Article published by José Alberto León Alonso on 11/17/13 in Diario de Avisos.
Almost a decade after Zapatero proclaimed that lowering taxes was left-wing, the PSOE once again proposes a new tax reduction in the Income Tax (IRPF). On the surface, the change is most progressive, with the poor paying less and the rich more. In practice, it makes the common mistake of giving disproportionate importance to how taxes are collected and not how they are spent.
I know that what I say does not get votes but, even if it means preaching in the desert, I will repeat it again. Income is not redistributed through taxes, but through spending. The study by the Luxembourg Income Study Database shows the effect of taxes (on work or consumption) and spending (unemployment programs, scholarships, social aid or pensions) on the distribution of income in ten developed countries (United States, Sweden, Finland, Germany, Denmark, United Kingdom, Norway, Australia, Netherlands and Canada) and its conclusions are clear.
1º) The reduction of inequality through taxes is negligible regardless of the tax design of the countries, with higher or lower taxes.
2º) Reducing inequality through spending programs is much more effective, although it depends on the social spending policy in each country. While in the United States or Canada the impact of social protection is very small, in Scandinavia they achieve extraordinary reductions. The key is in the nature and amount of the State's social spending. When social spending is concentrated on the most disadvantaged groups, inequality is reduced much more than with redistributive attempts through the tax system.
The problem with high marginal rates in personal income tax is that the high level of progressivity in labor income creates quite considerable distortions in the incentives to work. High taxes on labor income fall on a very specific group: high-level and competent employees, who are precisely those who have sufficient flexibility to decide how many hours to work. So when you punish them with high taxes (56% in Catalonia, for example) they reduce their working hours and increase their leisure time, since it is not worth it for them to work more so that the State appropriates most of their additional income. Consequently, revenue for the State paradoxically ends up decreasing. In general, a low tax on a broad base of taxpayers generates fewer distortions than a high tax on a small number. The flat rate tax on personal income is based on this idea. The objective is to eliminate the multiple existing deductions on the personal income tax tax base, which will amount to no less than 38,360 million euros in 2014, in order to establish a relatively low single tax rate and introduce progressivity with a large exempt bracket below which nothing would be paid. Regarding capital income, there are no reasons to introduce progressivity in its taxation, given that less fortunate individuals have low or no levels of this source of income, but their tax rate should be increased, now between 21% and 27%. Juan Carlos Conesa in his excellent article “Inequality and fiscal progressivity” suggests that the optimal degree of progressivity in income taxation is obtained with a single rate of 23% and an exempt section of about 4,250 euros on labor income, together with a single rate on capital income of 36%. This tax system allows obtaining the desired level of progressivity with the least possible distortion in individual decisions. The system adds another great advantage: its simplicity. Simplicity is a value in itself, as it encourages compliance, facilitates the inspection and verification work of the Tax Agency and favors the fight against tax fraud.
Are there more policies with proven success to reduce inequality that are complementary to the flat income tax? Roger Senserrich points out, among others, the tax credit on earned income and the promotion of public daycares and early childhood education.
With the earned income tax credit, any low-income worker receives a subsidy in the form of a tax credit to supplement their salary, that is, an amount that is progressively reduced as their salary increases. Established in the United States, it is one of the most effective poverty reduction programs in the country, with more than 21 million beneficiary families. The maximum subsidy for a person without children is $475, while with one child it increases to $3,170, up to $5,236 with two children and up to $5,891 with three or more children. This is a variant of a Milton Friedman proposal, the negative income tax, but limiting access exclusively to working people. This social program has several advantages: first, it encourages work, boosting income even in marginal jobs. Second, it creates a tremendous incentive for part of the underground economy to emerge since declaring low salaries (those typical of the underground economy) generates the right to subsidy. Third, it does not discourage benefit recipients from accepting a job, since any salary increase is accompanied by an increase in income, since the tax credit progressively disappears. Fourth, the money is directed only to those who need it most, without wasting resources subsidizing the middle classes. And fifth, it increases work participation, since even a part-time job generates solid income when the tax credit is added.
If the results of the program make it tremendously effective in reducing poverty levels, why then reduce it only to workers, and not universalize it as Friedman proposed? First, because a pure negative tax (a minimum income for every citizen, whether they work or not) would become unsustainable by permanently subsidizing those who have never shown any desire to work. And second, because we want to create incentives for people to work, not for them not to.
Regarding spending on daycare and early childhood education for low-income families, the economic literature is conclusive: there is no investment with a greater impact on improving equality of opportunity than early childhood education (from 0 to 3 years) for children from families with reduced income. Because? First, it improves the education of children from disadvantaged families, something that results in future access to better jobs with higher incomes. Second, it facilitates the reconciliation of family and work life by allowing parents (especially women) not to be forced to choose between their professional career or caring for their children, lacking sufficient funds to pay for private daycare. And third, it encourages an increase in the birth rate, which in the long term will contribute to paying pensions. Low-income citizens need public daycare centers to continue working once they have a child and not personal income tax deductions that are of no use. Again, it is not taxes but spending that generates equity and reduces inequality. Wouldn't it be better to propose solutions with proven effectiveness to reduce it, instead of ineffective but electorally profitable remedies?
