Nova workboard

a blog from young economists at Nova SBE

Is our tax system really that progressive?

Most of us agree on two things when it comes to income taxes: there is no consensus on how progressive the tax system should be – since the equity discussion involves ethical and moral arguments – and regressive taxes should definitely be avoided at all costs – they are both inefficient and unjust, since wealth redistribution creates internal demand and promotes equality of opportunities. In that way, it should be a concern to us whether our tax system is in fact progressive.

Although our taxes are designed to be progressive, nowadays that is not enough to guarantee a real redistribution of wealth. Not only have taxes become less progressive in the last few decades, but deductions and social contributions unburden the rich more than the poor, since they are mostly given through consumption. Another thing that hinders progression is the ever growing sophistication of tax evasion mechanisms. IMG_0176 Source: OECD

The French website www.revolution-fiscale.fr defends that, due to deductions and exemptions, tax system actually becomes regressive: the people with higher incomes end up paying a lower percentage of their income in taxes since the deductions make for a higher slice of their taxes.

Not only deductions, but also the trivialization of offshoring and other practices that allow individuals to legally avoid taxes, make taxes less progressive. The problem seems to be that tax rules have failed to keep up with the advances in technology and globalization: “A web of arcane bilateral tax treaties allows clever companies to shift their profits from high-tax to low-tax jurisdictions, whether by registering patents or setting up intra-company loans. A firm’s tax bills depend more on what industry it is in and how clever its accountants are than its profitability.” Although it seems that some countries are already working towards that.

The effects of taxation on income distribution need to be seen in the context of the trade-off between growth and equity that come with progressive tax rates. There is a reason why policy makers avoid too much taxation on the rich, even though it does promote equity: efficiency losses. “The rich do not often respond to tax increases by working less, for instance, as was widely assumed. But taxable income is very responsive to tax changes. The rich adjust by tweaking the manner and timing of their consumption.” But for the last twenty years, it seems that relieving of the tax burden on the rich has become a bigger concern – flatter tax systems are gaining ground in most developed countries. In America the average top marginal rate fell by nearly 11 percentage points and income inequality rose. In these twenty years, developed countries have become more unequal. IMG_0174 Source: OECD

With growing income inequalities in most OECD countries, it is important to reinforce the mechanisms that redistribute wealth, either by deciding on a more progressive tax system, by widening the tax base, or by ending deductions and increasing the control on fiscal evasion. Otherwise, as the tax system gradually becomes regressive, inequalities will rise with no apparent benefits for the lower income share of the population.

Ana Martins, 734

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Author: studentnovasbe

Master student in Nova Sbe

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