The Fallacy of Redistribution through Taxation
One justification for taxes is that they redistribute earnings from wealthier to poorer workers. They in fact redistribute money from the productive, and do so unfairly.
One of the key tenets of the failing social democratic states in the West is that the Government organizes us all to chip in some tax to redistribute income from workers with high incomes to workers with low incomes as a matter of ‘social justice’. This is a fallacy.
Firstly, we are not all in it together. Only productive members of society pay tax in economic reality. Taxes ‘redistribute’ resources from the productive to the unproductive, but not necessarily from rich to poor. The unproductive population includes many very well-paid people in official employment or favour.
Average incomes in the US and UK state sectors are significantly higher than in the productive sectors for comparable employees. This is especially clear once pension deals and job security are factored in. In contrast, taxpayers face economic insecurity at all levels, and many are relatively poor too. State sector featherbedding is what you would expect if the state were a predatory racket, rather than our ‘servant’.
Secondly, using progressive income taxes (i.e. with basic and higher tax rates) to redistribute wealth from high earners rests on a misunderstanding of how different people’s life patterns cause them to move in and out of the higher earner groups. For example, as Jordan Peterson said to one university audience, his listeners were not poor people. They were future well-off people who hadn’t got their money yet. Yet the same overall lifetime earnings can pay radically different tax. This is not justice, social or otherwise.
ONLY PRODUCTIVE PEOPLE PAY TAX
Only productive people - whether they produce by deploying capital or labour - actually pay taxes. Surely not, you say. Everybody is subject to the same tax on their incomes including state employees. So, everybody pays tax. We are supposedly ‘all in it together’. No, we are not. The state simply takes a cut of the marketable output of productive people to reward its much less productive supporters. Unproductive people do not produce much, if any, marketable output, by definition, so little or none can be taken from them. A state with no productive inhabitants in its ‘protection’ area would collapse immediately for want of resources, regardless of its notional tax income in money terms.
There are a couple of ways of seeing this. One can consider the case of a government official who is notionally paid, say, £60,000 p.a. and ‘pays’ a third in tax to his state employer, keeping £40,000 for himself. Now the government could just as easily exempt him from tax and cut his official salary to £40,000. That would tidy things up and save trouble. It would eliminate £20,000 of notional income and purely notional output which puff up the state’s misleading GDP National Income Accounts. It would make no difference to the resources available to the state because its own employees mostly don’t produce any. (Those state employees who may be productive, such as health or law enforcement personnel, have outputs which are very hard to measure and are inefficiently provided.)
In contrast, if the state exempts from taxation someone earning £60,000 annually from producing marketable resources, it would clearly feel the difference this time. It would lose access to £20,000 worth of the real value that person creates annually.
REDISTRISTRIBUTION OF COCONUTS FROM WORK ISLAND TO STATE ISLAND
Another way to see this is to imagine a two-island state. Coconuts are its principal produce, means of exchange and sustenance. On Work Island the population is devoted to growing all the coconuts. A 40% coconut production levy is taken under threat of force from the Work Islanders and brought to nearby State Island. State Island’s entire population comprises retired and current government employees and beneficiaries of a universal dole. They live wholly on the coconuts seized from Work Island.
Inevitably a fiscal crisis occurs. More and more Work Islanders leave their coconut plantations. They move to State Island for the dole funded lifestyle. The government needs somehow to get more coconuts to keep its promises to its dependents on State Island. But it knows that the current 40% coconut levy in Work Island is the maximum achievable without unrest and/or a slump in production. To meet its promises to State Islanders, the government decides to impose a 40% levy on coconuts produced in State island too.
How many additional coconuts will the new levy in State island contribute to the government’s income? None. Because none is produced there. It doesn’t matter what the tax rate is. There is no coconut production in State Island and so there can be no addition to the state’s overall coconut revenues. These can still only come from Work Island where they are all produced. There is no politically feasible solution. The state is out of options. It can’t even stave off failure by ‘printing’ coconuts. It is facing breakdown – probably precipitated by civil disobedience in Work Island, if not outright secession.
