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Taxes & Spending Income Tax: Flat vs Progressive

Income Tax: Flat vs Progressive

Reads at about grade 5Both sides shown7 sources cited

Income tax is money you pay on what you earn. Should everyone pay one flat rate? Or should higher earners pay higher, 'progressive' rates?

What it is

Income tax is money you pay the government on what you earn, and states pick how to set the rates. A flat tax charges everyone the same rate; a progressive tax charges higher earners a higher rate. California has one of the most progressive income taxes in the country. Rates run from 1% up to 13.3%, and a bit higher on wages, so a small group pays most of the tax -- the state's Legislative Analyst's Office says the top 1% of filers paid just over half of all income tax in 2012. One side effect: state money jumps up and down a lot from year to year. The main fight is about the rich. One side says higher rates on top earners are fair and fund schools, roads, and health care; the other says they punish success and push people and businesses to leave. What does research show? Experts agree on one narrow point: even studies that find high rates costly agree that few top earners actually leave the state, and one careful California study found only about 0.8% more high earners left after a tax hike. But experts disagree about the bigger question -- how much do very high rates really cost California? The debate is not about a mass exodus. It is about whether top earners quietly change their behavior enough to shrink the new tax money. Both sides can point to real evidence, so this is a live debate, not a settled question.

How it works

There are two big ways to tax income. A flat tax uses one rate for everyone -- if the rate is 5%, a teacher and a CEO both pay 5% of what they earn. A progressive tax uses tiers called brackets: your first slice of income is taxed at a low rate, and higher slices are taxed at higher rates, with only the money inside each tier getting that tier's rate. The rate on your top slice is your "marginal rate," so earning more never leaves you with less after tax -- only the extra dollars are taxed higher. California uses a steep progressive tax. Rates start at 1% and climb to 13.3%, and an extra tax on wages pushes the very top to 14.6% -- what the Tax Foundation calls the highest combined income tax rate in the country. Because rates rise so sharply, a small group pays most of the bill: in 2012 the top 1% of filers paid just over half of all California income tax, the Legislative Analyst's Office reports. That has a downside. When the stock market or a few big earners have a bad year, state revenue can drop fast -- the office found California's income tax is "more than five times as volatile as personal income itself." People debate two things. First, what is fair: treating everyone the same, or asking the rich to pay a bigger share? Second, what works: do high rates fund needed services, or push wealth and jobs out of the state? Thoughtful people disagree, and the evidence is mixed.

The debate — equal weight, both sides

The case for progressive income taxes
Most often made by the political left: Democrats, labor unions, and anti-poverty groups.

People who earn more should pay a higher rate -- that is the heart of a progressive income tax, and supporters say it is simply fair. A dollar means less to a rich family than to a struggling one, so the well-off can pay a bigger share without real pain. Experts call this "ability to pay." Supporters also look at the whole tax system, not just income tax. Poorer families spend almost everything they earn, so sales taxes -- the extra you pay when you buy things -- eat up a big part of their income. A high income tax on the rich helps balance that out. The Institute on Taxation and Economic Policy, a group that favors progressive taxes, found California's system "tilts slightly progressive," with only a few states more progressive. Supporters credit the graduated income tax and warn that without it, the poor would carry more of the load. And the fear that the rich will flee? Supporters say it is mostly a myth. Sociologist Cristobal Young studied millionaire migration and found that "millionaires tend to stay put" -- people rarely uproot their families, jobs, and friends just to save on taxes. So states "can raise taxes on the rich without triggering mass flight," and spend the money on schools, health care, and roads that everyone uses. Higher rates, they argue, make life fairer and shrink the gap between rich and poor.

The case for a flatter, lower income tax
Most often made by the political right, libertarians, and business groups. Some budget experts also worry about relying on a few top taxpayers whose income jumps around a lot.

Everyone should be treated the same by the tax code -- that is the core idea behind a flatter tax, where income is taxed at one low rate, or close to it. Supporters say steep, rising rates punish people for working hard and doing well. The Cato Institute, a libertarian think tank, argues that "the tax rate should not penalize people for being productive." A flatter tax is also simpler, bringing "simplicity, fairness and transparency," Cato says, so people "make decisions on the basis of good economics rather than clever tax planning." They also warn that very high rates can backfire. California already has the nation's top income tax rate, up to 14.6% on wages, says the Tax Foundation, which ranks California 48th out of 50 for tax competitiveness. When rates climb this high, some top earners leave, and others arrange to report less income. Economists Joshua Rauh and Ryan Shyu studied California's 2012 tax hike, Proposition 30, and found an extra 0.8% of top-bracket taxpayers left the state -- and that behavior changes "eroded 45.2% of state windfall tax revenues within the first year and 60.9% within two years." There is also a stability problem: because so few people pay so much, the budget swings wildly when the rich have a bad year. A flatter, lower tax, supporters say, would keep talent and businesses in the state, and make the state's income steadier and its people freer.

Sources

Behind the summary
Cited by "The case for progressive income taxes"
Cited by "The case for a flatter, lower income tax"

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