If you ever took a college economics class, there’s a strong likelihood that you were instructed that because poor people value a dollar more at the margin than do wealthy people, it follows that when the government imposes “progressive” income taxes, it raises the overall level of utility. The rich don’t miss the money taxed away from them as much as the poor value the money they’ll get through governmental redistribution. Therefore, redistributive tax policies are good.
Chances are also very high that you never heard any counterargument to that.
In this AIER essay, George Mason University economics professor Don Boudreaux provides the necessary counterargument.
He points out that the simple marginal utility case overlooks something important, namely the consequences of investment.
Boudreaux writes:
Suppose that multi-billionaire Bezos invests rather than spends an extra dollar that he earns today. Obviously, he thereby forgoes the utility — the satisfaction — that he’d enjoy today had he spent that dollar on consumption. So if that dollar is instead transferred through taxation to a poor person, it is illegitimate to compare the utility the poor person gets from today spending that dollar to the utility that Bezos would have gotten had he instead today spent that dollar. Given that Bezos in fact invested that dollar today, the utility the poor person would get from today spending that dollar must be compared with two alternative utility “experiences” — one enjoyed by Bezos and the other by many strangers.
If you are only interested in short-run income equalization, progressive income taxation is appealing, but if you care about the long-run maximization of societal wealth, you should reject it.
I’d like to add a couple of points to Boudreaux’s argument.
First, people who are not rich will, in a free society, devote considerable effort to finding goods and services to produce to sell to the rich. They have a strong incentive to produce and trade as the means of bettering their condition. Those incentives are highly beneficial, but they are weakened once politicians begin their redistribution schemes. At the margin, some people will think, “Why trouble myself with work when the government will give me money?”
Second, a dollar taken by taxation from a rich person does not magically find its way into the pocket of a poor one. It goes into the government’s treasury, to be spent by politicians as they see fit. Some of that money does wind up being given to the poor in welfare payments, but most of it is spent otherwise, on a host of things that politicians like: wars, “infrastructure,” subsidies for this and that, government employees, and so on. Subtract all of that and the dollar for the poor has shrunk to a few pennies.