tax — perhaps like a sales tax.

  • Insurance premiums in the American healthcare system. As a zeroth approximation, everyone pays the same amount, with different employers paying different fractions of the total of about $7000 per year per person. There are corrections to this model (individual coverage is extremely expensive, on the one hand; on the other hand, some states offer low-cost plans to residents without employer coverage), but overall it’s a poll tax. When is Wat Tyler’s rebellion coming to the American medical system?

  • Tobin tax. It’s a sales tax on financial transactions, so, assuming that financial transactions grow in proportion to wealth, it’s akin to a flat wealth tax.

  • Estate taxes in the U.S. The first $5 million is taxed at 0 percent, and amounts above this threshold are taxed at 35 percent (but these provisions change almost yearly). So it’s a progressive wealth tax.

  • Subway/bus fares. Fares are roughly the same for almost everyone, although seniors and children often pay less. So the fares are a poll tax or worse (my moral valuations are showing!): The very rich travel by limousine, helicopter, and Lear jet, not by public transport.

  • Private college tuition in the United States. It’s an expensive poll tax, mitigated somewhat by financial grant aid (I don’t count loans). However, not all educational institutions use this poll-tax model.

  • Waldorf schools in Germany or, at least, the one that friends’ children attend. To cover the portion of the costs not paid by the state, the school charges 11 percent of the family’s after-tax income, no matter how many siblings attend the school. Thus, it is a flat income tax. (See the school’s tuition table [in German].)

Have fun trying the taxonomy on your favorite taxes and charges!

Years ago on a final exam in environmental geography, I proposed that the charge for admission to Yellowstone National Park become a tiny fixed fraction of income (the Waldorf tuition model). I think I proposed 0.02 percent: $8 for a family making $40,000 per year, versus $200 for an high-level executive making $1 million per year. The professor so loathed the idea that he gave the whole exam an F, earning me my only college D. Now, however, I think that my proposal was not quite right. The public already pays for Yellowstone through progressive taxation. Thus, let the cost at the park gate be zero. That would be the only poll tax I support!

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  1. Greg says:

    I believe that, in many cases, paying for the goods/services that you consume is the fairest way to pass along costs. Externalities (pollution, education, beautification) need to be factored into the cost. Risk pooling (insurance, pensions) is appropriate as long as it is setup in a way that holds the users and managers of the pool accountable.

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    • Impossibly Stupid says:

      This is not a straightforward cost to determine for public services. For example, a fire department would have pretty much a fixed cost to handle any house fire in my town, but if I had a $100 million home and most of the people in my town had $1 million homes, said firefighters are *definitely* worth more to me. I should be eager to pay more for them to have above average equipment, because I have an above average house even though a fire might not cost them any more to fight at my home compared to any other home.

      Another great example is law enforcement. Who is the “consumer” there? The criminals or the victims? If I can barely scrape together $100, what real incentive is there for *me* to fund the police? However, if I’m rolling in billions, I should damn well be happy to throw a few hundred million to the city to keep things running smoothly.

      Of course, the inherent problem in there is that oftentimes the rich feel they are *entitled* to more because they pay more. Nothing could be further from the truth, but good luck trying to get them to listen to that before the revolutionaries are pounding on the door!

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  2. Rick says:

    I won’t nitpick FICA, but private insurance, buses, and higher education are all voluntary with a price tag attached, just like any other service. How is that a “tax”? Is buying food a tax? Is rent or mortgages a tax? It makes for very sloppy nomenclature.

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    • nobody.really says:

      I share this concern. If I buy a hotdog from a vendor, do a pay a “price” or a “tax”? I sense Mahajan would say that the answer depends on whether the vendor is a private actor or the state.

      I’m not entirely opposed to this understanding — but then, to understand the progressive/regressive nature of the transaction, it would seem to be necessary to look not merely at what is paid but also at what is received. After all, if government offered college educations for $1, but only accepted the children of aristocrats, would Mahajan call that “progressive” because the program took money only from rich people? You need to consider both the quid and the quo.

      A propos, the Economist argues that European taxes tend to be quite regressive when viewed in isolation — but quite progressive when viewed in conjunction with the social welfare state that the taxes make possible. See http://www.economist.com/node/2553322

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      • Enter your name... says:

        It’s not even a private-vs-public distinction. He says that if a bunch of private individuals get together, and decide to sell a product called “education”, then the fees they charge to their voluntary users of their private organization’s product are “poll taxes”.

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      • nobody.really says:

        Wow — good catch, Enter your name…! And, upon reflection, Mahajan’s taxonomy is even worse than I’d realized:

        “Poll tax. Everyone pays the same amount….

