Monday, October 29, 2018

A Progressive Take on Regressive Taxes

Election Day is nearly here, and buried deep down on our Tempe ballot is Proposition 417, which would increase sales tax by a tenth of a percent to fund the arts in our city. Even deeper on page two of our ballot is Prop 126, which aims to prohibit levying any future sales tax on services. (Currently, our local government can only tax goods.)

I don't know if this makes me a closet conservative, but these particular taxes rile me up. Not because I hate paying taxes: a part of me kind of likes the idea that some of my money is baked into every new sidewalk and folded into every library book. And a tenth of a percent sales tax, or applying sales tax to services, isn't going to make a dent in our high-income budget.

Still, I hate these sort of tax proposals because they are regressive: they hit people with lower incomes harder than they hit people like me. They ask someone earning minimum wage to pay a bigger percentage of her income for these taxes. Which is a really fucked up way to raise the revenue you need to run a city or a state: by going after the poorest people in your community.

So let's talk about that a bit today: why local governments get so much of their revenue by taxing the citizens who can least afford it.

Sales Taxes
Sales taxes are a favorite of local governments and conservatives alike, as they tax consumption and masquerade as a 'flat taxes'. You buy a new cell phone, your wealthy CEO across town buys the same phone, each of you pays the same six or eight percent to your state or local governments, and a whole basket of services from education to parks gets funded. Who could argue with that?

Except that flat taxes aren't really flat: they're regressive. I can already hear the whiny retorts from both of my right-leaning readers.

"How can a sales tax be regressive," they lament in that tone we all hate, "when everyone pays the same rate?"

The catch is that regressive taxes aren't defined by the rates in isolation. Rather, the term refers the percentage of a person's income that has to be allocated to pay for that tax. So when the working poor have to pay a higher effective tax rate for purchasing goods than high earners do, then the tax is regressive. (Fierce defenders of 'flat' taxes should read this primer titled "Understanding Taxes", written for school-age children, and put out by the good people at the IRS.)

The sales tax was born out of the Great Depression, when state governments desperate for revenue turned to this consumption tax. People mostly bought goods back then, so this was a way to keep governments running even when the economy nearly ground to a halt. No matter how bad things got, people still needed to buy stuff.

The problem with this approach is that a tax on goods which some people need to buy regardless of their income (say, groceries, or buying a vehicle to get to work) are going to cost more to those with less income. Sales taxes are not only an inefficient way to raise funds for governments, but are also a fairly fucked up way to target your poorest citizens: many of whom might live in a food desert, and thus won't even enjoy the exemptions most local governments make for sales taxes on groceries.

Property Taxes
Property taxes similarly charge lower income households a higher effective tax rate than they do higher-earning households within the same locale.

Let's say that there are two similar houses for sale on a street in a fairly nice, up-and-coming part of town, with identical sales prices. I, the lucky prick with a six figure income, move into one of them. A family earning right around the median household income of $56,617, moves into the other.

Since both of the houses are valued by the county identically, both of our households will pay the same dollar amount in property taxes: with an average cost of $3,399 in 2017. And maybe that sounds fair: both families use the roads every day, both take walks on the sidewalks after work, and maybe we send the same number of kids to the public schools funded by those property taxes. Why shouldn't we both pay the same amount?

But while the $3,399 we both pay in property taxes represents not even 2.6% of our ridiculous household income, it represents more than double that for my neighbors who earn the median income. They are paying over a 6% effective tax rate for their property taxes, because, just as with sales taxes, their relative wealth or income never enters the equation.

Regressive Taxes and Inequality
Besides being a regressive tax and a shitty way to raise revenue, property taxes also just happen to fuel inequity in our school systems. Because certain neighborhoods have much higher property values than others, those areas end up contributing a much higher dollar amount per household to their school districts.

Students graduating from those better-funded schools perform better, undeniably. In turn, the existing income and wealth inequality between communities is maintained. While property taxes or any other regressive tax might not be a root cause of wealth inequality per se, they are part of a financial system which perpetuates the problem, rather than trying to mitigate it.

