What at all justifies income taxes (as opposed to sales taxes only)?

Question

For those who do not know, in America, the higher your income, the higher the percent of it is spent on taxes. This means that, whatever tax money is used for, those who are more hardworking (or, at least, those who are more skilled) are essentially punished. And, because we tax low-income citizens less, we are making their life quality nearly the same as everyone else, which encourages unemployment.

If, on the other hand, income taxes were to be eliminated and sales taxes raised significantly, we would be punishing those who spend a lot - essentially, those who abuse their wealth more. (Obviously this is not necessarily always so, but it is more so than if we apply taxes to anything else like income). This, therefore, would encourage philanthropy (and otherwise spending money on things other than buying.)

Note that this can be engineered in such a way that the total tax money the government gains stays the same.

The Question: Why does much of the world still have income taxes? Is there anything (and if so, what?) that makes them better, fairer, or more productive than sales taxes?

*This question is not a copy of the question Are sales taxes regressive? because the linked question is asking specifically whether sales taxes decrease in burden as income increases. My question is explaining that that doesn't matter.

Answer 1

There's a fair amount to unpack in the question, so it might be useful to take it step by step, and consider everything from a more abstract, economic theory perspective.

...those who are more hardworking (or, at least, those who are more skilled) are essentially punished....

We should be careful making statements like this for a couple of reasons. First, the assumption may or may not be true, depending on what model of wages you think applies. For example, if wages are largely determined by bargaining, then it isn't clear that wages necessarily directly (or perfectly) correlate with how hard an individual works, or their skill level. Even if we use a non-bargaining wage model, plenty of "unskilled" jobs (for example, auto workers or welders) make more than "skilled" jobs (for example, many teachers). Second, it isn't clear that progressive taxation should be considered "punishing" high income earners. Given that tax brackets are all applied at the margin, earning more only means that (all else equal) your last dollar will be taxed more than your first dollar.

because we tax low-income citizens less, we are making their life quality nearly the same as everyone else, which encourages unemployment.

While we're flattening the differences between the highest and lowest income earners a bit, I'd hesitate to claim that "we're making the quality of life [of low income earners] nearly the same as high income earners." Given that income still has substantial impacts on quality and duration of life, I'd be hard pressed to agree that we've equalized quality of life.

Beyond that, of course, there's the larger Social Choice problem of "why is somewhat equalizing quality of life a bad thing?" Given that employment and income potential aren't entirely defined by an individual's own effort, but are correlated with many factors that are determined by one's "luck of birth," creating a society that doesn't at least attempt to account for this exogenous "luck" factor seems arbitrary and somewhat cruel.

...we would be punishing those who spend a lot - essentially, those who abuse their wealth more.

Again, I'm a bit intrigued by your choice of wording there- why do you consider someone spending income "abusing" it, particularly if we accept your earlier premise that income is tied closely with effort? Isn't spending one's income merely realizing the actual utility potential they earn from doing a job? And if that's the case, why should we discourage spending one's income by substantially raising sales taxes?

This, therefore, would encourage philanthropy (and otherwise spending money on things other than buying.)

There already exist commonly used mechanisms to encourage philanthropy through taxation: deductions. This method provides a much larger potential incentive to encourage philanthropy, since it effectively makes giving to charity "cheaper" than both spending and holding earned income (since money given isn't counted against your income), as opposed to merely spent income under your proposal. In other words, with an income tax of $\tau$, every dollar I give to charity only costs me $(1-\tau)$, which is the amount I would keep if I took the dollar as opposed to donate it. If there's only a sales tax, then the cost is the full dollar.

So, getting to the crux of the question- there are several reasons the world currently has income taxes. First, there's a distributional concern: the sales tax that would be required to offset income taxes would be quite high, and would cause significant hardship for poorer families. Moreover, only having a sales tax can lead to incentives for wealthier individuals to horde wealth as opposed to spend it, which actually leads to significant economic distortions, and adverse economic outcomes (for example, a fair amount of recent research suggests that too high levels of wealth inequality can lead to slower overall economic growth). As to whether there are fairness implications, I'd point out that the regressive nature of sales taxes are important on this point. Given that a comparatively larger burden of the tax would fall on poorer individuals (since they spend higher proportions of their income), eliminating the income tax in favor of a consumption tax would have distributional consequences.

I don't mean to sound nit-picky or like I'm dismissing your question out of hand, for the record. There is an important debate to be had for any society regarding how its citizens should shoulder the combined tax load. However, I think most of the debate occurs "inside" of your assumptions made in the question, and only by closely examining those can the debate be meaningful.

Answer 2

in America, the higher your income, the higher the percent of it is spent on taxes

Progressive taxation is even worse in many European countries. Progressive taxation is marketed by depicting grotesque disparities between the super rich and the poor, but the fact is that modest levels of income (affording modest levels of purchase power) readily fall in [the top] tax brackets of over 45%. This means that the middle class in those countries works approximately six months per year only to fund government's budget.

Why does much of the world still have income taxes?

Because it creates frictions which protect reactionary interests, regardless of elite's political affiliation.

Progressive taxation is largely a mechanism to preserve the status quo. Indeed, progressive taxation is a huge, direct obstacle to economic mobility. That obstacle is most hindering to those who pursue most aggressively a certain combination of education and hard work.

For many centuries, suppression of knowledge was the elites' method to preserve power. Now with literacy and technology having gotten "out of hand" (from the perspective of religious or political elites), the modern method consists of confiscating greater portions of income from those who are most likely to uproot the configuration of power. The obsolete blackmail of "God's will and the world to come" has been replaced by the blackmail of "social fairness", apropos of the ideals emanated from the French Revolution.

Is there anything (and if so, what?) that makes them better, fairer, or more productive than sales taxes?

I personally doubt it. Income tax is just easier to implement than sales tax (especially easier than progressive sales taxation). It is also more drastic, as it affects income destined to consumption as well as income destined to savings. That being said, I would not deem income tax fairer or more productive than sales tax.

Economics is premised on the scarcity of resources --referring to goods and services, not to currency--, and the law of supply and demand. Thus, it makes more sense to address the scarcity of goods and services through sales taxes in that, the higher the consumption of certain good by an agent, the greater extent to which he deprives others of that scarce good.

By contrast, confiscation of income discourages efforts that could otherwise be spent toward achieving more desirable levels (in both quantity and quality) of production.

Answer 3

As I'm sure you're aware, sales tax is regressive, and income tax is at least intended to be progressive. This is viewed as basically a mechanism to transfer wealth from the rich to the poor. Some view this as fair because the rich presumably benefit more from our society than the poor. Economically, it is also seen as good because of the diminishing returns of having each additional dollar.

However, it turns out that the US income tax code is actually regressive, despite its bracketed taxes, because of countless loopholes and shinanigans. So it doesn't actually have that potential benefit in the US.

One way that sales taxes are even worse than income taxes are that they incentivize inefficient vertical company mergers. Rather than having a sale between two companies paying a sales tax each time, those companies can merge so that sales tax can be avoided. Value added taxes don't have this problem.

This is one reason to believe that sales tax causes even more deadweight losses than income tax. Income tax itself has been estimated to have deadweight losses of around 30% of the amount collected - which is the same as the estimated deadweight loss of all taxes on average. Sales tax is likely worse.

Sales taxes are not great taxes. They're regressive and cause large deadweight losses. Income tax isn't much better, but it does seem to be likely to be at least partially better.

Land value taxes are much better taxes because they solve rather than create deadweight losses.

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