Perverse good heartedness

The good heartedness that I am referring to is progressive taxation. Progressive taxation means that the tax rates increase with income level. (Precisely what Gov. Jerry Brown wants to continue for five years in California.)

There are two distinct perversities with progressive taxation.   The first is that it becomes meaningless as it gets above a gross level of 30% of income.  It is very rare in any circumstances and anyplace in the world to effectively tax citizens at a level that yields more than 30% revenue on real income.

That is a perversity that occurs for several reasons. First, people who were subject to higher effective tax rates simply leave the tax district. Additionally, upper income taxpayers spend money to find ways to avoid higher tax rates. Most importantly upper income taxpayers change their behavior, change their portfolios and change their lifestyle in order to avoid an effective tax rate above 30%.

That makes the taxing government a hypocritical entity, claiming to set progressive income taxes above a 30% rate but not actively collecting the higher rates.

The second perversity is probably the most serious. Those states that have been facing near bankruptcy and cities as well for the past 2 to 3 years are facing this problem because they have progressive income taxes. During a recession or business slow down, upper income taxpayers face the greatest decline in income and their personal decline in income is passed on as a decline in tax revenue.

In California where the top income tax rate is 9 ½%, a very small percentage, under 2% of the population, pays taxes at this rate. More than 70% of the state income taxpayers pay nothing. It is easy to see that economic volatility makes income tax revenue highly volatile when it is dependent on such a tiny portion of the population and ignores the base income generating population below them.

Desire to be goodhearted and to tax wealthier people at higher rates than ordinary people turns out to be a perversity. Such a policy makes state, city and federal revenues more volatile and creates consequent fiscal disruptions that hurt everyone.  This tax volatility consumes vast amount of everyone’s time, and generates significant emotional distress.