Progressive Taxation

C1) Progressive taxes reduce growth Research regarding the growth impacts of progressive taxes has been almost unanimous: progressive taxes reduce growth. Progressive taxes mean the rich pay a larger percentage of their income to the government compared to poor people. Progressive taxes by their very definition means higher tax rates on the wealthy. Forcing the rich to pay higher taxes reduces economic growth as income taxes are inherently biased against saving and investment. Due to the fact this debate is about income taxes, I won’t argue for consumption taxes, which I will do in my debate with Bossy. The neoclassical economic model argues that wealth must first be produced before consumption can increase. In order to increase consumption you must first increase production. Income taxes disrupt capital production, so progressive taxes tend to reduce production and harm the economy. Progressive taxes reduce the return on higher education, since the wealthy are the most likely to be educated, and reduce incentives to produce capital. The effects of progressive taxes include “reduce[d] investment, risk taking, and entrepreneurial activity since a disproportionately large share of these activities is done by high income earners.” [1. http://taxfoundation.org...] Reducing invesement and entrepeneurial tend to shrink the economic pie, so both low and high income earners are worse off. A progressive tax will not mean that all businessmen cease to innovate, of course, but it tends to reduce beneficial pro-growth activities. This argument is not entirely theoretical; there is empirical support for these assertions. Some cross-sectional studies fail to find the effect of progressive or high taxes on growth. But these studies fail to take into account the endogenous nature of taxation. This is called the ‘endogeneity’ problem. Something that is endogenous means it reacts to something else. For example, high crime states adopt the death penalty in order to respond to the high crime--the high crime is not the result of the death penalty. With taxation, uncompetitive countries may adopt non-progressive taxation to increase competitiveness. Their lack of growth is not because of high taxes. So endogeneity must be controlled for in studies which compare the growth of one nation to another. A study by the Philadelphia Federal Reserve does just this. It controls for the endogenous nature of taxation and compares the progressivity of the tax vote to subsequent economic growth. The study concluded that “a decrease in tax progressivity did lead to higher growth … differences in tax code across countries could explain up to a two and half percent variation in economic growth.” [2. https://www.philadelphiafed.org...] Although the study did find smaller effects of tax law than other studies, the progressivity of the tax code does seem to matter when it comes to economic growth. Unfortunately, the more progressive a tax code is, the less growth there actually is. Another study focused solely on the United States. This is important because cross-sectional studies have many variables which are difficult to control for, and sometimes are not controlled at all. Controlling variables within one country is much easier. A study published in 2012 used NBER data and IRS data in order to construct two proxies of progressivity. The effects of progressivity have a three year lag--the tax code changes to more progressive reforms do not begin to negatively harm the economy until three years have passed. At the three year mark, “tax progressivity has a strong negative effect on the annual growth rate of real gross state product.” [3. https://www.aeaweb.org...] The results are shown below. Both are two different proxies for the progressivity of the tax code. Both show strong statistically significant decreases in growth when the effective progressivity of the tax code increases. It is important to stress that the study focused on *effective* taxation because high marginal rates are not always associated with higher taxes. *Effective* taxation tells us that when a tax code is *truly* progressive, and actually *enforces* higher taxes on the wealthy, that there is a subsequent reduction in growth. The very idea of progressive taxation harms the economy. C2) Counter Plan: Flat Tax As I am not allowed to argue for a progressive consumption tax, I will instead argue for another alternative: a flat income tax. It is important that any flat tax is revenue neutral for long-term growth as long-term debts tend to constrict economic growth. So any flat tax proposal must keep the revenue level the same or higher than the current progressive tax system. The flat tax proposal by the Heritage Foundation does just that. The Heritage plan puts the tax rate at 28%, the same top rate under the Reagan administration. Many argue that this would harm the middle class, as their tax rates are much lower (15%). But if you include payroll taxes, their rates are 30.3%; the wealthy come in at 40.3%. The rich get a tax cut by 12.3%. And contrary to what liberals claim, the poor get a cut too--a 2.3% cut [4. http://www.heritage.org...]. There are still some tax credits for the poor which gives them more benefits other than the 2% cut, including “a tax credit of $3,000 ($2,500 for singles) toward the purchase of health insurance.” The plan is also revenue neutral. When a flat tax proposal does not increase the deficit it is predicted that there would be an increase in growth. A study published recently focused on small business as small businesses are the driving force behind economic growth (and I must add that many small business owners fall into the ‘one percent’ and get punished in progressive systems). A theoretical business making $13,000 per year under the current tax code would make $19,000 the next year under a flat tax. In the second year if sales increase, the business would make $29,000 under the current tax code. Under a flat tax profit climbs to $41,000 [5. http://www.aabri.com...]. When you factor in payroll taxes the flat tax benefits everyone. In this study, when they didn’t even take that into account and the flat tax raised taxes on some people, there was still growth because the one rate simplicity and reduced progressivity helped business. The Federal Reserve Bank of Kansas has also estimated the effect of flat tax reforms on growth over the long term--the study above focused mainly on short-term profitability. If you implemented a flat tax, output would increase 4.5%, capital stock increases 15%, and the labor supply increases 1.3% [6. http://www.kc.frb.org...]. My opponent will be quick to point out that asset value decreased in the study, but “the decline in the real value of existing assets actually contributes to the positive effects of … real output.” C3) The flat tax worked in Russia You could always argue that you can reduce progressivity in a progressive tax system and lower the rates. Although this would stimulate growth, it would not stimulate as much growth as a full transition to a flat tax. This can be shown by the experience in Russia, where taxes were low before they went to an even lower flat tax rate. They had a low tax system with little progressivity, and they still saw growth as a result of flat tax reform. The International Monetary Fund, which traditionally pushes for higher tax rates, unsurprisingly claims that the Russian flat tax produced no supply-side benefits. It should be noted, however, that they did admit that the flat tax reduced fraud, increased revenue, and increased tax compliance [7. http://www.imf.org...]. So, overall, they did admit that the reform has many positive benefits. An important study by Stanford economists found that the flat tax in the baltic countries benefited the countries. Studying Lithuania, Russia, Slovakia, Ukraine, Romania, and Georgia, the sample is fairly large. The findings were consistent: the reduction in the marginal rate from flat taxes causes growth and incentivizes work. The labor supply also increased. All of these effects lead to growth [8. https://economics.stanford.edu...]. Only in Estonia did the labor supply fall, and that was because marginal rates were increased. So flat taxes that lower the marginal rate cause growth. As noted above, progressive taxes tend to have higher marginal rates, so they reduce growth. Despite the above study finding a shrinking labor supply for Estonia, some benefits still accrued simply because of the tax structure. “The flat tax in Estonia encouraged capital formation, led to higher productivity levels, higher wages, and job creation.” [9. http://adamsmith.org...] Again with Russia, “the average annual real growth rate in Russia over the last three years averaged 5.5 percent.” So the growth rate in Russia was extremely high after the flat tax reforms. My opponent is likely to cite a Brookings Institute report in response to this contention, but as noted earlier, progressivity seems to lag by about 3 years before we see growth. So the Brookings argument that GDP was not changing at a different rate a few years after the reform when compared to the 1990s is expected. Assuming the 3 year lag above, we see that Russian growth actually boomed 3 years later in 2004 [10. http://www.tradingeconomics.com...]. So economic growth in 2004 is, at least in part, attributable to the flat tax--and the lag means we shouldn't have seen growth until that time. The Brookings report does not take into account the lag, so their analysis is lacking.