Taxes: Who should pay what?

Posted on March 12, 2012 at 11:17 am,

Today we’re continuing our critique of Wayne Grudem’s Politics According to the BIble by looking at the issue of taxes. Last time, we looked at some wider questions about the tax system, today we’re looking at the balance of tax between rich and poor, and between people and corporations.

Income tax: who should pay what?

Grudem begins his look at income tax by explaining how the US system is set up. Like most (and probably all) Western nations, it has what’s called a progressive tax system, which means that the more you earn, the higher the rate of tax you pay. Tax systems where everybody pays the same proportion of their income, or where the poor pay more are called regressive tax systems. Both terms can be applied to an individual tax, or the tax system as a whole.

Anyway, he points out that income tax is calculated by tax bands. In 2009 single Americans paid 10% on the first $8,350 they earned, 15% on anything between $8,351-33,950 and so on. The UK system works in the same way, and I presume that every income tax system on the planet follows the same basic structure. As an incidental note, Grudem says that the marginal rate (the amount you’ll be actually be paying on any increased income) affects peoples’ decision-making. Which, given how few people actually plan their finances, seems somewhat optimistic.

He then says that the fundamental question is whether such a system is fair. He starts looking at this question by pointing to the Old Testament law, and its demand that everybody pays a tithe (10%) to God (Deuteronomy 14:22-23 and Leviticus 27:30-32). He also points out that there was a point (Exodus 30:13-15) where there was a census tax that was the same for everybody. The thing Grudem doesn’t mention here is that none of these examples are of the regular taxes that pay for the continued running of government. They can’t reasonably be used as evidence for or against a progressive tax system.

Grudem then argues about the question of fairness by using a string of examples of various income levels at a flat rate of tax. In short, he argues that notions of fairness are, in practice, often a relative concept – everybody judges it relative to themselves and their situation. He then suggests that the truly fair position is that everybody deserves what they have legally earned in a year – citing Luke 10:7, 1 Corinthians 3:8, and Luke 19:17. He dismisses the idea that what is fair depends on what somebody has left after paying taxes. He then insists that, even if somebody’s wages are thought to be unfair – or just too high – that they have come across because society as a whole has “voted” with their money for these wages – market demands are, in Grudem’s view, a fair way to decide these things, because people choose to pay for the product that ultimately pays for the wages. If we don’t like it, his view is that we should change the habits of society.

There are, of course, several problems with this view. Firstly, if we deserve to take home what we have legally earned in a year, then either nobody deserves to pay any taxes at all, or everybody deserves their post-tax income rather than their pre-tax income. As we’ve already established (see the previous post in this series) that the government has a right to levy taxes, then we have to take the second option. And that means that this principle is irrelevant to the question of what tax levels should be.

Secondly, the idea that I’ve “voted” for the wage levels of high earners simply because I’ve watched their film, or brought goods from their company is somewhat laughable. Unless (unlike most people) I have the option of shopping exclusively from small businesses, and actually do so, I have no option but to buy products from large corporations. And in large corporations, pay levels at the very top are rising at a rate that bears no relationship to general wage levels, inflation levels, or even company performance. If I think such wages are unfair or unjust, then I cannot easily protest by spending my money elsewhere. And, in any case, voting with my spending means that the high earners automatically have a bigger say than I do.

For most people, the most effective way of protesting against excessive remuneration is, in fact, by pressuring politicians to enact laws which reign in the potential earnings of such people (whether by introducing maximum wage laws, or by increasing tax rates). And Grudem doesn’t offer any argument why changing things through the political process should not be an option. He seems to just assume that it should not be.

Grudem also looks at current tax receipts in the US. He says that the top 50% of earners paid 97% of taxes in 2006, with the richest 1% paying 40% of income tax. He compares it to 1990, when the richest 1% paid 25% of income tax and 2000, where they paid 37%. Unfortunately, he misses the key statistic that might give us any idea how fair this is – how much of the national income that top 1% got. If, for example, the richest 1% had 60% of the income, then that tax rate is unfair by anybody’s measure.

