Ethical Taxation: Progressivity, Efficiency and Hourly Averaging
Fig. 9.1
Tax rate graph
The graph also shows that it would be possible to impose very high tax rates without and sudden jumps in tax rate. The point about smoothing can be further emphasised at this point. As people move along the graph their lifetime tax rate could change, but changes in a taxpayer’s rate will often occur much more slowly than the change in gross income, since this will only gradually alter the hourly average. Furthermore, since past tax payments would be accounted for, even if someone’s tax rate increased rapidly their gross income will always cover their tax bill and so people will not have to repay the tax authority.15
Another point to make is that the marginal tax rate someone will face will not work in the same way as it does with any other tax proposal. This is because multiple factors determine what proportion of someone’s next payment they will pay in taxation. Someone with a low hourly tax rate could pay a large amount of their next chunk of income in tax if greatly increases relative to their total hour credits. This occurred in Jack’s third period in the example above. Meanwhile, someone with a very high tax rate could receive a large additional payment from the tax authority on top of money that they receive. This is because they will have paid a large amount of tax in the past, and so if their average drops upon the receipt of additional hour credits this will release some of their previous tax payments to them. These smoothing features make it much more palatable to impose very high rates of taxation on consistently high earners. After all, those with temporary good fortune will not, over the course of their life, pay a very high rate of tax overall. This means that it is possible to tax the most economically fortunate at very high rates.
The general point I am making in this section is that lifetime hourly average is the best available observable indicator of economic fortune. This also applies to low earners as well, since those who work many hours but earn relatively little are likely to do so because they would like to earn as much as possible but struggle in the job market. The negative hourly subsidy provides the least economically fortunate with as high an economically sustainable income as can reasonably be expected (see also Bamford 2014b, pp. 57–65). Some people who are highly capable may of course earn a low income as they work in a job or sector they care passionately about. For this reason I suggest placing a higher minimum gross hourly income on certain sectors and job types which are also activities that people do as leisure activities or in order to support causes about which they are passionate (Bamford 2014b, pp. 28–29). This would put a limit on the amount of subsidy that people could obtain in order to pursue their personal interests. Aside from applying this policy, I do not see that the above issue is very problematic. There are strong reasons not to take account of the earning abilities that people have when calculating their tax rate, such as the epistemic problems of reliably in determining this ability and the intrusiveness of attempts to place a monetary value on someone’s ability. In contrast, assessing someone’s actual market activity—as income taxes do—is entirely straightforward.
I have so far discussed hourly averaging as though it would be applied to earned income only. However, it could also be applied to all the gains that an individual receives irrespective of the source.16 This would ensure that people with multiple forms of good luck would be taxed at as high a rate as possible while those who have one brief form of good economic fortune will have this taken into account with regard to their overall lifetime economic position.
9.6 Hourly Averaging, Incentives, and Economic Efficiency
As I have mentioned at several points above highly progressive taxation—including support to the less economically successful—is generally taken to be a strong drag on economic growth and efficiency. This is because it reduces the rewards of economic success and softens the fear of economic failure. While this may be worthwhile overall, there are usually assumed to be strong reasons not to have a highly progressive and redistributive tax system of the sort I have outlined in the previous two sections. In this section I will explain why these worries about disincentives and economic efficiency are less troubling for hourly averaging than other highly progressive proposals.
There is a general assumption that the unfettered market will generate the best economic returns. This may well be true, but the theories of justice outlined above would rule out the application of totally free market policies. This is because these policies would work poorly for a large subset of society and this group are entitled to equally as good treatment by their society as the economically fortunate. In this section I will ignore this ideal of the free market outcome and instead focus on what makes the free market outcome attractive; that it provides incentives for people to work and trade and that it generates the products that people need and want as cheaply as possible.