Okay, Smart Ass. How Else Should We Fund Our Schools, Roads, and Infrastructure if not through "Regressive Taxes"?
So this is a question we'll tackle in a series future posts since, as the Republicans recently learned when they gave governing a shot, making major changes to the tax system ain't easy.

But if you gave me a magic wand that could make sweeping changes to the tax code, here's what I'd do:
  • Eliminate all consumption taxes entirely, because they regressive and stupid: no more sales tax, no taxes on a gallon of gasoline, no sin taxes on alcohol/cigarettes/soda. Instead, replace them with a local progressive income tax. You know: the same progressive tax system that we already have at the federal level and in almost all states. If you make income, we apply different marginal brackets based on how much you earn in a year. This sort of progressive system raises revenue in a way that takes more from those who earn more, and takes little or nothing from those who have earned little or nothing. 
  • A local income tax is not such a wild idea: New York City is a municipality that's created its own progressive income tax. So has Washington, DC. And several other cities have local income taxes (though many, sadly, are "flat" taxes).
  • Let's also stop funding schools through local property taxes, as they just exacerbate the existing inequality between rich neighborhoods and poor neighborhoods. Instead, I'd propose that a state outlaw local property taxes altogether within its borders, while concurrently raising its progressive state income tax rates, and aiming for a net offset. The state would then be in a position to provide equal funding per student to all districts in the state: a move that would at least begin to address the huge funding and achievement gaps between rich neighborhoods and poor neighborhoods.
  • And while I've got this sweet magic wand, why not utilize the federal budget to address the funding gap between rich states and poor states, too? The federal government could either send additional funding to states spending less per student, or we could go really big and shift the burden of funding schools from cities and states entirely to the federal government. You know, for funsies.
I have even more ideas in the hopper. (Like, how about we address the fact that very high earners stop paying Social Security altogether on all earnings after $128,400. At that point, their tax goes to zero, so high earners' effective tax rate on Social Security ends up being lower than that of anyone earning minimum wage: a truly regressive tax.) But before I put your ass to sleep in your cubicle on a Monday morning, let's wrap this thing up.

I feel so strongly about these taxes because I, in my lefty old age, have finally understood that inequality is one of the most dire problems facing America right now...but it's also one we can mitigate. You know, with the historic and obscene amount of wealth our country has, and the fact that we sometimes get to vote, in direct democracy, on how we want to tax our citizens and businesses.

I sometimes think of inequality as this nebulous thing that somehow just "happens". It's a real problem that causes a lot of suffering unnecessarily and unfairly, sure. But who even knows where it comes from, or what we can do about it?

Instead of thinking of inequality as some vague concept, we ought to consider the fairly obvious fact that the way we tax our citizens has a direct, bottom line impact on those already terribly unequal household budgets.

Do we want to make those household budgets a little more equal, by changing the way we gather taxes? Or do we want to tax the working poor disproportionately, and make things even more unequal?

*Photo is from Kay West Wedding Photography at Flickr Creative Commons.


  1. You can move to Oregon! We have 10% income tax and no sales tax. I hate it.

    1. Hey, Joe. I can appreciate how frugal, high earners don't like the progressive nature of an income tax (as opposed to a tax on consumption which doesn't hit them much), but Oregon's doesn't seem too bad. The 9.9% only hits those earning north of $125k, right?

    2. Is 10% income take meant to be 'bad'? I live in Australia, we have a nationalised 10% sales tax (non essentials - so fresh food isn't taxed). My income tax, which is federal, is 37%.

    3. Hi Sarah! I know the US enjoys a very low tax burden compared to much of the rest of the world, and your numbers sure show it.

      Does Australia's progressive tax system work similarly to the US's federal income tax, where the first chunk of income is taxed at a low rate, and the next chunk is taxed at the next rate, and so on?

