Progressive taxation is a legislative policy that takes a greater percentage of a taxpayer’s income when they earn more money. The United States currently uses a progressive tax system when assigning tax brackets and each bracket is adjusted to reflect changes due to inflation.
In the 2017 tax cycle, those who earned up to $9,325 of taxable income were taxed at a rate of 10%. Those who earned more than $418,400 were taxed at a rate of 39.6%. Between these two levels are 5 additional income brackets.
Each taxpayer pays the amount of taxation for the income in that bracket. For the taxpayer earning $418,400 or more, the first $9,325 of their taxable income would be taxed at 10%. Then the next portion of their income, up to $37,950, would be taxed at the next rate level, which was 15%.
Here are the pros and cons of a progressive tax system to consider.
List of the Pros of Progressive Tax
1. It places the majority of an economic burden where it belongs.
When a universal system of taxation is implemented, then the overall economic burden is shouldered by the poorest households in a society. Although the poor and the rich would pay the same percentage of their income in taxes, a greater share of the poor household’s disposable income is taken away. That means having less money for basic necessities when compared to wealthier households.
2. It allows everyone to invest into their country.
A system of progressive taxation makes it possible for all households to contribute to the welfare of their country in some way. Although the contributions may be minimal, the process of paying taxes still creates a personalized investment into their citizenship. At the same time, actual revenues can be generated through taxes charged within the upper tax brackets. It creates a form of equality through patriotism, even if economically, two households are very far apart from each other.
3. It produces more total income.
When progressive taxes are implemented, the government receives more income than it would otherwise. That is because the greatest burden of taxation falls upon the people who have the most money. Imagine if the household earning $418,400 only paid 10% of their income, just like someone who earned $9,325. The wealthier household would pay considerably more ($41,840) than the other ($932). They would also have considerably more money to spend on themselves. By having a wealthier household pay a higher percentage, fewer budget deficits occur.
4. It improves the spending power of the economy.
Low-income earners struggle to have the value of their income make an impact within their community. Many live paycheck to paycheck, one emergency away from disaster. A system of progressive taxation helps to stimulate the economy more because it can enhance the effects of growth while reducing the effects of recession. That allows lower income earners to stretch their money further than in other systems of taxation.
5. It gives more households a chance to pursue success.
Because the relative tax burden for low-income households is typically less in a system of progressive taxing, they have a greater percentage of income that can be used to improve their financial situation. Although this does mean higher earners are effectively subsidizing these efforts, universal systems would have the poor subsidizing the rich. That is ultimately why the U.S. implemented this type of taxation system in the first place.
6. It requires ongoing payments.
Progressive tax systems are usually a “pay as you go” system. That means when you earn money, it gets taxed. If a household experiences the loss of an income, then there isn’t a tax burden awaiting them because of a pre-assessment of their earning capabilities. That means any tax payments which are required can be easily budgeted.
List of the Cons of Progressive Tax
1. It creates incentives to reduce taxable income.
The system of brackets that is used in the United States creates a tax system which incentivizes certain purchases or economic activities. By reducing taxable income levels, incentives are created to avoid paying taxes within the bracket of the actual income earned. The number of tax deductions or exemptions that were available in the 2017 require almost 74,000 pages of documentation to review to ensure each one taken is in compliance.
2. It costs more to implement.
The IRS estimates that it costs about $20 billion annually to implement the system of progressive taxation in the United States. When all compliance costs are evaluated, including personal and corporate costs, the total may be more than $200 billion annually. By shifting away from this tax system, the compliance cost savings could do a lot of good for the economy, helping low-income earners in ways other than a lower tax bracket percentage.
3. It is a system which encourages inequity.
Under the current system of taxation in the United States, about 47% of people do not pay any taxes at all. On the other end of the spectrum, when state and local taxes are included, some upper-class families outside of the wealthy class may pay up to 50% of their income in taxes. The goal of a progressive tax system is to create a system of fairness where everyone pays their “fair share.” The reality of such a system is that many households pay more than they should because many pay nothing.
4. It greatly impacts people at the bracket cutoff levels.
There is less of an incentive to earn more money in a progressive tax system if a household’s earned income is near a bracket cutoff. Income up to $37,950 is taxed at 15% or less in the United States in 2017. The next tax bracket goes to 25% for income between $37,950 and $91,900. For those who just make it into the next bracket, their tax burden can actually be higher than if they had stayed in the lower bracket.
5. It still impacts low-income earners in an unhealthy way.
Warren Buffet famously reported that he paid an effective tax rate of 17% on his income. That was about the same tax rate that his personal secretary paid that same year. If a household doesn’t qualify for certain deductions, such as a mortgage interest deduction because the family rents instead of owns, then their effective tax rate in a progressive system could be higher than wealthier earners.
The pros and cons of progressive taxing create a system where income can be generated to reduce deficits and provide domestic programs and support. Every tax system creates an injustice for some demographics, and the progressive system is no exception. Deductions and exemptions attempt to rectify that problem. In practice, however, some households still find that the negatives outweigh the positives with this form of taxation.