REGRESSIVE TAX

A 'regressive tax' is a tax imposed so that the tax rate decreases as the amount to which the rate is applied increases. The term "regressive tax" can be applied to any type of tax (income or consumption). It is frequently applied in reference to fixed taxes, where every person has to pay the same amount of money, such as a poll tax. The term ''regressive'' refers to the way the rate progresses from high to low. The opposite of a regressive tax is a progressive tax, where the tax rate increases as the amount to which the rate is applied increases. In between is a proportional tax, where the tax rate is fixed as the amount to which the rate is applied increases. Regressive taxes reduce the tax incidence of people with higher incomes, as they shift the incidence disproportionately to those with smaller incomes.
The regressivity of a particular tax often depends on the propensity of the tax payers to engage in the taxed activity relative to their income. In other words, if the activity being taxed is more likely to be carried out by the poor and less likely to be carried out by the rich, then the tax is regressive. To determine whether a tax is regressive, the income-elasticity of the good being taxed as well as the income-substitution effect must be considered. A simplified illustration of a regressive tax on income (proportional on consumption) is as follows: If Jane has $10 and John has $5, a tax of $1 on a purchase would result in an effective tax rate on the total of 20% for John and 10% for Jane. Thus, a tax that is fixed to the value of the good/service (without exemptions or rebates) would likely, in effect, result in a higher rate of taxation to people with less money (depending on consumption level and timeline examined - year or lifetime). A regressive tax system does not mean and likely would not result in low income earners paying more taxes than the wealthy, only that the effective tax rate relative to income or consumption would be a larger tax burden to low income earners.

Contents

Advocacy and criticism

Examples

See also

Notes

External links

Advocacy and criticism

Supply-side economics advocated regressive taxes as a means to solve the problem of stagflation. There is considerable debate as to whether regressive taxes are such a solution, in practice and in theory. The highest tax bracket in the United States before Ronald Reagan became President was 70%, a percentage viewed by some as being too high, and thus straining the main arguments for progressive taxes. Opponents of high tax rates for the rich argue that it lowers the incentive to work and innovate, while proponents argue that since the rich are still indeed rich, their incentive is left intact (or, alternatively, they may argue that most of the rich no longer work and innovate once they reach a certain level of wealth, or at least have no particular need to do so in order to maintain their lifestyle). Counter arguments include the view that high taxes on the rich could reduce their ability to expand their businesses and thus fewer jobs in the market, assuming no differentiation between corporate income and personal income.
As of 2004, the highest tax bracket in the United States is 35%, one of the lowest in the world; however, many American states levy their own income tax in addition to the federal rate and added with FICA taxes, which are also based on income, up to a certain threshold level. The combined tax burden can amount to half or near half of an individual's income. Opponents of regressive taxation state that a regressive tax effectively punishes the poor for being poor, placing a higher burden on those least able to bear that burden. Advocates would state that every person should be treated equally under tax law regardless of income and that progressive taxation amounts to class warfare, wealth envy, and Karl Marx communism with "From each according to his ability, to each according to his needs."
At least one critic in the United States has argued that progressive taxation is not what that nation’s founders intended. Dr. Burton W. Folsom at the Mackinac Center for Public Policy has written:
::The principle behind the progressive income tax—which asserts that the more you earn, the larger the percentage of tax you must pay—is not what the nation’s Founders wanted. An attempt by Congress to impose one late in the nineteenth century was declared unconstitutional by the Supreme Court. It took a constitutional amendment, ratified in 1913, for such a tax to be legal.^[1]
In the actual text of the two decisions in the Supreme Court case, Pollock v. Farmers' Loan & Trust Co., 157 U.S. 429, ''aff'd on reh'g'', 158 U.S. 601 (1895), the Court did not mention the terms "regressive tax" or "progressive tax" and, whether the tax was progressive or not, there is no mention in the texts that the parties even raised the issue of the constitutionality of the 1894 income tax statute based on any theory about the tax being either progressive or regressive. The Court in ''Pollock'' ruled that the 1894 tax on income from property (e.g., rental income) should be treated as a direct tax (i.e., should be treated in the same way that a tax on the property by reason of ownership would be treated) and that, since the 1894 income tax was not apportioned among the states according to population, the tax was unconstitutional. The effect of that rule was indeed overturned by the Sixteenth Amendment in 1913.

