Some unpleasant fiscal arithmetics

One frequently hears in France that our tax system should be more progressive, because it is supposedlynot progressive enough. Indeed many proposals and actual policy measures go in this direction, like payroll tax cuts on low-wage earners, capping some family benefits, the 75 % tax on high wage earners, or introducing progressivity in an additional tax invented a few decades ago and called CSG. Yet as long as a serious effort is not made to reduce the size and scope of the government, these reforms are bound to crash, for a very simple reason: The highest the average tax rate, the smaller the scope for progressivity. The reason is simple: in such a situation, cutting taxes on the poor can only be matched by near confiscatory taxation on the rich. These people will likely exit the country (as did Gerard Depardieu and Mathieu Valbuena), or severely reduce their labor supply (as many medical doctors do). The economy will suffer large distortions and in the long run will probably end up on the wrong side of the Laffer curve for the tax receipts coming from the rich. Suppose the government wants the bottom 20 % of the distribution to pay no taxes, the next 60 % to pay an average tax rate, and the top 20 % to make up for the rest. With an average tax rate of 40 %, the top 20 % need to pay an amount equal to 12 % of aggregate income, i.e. an average tax rate of 60 %. But when the average tax rate is 50 % (as in France, although the long-term figure should be even higher), the middle class pays 0.6*50 = 30 % of national income, and we need the top 20 % to pay an average tax rate of 100 %. If we now remember that we cannot have such jumps in the tax schedule and that there will be large distortions, we see that the scope for progressivity is quite small. When the government confiscates 50 % of more of national income, pretending to implement a highly progressive tax schedule is simply a lie. Everybody has to contribute a big deal. This is why each time money was really needed, governments resorted to broad-based measures like the introduction of CSG, raises in payroll taxes, VAT, or corporate taxation (without mentioning the clearly regressive gasoline tax which has the merit of having a broad and inelastic tax  base). How about making the expenditure side more redistributive, for example by capping pensions, excluding people above a certain income level from access to public hospitals, privatizing theatres, operas and museums, and introducing tuition fees in higher education? After a while people will integrate those restrictions in their economic calculations and they will likely result in huge economic distortions as the implicit marginal tax rate associated with losing those benefits is very high.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s