Tax, theory and practice

Should income taxes be progressive? There's some debate in today's comment section. To me, the moral answer is obvious: yes. Warren Buffet sacrifices a lot less by losing 30% of his income than some regular schmoe loses when he gives up 15%.

But optimal tax theory makes that more complicated. Taxes on the wealthy have especially high deadweight loss. Warren Buffet might not stop working if you ratcheted his tax rate up to 60%, but a goodly number of highly paid consultants, lawyers, small business owners and so forth would, and though it's common to portray them as leeches on society, in fact, they make a lot of stuff run a lot more smoothly.

The wealthy also have more latitude about when and how to take their earnings, because they aren't living paycheck to paycheck. That means that they will spend a lot of time and energy avoiding taxes. Do not natter about closing the loopholes. Above the complexity level of "Me Urgh! You give Urgh all your acorns!" there is no such thing as a loophole free tax. And come to think of it, I bet Urgh didn't get all the acorns, either.

If high taxes on the wealthy have very high efficiency costs, you can well end up with a smaller economic pie that doesn't actually make the poor much better off. That's why optimal tax theories tend to favor a relatively flat tax, with progressive distribution.

To me, the research suggests a relatively low level of taxation, but one that is steeply and continuously progressive to, say, a ceiling of perhaps 40% (combined federal, state and local), and goes negative for some income level. In other words, everyone should face pretty much the same marginal rate on an extra dollar of income--the poor, as well as the rich, should have to decide whether they want higher taxes and more government spending, or more cash and less spending. And all middle class subsidies should be abolished.

Note that the political odds of anything close to optimal taxation are about the same as the odds of my throwing the winning pass in next year's Superbowl.