    4. That's 10% state tax in additional to federal tax and such. SO we're paying pretty close to your 37%.

      Oregon income tax isn't very progressive. Most people pay 9%. When you make more, then you get to 10%. That's not a big difference. It seems very flat to me.

    5. Good point on Oregon's tax not being all THAT progressive. It only barely qualifies, but at least it is a ramp...even if one that's pretty close to flat. ;)

  2. I know they would need to withstand some reality testing but I like the idea of trying out some of your suggestions. There's got to be a better way than the many regressive taxes we keep experiencing as a nation.

    1. I hear you on the reality testing, Revanche. Literally none of my ideas would have a snowball's chance in hell...unless people saw that it really might be tax neutral or to their advantage.

      The messaging would be the key. Though it's such a new concept for many people, and I doubt many people have any clear idea on what they pay in sales tax & property taxes...and it's such a big change at the state or national level. I'm surely just dreaming.

  3. Part of me feels that all taxes are regressive in that they hurt the poor more than the rich. Even if you have a "progressive" income tax, the poor person has a harder time (financially) giving the government 10% of their income than the rich person has giving 50% of their income.

    Also, in Ohio, the Ohio Supreme Court declared funding schools via property tax unconstitutional (via the Ohio Constitution, for basically the reasons you stated here). This was back in the 90's, and basically no changes have been made about school funding since then.

    1. "JoeHxOctober 29, 2018 at 11:57 AM
      Part of me feels that all taxes are regressive in that they hurt the poor more than the rich. Even if you have a "progressive" income tax, the poor person has a harder time (financially) giving the government 10% of their income than the rich person has giving 50% of their income."

      Totally! I think that's an unfortunate reality, but as the twelve steppers say, it's about progress, not perfection. I'd settle for a truly progressive tax system, even though it would in no way address the full financial hardships of low earners.

      I'll have to look into the funding for schools in Ohio, too. Thanks for the tip! Are you from Ohio? I'm originally from just over the state border in Pittsburgh.

    2. A "truly progressive" tax system would surely end up paying poorer people in negative taxes so that everyone ended up earning literally the same amount of money?

      I don't think anyone would ever want that!? :)

      But it's clear that far more redistribution of wealth would be a good thing (to me at least). I like all your ideas! Apart from the sin taxes.

      Taxing cigarettes is one of the easiest ways to lower the amount of people smoking. Not really sure why you'd want to deliberately increase that?

      Apart from that though I'd vote for you governor DbF!

      That's eye opening about the schools being funded by the property taxes... Although now thinking about it not surprising. I wonder if it works the same in the UK... I shall have to investigate!


    3. Hey there, FIREstarter.

      While I'm no socialist (and honestly a bit of a moderate on economic issues), regressive taxes & consumption taxes have always struck me as a particularly cruel & inefficient way to get money. Yes, even on "sin" taxes like cigarette taxes.

      While there are surely benefits to taxing bad behavior like smoking, I honestly don't think that's why the regressive taxes are put out there by politicians. Rather, sin taxes are easy taxes to pass because they have the allure of being a public health policy. A progressive tax is a far better way of raising money, but they are hard sells and politicians are, generally, cowards when it comes to telling their constituents they may have to pay for something.

  4. Hmmm... interesting. I believe food is exempt from sales tax, so that does level the playing field a bit, but I get your point. There's an amendment on the ballot this year in Colorado to establish state income tax brackets, and use the money collected from high earners to fund our public schools. It will be interesting to see how it fares.

    I totally agree that income inequality is a huge issue, and it's probably going to lead to a major depression - which won't be good for anyone, rich or poor. IMHO there are a lot of things that need to be done to combat it - raising the minimum wage, government funded healthcare, childcare, & eldercare, better public transportation, and even guaranteed minimum income. Of course, all of that will require money, which will require taxes, and I totally agree that those taxes should be paid by the top earners.

    1. "I believe food is exempt from sales tax, so that does level the playing field a bit, but I get your point."

