Trying to Understand “Fair Share”

There is a lot of talk on both sides of the Atlantic Ocean these days about so called “fairness”. Here in the United States the fairness frenzy comes from liberals, clustered around president Obama, who demand higher taxes on higher incomes. By international comparison their demand is relatively modest, with a return to the top tax rates that were in place under President Clinton. That means 39.6 percent on incomes higher than either $250,000, $400,000 or one million dollars, whatever finally comes out of the “fiscal cliff” talks.

In France, fairness is defined as a 75-percent top income tax on earnings above one million euros. There is no doubt that many liberals in America would like to raise federal income taxes to that level; one of them is Paul Krugman whose “twinkie manifesto” proposes a 91-percent top income tax rate.

I doubt that Krugman, when he got the Nobel Memorial Prize in Economics, was willing to give Uncle Sam $910,000 of the $1,000,000 he received. If he truly believed his own rhetoric he would have written a check to the U.S. Treasury for his preferred top tax rate. The fact that he did not, and instead spent the money on a condo on Manhattan, shows that Krugman is just blowing hot air out of his left nostril, like so many other high-income liberals.

But beyond the obvious fact that most of the leftist propaganda for higher taxes is little more than verbal vanity, there is a more serious question that none of the tax hikers have yet answered: What is fairness?

We can focus the answer on tax rates, which of course is important. But the real question that drives the tax-rate debate has to do with what share of a government’s total tax revenues are paid by whom.

Put bluntly: how much of each $100 of tax revenue should high-income earners pay before they have paid their fair share?

To answer these questions you have to start somewhat differently depending on where you are. It is well established that here in America the higher-half of income earners pay almost all federal taxes, a fact that justifiably makes many people question the fairness argument for higher taxes.

This article is not an exercise in numbers. I will have an article next week that analyzes tax rates, tax income data and income shares. Today we are taking a look at the fairness concept per se, which actually drives the entire debate.

Since no liberal has provided a systematic definition of their “fair share” that they demand from high-income earners, we will have to find that definition here. There are three candidates:

1. The fair share is a percentage of a person’s income. If this is what liberals mean, they simply say that when a person earns above a certain amount of dollars it is unfair of him to keep the same share as he did when he made less money. The problem they run into is that they will have to motivate why dollar amount X should serve as this income threshold, and not dollar amount Y or Z. It is of course impossible to pull such a number out of a hat and still make a coherent tax-policy argument based on it. Since we want our tax rates to be determined by rational analysis rather than what comes out of an oracle, we can dismiss this candidate for the “fair share” definition and move on to the next.

2. The fair share is a percentage of government tax revenues. Here, the liberal would say that some people have the obligation to pay a large share of tax revenues while others have the right to escape with paying a small share. The tax rate on those with the obligation would be determined by whatever their “fair share” of government revenues would be.

Suppose the liberal fairness doctrine says that Jack should pay, say, three quarters of government tax revenues, and that Jill should pay one quarter. Suppose Jack and Jill together make $10,000, of which Jack makes $6,500 and Jill makes $3,500. Government wants $1,000 in tax revenues, obligating Jack to pay $750 and leaving $250 to Jill. Jack’s tax rate is now 11.54 percent while Jill ends up paying 7.14 percent of her income in taxes.

In other words, government has obligated Jack with paying a larger share of its tax revenues than he makes of total income. When liberals define “fair share” in terms of who pay how much of the tax revenues, they do not consider how large a share of total income the high-taxed taxpayers make. As a result, the tax revenues that liberals advocate under this definition will be more or less arbitrary. We cannot have a tax policy that is ultimately determined by arbitrary, irrational definitions.

Which leaves us with only one remaining candidate for what the “fair share” is.

3. A person’s contribution to government tax revenues should be in parity with his share of total earnings. This is actually a rationalization of the previous candidate. The basic idea is that the more a person earns, the bigger a responsibility he can take on for any given package of spending programs that government needs money for.

However, by tying the tax obligations to income shares we end up with a different result than in the previous example. Suppose Jack and Jill together make $10,000, of which Jack makes $6,500 and Jill makes $3,500. Government wants $1,000 in tax revenues, which it splits between Jack and Jill based on their income shares. By asking them both to pay a share of tax revenues that equals their share of total income, government ends up imposing a tax rate of ten percent on each of them.

This is the only consistent, logically functional definition of “fair share” that can come out of the liberal rhetoric. But its outcome also happens to be equal to the flat-tax argument proposed by many conservatives.

Liberals need to make up their mind about what they really mean by “fair share”. Hopefully, when they do they will come down on the logical, rational side of their own term. If they do, there is a fair amount of hope that Democrats and Republicans can screw together a workable, sustainable tax policy to the benefit of the American economy and the prosperity of all Americans.

Next Friday, we will discuss the numbers behind tax revenues and income shares. You’ll be surprised to learn that under the “fair” and “sophisticated” European welfare states that liberals want to import to America, low-income earners are actually punished with higher taxes than high income earners.