Economics 101: Explain Regressive Taxes

Factual Questions
1

I have never had a good grasp of economics, ever. I had a question inspired by this thread. In it a poster states that sales tax is a regressive tax, in that it takes the most money from those least able to pay.

That definition of regressive taxes completely makes sense to me- you have 2 people, one makes 20k a year and the other makes 100k. You have a flat income tax of 20%- that leaves Person A with 16k and Person B with 80k. Even though Person B paid more in taxes, and it’s the same % for both, it makes it considerably more difficult for Person A to make ends meet, while Person B will, I dunno, have to settle for a cheaper car or take a shorter vacation.

First, is this a complete misunderstanding of regressive taxes? And if not, I still don’t see how a sales tax is regressive. Because Person B has more disposable income, he is able, if not actually more likely, to buy more stuff. I know there are misers out there who invest it all and live modestly, but let’s assume that most people would actually spend some of that money. Not go crazy, but buy nicer clothes and bigger/faster cars and go out to nice restaurants and things. And let’s assume Person A, who isn’t so destitute they can’t do anything, of course spends money going out to the movies and shopping, just cheaper products, and fewer of them.

So, generally speaking, wouldn’t a wealthy person spend more money? And thus pay more in sales tax? I mean, my assumptions could be way off but I just don’t see a lot of wealthy people obsessively clipping coupons and shopping in thrift stores.

I recall in my American Government class some students proposed abolishing income taxes altogether and just having sales taxes. They did a bit of research, with which my teacher was apparently familiar, to the effect that states without income taxes (like Florida) have stronger economies than states that have them.

Can anyone help me understand? :confused:

2

Your understanding of regressive taxes is correct.

The reason sales taxes are regressive is because the poor spend a far larger percentage of their income for day-to-day necessities than do the rich. That’s why things like food are generally not taxed, but stuff like clothes, gasoline, drugs (in many cases), housewares, school supplies, and so on are all subject to sales tax. Your $20,000 a year guy is just getting by, spending almost everything he makes on stuff he needs to take care of his family, and being taxed on all of it. Meanwhile, your $100,000 a year guy spends maybe $50,000 on stuff he needs plus luxuries, while socking away the rest in home equity, a 401(k), investments, and savings.

3

I think the point isn’t whether the total effect of sales taxes ends up taking more money from rich people than poor people, or even whether it ends up taking a higher proportion of rich people’s income than poor people’s. The point is that in any individual case where a sales tax is applied to the purchase of a particular item, its effect is regressive.

That is, the poor person and the rich person have to pay the same amount in tax on any given item, which hits the poor person’s wallet harder than the rich person’s, which makes it a regressive tax.

4

It’s the same argument you made against a flat tax. Just change the percentage.

A person has $20k in income. Say he has to spend $10K of that on taxable necessities. The 8% tax means he has to pay an extra $800 that he can’t afford.

Someone who makes $100K, OTOH, might spend $50K on taxable necessities. But the extra $4k in taxes is more easily handled.

Post hoc ergo propter hoc.

5

:smack: I’m a big dummy.

I forgot the point I had made in the previous paragragh, that even if the rich guy pays more in taxes, it’s still easier for him to pay bills and have money left over, as opposed to the poor guy.

How embarassing. Told you I have a very questionable grasp of economics. I’m really not this stupid IRL, I swear!

6

What you’re describing here is a flat tax, which is not the same thing as a regressive tax. To make it regressive, you’d have to take a higher percentage of the poor person’s income–say 25% for anyone making under 30k, and 20% for anyone over.

The wealthy person may spend more, but they spend a lower percentage of their income. Pay attention to the percentages here, not the amounts.

7

No, a regressive tax is one that causes someone with less income to pay a larger percentage then someone with a more income. If the statement that I bolded in your post is true, the tax is in fact progressive.

The reason a sales tax is usually regressive is that the lower ones income, the larger portion of it will go towards purchases and thus the larger portion of ones income will be subject to the tax. The fact that it’s also harder for a less well off person to pay the tax isn’t necessarily what makes it regressive

8

It always bothers me that regressive-progressive taxes are based on proportion of income. Why logically should this be? Why shouldn’t it be wealth or consumption that is used as a basis. In fact I think consumption makes the most sense. Money that is earned, but not spent on consumption goods or services hasnt’ really gone anywhere. It’s beenn saved and (though usually not directly) invested in producing more stuff (technical term for goods and services at a future time) – not to mention more income for the person saving.

Taxing income incourages spednign on consumption rather than savings and investment. Taxing consumption taxes those and that which use up resources that others then can’t have.

Now I’m not saying tax all conusmption. I could see arguments that basic food clothing shelter might not be taxed, but it does seem to make more sense that the primary tax in the US should be consumption based and not income based – perhaps with the first $20K per person exempt. Those are just some wild guess numbers there.

9

A shift to a tax on consumption will cause a shift from selling to bartering which will make pricing less standardized and thus less useful in helping markets put resources to their highest use.

10

You could use other things as bases and people do. A single rate consumption tax with no exemptions would be proportional (neither regressive nor progressive) against consumption but regressive against income because savings grow as a proportion of income as income rises. A personal consumption tax could have progressive rates and be progressive against both income and consumption. Narrow based sales taxes or broad taxes that don’t tax services very effectively will be regressive against consumption.

