Manon's Econ Blog

Tax reforms: Soak the Very, Very Rich

Posted on: August 24, 2010

Irfani posted this article “Soak the Very, Very Rich” on Diigo that I thought was really interesting in the sense that it shows the different concepts of taxes. It talks about the tax cuts that Bush implanted when he was the President of the United States and that are expiring at the end of 2010. Obama’s dilemma is to figure out whether he should keep the tax cuts, abolish them all, or modify them.

Before starting to talk about the actual situation and the future of the taxes, one thing to know is that there are three types of taxes: progressive, proportional and regressive. Those are illustrated on Figure 1 down below.

Proportional taxes are the easiest to understand: no matter the income earned, the fraction of that income that has to be paid as taxes is fixed. For example, in that case someone who earns 10 thousand dollars a year and someone who earned a million dollars a year will both have to pay 15% of it as taxes. The fraction is fixed; therefore the line makes a 45° angle: it is proportional.
Progressive taxes are so called when the fraction of income paid as taxes increases at the income increases. For example, the person earning 10 thousand dollars a year will pay only 10% of taxes, while the person earning a million dollars a year will pay 20% of taxes. The fraction is not fixed, therefore as income increases the fraction increases, and the curve on the graph is higher than the proportional one.
Regressive taxes are a quite strange concept, as it implies that the more money someone earns the smaller fraction of it he has to pay as taxes. In that case, the 10 thousand dollars person will pay 20% of it as taxes, while the million dollars person will only pay 10%. The fraction is not fixed, but as income increases it decreases, and the curve on the graph is lower than the proportional one.

James Surowiecki, author of the article, explains his point of view clearly: richer people should pay a high proportion of their income as taxes. For now, “someone making two hundred thousand dollars a year and someone making two hundred million dollars a year pay at similar tax rates,” but Surowiecki does not believe that it is fair. Fairness is a hard concept because it changes depending on people. Surowiecki thinks that progressive taxes (where richer people pay more taxes) are fair, while those same rich people may think taxes should be proportional, or regressive.

In order to solve this problem of taxes, Surowiecki has some solutions, since he says “A better tax system would have more brackets, so that the super-rich pay higher rates.” This is a great solution for the people from low to middle class since that will mean fewer taxes for them, but not so great for rich people since they will have to pay more. This solution is one that should be taken into consideration since it has quite valid arguments, but it also has some problems. One major problem is that it does not take in consideration that “in a place like Manhattan, where the average apartment sells for nine hundred thousand dollars, your money doesn’t go as far.”

That solution may need some changes, but it is a possible solution for the problem of Bush’s taxes cuts expiration.

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