One of the more formidable voices in economics was that of the late Friederich A. Hayek (1899-1992). In his classic, The Constitution of Liberty (1960), he argued that progressive taxation does not accomplish what most people believe. Taxing the wealthy at higher rates, in order to provide for larger government spending for the poor, does not obtain the desired goal according to Hayek. Hayek said: “Not only is the revenue derived from the high rates on large incomes, particularly in the highest brackets, so small compared with the total revenue as to make hardly any difference to the burden borne by the rest; but for a long time . . . it was not the poorest who benefited from it but entirely the better-off working class and the lower strata of the middle class who provided the largest number of voters.”

Hayek believed, as do most fiscal conservatives, that in principle the progressive tax is a political issue more than a tax issue. In theory it sounds like it is fair for the wealthiest few to help the rest of us but sharing their income in certain managed ways but in practice this is simply not what actually happens. This argument seems counter-intuitive until you actually examine both revenues and the history of what the progressive income tax has done to our nation’s ability to generate larger sums of revenue through higher rates of taxation.

The largest number of Americans seem to believe that raising taxes on the rich is good for all the rest of us but remember that the definition of “rich” gets changed as things move along thus before long the tax rates filter down to most middle class people too, in various ways that are not all rooted in taxes. The real loser could be the small business owner who is the backbone of any economic recovery. I do not debate the question of “stimulating” the economy by creating bank liquidity but I do believe a wholesale government spending spree will not have an overall positive impact on our economy. Why? There is no real proof for this conclusion.

One of the greatest downsides to this approach is the way it kills the incentive of the very wealthy to create new jobs, to spend large sums of money on new capital ventures and thus to raise the boats of all of us in the process. The myth that often supports this theory is the one which sees the whole economy as a finite pie. There is only so much pie and we must more evenly share the burdens and the benefits of that pie. But what if we can make a larger pie? The truth is that we can and we have and this is part of the greatness of America.

The solution, it seems to me, is not to reduce the pie but rather to better regulate corrupt practices of some and enlarge the pie at the same time. Hayek also believed, and I think demonstrated, that progressive taxation tended to push the worst people to the top and not the best people. Maybe we had better rethink the class warfare danger that promotes so much through more taxation before we remake society along class lines.

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  1. jls March 5, 2009 at 12:17 pm

    As long as progressive tax rates are in place, they will never cease to be a political football for one simple reason: No one can argue, in any convincing way, exactly what the “correct” or “fair” rates are. A flat tax can be seen as fair by many people because of its simplicity: everyone pays the same rate. A communist system that takes 100% above a threshold so that everyone earns the same amount would seem fair to those who believe in communism, and of course it would decimate the economy. Anywhere between these two extremes (and I don’t really intend to call a flat tax extreme, because I think it has some merit), you are on a slippery slope. Among those who argue for more taxes on the rich, I have never heard anyone give a precise number for what the highest tax rate ought to be. Rather, they will say something like this: “I don’t know exactly what that number is, but I know it’s higher than what they are paying today.” It seems that they will always reserve the right to take a little more in the future.

  2. Molly March 5, 2009 at 4:58 pm

    Hi John,
    I live in Europe so I’m used to higher taxes than those in the USA.To be honest I don’t mind paying them(42%) as it provides free health care, good free education all the way to college level.No system is perfect but I feel taxes provide a safety net which every citizen needs to avail of at some stage.My opinion makes me an average punter here, my American friends seem to regard such views as verging on communism!
    God bless you and yours.

  3. Keith March 6, 2009 at 1:13 pm

    I think Molly’s vision is too short-sighted and mixed with error. For example, how can one say “I don’t mind PAYING 42%” and then claim it is *free* health care or *free* education?
    It also seems to suggest that mere income tax policies is an indication of the freedom in a country’s economy. The Heritage Foundation has produced a fine report tallying economic freedom in the world & the U.S. isn’t that much more free than many European countries. To assume, as is oft done in the media and by Europeans, that we are a “capitalist” (read laissez-faire) economy couldn’t be further from the truth.
    Yet, for all the glories claimed by many Europeans for their govt’s the official Swedish site says, “In recent decades, once the country’s previous steady, high economic growth had come to an end, the Swedish welfare state has been under heavy pressures. Today the country’s economic security systems are financially burdened and are struggling with serious structural problems.”
    The basics of economics – no such thing as a free lunch. Unfortunately, it seems most Europeans and most Americans think there is and it is produced by fiat by the government. The “free” system Molly speaks of is not sustainable in the long run.

  4. Ron Henzel March 7, 2009 at 4:54 pm

    Sweden was able to support an all-pervasive, cradle-to-grave experiment in socialism for 15 years after Britain’s less-ambitious attempt succumbed to Thatcherism. The reason the country was able to pull it off for so long was because it was merely taking advantage of a circumstance that few other nations on Earth enjoy: the combination of a relatively small population clustered at its far southern end and a vast wilderness to the north brimming with highly marketable natural resources. The closest parallel would be countries like Saudi Arabia, which use vast oil revenues to support their pork-laden domestic budgets, with the difference being that resource shortages hit Sweden years before the phrase “peak oil” made it into our cultural lexicon. And, of course, the latter has yet to play out, although I believe that nations with oil-dependent economies are already thinking about Sweden as they ponder their own futures.

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