You could also use lifetime income or wealth as your standard. You could include an imputed value for leisure and other non-market benefit as your “full income” base - this is an important dimension when dealing with the distributional aspects of taxes levied by household instead of the individual.

None of this of course says anything about the desirability of regressive taxation or of different tax bases. It’s just a measure or series of measures referring to the distributional impact of a tax.

11

To do a definitional nitpick: A true regressive tax is one which is levied in inverse proportion to wealth – it literally taxes the poor at a higher rate than the rich. While this may seem absurd, ancien regime France had a number of taxes from which the aristocracy were exempt (hence paying a 0% tax rate). The discussion above has been based on the sound principle that a flat-rate tax has a regressive effect.

One point that is definitely worth picking up on, though, is the extent to which perqs and benefits may introduce a strongly regressive effect. The average machinist or secretary, to say nothing of the burger slinger, does not get a company car – yet may have as much need for a vehicle – and the sales tax on an automobile, though usually covered in the financing, is a substantial figure. It is generally the lower-paying jobs that are not accompanied by a company medical plan. There are literally hundreds of such often-minor-by-themselves but cumulatively high-impact benefits that make the difference between an officially-$12,000-a-year job and an officially-$40,000-a-year job and between them and an officially-$120,000-a-year job, actually one or two orders of magnitude greater than what appears from the official income levels.

12

And then you have the lottery, which is a regressive tax on the poor, the elderly and the stupid.

Oh, it ain’t a tax, because you are not forced to make lottery purchases, but it works just like one.

Taxes on cigarettes and alcohol are often cosidered even more regressive because of the people who are likely to spend disproportionate am’ts of income on them.

13

But this would apply to all taxes, wouldn’t it? Sales tax, income tax, property tax, whatever – In all cases, lower-income people have more difficulty buying things than higher-income people do, right?

Can someone give an example of a tax that is not tougher on the poor than on the wealthy? (The only example I can think of would be an income tax which exempts all but the super-wealthy.)

14

As a former teacher of Public Finance I must take nitpick. Taxes are progressive or regressive with respect to a tax base. So it is appropriate to say “sales taxes are regressive with respect to income”. It seems small but it can lead to confusaion. A sales tax is a flat tax generally, it is flat with respect to what it is taxing, which is sales. But it is (or at least can be) regressive with respect to income.

15

Well think of it this way, it’s a tax on consumption only. Theoretically the guy earning 100k a year doesn’t have to spend any more than the guy earning 20k a year. It’s only regressive in the end result that it effectively leaves the rich with a much higher portion of their income untaxed.

I could be wrong, but it seems to me that all sales taxes are technically neither regressive nor progressive in that they don’t discriminate on the basis of income level. It is probably referred to as regressive because it’s the opposite of progressive which is the system that we have. The point is to get more money from the rich because they can afford it.

For it to be literally regressive it would have to charge the poor more. It could be a fair system if the rich actually spent the same amount of their income each month in consumable goods (i.e. like overhead costs, electricity, water, foods) that would result in no value at the end of the year. But this isn’t possible because the rich have too much money to spend like that without actually getting some kind of asset that is worth money. Like in Brewster’s Millions, it’s hard to purchase things that leave no value behind!

So a sales tax-only system isn’t inherently regressive like making the poor guy pay 25 % and the rich guy 10 % but it works out that way in reality. We all measure tax as a portion of our income, so if you can consume less, then you still pay taxes in our current system, but if there were only sales tax then you’d get a tax break for buying less.

It would also be horrible for the economy to make a disincentive for consumption. With out current system (little to no sales tax) consumption isn’t as discouraged.

16

Err…read what I (or most of the other posters to the latter half of this thread) wrote, I think you’re misunderstanding it.

A tax isn’t regressive simply because it’s tougher for the poor to pay (obviously low-income folks are going to have a more difficult time paying any tax that applys to them then Scrooge McDuck types) but because it takes a larger percentage of the wealth of the poor then it does the rich. Specifics matter, but by and large (non-flat) income taxes, property taxes, etc are all progressive since they take a larger percentage out of the riches wealth (since they’re usually in a higher tax bracket, or usually have more of thier wealth tied up in property) then they do the poor.

17

That’s true, but another way of looking at it is computing the value of a dollar to different people with different income levels. A windfall of $1,000 may be vitally important to a person making $10,000 a year, but Bill Gates would never notice it. Thus a tax that is not strictly regressive in terms of absolute dollars may be regressive in terms of value.

Progressive taxation tends to try to balance the value of what is paid, by increasing the amount for the wealthier.

18

You need only look at the social security tax for that. A worker earning $30,000 per year pays 6.2% of their income for social security. A worker earning $200,000 per year pays less than half of that, 2.8%. And a non-worker, with $1,000,000 in unearned income, interest, dividends, rents, capital gains, whatever, pays 0.0%.

19

This might be going into more of a GD area, but the Fair Tax isn’t regressive, since they issue a tax refund on sales tax purchases up to the poverty level.

20

It can still be regressive, or at least regressive above the poverty line, since the middle class presumably also spend a larger portion of thier incomes on taxable purchases then the wealthy.