When is a Dollar More Like a Penny: Why a Flat Tax is a Terrible Idea
A common claim from wealthy Americans (and the politicians that kneel at their feet for campaign contributions) is that it’s unfair to tax the rich more than the rest of the general, tax-paying population. They say that our current progressive personal income tax system, in which the more money you make the more that money is taxed, is egregiously unfair, and that the only real fair tax system would be a flat tax, in which everyone pays the same percentage of their income regardless of how much they actually earn. And on the surface, it seems almost reasonable.
Luckily, we don’t make tax policy based on shallow, surface level understandings of how the world works (well, we shouldn’t at least, forget about the Republican tax bill for a minute).
The reason a flat tax is a terrible idea, the same reason that virtually every single country in the entire world has a progressive income tax system, is a little thing called the ‘marginal utility of money.’ It may sound like a complicated economics term, but it’s actually pretty simple – the more money you have, the less valuable each additional dollar is to you.
Who Needs $100?
Say you’re a student and you have $100 in your checking account. If someone gives you $100, that’s a huge windfall. You’ve doubled your money and that extra $100 can do a lot for you – pay bills, buy books (well, considering college textbook prices more like one-quarter of a book), or purchase groceries.
On the other hand, if you’re a millionaire, that money means basically nothing to you. Millionaires and billionaires have so much money that an extra $100 would have absolutely no impact on their quality of life. Many of the ultra-rich have so much money that they can’t even think about it in a practical way anymore, because there’s no way for them to realistically spend it all in their lifetime. It’s all abstract numbers with no effect on their real lives.
For a billionaire, giving a thousand dollars away is about as impactful to his life as a middle-class person giving away a dollar. It’s barely even real to them anymore, but for some reason, they’ll fight tooth and nail to ensure they don’t pay one cent more in taxes to the government.
When is $1,000 More Than $1 Million?
Even when comparing percentages of income, not dollar amounts, the same principle holds.
Take a flat, 5% tax rate increase across the board for all income earners. Someone making $20,000 would be much, much more negatively impacted by this increase than someone making $20 million a year. The millionaire may need to buy a slightly smaller yacht, if he even noticed the difference at all, while the low-wage worker, someone who was almost certainly already struggling to make ends meet, would be devastated.
5% of $20,000 ($1,000) is much less than 5% of $20 million ($1 million), but to the low-wage worker, that money means rent, food, heat, and transportation. Most Americans do not have an extra thousand dollars. It has a much higher marginal utility than the $1 million does to the millionaire, who already has those things and more covered.
On a side note, even if the marginal utility of those amounts were equal (and they aren’t even close) in order to raise the same amount of money in total, you would perhaps mildly inconvenience 1 millionaire, vs. putting the basic stability of 1,000 low-income Americans at risk.
NEXT: Taxes Schmaxes: Why Tax Rates Don’t Affect Investment →