Policy Documents

Research & Commentary: Progressive Taxation

July 15, 2013

One of the primary tax reform debates taking place in several states is an argument over which type of tax system most efficiently raises revenue for the government while not unduly burdening taxpayers or harming economic growth.

Currently, 34 states have progressive income tax systems, while seven states have flat tax systems. The remaining nine states either have no income tax at all or a limited income tax on individuals, taxing only dividend and interest income.

Under a progressive tax system, tax rates increase as the taxable income amount increases. Progressive taxes are a form of income redistribution, with the taxes paid by higher income earners used to cover government services for lower income earners. While supporters of the progressive tax argue this is both fair and an example of social justice, these taxes violate democratic tax principles by placing an undue burden on certain groups of taxpayers. Even under a flat tax, those who earn higher incomes pay more in taxes, the “social justice” progressive tax proponents claim to seek.

Progressive taxes are problematic for several reasons. First, as a 2008 Organisation for Economic Co-operation and Development working paper explained, progressive income tax systems across the world have demonstrated a negative effect on economic growth. By increasing taxes on higher income earners, progressive tax systems dis-incentivize certain economic activities like investment, entrepreneurship, and financial risk-taking – activities that are the engines of economic growth and more commonly undertaken by those with higher incomes. 

Progressive tax systems also create unique difficulties with predicting tax revenue and preparing state budgets. Progressive tax systems result in tax revenues that are more volatile than flat tax systems. As the economy waxes and wanes, tax revenue received from taxpayers, especially those in the upper brackets, rises and falls. When the economy improves, more individuals and corporations move into higher tax brackets and pay larger percentages of their higher incomes in taxes. Relying on a small percentage of higher income taxpayers for a larger percentage of revenues often generates larger budget gaps during economic recessions. 

Lawmakers considering switching to a new tax system should considering moving away from the progressive tax model while moving towards a flatter tax system. This would help improve economic growth by removing double taxation, attracting capital, and improving the business climate.

The following literature examines progressive taxation from multiple perspectives.

Ten Principles of State Fiscal Policy
http://heartland.org/policy-documents/ten-principles-state-fiscal-policy
The Heartland Institute provides policymakers and civic and business leaders a highly condensed, easy-to-read guide to state fiscal policy principles. The principles range from “Above all else: Keep taxes low” to “Protect state employees from politics.”

What's Wrong with the Progressive Income Tax?
http://www.mackinac.org/1706
Burton Folsom writes for the Mackinac Center about the progressive income tax. The progressive income tax – based on the principle that the more a taxpayer earns, the more he or she should pay – is not what the nation’s Founders intended. The progressive income tax allows politicians to protect friends, punish enemies, and tax certain groups to give benefits to other groups.

Comments on Who Pays? A Distributional Analysis of the Tax Systems in All 50 States
http://heartland.org/policy-documents/comments-who-pays-distributional-analysis-tax-systems-all-50-states
Elizabeth Malm of the Tax Foundation critiques a recent report from the Institute on Taxation and Economic Policy (ITEP) that  attempts to examine the overall level of regressivity of the tax systems of the 50 states and Washington, DC. Malm finds ITEP’s recommendations are at odds with sound state and local tax policy.

Does Progressive Taxation Make State Budgeting More Difficult?
http://neighborhoodeffects.mercatus.org/2011/05/27/does-progressive-taxation-make-state-budgeting-more-difficult/
Matt Mitchell discusses the effect of a progressive tax system on state budgeting in this  Mercatus Center report.. Mitchell says states with a progressive tax system have found it increasingly difficult to forecast tax revenues and set budgets. “In sum: it appears that progressive taxation seems to be a recipe for rapid revenue growth when the economy is expanding (even tepidly). But it also seems to lead to larger budget gaps during recessions.”

What Is the Evidence on Taxes and Growth?
http://heartland.org/policy-documents/what-evidence-taxes-and-growth
In this Tax Foundation study, William McBride examines the effects of tax policy on economic growth. He finds the literature on the topic demonstrates that long-term economic growth is to a significant degree a function of tax policy. If governments seek to spur investment, he writes, they should lower taxes on the earnings of capital. If  they seek to increase employment, they should lower taxes on workers and the businesses that hire them. This piece includes a discussion of the effects of progressive tax systems.

The Inequity of the Progressive Income Tax
http://www.hoover.org/publications/policy-review/article/72291
Kip Hagopian of the Hoover Institution contends the most compelling argument against the use of the progressive income tax to redistribute income is simply that it is inequitable. “Under a progressive income tax, the welfare of one group in a society has been increased at the expense of the welfare of a different group.” Hagopian dismantles arguments for the progressive income tax and proposes a new doctrine of tax fairness.

Tax Progressivity and Income Inequality
http://heartland.org/policy-documents/tax-progressivity-and-income-inequality
This paper by Denvil Duncan and Klara Sabirianova Peter examines whether income inequality is affected by the structural progressivity of national income tax systems. The authors find that while progressivity reduces observed inequality in reported gross and net income, it has a significantly smaller impact on true inequality, approximated by consumption-based measures of Gini. They show theoretically and empirically that, under specific conditions, tax progressivity may increase actual inequality, especially in countries with weak law and order and a large informal nontaxable sector.

The Effect of Progressive Tax Codes
http://heartland.org/policy-documents/effect-progressive-tax-codes
Bill Ahern of the Tax Foundation discusses the effect different kinds of progressive taxes can have on taxpayers and the economy.

Indiana and a Progressive Tax Structure
http://heartland.org/policy-documents/indiana-and-progressive-tax-structure
This short essay by Cecil Bohanon examines the essential difference between a proportional (aka non-graduated or flat) income tax and a progressive or graduated income tax. He analyzes data that indicate how progressive income tax structures actually operate in the 34 states where they are in place. 

Nothing in this Research & Commentary is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit the Budget & Tax News Web site at http://news.heartland.org/fiscal, The Heartland Institute’s Web site at www.heartland.org, and PolicyBot, Heartland’s free online research database, at www.policybot.org.

If you have any questions about this issue or The Heartland Institute, contact Heartland Institute Senior Policy Analyst Matthew Glans at 312/377-4000 or mglans@heartland.org.