Since Money Beagle is away on vacation, there will be a couple of guest posts this week. Here is a post from a somewhat new blogger. Please welcome Teacher Man from My University Money.
Hello, fellow young personal finance readers. I go by the pen name is “Teacher Man” due to the fact I recently graduated university and am in my first year of teaching high school. My partner and I have recently started up a website aimed at helping young people in high school, as well as those in various post-secondary avenues, and finally, students that have recently graduated and are facing ‘the real world’ for the first time. The inspiration for our website came about when we were reminiscing about our time in university and how if we knew then what we know now, we would have been a lot better off. Thus, My University Money was born. Our goal is to help young people in their quest to learn how to succeed in their educational, financial, and career pursuits.
One of the great personal finance debates out there is, “Is the progressive tax system a positive/effective system?” The theory behind progressive income taxes is that people who earn more money can generally afford to contribute a little extra towards the common good. The government has decided that this can be done best through taxes. So the government in most Western World countries sets arbitrary income levels that will determine how much income tax is taken from their citizens. The usual debate ends up with people on the left-wing yelling about how the rich need to, “pay their fair share,” while the right-wing usually screams back about how unfair it is that they be expected to prop-up the rest of society (the top 1% of income earners pay 38% of the total income tax in the USA).
It’s All About Incentives
I think one of the main consequences of a progressive tax rate that most people don’t take into consideration is the negative incentive for people to produce more. Since reading the books Freakonomics and Superfreakonomics I have been looking at the world through the eyes of an economist and considering how incentives affect behavior all around me. When you stop to look at our progressive tax system it is really a negative incentive to earn money and produce more in general. For the absolute top earners it probably doesn’t make much of a difference since they are so far into the top pay bracket that they probably don’t even consider lessening returns on effort because of tax rates, but there are many other income earners it does affect.
The real negative incentives would belong to people that earn middle class wages. Think about how someone who works at a construction or factory job might look at working 10 hours of overtime in a week. Perhaps a good wage incentive is offered to encourage them to take the extra work and produce more of a product that is in high demand. This incentive is often cancelled out by the fact that the income they earn will be taxed at a higher rate. Sometimes you can get this extra tax back in the form of a tax rebate, but unless you have a good understanding of the tax code you probably won’t take that into consideration. Another example would be a person who is running their own business. Should they take risks to expand their initially small business when the proceeds will be taxed at a higher rate (I realize that business taxes are substantially lower than income taxes, but lets assume that if someone’s business grows they will also pay themselves more)? Also, if they have a “hot” product and need to quickly step up production, they now have to offer an even stronger overtime incentive (say going from “time-and-a-half” to “double-time”), to get people to work, since it has to overcome the negativity involved with losing a lot of that overtime cheque to taxes.
Could We Flip The Whole System?
I am by no means an economics guru, and I realize there are some pretty serious problems with what I’m about to propose, but it would be a very interesting experiment to try. What would happen if we actually scaled tax rates down after say $60K (or a number better thought out by people smarter than myself)? So we keep the progressive tax rates up to a certain level, but then we actually lower the tax rates a little as you climb the income ladder. Think about the positive motivation this would give people to work more. Would this actually function as a sort of bizzaro supply-side economics-type of theory? Would enough people actually work more to get to the lower tax rates, that it would offset the initial reduction in taxes? I honestly have no idea, but it is a very interesting concept to consider from an “outside-the-box-Freakonmics-ish” perspective. The proposal could be adapted to stop scaling down very much after a million, or 5 million, depending on what the overall economic impact would eventually become. I just know that a positive incentive to work harder and increase production is worth exploring, rather than this endless fight back-and-forth about who should pay for what.
Should everyone contribute something?
The other element of the tax code that draws a lot of ire from people is the fact that so many citizens pay nothing (and then often complain that the rich don’t pay enough). One thought is to make everyone pay at least a little bit. I think this suggestion has some merit. Even if we only made people in the lowest tax brackets pay $10 per-week in taxes, they would be less inclined to simply yell for more taxes on the rich because they would now know what having money taken feels like. I don’t think that the radical step of a “flat-tax” where everyone gets charged the same thing amount on every dollar they make will work very well. It does hold the allure of being very simple to enforce (and I am a fervent supporter of closing tax loopholes, so this would be the ultimate loophole-closer), but I think that wealthy people should pay a slightly higher rate, at least for the time being.
A Utopian Solution
If we were all ideal citizens, what would be a neat trick would be a flat tax with the wealthiest people taking the lead of Bill Gates and Warren Buffett and using their newfound wealth for philanthropy. I think this is a far better solution than the government trying to handle things in their usual bureaucratic, inefficient way. If we allowed the most efficient and productive members of our society to use capital in the best way possible, and then re-distribute it with the same efficiency and ingenuity that they used to accumulate it, this would be the best overall system in my opinion. Unfortunately there are many wealthy people that are not as altruistic as Gates and Buffett so this wouldn’t work very well in theory.
The current tax code is simply not working for anyone. Tax rates are the lowest they have been in decades in the USA and are substantially lower than they were under Nixon, yet the economy is sputtering (even with the injection of huge amounts of cash from the Federal Reserve). There are nearly 50 million Americans on food stamps now, and unemployment benefits are being used more than ever. We need to try and reduce negative incentives to not look for a job, walk away from a mortgage with a “strategic foreclosure,” store money in offshore tax-shelters, and a hundred other inefficient areas. Does anyone else want to try and join me in thinking outside the proverbial box?Editors Take: I think the system as it exists (in the USA) today is broken. The problem is that it's like an old house that's been added onto over and over again with no master plan. Each addition and change to the tax code was done for a particular reason at the time, but over time, everything has gotten bloated, counter-productive, and it simply doesn't work as it exists today. I don't think that the rich need to pay less taxes, because even though the top 1% pay 38% of the taxes, my guess is that they also hold that percentage (or more) of the total wealth.