Taxes are one of the most important tools policymakers have at their disposal to change the way our society works. They can correct market failures, they are important for financing critical public goods and services, and almost everyone hates them.
There are a lot of opinions out there about exactly how our taxes should be structured, but one thing most people can agree on is that regressive taxes are often undesirable. As a reminder, regressive taxes are those where people with lower income end up paying a greater percentage of their income on the tax.
The opposite of regressive taxes are progressive taxes, where as income increases people end up paying a higher percentage of their income on the tax. The most well known progressive tax is income tax, where increasing tax rates are specifically part of the structure.
Progressive taxes are good because they are often one of the most effective tools for reducing inequality. This is because lower-income individuals often receive a bigger portion of the benefits from public goods and services. When a higher percentage of the funds that pay for those programs comes from higher income individuals then inequality should fall.
One issue with income taxes in particular is that as people get wealthier, they tend to rely less and less on wages as their primary source of income. Instead, the ultra wealthy tend to have a much higher percentage of investment income compared to everyone else.
Through strategies such as “buy, borrow, die” the ultra wealthy are effectively able to dodge paying capital gains taxes on their investments, allowing them to maintain an extremely high level of consumption without paying nearly as much in taxes as if they were being paid an extremely large salary.
One solution to this loophole proposed by the Tax Policy Institute is to institute a value added tax (VAT) and use it to finance a universal basic income (UBI) program. Researchers have estimated that such a program would increase the after-tax income of the poorest 20% of households by 17 percent.
And because a VAT is a tax on consumption, everyone who consumes is liable for taxes relative to how much they consume.
This is a great example of excellent policy analysis practice. There is an identifiable problem (the ultra wealthy are largely able to avoid being taxed despite having high levels of consumption), an interesting solution (VAT), and a quantifiable outcome showing the impacts across the income distribution.
While it’s possible for a state to add a VAT to their tax code, a policy change that significant is much more likely at the federal level. What State and local policymakers should try and take from this study is an understanding of just how valuable progressive taxes can be.
Assuming those funds are earmarked for programs that have high returns on investment, especially if they benefit lower income households, progressive taxes can do a lot of heavy lifting on reducing inequality.