        * * *

        Private college tuition in the United States. It’s an expensive poll tax, mitigated somewhat by financial grant aid (I don’t count loans). However, not all educational institutions use this poll-tax model.”

        Now, I’m sure that there are some private colleges that charge every student the same amount. But archetypically, college financial aid offices are ruthless price discriminators, with the result that every college student pays a DIFFERENT amount. Consequently I expect that a college tuition bill more closely resembles an income/wealth tax than a poll tax.

        Can an MIT professor really be so unacquainted with financial aid offices?

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      • Evan says:

        The difference is that taxes are essentially involuntary. The price of a hot dog is a purchase because you can choose not to buy it at all. However, if there’s a sales tax on hot dogs, that’s a tax because you can’t choose to buy the hot dog and not pay the sales tax – even if the sales tax is earmarked for a specific service you don’t consume, like public transportation.

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  3. Bill Harshaw says:

    You skipped the all-important real estate taxes which support local government and schools.

    FYI, the Park Service now sells a lifetime pass to seniors for a one-time fee: used to be Golden Eagle but now is “Interagency Senior Pass” (also one for those with disability).

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    • Joe Dokes says:

      Real Estate taxes are simply a form of wealth tax.

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      • nobody.really says:

        I would characterize a real estate tax as a consumption tax — or a displaced income tax.

        If I rent my home to someone, I deliver housing services to my renter; I receive rent payments which I must report as income, and upon which I may be liable for tax. If I rent my house to MYSELF, then I receive the housing services, and I receive the (now implicit) rental revenue stream. Ideally, I’d be subject to the same tax regime regardless. Because we have difficulty taxing implicit revenues, we substitute a property tax regime.

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  4. Joe says:

    Not sure I agree with your taxonomy. “Progressive” isn’t necessarily defined the way you define it, for one; you seem to organize it with wealth redistribution in mind, but the rich are not the only ones with wealth. Retirees would be very hard hit by a non-exempted wealth tax, for example; if I have $1MM in the bank as my retirement fund, intended to give me $50k/year from 65 to 90 assuming some reasonable but low rate of return, I’m hardly rich, but I have a lot of ‘wealth’.

    Secondly, a sales tax – or rewritten as a ‘consumption’ tax – is by no means nonprogressive, if implemented properly. You can have a ‘flat sales tax’, which is indeed nonprogressive, but just as easily you can have a progressive sales tax. We already have this now; food, drugs, other necessities are exempted or taxed at a very low rate in many states, as well as rent and similar expenditures that are a significant portion of a poor or even middle class person’s budget (25-33% of most). If you look at what people actually pay sales tax on, I suspect you’d find that even now it is a fairly progressive tax, at least on the lower end.

    When it becomes less progressive is when you have people who invest a lot, which is also exempted; but that just identifies one of the failures of the term ‘progressive’. It only measures one axis, and measures all wealth/expenditures/income on that one axis. Take two people with net income of $1MM last year. One spends $800k on boats, houses, cars, whatever, plus normal living expenses (ie, normal purchases not really ‘luxury’ goods), and saves/invests the rest; the other spends $100k on luxury goods, $50k on normal living expenses and invests the rest. The first person pays a 10% sales tax on about 750k and 1% on 50k, while the second pays 10% on 100k, 1% on 50k. Is your tax progressive or not? Person A looks progressive (he pays a high percent of tax, 8.1%, compared to a poor person who pays 0% on one third of his income, 1% on around one third of his income and 10% on one third, so around 3.4%) while person B looks regressive (paying only 1% on average). So is it a progressive tax or a regressive tax? How about, it’s a good tax – it takes ‘excess’ money from the person who’s just throwing it around, and doesn’t take as much from the person who is investing it, which is better for the economy.

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  5. Mike B says:

    First you forgot to distinguish sales taxes and value added taxes of the type popular in Europe. Yes they are similar, but the difference is worth distinction. Second, most private schools implement a form of progressive income tax. Very few students pay sticker price, instead only those with high income are charged the full tuition with most other students getting some form of discount.

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  6. MarkB says:

    The wealth tax seems like a great way to discourage saving. Under the current system, even a person of moderate means can become reasonably wealthy through a lifetime of self-sacrifice and saving. It would be heinous to disincentivize this. (My moral valuations are showing, too!)

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    • JAM says:

      I agree. Penalizing future consumption relative to present consumption is not only anti-capitalist, but seems to be at the root of many of the world’s present problems.

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      • Impossibly Stupid says:

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      • JAM says:

        In reply to Impossibly Stupid

        The whole basis of capitalism is the deferment of consumption today to invest in future consumption tomorrow. In order to start a business or other enterprise, someone has to defer consumption of resources today to invest in production of goods for consumption tomorrow.