Examples

Some payroll taxes, such as Social Security taxes in the United States are regressive. The rate is 12.4% on an amount of income adjusted annually for inflation called the wage base (e.g., $94,200 for the year 2006, and $97,500 for 2007^[2]). Half of the tax is withheld from the employee's pay with the other half being paid by the employer. Self-employed individuals pay the entire amount of applicable tax. However, whether this tax should properly be called regressive is disputed because under the benefit formula for computing retirement benefits, the benefit of those with higher lifetime earnings is proportionally lower compared to those with lower lifetime earnings. A recipient's lifetime earnings on which Social Security tax is withheld is indexed and averaged over the highest 35 years of earnings to obtain an Average Monthly Indexed Earnings amount (AIME). If Social Security benefits begin at a person's Normal Retirement Age (65 to 67, depending on year of birth), the monthly benefit in 2007 is 90% of the first $680 of AIME, 32% of AIME above $680 and less than $4100, and only 15% of AIME in excess of $4100. For example, an individual whose indexed earnings were at the poverty level of $10,200/year would receive 78.4% of that in benefits, while an average earner of $37,000/year would receive only 44.8% of that in benefits, and individual's with above average earnings receive an even lower proportion in benefits. Wages on which Social Security tax is not withheld, for example that amount earned in excess of the wage base or that of certain public employees, is not included when the AIME is computed and therefore does not increase a person's benefits.
A value-added tax or other sales tax on food and other essentials such as clothing, transport, and residential rents can be regressive. Since the income elasticity of demand of food is usually less than 1 (''see Engel's law''), it tends to take up a higher percentage of the budget of a person or family with a lower income. A poll tax is a fixed tax for each person: since each person pays the same amount of money, it is a lower proportion for people with higher incomes. Television licences that are implemented in many countries, especially in Europe, are considered regressive taxes and in most cases consist of a flat annual payment for the use of a television.
Property taxes are often called regressive. Because the income elasticity of demand of housing is usually less than 1 and property taxes contribute to the cost of owning or renting housing, property taxes often consume a higher percentage of a lower income budget than they do for a higher income budget.
The regressive aspects of property taxes are, however, disputed. Only a fraction of property is used for housing, with most of the value held in property being tied to agricultural, manufacturing, and office facilities. This is both due to the greater area used for non-residential purposes and the much greater value of the improvements often associated with the same.
High-income owners may also tend to own substantially (and disproportionately) more property, either directly or through companies in which they hold stock. High income owners also tend to own more industrial, retail, and office property than low-income earners, with this effect seen strongly in the finances of municipalities. Towns and cities with a large number of "ratables" (commercial property excluding rental housing) raise substantially more revenue than towns of equal wealth and size but fewer ratables. Thus, property taxation is arguably more often progressive in practice.
William H. Gates, Sr., the father of Microsoft co-founder Bill Gates, came to a different conclusion in a 2003 study of tax schemes California, Idaho, Oregon, and Washington, arguing that property taxes were regressive by one to three percent (depending on the state), between the lowest and highest income brackets.

See also

★ Progressive tax

★ Proportional tax

★ Tax incidence

★ Laffer curve

★ Suits index

Notes

1. What's Wrong with the Progressive Income Tax?, Mackinac Center for Public Policy, ''May 3, 1999''
2. Publication 15, ''Employer's Tax Guide (Circular E)'' (Jan. 2007), p. 16, Internal Revenue Service, U.S. Dep't of the Treasury.

External links

★ Historic Struggles - A chapter from the 2004 book, ''Greed and Good'' ISBN 1-891843-25-7, that traces the history of efforts to create and maintain a progressive tax structure in the United States.