Wednesday, May 21, 2008

Progressive Taxes and Price Discrimination

If you look at the facts, the two are a LOT alike.

First, some background:

Progressive taxation essentially means taxing people a higher percentage of their income as their income increases. If you make $50,000 in the United States, you are probably paying something closer to 10% of your income in federal income taxes, as opposed to 20% if you are making $200,000 annually. Theoretically, this allows the government to raise funds more easily and reduces inequality.

Price Discrimination means charging different people different prices for a product. A lot of people thinks this means that businesses are being mean to minorities or women: not so. Amazon bundling books on their website is price discrimination, as is a movie selling a cheaper ticket to a student or a senior citizen. Businesses do this whenever possible, because it is profit-maximizing.

How are these two similar in any way?

Well, businesses price discriminate primarily because, for any given product, there are heavy users and casual users. Consider Cubs games. There are those, like some of the Brothers in my fraternity, that REALLY love the Cubs and try to watch every home game. On other hand, I watch a Cubs only every once in a while. So, we have different demand curves. If possible, you want to charge the people that have higher demand curves a higher price, since they are willing to pay it.

Governments are capable of doing the same thing. Government is a bit like a service or a product offered by businesses. What it offers is safety and enhancement of welfare. That doesn't mean that government should be maximizing profit (that'd be a bit immoral, no?), but it does mean people have different demands for government services. For government, though, the demand curve is based less on the "need" for the service and more on the ability to pay: Rich people have more money, and thus can afford more government...their demand curve is therefore higher.

So, if a government wants to effectively raise income, it should be charging rich people more. And progressive taxation.

Now, that's not to say that progressive taxation is always the way to go. Income taxes typically are expensive to operate. They require good census data and a big agency to enforce the laws (the IRS is by no means "small" or "uncostly"). So, income taxes should only be used if you need to raise a LOT of money.
But if you are going to use an income tax, you might as well do it right: go progressive

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