It may be objected that a 40% levy on State Islanders’ coconuts, given to them by the government itself, would improve the government’s finances. The state could reclaim pilfered coconuts that it just gave to its supporters on State Island. But this is not an increase in the state’s overall revenues. It is a spending cut. The state is a predatory association which exists to extract tribute from productive people to spend on its members and supporters. So real spending cuts are always ‘politically difficult’ and to be avoided.
‘PROGRESSIVE’ TAXATION FAVOURS LOW ASPIRATIONS NOT JUSTICE
Not only is taxation in reality simply paid by productive people to unproductive people. The alleged redistributive benefit of progressive taxation between high and low earners in the productive sector is often not what it seems.
To see this, let’s follow two hypothetical people - imaginatively called A and B - through their very different careers. At twenty, A goes to work in a relatively ‘good job’. He gets an unchanging and uninterrupted income from 20 to 65 which we will assume to be £50,000 annually. He earns £2,250,000 in his working lifetime.
But B is an entrepreneurial type. Maybe he hopes to write the next Harry Potter or become a TV actor or set up a business. Certainly, he chooses a riskier career trying to achieve higher-than-average earnings. In the event, despite his efforts, he only ever enjoys moderate success (which is the lot of most such people). He struggles along earning £20,000 every year, except for a five-year period of relative success when he earns £290,000 each year. Thus he also has lifetime pre-tax earnings of £2,250,000.
Income tax is assumed to be levied at 20% on annual incomes between £10,000 and £50,000 (with the first £10,000 exempt), 40% on annual income between £50,000 and £100,000, and 60% on any income earned in excess of £100,000. This not wholly dissimilar to income taxation in Britain over the last couple of generations.
It won’t have escaped the eagle-eyed attention of readers that A and B have the same pre-tax lifetime earnings. So, both should have paid the same tax, if the system were just, since there is no reason to redistribute income between A and B, right? Wrong. A moment’s calculation shows that A pays £360,000 on his lifetime pre-tax income of £2,250,000 in tax. B pays nearly £800,000 in tax of his identical pre-tax lifetime income. This makes a mockery of the ‘social’ justice argument. Our man B has been made poorer than A, even though his overall productive contribution to society has been the same (if not rather greater).
This outcome is clearly unjust. The system simply discriminates against those prepared to get additional training or accept more risk in order to improve their potential earnings and productivity. The effect is to discourage precisely the ambitious and entrepreneurial people on whom society actually depends if progress is to be achieved.
No wonder HM Treasury published the information that the tax system inflicts an additional 60p of pure economic damage on society for every £1 spent by the state. Much of this is lost output because taxation, especially progressive taxation, discourages enterprise.
THE REDISTRIBTION NARRATIVE ASSUMES A STATIC SOCIETY.
Yet again, the state’s rhetoric, in this case about redistribution, is at odds with the harm that it actually does. The whole redistribution narrative only looks plausible because politicians present a false view of the world where high and low earner positions are permanent. In other words, the same people are always in the same positions on the relative earnings scale. In an impoverished big state society like Britain, that assumption comes nearer to the truth. Incomes are more dependent on state favour and meddling than on productivity.
But free societies have always been (and will always be) much more competitive and productive. Incomes in free societies depend on cooperating effectively with others to produce things people actually value. I mean that people value marketable goods and services enough to pay for them voluntarily. This is not the case with most state output - which is therefore not ‘marketable (and therefore is of less interest as tribute).
Free societies are dynamic. There are few if any protected incomes. People often change their relative positions in the earnings table. Redistributing money from people who are temporarily in the high earning category, like B in the example above, is even more obviously dumb, damaging and unfair.
One indication that there is a lot of movement between different income levels, even in statist Britain, is this: the average annual expenditure of the bottom 10% of income earners is the same as the annual expenditure of people earning the average UK income. The former therefore spend much more than their incomes. That would be impossible if they always stayed in the same lowly relative earnings position year on year. This must mean that many members of the lowest income group have had much higher incomes in the past, and/or expect to have much higher incomes in the future.
Once one recognises that individual incomes often vary from year to year, the idea that high marginal tax rates, and indeed taxation itself, are desirable on redistributive grounds becomes much less plausible. It’s just another narrative to justify the state extorting more resources. Fortunately, in a free society nobody will have to bother with any of it.