      Totally, and I think this is an area where we have part of a good tax system, but it's still hurting poor people disproportionately. In our city, you pay much less (almost no) sales tax on produce & meat...but you pay full sales tax on chips, soda, frozen dinners, etc. On its face, I actually really like this tax policy as it's encouraging good behavior. But, since food deserts are a thing and poor people disproportionately live in them, when they go out to the places they can get to for food (convenience stores, liquor stores, fast food, etc) they pay full sales tax on everything.

      And yes, all the things you mentioned are going to have a much bigger impact on inequality than a more progressive tax system: raising minimum wage, healthcare through something like single payer, basic income, all that stuff is way more impactful, for sure.

    2. fyi - food is NOT exempt from sales tax in all states:

      This is the most agregious of all the regressive taxes, in my opinion.

    3. That's a good resource, Retiredat49. I'll have to include that in a future post: thanks for sharing. And yes, taxing food is surely the worst kind of regressive tax.

  5. This is why I appreciate that in Minnesota, clothing and food are not subject to sales tax (a most progressive approach!) Daddy Warbucks will, on the other hand, get nailed pretty hard with the sales tax on his new Tesla Model X. (While Cubert happily scoots to work in his wee, used Honda Fit or bi-cycle!)

    1. Hey there, Cubert!

      While I agree that exempting food & clothing are a great way to ensure the poor don't have to pay a higher share of their income for necessities, people still have to buy so many things that are subject to the regressive tax. Most of us still buy cars from time to time to get to work, there's a certain amount of stuff you need to replace and repair in a home, etc. etc.

      I don't even mind consumption taxes per se, but if there were a way to wrap income into the mix (idea in a future post) then I'd be more on board.

      But yes, that guy in the new Tesla: he can pay full tax. ;)

  6. I must be one of your now 3 right leaning readers. Speaking on behalf myself, not all 3 of us, I think it's a problem, but like healthcare not an easy one to solve. I also find it odd, that the FI community as a whole constantly talks about how to keep income down to basically qualify for ACA subsidies and FAFSA for college aged children. I'm sure the programs weren't set up for millionaires to get more money, but since we base everything on income, people take advantage. I get it, I would too, I just can't based on my earning. But I find it at least a little hypocritical to say the rich need to pay more, while having a 7 digit net worth and receiving any ACA or FAFSA subsidies.

    At some point if things get too progressive these "rich" people are going to say enough, I'm FIRE-ish enough to stop working, and keeping only 50% and then we are worse off. I've been a right leaner all of my voting life, however honestly I have faith in either side of our government. I'm trying to simply help my family and play the tax game with the rules that are setup. I appreciate the article just trying to calmly discuss the other sides thinking, at least my side of thinking.

    1. Hi there, Anonymous right leaning reader!

      For what it's worth, I don't take any ACA or FAFSA subsidies. :)

      I think you're hitting on a key distinction in our tax code: income and wealth are two different things, and we only tax one of them. Again, more ideas to come in a future post, but you can probably guess what a lefty's solution to this might be.

      I've heard the argument that a too-progressive tax system will have drastically bad consequences, and very intelligent high earners will do things like quit, or move, etc. I wonder if these people have looked at the very recent history of our tax code over the past 80 years or so. The brackets used to be WAY higher, like, rates that are guaranteed to shock people the first time they hear about them. Just saying, there's precedent, and I am pretty confident there's more room to scale before bad things happen.

      As you noted, it's our job to help our family and abide by the tax laws as written. But as citizens in a democracy, it's also our job to try to improve things for people outside our family. Conservatives and liberals alike know the tax system can be improved. We can take actions to create an economy that has broader growth, and taxes in a way that's more fair but does not threaten that growth.

    2. To me the FIRE movement in general feels like high income earners like yourself, myself, and probably most of your readers, doing exactly that. Saving up money to eventually quit and make a lot less to recapture time. Having wealth taxes do seem inevitable, we can see hints of it with healthcare surcharges. I expect one day social security will be capped based on something wealth, income dunno. I do like to read opposing points of view without the name calling most political posts become. Look forward to reading your additional thoughts on new articles.

