Paying One’s “Fair Share” of Taxes Redux

[Note:  This post is an update of an earlier one to take account of more recent developments, including President Obama’s news conference on May 6, 2016.]

In his news conference on Friday (May 6), President Obama reiterated his claim that, owing to tax loopholes, the wealthy do not pay their “fair share” of taxes, a claim he has made several times during his presidency.  Vermont Senator Bernie Sanders has made this same claim in most, if not all, of his presidential campaign speeches.  Former Secretary of State Hillary Clinton has also stated that, if elected president, she intends to institute a four percent “Fair Share Surcharge” on Americans who make more than $5 million a year.

I have always been puzzled when I hear politicians, particularly Democrats and others of the left, talking about people needing to pay their “fair share” of taxes.  What President Obama, Senator Sanders, and Mrs. Clinton mean by this idea is that those earning higher incomes owe society more in taxes than they already pay, notwithstanding that income tax rates are already progressive, i.e., marginal rates increase with income.  Rarely, however, do proponents of raising rates on high income earners say exactly what a “fair share” of taxes is or, more precisely, what the upper limit, if any, of a “fair share” of taxes is.  Even more vague is their philosophical basis, either in ethics or some other grounding, for what constitutes “fairness” in this context.

It seems to me that Obama, Sanders, Clinton, and others of similar views have the tables turned upside down.  In fact, rather good philosophical arguments can be made from both an ethics and an economics perspective that, if anything, high income earners are already paying well more than their fair share of taxes and that their absolute tax payments or marginal rates should therefore be reduced.

Taxes are the cost of financing government.  In our democracy, every qualified voter is afforded one vote, no more and no less.  Just as this political shareholding is allocated equally among citizens, it would seem intuitively fair that the burden of the cost of government should similarly be allocated equally.  That is, everyone should pay the same amount in taxes in the form of a simple per capita tax.  This way, each person contributes the same amount toward the cost of government, much like dues assessments in a club.  At the least, it would be interesting to ask President Obama, Senator Sanders, and Mrs. Clinton to explain, from an ethics standpoint, why their proposals to make taxes even more progressive, i.e., even more unequal, are fairer than an equal per capita tax.

Of course, as a practical matter, given the current size of government, an equal per capita tax would necessarily mean that many, if not most, taxpayers would owe more than they earn or have in savings and, in some cases, likely much more.  Such a tax thus would be unworkable unless government were shrunk substantially.  The cost of government would have to shrink at least to the point where the per capita tax would be affordable by each taxpayer, a goal unlikely to be shared by the political class, left or right.  Even so, the size of government and the practical ability to have fairness in the tax code would seem to be inextricably linked.

Admittedly, I am uneasy to render judgments on purely ethical grounds about whether the amount of taxes a particular taxpayer pays is fair for that taxpayer.  I do, however, claim some expertise in economic reasoning.  On that basis, I think an argument can be made that, in the alternative to a per capita tax, a regressive income tax is actually fairer than a progressive one.

The argument rests on the idea that whenever there is voluntary exchange, every transaction creates wealth.  A voluntary transaction will not take place unless each party becomes better off as a result of the transaction.  It follows therefore that, so long as high income earners obtain their income through voluntary exchange of their labor, services, or other resources, each dollar of that income is the product of a wealth-creating transaction.

Significantly, however, the high income earner does not keep all of the created wealth, but only a fraction.  The rest of the new wealth necessarily accrues to everyone else with whom the high income earner engaged in voluntary exchange, either directly or indirectly.  Thus, the higher the income of the high income earner, the greater the earner contributes to other people’s wealth.  It follows then that high income earners benefit society more than lower income earners before any taxes are taken out of those earnings.

Based on this reasoning, one possible way to measure tax fairness would be on the basis of relative additions to aggregate social wealth.  Under such a definition, people who contribute less to social wealth would be required to make up for the deficit by paying more in taxes, while those who contribute most to social wealth would be rewarded by lower taxes.  Put another way, fairness would require that high income earners be taxed less than low income earners.  The former have already made a disproportionate positive contribution to social welfare.

Of course, as with the per capita tax, a regressive income tax would require considerable downsizing of government.  Such a tax simply could not finance the current government.  Once again, the size of government and the practical ability to have tax fairness are inextricably linked.  But that practical consideration aside, a fairness argument for a regressive income tax that rests on economic reasoning, unlike the Obama, Sanders, and Clinton fairness arguments, at least has an analytical grounding.  It would be interesting to learn how they would respond to the argument.

In that regard, I will myself volunteer one necessary exception to the general conclusion.  The exception owes to the fact that many high income earners today derive their high incomes not from contributing to aggregate wealth but rather by using the machinery of government to expropriate the wealth created by others.  Rent seeking can be very lucrative.  Thus, if “paying one’s fair share” in taxes is inversely related to one’s contribution to social wealth, these high income rent seekers should be taxed at a 100% marginal rate.  Given that the Democratic left has its own set of favored rent seekers, however, I am not sure that Obama, Sanders, and Clinton could even agree to this exception.

To be sure, I write all of the above with a considerable amount of tongue in cheek.  I stand by the larger point, however, that tax “fairness” is hardly a known parameter, and that one can construct ethical and/or syllogistic arguments leading to completely opposite conclusions as to what is fair.  In view of this conundrum, it seems to me that we all would be better served if politicians and policy makers purged “fairness” from their thinking (and speeches) and simply focused on a tax system that finances essential government functions in the most efficient manner possible and impedes economic vitality and long-term growth as little as possible.  I suspect that, in a prosperous and growing economy, questions of “fairness” will lose much of their political cachet and recede to the academic lounges where they belong.