        You classify this deferment as “hoarding”, in a rather derogatory way. However, the truly morally bankrupt are those that consume everything in sight today with no thought of investing for tomorrow’s consumption.

        I imagine that in the fable of the ant and the grasshopper, you probably think the grasshopper was noble in his pursuit of complete consumption in the moment and his want to live off the charity of “hoarders” in the future.

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      • Impossibly Stupid says:

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      • James says:

        The problem is not the people who are “hoarding cash”, it is the people who drove the economy into an unsustainable bubble (and subsequent inevitable crash) by spending money they didn’t have – easy credit, and often the imaginary money created by home appreciation – on consumption for the sake of consumption.

        As for those living paycheck to paycheck, there’s no actual law that says you have to spend every penny you earn. (Granted, there are some at the low end who must to survive.) Why should I, who live comfortably by spending rather less than half my typical income, be expected to waste the balance on things I neither need nor want (and in some cases, positively want not to have in my life) in order to somehow compensate for your poorly organized economy?

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      • Impossibly Stupid says:

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      • James says:

        “I think we’re just arguing about two sides of the same coin…”

        I don’t think so. Seems to me you’re arguing that the economy would be helped by a massive dose of “retail therapy”: people buying stuff they neither need nor want because it makes them feel better (on the personal level) and creates jobs making all that unwanted stuff.

        You’re not seeing the real question. I can and do live more than comfortably on $30-40K a year, yet in a good year I earn (after taxes) about twice that. I enjoy the work I do, and don’t want to work less, so what should I do with the excess? There is really nothing I want, so what should I do with the excess? Another horse? I can only ride one. Another airplane? New cars, when I like the ones I have better than any new model?

        The alternative seems to be spending the money on stuff I don’t want, and it seems this is the way the mainstream economy has been working – or rather, failing to work. People are persuaded, via advertising, to buy stuff that they wouldn’t want if left to themselves. They get a little buzz, the stuff sits unused in closet, garage, or driveway, and they go looking for another buzz. Pretty soon they’re shopping addicts, buy on credit, become overextended, and when enough of them have done it, the economy crashes. They lose their jobs, go underwater on the house, and soon (because they’ve been living paycheck to paycheck) find themselves in the streets.

        But it creates jobs. [/sarcasm]

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      • JAM says:

        In reply to Impossibly Stupid

        It seems you are completely missing the point of capitalism.

        In the case of the investor, you are investing in capital of some sort from which to derive future consumption. The simple case of a man who buys a set of tools (invests in a set of tools) with which he can perform his trade in the future, is not consuming his tools in any reasonable definition of the word consumption. In this case, he does not eat the tools, sleep with the tools, or derive pleasure out of them in any other fashion. The man is deferring consumption today and putting his wealth into capital from which he expects to derive future consumption. It is true that investment in capital creates economic activity which allows others to consume today, but only because someone decided to defer some of their consumption today for future consumption.

        In the case of a person who “hoards” cash, most do this in the form of placing their cash with a lender of some sort who then makes the cash available to other capitalists to use. Therefore, they are not simply “hoarding” cash, but allowing others to use the resources represented by that cash for economic growth.

        It is through the activity of these capitalists, the deferment of consumption today for the purpose of consumption tomorrow, that we can have a vibrant and sustainable economy.

        It is at great peril to society when some today try to stir envy in those who chose to consume in the past against those who sacrificed consumption in the past for the prospect of present and future consumption. In creates a tremendous disincentive to plan for the future.

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      • Impossibly Stupid says:

        I wish I could continue what I thought was an interesting discussion, but the mods wins.

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    • twobeef says:

      All taxes discourage something. An estate tax discourages passing on money to your heirs. An income tax discourages putting all of your wealth behind income, encouraging the use of worker benefits or stock options, etc. A sales tax discourages spending and particularly hits those that are in a position where they must spend.

      The problem with this analogy is that most people don’t save on a grand sale. Your median 40-year-old American has, what, $200K in his 401k and maybe three or four months of life expenses in his savings account, but most wealth is still concentrated in a relatively small number of bank accounts. I’d not be certain that people would save any less than they do now under a wealth tax system.

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  7. Joby Elliott says:

    “Tobin tax. It’s a sales tax on financial transactions, so, assuming that financial transactions grow in proportion to wealth, it’s akin to a flat wealth tax.”

    I think that’s a bit of a stretch. It’s akin to a sales tax (applied to the buying of currency). It’s just applying a sales tax to something that has normally been exempt from sales taxes (maybe because it’s a transaction primarily engaged in by rich people).

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  8. Eric M. Jones. says:

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