My claim is that the hourly averaging proposal would do a good job of incentivising people to work while taxing the economically fortunate as much as possible (Bamford 2014b, pp. 66–73). In the previous section I made some points that are also important to the argument in this section. The first is that the smoothing element of lifetime averaging means that higher tax rates will not be applied to all those who temporarily earn high amounts. This means that there is no disincentive for those who find themselves in a situation where they can make a decent amount of money in a short time period. The marginal tax rate will be nowhere near as high as it would have been if the tax had been calculated over a shorter period. Furthermore, any income that someone receives will continue to be on their tax account for the remainder of their life and will continue to generate net income when they obtain more hour credits.
A further point relates to marginal taxation. As I said in the previous section, marginal tax rates are not as straightforward as they are with other tax systems. Since the marginal tax rate will depend upon many variables people will have a strong incentive to work and earn irrespective of what their headline or average rate happens to be at that point in time. An important factor in determining tax rate is the number of hour credits and these will impact upon marginal tax rates in a manner that will encourage people to work and earn more.
Since hour credits reduce tax rates at all points on the income scale there is always an economic incentive for people to work an extra hour when they can receive an hour credit for doing so.17 One way to look at this is to say that hour credits will reduce someone’s tax rate, certainly compared to what it would have been without that additional hour credit. As a result, people at all points on the hourly average tax graph would have an incentive to work for marginal tax rate reasons. This applies to people with a strongly negative tax rate whose tax rate could rise very quickly with increased gross income and also to those with tax rates of 90 % or more.
As well as marginal effective tax rates a similar point applies with regard to Participatory tax rates (Brewer, Saez and Shephard 2010; Saez 2002). This is the issue that someone does not only choose whether to work another hour, but can decide between working some hours or no hours at all. Other forms of progressive taxation and benefit payments18 may encourage high earners to retire earlier and low earners to stop work altogether and utilise state support instead. Hourly averaging would strongly encourage participation on two counts. The first is that hour credits offer the chance to receive tax rebates where they reduce someone’s average, and second that hour credits always create income for their recipient irrespective of their headline tax rate. If hourly averaging is combined with a comprehensive tax system, as I would suggest it should be, this would also mean that those who can obtain resources from their family or other sources would not be able to use this to avoid participation in the job market. Such people would need hour credits in order to release this unearned income and would therefore be more likely to work for hour credits than those without such economic fortune.19
I have said that hour credits will encourage workforce participation and that this will mean that more work is performed in society than it would be under rival progressive and redistributive proposals.20 This should mean that prices are kept lower than they would otherwise be and most people would have greater disposable income as a result. This would be of benefit to all members of society whatever their level of economic fortune.
I have so far emphasised that hourly averaging would retain incentives to work that progressive systems may otherwise dampen. Some may worry that the high tax rates on some and negative tax rates for others would dampen market signals and thereby undermine the advantages of a free market economy.21 I do not think that this is a serious worry, however. As I have said people still have incentives to do work that will increase their gross income. Furthermore, capitalism would still work in the same way. People would use their income to purchase what they desire and this will influence market prices and production decisions. Another point to emphasise is that a lot of the productivity of capitalism comes from the competition between firms and this would continue under the system I propose. The more efficient firms will thrive and those which fail to keep up will fail (or they will be taken over by their more profitable rivals).
In this section I have briefly presented the reasons we have to think that hourly averaging would create a very efficient economy. This fits into my argument as I would claim that hourly averaging can provide much greater progressivity. It does so by taxing people who are clearly very economically fortunate at very high rates and redistributing to the less economically fortunate while retaining economic incentives for all members of society. These economic incentives would lead to a more economically productive and efficient society than rival tax progressive systems could manage, and this therefore would be the most attractive institutional response to all of the approaches to distributive justice I outlined in the third section above.
9.7 Conclusions
In this chapter I have argued that tax policy should make use of hourly averaging. I began by arguing that since tax policy has such important distributive consequences this needs to be guided by the principles of distributive justice. I then took an ecumenical approach and presented a number of attractive theories of distributive justice, which would all agree that the tax system should redistribute in a progressive manner when compared to a free market baseline. However, all of the proposals I described would also be concerned about the effects of the tax and benefit system on economic efficiency as the size of the economic pie would matter alongside the equality of its distribution.