Why the Government Needs the 1%

Imagine two island nations with the same population and resources. Each one has 1,000 citizens and a surplus equaling $1,000,000 per year.

 

On Island A, 1% of the population owns 90% of the surplus.  This means that 10 citizens own $900,000.  Put another way, each rich citizen makes on average $90,000 per year.  The 99,000 citizens own $100,000 of the annual surplus, meaning that each poor citizen makes on average $1.10 per year.

 

On Island B, the surplus is distributed equally.  This means that each citizen makes $1,000 per year.

On Island A, people pay taxes depending on their tax bracket.  The rich citizens pay 50% of their income in taxes.  This means that, for each rich citizen, $45,000 goes to the government and $45,000 stays in their bank account.  Each poor citizen pays just under 10%, meaning that they each give the government 10¢ and keep $1.  All together, the government of Island A makes $459,000 per year.

 

If the government of Island B is to make the same amount as Island A’s government, it would have to tax each citizen 46% of their total income.  This means that one who makes $1,000 on Island B would be taxed in the same bracket as one who makes $900,000 on Island A.

 

The government of Island B would not be able to tax 46% of its nation’s wealth without inciting a revolution, but the government of Island A taxes 46% of its nation’s wealth with no problem at all.  Island A’s government makes more money than Island B could ever make because of economic inequality.

 

If Island B’s government wants to make as much as Island A’s, it has to do one thing; raise taxes.  They must do it slowly, because you can’t take $500 away from someone with $1,000 without making that person very upset.  Right now, Island B taxes 10%, taking $100 from each citizen, leaving each with $900, making its government’s revenue $100,000.  If it raised the taxes to 15% (perhaps pointing to some public crisis as a justification) it would make $150,000, but something else would happen.  It would hurt its citizens.  Each person would only keep $850, which means each person would probably try to make that up in some way:  They might spend less, but most likely they will find a way to stretch their money.  For example, instead of going without cookies, they will find cheaper cookies.  Another way it would affect people depends on how they relate to their income.  If the citizens of Island B are mostly self-employed, the extra 5% tax will cause some to produce and sell more, some to cut corners and produce more cheaply, and some to lower their standard of living.

 

When the economy of Island B rocks slightly then stabilizes after the increased tax, it does it again, raising taxes from 15% to 20%.  What a serial (and ever so slight) increase in taxes will do is to pressure its citizens into changing their behavior and seeking alternatives to economic security (because their government is making their income less secure by the year).  Citizens will find ways to make more money for themselves at the expense of other citizens.  When its economy becomes too imbalanced, Island B will be forced to adopt a “fairer” form of taxation and, before long, its government will be as rich as government A’s, laughing all the way to the bank with its richer citizens.