There’s often a lack of understanding about increasing tax rates the further up the wealth ladder you go.  Most often the argument in favor of this progressive tax rate system is that those with the most income and wealth should pay the most taxes.  To the majority who are not in the top quintiles, this is considered fair.

The more accurate reason for progressive tax rates is that the “marginal utility” of another dollar is less for someone who is wealthy, than it is for someone who isn’t.  If you have income of $10 million per year, then another $50,000 doesn’t make that much difference, compared to a person who earns $80,000 per year.  For the lower income person, the extra cash has high marginal utility.  For the $10 million per year person, it doesn’t.

Progressive tax rates are based upon this concept.  If you’re going to raise tax revenue, you tax at a higher rate that money with low utility, not that with high utility.

There are government expenditures with high utility where this money can be used.  Base electric generation, for example, is a regulated utility.  With the nation facing the necessity of transitioning to sustainable, clean energy sources, putting investment into this effort transfers money with low marginal utility into money with high utility.  A wealthy person might take the extra $50,000 to buy another Benz, whereas the government can take the money and invest it in a “smart electric grid” which benefits the nation as a whole.

The same could be argued for universal health care.  With more than 40 million Americans without health insurance, it is a given this creates costs due to poor health care.  Putting tax revenue into a healthier population represents spending with high utility.

The truth is that America has a relatively flat tax rate system.  The difference in tax rates between the vast majority of Americans and those at the upper end is, at most 3%, ranging from about 27% to 30%.  And there are some real “whoppers” in this system, not the least of which is hedge fund managers who can make hundreds of millions of dollars in one year, but are taxed at 15%.

President Obama wants to return the upper income bracket top rate to 39%, which was where it was under President Clinton, and below what it was under President Reagan.  He’s also made some major budget policy changes by putting “on budget” real expenditures that under President Bush were, in effect, hidden as “off budget” items.  Obama believes that you shouldn’t hide the real amount being spent.  It’s a major cultural shift compared to past Presidencies, Democrat and Republican alike.

You tax at increasing rates income which has decreasing marginal utility.  You tax at decreasing rates income which has increasing marginal utility.  That’s a progressive tax system.

Tags: Obama, Progressive Taxes, Universal health care, Utilities

This entry was posted on Wednesday, April 15th, 2009 at 10:42 am and is filed under Economics. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.