THE LOGIC OF REDISTRIBUTION
BY JONATHAN SHORT
BY JONATHAN SHORT
How progressive taxation increases the total wealth of society – an economic explanation
Taxation tends to take two basic forms:
The first is where taxation is used to purchase communal goods and services that would otherwise not voluntary be purchased by individuals.
The second is where wealth is where tax is taken from one group of individuals and redistributed to another group of individuals.
The second form of taxation is what is of interest to us today. Such redistributed taxation is usually justified on the grounds that it is in some way morally correct to redistribute wealth within a society. Such taxation is generally labelled ‘progressive’ when taxation is taken from a wealthier group in society and distributed to a poorer group in society and ‘regressive’ when taxation is taken from a poorer group of society and given to a wealthier group in society.
What will be shown here is how ‘progressive’ taxation results not only in a more equal society but also a ‘wealthier’ society as an aggregate whole. Before we do that let us first put aside the sociological arguments made in favour of progressive taxation. Such sociological arguments for progressive taxation tend to focus upon claims that a more equal society will (as claimed by some) create positive social outcomes such as lower crime levels, greater meritocracy, a greater safety net, and so forth, and therefore society becomes a socially wealthier place the more wealth is distributed. These arguments may very well be true but let us instead take a position in favour of progressive taxation based more on economic science than sociology:
It may reasonably be asked how possibly taking a unit of money from one person and giving it to another increases societal ‘wealth’. Surely all that has happened due to redistribution is that the money in question has changed hands and the overall wealth of society has not increased at all?
To understand the issue at hand we first have to realise the nature of ‘money’. Money is a phenomena which has a quantitative nature, what this means is that a quantity of money has a numerical value, say £1000. If we think about ‘wealth’ in these very simplistic quantitative terms then it is indeed correct to say that redistributing money in no way increases the overall wealth of society.
A more refined and indeed accurate understanding of money is that a quantity of money allows individuals to have control over goods which have ‘utility’. It is often difficult to understand this difference between ‘money’ on the one hand and ‘utility’ on the other so let us try better to understand it. Money in and of itself has no value other than the paper it is written on, where its power lies is in its ability to purchase goods which have actual value in their consumption i.e. utility. For instance £1000 worth of notes has little utility in itself but it can however purchase £1000 worth of things that have real utility. Therefore ‘money’ is the societal power over real world utilities.
Now we must now understand the concept in economics known as marginal utility – don’t worry it’s not complicated!
Marginal utility put simply is the increase or decrease in ‘utility’ (real world value as outlined above) found from gaining or losing one unit of something. We will use apples as an example. In terms of direct consumption if we gain one apple we also gain a real world utility from it, the taste nutrition and so forth, if we gain a second apple we may very well double the utility of having just one apple. However, if we imagine having 99 apples and gaining one more apple there clearly is to be found little or no increase in utility. We after all can only eat so many apples. The first apple and perhaps the first few brought increasing real world utility but after a while this utility decreases. Economists call this the ‘law of decreasing marginal utility’. Put simply the more units we have of something the less real world value each additional unit of that thing brings us.
Goods as a whole and not in their individual nature have the same relationship to marginal utility. Instead of apples alone, think cars, houses, boats, clothes etc. as an aggregated whole. Sure no matter what amount of money we have we probably can find something else to purchase but as a general rule each additional thing has less utility to us than those goods accumulated previously.
Therefore, as command over quantity of money increases the marginal utility of real world goods that can be purchased diminishes. This is the basis of the argument as to why progressive redistribution of wealth increases the overall ‘wealth’ of society. If ‘wealth’ is seen not in the false notion of quantitative money but in the true abstract utilities of what that money can purchase then:
If someone has a relatively very large quantity of money then the goods they can purchase with a proportion of that money has a relatively much lower marginal utility than the marginal utility that could be purchased by a less well-off person with the same proportional quantity of money. Therefore if quantities of money are redistributed from much wealthier individuals to less well-off individuals the overall utility and true ‘wealth’ of the society as a whole increases.
We can even think about this in a very straight forward common-sense illustration:
Imagine a society where 1 person has £10,000
1 person has £1,000,000
If the 1 wealthy individual has £5,000 removed by tax and redistributed to another individual then one individual is £5,000 wealthier and another is £5,000 poorer. However the marginal utility of goods that is lost by the wealthier individual losing £5,000 is less than the marginal utility of goods gained by the less well-off individual gaining £5,000. In very simple terms it is easy to imagine that if you have £1,000,000 and you lose £5,000 your lifestyle does not really change, however if you have £10,000 and gain £5,000 your lifestyle is greatly enhanced.
What this shows is that even if the overall quantity wealth of society (money) is unchanging redistributive taxation can increase the overall or aggregate wealth of society by increasing the utility available to individuals in society as an aggregate whole and demonstrates clearly how the redistribution of income does indeed increase the overall wealth of society.