Question

Is it fair to penalize the rich by making them pay higher and higher taxes? How high do you think we can increase the tax rate on the rich? Should the tax rate be increased to 50%, 60%, 70%, or still higher? Wouldn't this create disincentives for people to work hard and make tough financial decisions?

Answer 1

There are several points that need to be considered when it comes to taxation on individuals.

The first point that is worth mentioning here is that the private and household sector are the dynamic sectors of the economy while the government sector is a relatively static sector of the economy. In other words, growth comes from the private and household sector and any policy that negatively impacts the sentiments in these two sectors is counter-productive. Purely from this perspective, it makes little sense to increase marginal taxes to 60% or 70%. The solution is to cut government spending and not increase taxes in countries that have sustained budget deficits.

Having said this, Sweden has a top marginal tax rate of 60% and the country enjoys high rating in terms of standards of living and happiness index. The key reason is the utilization of higher tax inflows. If higher tax inflow is used to attempt and redistribute income to the poor, it becomes counter-productive as the rich might have relatively lesser incentive to work. At the same time, the poor might not attempt to upgrade their skills because they derive benefit from redistributed income.

Therefore, relatively higher taxation on the rich is likely to work if infrastructure, healthcare, education and childcare facilities are excellent and translate into lower cost for the household sector (including the rich). This will offset the difficult in any financial decision that might arise out of higher taxation.

In addition, higher taxation on the rich is likely to work if the government utilizes incremental tax revenue that is collected to upgrade the skill of low income workers. This can potentially translate into a greater section of the population coming under a higher tax bracket (progressive tax structure).

The bottom-line there is that tax increase is justified on thew rich, but a sharp tax increase can be counter-productive. On the other hand, higher taxation will be productive if it is utilized in the right direction than just redistributing tax income to the poor or increasing government spending more than justified.