Thursday, February 26, 2009

Twisting fairness

This morning I read a news article about an Obama administration proposal to raise taxes on the wealthy. One of the mechanisms for doing this in the proposal is to cap deductions at the 28% tax bracket.

In other words, someone in the 28% tax bracket who makes a $100 donation would effectively get a full $100 reduction in their taxable income (and a corresponding $28 reduction in taxes owed), but someone who is in the 35% tax bracket who makes a $100 donation would effectively only be able to get an $80 reduction in their taxable income. (To help with the math here: they would get the same $28 reduction in taxes as the 28% tax bracket individual. Since they are in the 35% tax bracket, this is equivalent to a reduction in taxable income of $80, since 35% of $80 is $28.) In other words, people in high tax brackets could only deduct 80% of their donations.

The piece of the story that raised my hackles a bit was where they said "White House officials said it is unfair for high-income people to receive a bigger tax break than middle-income people for claiming the same deductions or making the same charitable contributions."

This is twisting the notion of "fairness" into a pretzel, and it is an unfair (pardon my pun) characterization of how the tax deductions work.

The problem arises from the fact that we have a progressive tax system, which is by definition unfair. I don't say that as a judgment about progressive taxation - in fact, I am quite OK with it - but let's not kid ourselves by pretending that it is "fair." "Fair" means everyone gets treated equally, and progressive taxation explicitly makes a point of NOT treating everyone the same; only a flat tax would truly be "fair." We (generally) accept this unfairness, though, because it has pragmatic benefits for the country as a whole, among them (a) it allows for a lower rate of taxation for the poorest people than a flat tax would allow (for a particular level of revenue), since the wealthy effectively subsidize the poor; (b) the wealthy are presumably most able to contribute and have most benefited from societal infrastructure that made their wealth possible, so it is reasonable to ask them to pay more than others, and (c) even the higher tax rate on the wealthy consumes a smaller percentage of their required income for necessities like food and housing. It's certainly possible to have too much progressivity in the income tax (perhaps we do today, though I doubt it; it's less progressive now than it has throughout most of its history), which can amplify the differences in taxation, but the right level of progressivity is not something I feel competent to debate. My point is that if we as a nation agree to have progressive taxation, then we have thus decided that an intrinsically unfair system is something we're OK with.

Given that, to imply that people in the 35% tax bracket should not get the full deduction from charitable giving is not correcting an unfairness; rather, it is compounding unfairness upon unfairness. In particular, it conveniently forgets the fact that the high-income person seeking the deduction is already paying a higher rate of taxes. So it seems quite hypocritical to complain about them getting a bigger deduction than the 28% tax bracket donor without complaining that they are already paying more taxes on $100 of incremental income than that 28% tax bracket earner; one cannot occur without the other, after all.

So if one is to accept a progressive tax system, which has an inherent unfairness built-in, the only "fair" thing to do is to allow that wealthy individual to get the full write-off of a deduction.

As an aside, this is also precisely the reason that I get annoyed when people complain that "the wealthy" get all of the benefits of a tax cut. Well, duh - it's because of precisely this math. The wealthy pay the most in taxes, so if you cut their rates, it has the greatest dollar effect on the wealthy. It's another immutable attribute of a progressive tax system.

If all of the above sounds like a rant against progressive taxes or against taxing high-earners, please don't take it as such; I don't have a philosophical problem with either concept, and I don't think the practice has been carried beyond any appropriate boundaries. My problem is simply with the notion that the White House is advancing that somehow we should compound unfairness in the name of being fair.

As a policy matter, I'd also add that this is a bad idea for another reason. As a nation, I'd think we'd want to be encouraging high-earning individuals to be giving more to non-profits and similar, especially in tougher times when people at lower income levels are giving less. It's high-earners who are going to be providing a larger portion of non-profit budgets over the next few years. This tax proposal specifically provides a disincentive for that, which will undoubtedly lead to lower giving.

If the administration wants to tax the wealthy more, then right way to do it, frankly, is to be upfront and honest: raise the top tax bracket by some nominal amount, but let people continue to take deductions to reduce their income dollar for dollar.

But it serves no purpose to distort the concept of "fairness" to make something palatable that is wrongheaded.

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