      #3 right leaning reader

    3. To me the FIRE movement in general feels like high income earners like yourself, myself, and probably most of your readers, doing exactly that. Saving up money to eventually quit and make a lot less to recapture time. "

      Yes, on that we agree. FIRE is certainly over-represented by high earners saving up to buy time. I'm not totally sure what you're linking that point to in the post about regressive taxes, other than the fact that perhaps you also now believe we high earners should pay more in taxes? ;) Maybe we'll make a liberal out of you, yet.

      Cheers, and good talking to you.

  7. Having spent the majority of my life in the utopia that is Massachusetts, which is the bastion of liberal ideology, I can say that it is much nicer on the outside looking in than it is for those who actually have to live there.

    This issue with the schools there vs my new home of Texas is very interesting and something I never understood until I moved. The northeast is very densely populated where small towns all border and touch each other and are small because the geography is small, not because they are distant. My home town with population 10,000 was still only 15 minutes away a major city.

    Here in Texas, towns are small and are surrounded by farms. So, there is a massive area geographically distant from major cities. To find a town with that population, it's probably 1 to 2 hours drive from the city I live in.

    So, you can really see why it's so hard for small towns to put together good schools in the rural south as compared to densely populated north east.

    Additionally, in the north, cities are bad places to live. People "move to the suburbs" the first second they can afford it. In the south (or at least Texas), the cities are the good places to live.

    In Massachusetts, the majority of school funding comes from the states and a small portion from local taxes. STILL, the inner city schools are terrible while the suburbs have great schools.

    So, the issue is not inequality in funding, but more about the teachers, the parents, and the students who attend those schools. That's not something taxes will fix.

    1. Hi there, Eric.

      I have family in Mass (Pembroke & Manomet). We'd visit twice a year, and I agree it's no utopia.

      However, I'd disagree with your analysis. The differences between the school systems you're describing aren't explained by the geography between cities & rural areas.

      And I agree that taxes would not solve the issues of schools but, of course, that is a strawman argument.

      No one is positing that taxes would solve those issues but, rather, the post argues that there there are ways of taxing that are more efficient and that which do not disproportionately hurt low income citizens.

    2. I did home in a bit on the property tax thing and didn't really discuss the rest of your article at all, so you're right about that. I pay an exorbitant amount of property taxes on my portfolio and it bothers me to no end to see that money wasted.

      I agree with the last paragraph of what you said though. There are a lot of really regressive taxes that truly hurt the poor, primarily consumption taxes. Some big examples are taxes on cigarettes, alcohol, etc. There are also certain things that are promoted by the state that are detrimental to the poor such as gambling, lottery tickets, and more.

      I believe local income taxes are a terrible idea as wealthy people are mobile and can work remotely or move more easily while poor people are more stuck. So, poorer people will pay it and wealthy people will just move to the city next door.

      Income tax works better at a large scale because it's hard to leave the country than to leave a state. It's harder to leave a state than to leave a city.

    3. "I believe local income taxes are a terrible idea as wealthy people are mobile and can work remotely or move more easily while poor people are more stuck."

      Is that what happened to New York City? All the high earners left and worked somewhere else? Is that what happened in all the other cities I mentioned, which have local income taxes?

      I see this argument trotted out, usually by conservatives, and it just doesn't match up with what actually happened in places that decided to levy a local income tax. Their fears didn't actually come to pass.

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  9. The problem with having an income tax and no sales tax leaves those in the underground economy (like drug dealers, those working off the books and otherwise working for cash) paying NOTHING to sustain our economy.

    1. That's true but I think we'd be letting the tax tail wag the dog in this case. I'm not in favor of systems that hurt the most vulnerable and are less efficient at gathering tax dollars, just because they happen to get some paltry tax revenue from criminals.