Taxing hard work verses taxing luck

In the year 2000, John McCain was asked by a student, "Why is it that someone like my father who goes to school for 13 years gets penalized in a huge tax bracket because he's a doctor. Why is that - why does he have to pay higher taxes than everybody else? Just because he makes more money. How is that fair?". To his credit, McCain did actually defend the idea of progressive taxation (those who make more money should pay a higher percentage of their income as tax).

It seems to be a common misconception amongst conservatives that progressive taxation is "punishing hard work" (or perhaps it just makes a good soundbite). But I don't think that even the most diehard liberals want to punish anybody for working hard - what should be (and is) punished is good luck. Many extremely wealthy people haven't had to work particularly hard for their wealth - especially those who have inherited it, but also those who have had the good fortune to be selling the right product in the right place at the right time (for example Microsoft in its early days with MS-DOS).

Also, there are a great many people who work extremely hard, but don't make a lot of money (those who work two or three low-paying jobs).

Progressive taxation decreases the reward for being lucky and thereby increases the amount of that reward that is due to hard work. So a (well implemented) progressive taxation strategy actually encourages hard work rather than discouraging it.

Not all progressive taxes are well implemented, though. In the UK there is a VAT limit of (currently) £68,000 per year. If your business makes more than that you have to register for VAT and pay 15 percent on all your profits (not just the profits over some limit). This greatly discourages people who are making just under the limit from working any harder, because if they did they would actually make less money.

I think one of the fairest taxes is the inheritance tax. This is much maligned as the "death tax", a moniker which doesn't make much sense to me as it isn't the dead person that pays the tax, it's the beneficiary. It's a fair tax because there's no hard work involved in inheriting money, you just have to have the good fortune to be born to wealthy parents. The downside of the inheritance tax is it's effect on the "family business" - a child wouldn't necessarily be able to afford to take over a business from his or her parents if there are large inheritance taxes to be paid, and this may lead to the destruction of some otherwise profitable businesses. But why, as a society, should we give that child the gift of this business and not expect anything in return?

A business which would be affected by this must have a large intrinsic value to be subject to the inheritance tax, but also make a small enough profit that it would take an unreasonably long time for the beneficiary to pay it back. I think the answer to this conundrum is investors - the beneficiary ceases to be sole owner of the business but the business can continue to exist and benefit society. Inheritance taxes should be set up in such a way that this can work.

One Response to “Taxing hard work verses taxing luck”

  1. [...] progressive than a sales tax. I think inheritance tax is one of the most fair taxes, as I’ve mentioned here before. Seignorage (if carefully controlled) is probably also a good idea. It would be nice if the [...]

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