Capital Gains: fair or dangerous?

Grudem also argues against capital gains tax. When you buy something expensive (e.g. a house) and later sell it at a substantial profit, you pay capital gains tax, rather than income tax. In most countries, capital gains tax is set at a much lower level than the standard rate of income tax. Grudem emphasises that this is a tax on the increased value of something purchased as an investment. He argues that, because the owner pays taxes on the annual income from the investment, it is unfair to pay taxes on the increased value of it. He also says that it should be abolished to encourage investment in the economy. He also cites claims by the Heritage Foundation (a think-tank which promotes right-wing political viewpoints) that an increase in the US level of Capital Gains tax would damage the American economy.

There are, again, several problems with this approach. Firstly, many of the richest people in Western nations make their living from buying and selling assets. Warren Buffet (who is one of the richest men in the world) pays a lower proportion of his income in tax than his secretary because almost all of his income is from capital gains. If capital gains were abolished, then people like Buffet would pay virtually no tax.

Secondly, many investments are not (at least directly) investments in the economy. Whilst buying new shares in a company is investment, buying existing ones is simply buying somebody else’s share of the profits. Buying a plot of land is only investment if you then use it for something. Many financial products (such as derivatives or investments in the futures markets) are so far removed from real businesses that they are more like gambling than genuine investments.

Thirdly, many people who trade things that are subject to capital gains taxes don’t see annual returns on the investment – they sell it off at a profit (or, sometimes, a loss) before they see any regular returns on their investment.

Should companies pay tax?

Grudem also addresses the issue of corporation tax. He argues that, instead of being a tax on the rich, it has the effect of causing higher prices, and hence is a tax on everybody He claims that lowering the rate of corporation tax would stimulate the economy, bring in foreign investment, increase the incomes of corporate employees, and therefore result in higher overall tax revenue.

Again, there are a number of issues with this analysis. Firstly, the idea that lower rates of corporation tax will lead to lower prices, more jobs, or better pay for employees is simply wishful thinking. Companies don’t exist for the benefit of their customers or employees – they exist to make their owners money. When it comes to publicly limited companies, they are legally obliged to make as much money for their shareholders as they can. Therefore, the effect of cutting corporation tax will be to transfer money from public services to shareholders. Now, this might lead to productive investments in the economy, thus offsetting some of the lost revenue, but the chances that all of it would do so, and that it would do so to an extent that it creates greater tax revenue seems unlikely at best.

Secondly, there’s a related issue which makes corporation tax much fairer. Businesses (particularly big businesses) have been quite successful at what’s called externalising their costs. Basically this means passing on the costs and risks of business activities to somebody else – usually the governments of the places they operate. For example, a company might dump toxic substances knowing that it will be the government that pays for the clean-up, and the costs to the local people and environment. Insurance companies refuse to insure nuclear power plants against the risk of an accident, so power companies rely on government guarantees if something does go wrong. There are examples of this kind of practice for almost every industry. Governments also subsidise business training costs, and pay direct subsidies for companies that engage in a whole range of activities.

In the light of this, corporation tax can be viewed simply as the government making businesses pay for the handouts they get. If it were abolished, then it would only be fair to stop all government subsidies, and make companies pay for the costs they have externalised. And it’s far more likely that doing so would cause higher prices and damage large sectors of the economy than it is that cutting corporation tax would benefit the economy enough to make up for lost tax revenue.

Next Time

So far, in the section on tax, Grudem has argued for the principle of taxation, but argued that income tax should be lower (and fall less heavily on the rich than it does at present), and argued against two of the other three major taxes that are commonly levied (capital gains tax and corporation tax). Next time, we’ll finish up the issue of taxes by analysing what he says about smaller sources of tax revenue.

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