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I recently read a great book called Capitalism and Freedom by Milton Friedman (on Amazon). One point Friedman touched on was that of graduated income tax and the redistribution of wealth. This struck a chord with me as I began to think of wealth, not just in a monetary sense, but as a measure of happiness. This line of thinking brings about some interesting implications.
Graduated Income Tax
Graduated income tax (or progressive income tax), in the simplest terms, is the act of taxing higher income brackets a higher percentage on their income than lower income brackets. For instance, someone who makes $20,000/year may be taxed 15% of their income, or $3,000, while someone who makes $100,000/year may be taxed 28% of their income, or $28,000, rather than 15% like the lower income tax bracket.
If an individual makes $20,000/year, and basic living expenses are assumed to cost $15,000/year, then that individual’s disposable income is $5,000/year, or 25% of their annual income.
If an individual makes $100,000/year, basic living expenses would still be $15,000/year, leaving that individual with $85,000 in disposable income, or 85% of their annual income.
There are number of arguments for graduated income tax, the strongest of which address a common standard of living and the redistribution of wealth. I’d like to get to my point, so I’m going to glaze over these, as they are outside the scope of my point. However, I encourage you to read up on these arguments in favor of graduated taxation.
The argument concerning a common standard of living is based on the fact it takes a fixed amount of money to afford the very basic of necessities for living in our society: food, housing, clothing, education. This amount is fixed, regardless of income earned, and it is the minimum amount needed to live. No matter how much money you make, this amount cannot be spent on anything else, since it must be spent to live. All other income that is left over after this amount is known as disposable income. This is the amount that typically gets taxed (the government determines the exact amount for the standard of living each year). Now, this argument for graduated taxation says that the higher income brackets should be taxed a higher percentage, simply because they can better afford it beyond the most basic standard of living.
The second argument for redistribution of income says that it is the government’s job to ensure the welfare of its citizens. At first glance, this seems a fairly reasonable assumption. Note that this is different than saying that it’s the government’s job to protect and ensure the freedom of its citizens to pursue and create their own destiny. As with most subjects, I am split between viewpoints. On one hand, I’d like to say that the government’s job is simply to protect the freedom of its citizens, and it is the citizen’s responsibility to ensure their own welfare. On the other hand, if taken to the extreme, without compromise, this would mean that there is no justification for programs such as state-funded mental health facilities, orphanages, etc. This is an extreme with which I disagree.
Graduated income tax aims to make the disposable income of each bracket more equal. If the low-income individual is taxed 20% of their income beyond standard living expenses (e.g. $5,000), then they would be left with $5,000-$1,000=$4,000.
At its extreme (and this is an exaggeration for illustrative purposes), let’s assume taxation leaves both brackets with exactly equal disposable income. This means the high-income individual should also be left with $4,000 of disposable income. Of the $85,000 left over after standard living expenses ($100,000-$15,000=$85,000), they would need to be taxed at 81% in order to leave them with $4,000 of disposable income.
The Point: What Is Equality?
The point I wanted to address concerns the issue of equality and redistribution of income. Let us assume that we do want equality in welfare for all citizens, regardless of each person’s capabilities and advantages. And let us also assume that it’s the government’s responsibility to help redistribute income in order to promote equality in welfare among its citizens.
The fallacy is that this is practiced today with the assumption that equality in welfare means simply fiscal equality; it is widely assumed that for all people to be equal, they must have more or less equal disposable incomes. But who decided that disposable income be the measure of equality? Is happiness not the real goal of the individual? Sure, many would argue that higher disposable income allows for a higher level of comfort, which directly contributes to an individual’s happiness. However, even if this were completely true (and many will argue it’s not), is happiness not still the ultimate goal? So wouldn’t true equality mean an equal distribution of happiness?
Where Does Happiness Come From?
Let’s look at two specific personalities, we’ll call them Frank and Fred. Frank loves being productive and creating things above all else. Fred loves relaxing and leisurely activities above all else. I’m sure from personal experience, you can agree that these two (overly simplified) types of people do in fact exist.
In order to satisfy his own enjoyment, Frank may spend his life starting and running his own business, at the expense of his social and personal life. He has little free-time, and may even fail repeatedly. But that’s okay, because it’s what makes him happy. Not to mention, he may one day enjoy the rewards of such a productive lifestyle in the form of monetary compensation, resulting a higher disposable income and affording a greater level of comfort.
For the same reason as Frank (to satisfy his own enjoyment), Fred may spend his time hanging around and playing video games. He is employed, but has no interest in putting forth extra effort or moving up in the company, so long as he can afford his leisurely activities and keep his free-time. Again, this is okay, because it’s what makes him happy. In doing so however, he has accepted that he most likely will not enjoy the eventual pecuniary rewards of Frank’s productive lifestyle.
When left alone, people tend to find their own balance to achieve the greatest happiness.
After paying a graduated income tax, though, Frank and Fred will be left with a more equal disposable income. Frank is taxed more heavily so that Fred may be taxed less heavily. In other words, Frank is picking up Fred’s slack. The argument for equality says that every individual should enjoy an equal amount of disposable income, regardless of capabilities and advantages. However, in redistributing income through a gradual income tax, the government has actually made the distribution of happiness more unequal, in favor of the lower income bracket. Not only is Fred now able to enjoy his more leisurely lifestyle and greater amount of free-time, but he gets to enjoy the a portion of the monetary rewards of Frank’s more productive lifestyle. Meanwhile, Frank still has less of a social life and less leisurely time to enjoy. And now he also less monetary reward to enjoy.
Governmental measures such as a graduated income tax attempt to create equality by redistributing income and thus making monetary rewards equal across the board. This tends to make the distribution of happiness unequal.
If you’re an Ayn Rand reader or a fan of Objectivism, this is where you’ll argue that Frank will eventually realize that his time is better spent relaxing, rather than producing. I.e. he will be left with more enjoyment from relaxing rather than producing. The government may take a disproportionate amount of his monetary rewards for producing, but it won’t take away his free-time for relaxing and notproducing. The overall result is a drive toward lower production and more wasted resources. However, this is not the argument I’m shooting for in this essay, largely because it relies on speculation rather than observation.
How Can Government Redistribute Happiness?
My point is that it is important to realize that different things make different people happy and comfortable to a different extent, and that disposable income is only one factor. If left alone, people tend to spend their time as best they can in order to satisfy their own enjoyments. This includes expectations for monetary rewards and desired disposable income. Sure, almost everyone would like to have a lot of money to play with, but it is evident in how people spend their time, as to who places more importance on this in relation to other factors in their lives. Is governmental distribution of income really the best solution toward equality?
Flat Tax
For completeness’s sake, I will simply point out that there is another solution for income taxation known as the Flat Rate Tax, or flat tax for short. It simply states that all income beyond the basic standard of living is taxed at a constant percentage rate. If you are not familiar, I encourage you to read more about it.
Update: Daniel Kahneman on Happiness
Since this post has been sitting in my drafts folder, I stumbled upon this TED 2010 talk by Daniel Kahneman, a Professor of Psychology at Princeton University. His talk analyzes the psychology of happiness, distinguishing the part of us that remembers happiness and the part that experiences happiness. At the end of the presentation (around 18:28 into the video), Daniel is asked how the study of happiness might influence governmental regulation and taxes. Needless to say, I’m glad I’m not the only one thinking of this stuff, and it was just the motivation I needed to finally post this essay. So, if you have the time, this is a great presentation to watch and well worth the 20 minutes:
