A Scheme to Determine Tax Rates Fairly and Quantitatively

I Prologue ONCE I DREAMED of finding an additional page of Thomas More's Utopia tucked inside an ancient copy of Euclid's Elements. On this page, More described a Utopian village of 101 adults, all of whom had a taxable income. Fu, one of the 101 adults, had $1,000.00 in taxable income and each of the rest of the villagers, all named Pin, had $10.00 in taxable income. Fu and the Pins in this Utopian village had to come up with a scheme to collect $1,000.00 in tax revenue. The tax scheme needed to be as fair as possible to everyone. In the village hall, the Pins argued that Fu ought to shoulder most of the $1,000.00 tax revenue needed because he could best afford it. If his tax had been $980.00, Fu would still have far more left than each of the Pins. On the other hand, Fu thought to himself that it was only fair that each villager pay the same amount, since he would not use more of the public facility to be built with the tax money than any of the other villagers. However, even Fu regarded it as morally wrong that his poor neighbors should pay as much as he did. Therefore, he opted for a flat tax rate, and proposed that he pay $500.00 and each Pin pay $5.00. Not satisfied by Fu's proposal, the Pins pointed out that although Fu had made his money legitimately by his own efforts, he consumed a large amount of public resources, such as underground water, for free. If everyone in the village had consumed as much underground water as Fu had, the village would have been deprived of drinking water by now. Fu countered that if it had not been for his making bricks to substitute for wood to build houses, their village would have had no more trees left. Although the Utopians did not care how much tax they had to pay, the concept of fairness to all intrigued them greatly. They argued and argued deep into the nights. To my greatest disappointment, I woke up before reading Mom's proposed solution. II Introduction THE REALITY REMAINS that a fair tax rate system does not appear to exist, even in a Utopian fashion. Each year countless pages have been written to simplify, improve, and revolutionize the existing tax systems with no convergence on the horizon. Among recent publications, Fox (2001), echoing many other authors, calls for broadening the tax base while still using income as the tax base. According to Fox, the untaxed income in the United States is $2.86 trillion, versus a taxable income of $3.41 trillion in 1997. McCaffery (2002) argued eloquently for a consumption-based taxation system, although he largely ignored that a major objection to the consumption tax is that a typical person consumes most when he or she is least able to pay. Day (2005) elucidated the benefits of taxing land utilization and discussed the enigma around this not being implemented. The most argued-about tax proposal, however, is that of the so-called flat tax system, advocated by Hall and Rabushka (1995). Because of its simplicity and departure from the multi-rate structure commonly used in the West, the flat rate system has attracted great attention and met strong resistances (e.g., Hicko 1996). Although there are various critiques of the (U.S.) taxation system, this article was motivated by and is largely concerned with the irrationality and inconsistency of the rate structure. The income tax rate of the top bracket was as high as 91-92 percent during 1951-1963, while it was only 28 percent during 1988-1990. (1) Such a large rate fluctuation can hardly be considered to be the result of rational and consistent tax policy. The objective of this article is to argue for a scheme that would make the rate structure more rational. More specifically, the article attempts to seek a quantitative answer to the problem posed in the Prologue. Whatever the reason for the lack of rationality in taxation, it is certainly not due to a lack of guiding principles. Many guiding principles, in fact, have been developed on every aspect of taxation throughout history. …