Is Our Tax Distribution Unsustainable?

April 15, 2010

There has been a lot of discussion recently over the fact that a large fraction of the U.S. population is not paying federal individual income taxes. This argument, let's call it the tyranny argument, says that having so many people not paying income taxes is a problem for democracy because these people will always support bigger and bigger government (because they don't have to pay for it).

Unfortunately, what is often not explicitly laid out by proponents of this theory is the imbedded assumption that people have a particular range of rationality on beliefs about taxes where they're not irrational but not too rational.

First, it requires that people actually realize they are not paying income taxes. However, as recent survey results show, even those making under $20,000 believe they are paying too much. It's likely that they are confusing payroll taxes for income taxes and/or misunderstanding the payroll/withholding system. But regardless of the reason, the assumption imbedded in the tyranny argument that these people be aware of their non-paying status doesn't seem to hold very well. (In fact, wouldn't telling them that they are non-payers make the situation worse?)

But while the tyranny argument assumes that people are aware of their non-paying status, the tyranny argument also assumes that the people can't be too rational. That's because even if people were perfectly rational, moving them from non-payers to paying isn't going to change their demand for government size. Any marginal increase in government size is still likely to benefit those that have been moved from non-payers to slightly income tax payers. Therefore, because they realize that such growth in government is beneficial to them, whether or not they have an income tax liability of $0 or $200 is irrelevant. If rational, they still have an incentive to grow government because, on net, they will be be better off.

Despite my concerns, it is possible that people are in this range of rationality when it comes to voting on the size of government. As an economist, though, I just feel that the assumptions that lead the theory to its tyranny conclusion should be stated.

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