Political Economy: Fiscal Policy

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Example: The U.S. government has used tax policy to achieve housing goals. For the past fifty years, the federal government has allowed homeowners to deduct mortgage interest from income when determining taxes. This deduction encourages people to buy houses because owning a home can help them save substantially on their tax bill. Because most people who buy houses have a moderate or greater income, the effect of this tax policy is to create a subsidy for housing for the middle and upper classes. In fact, the total cost to the federal government of the home mortgage interest deduction is roughly two and half times what the federal government spends on housing for the poor.

Progressive Taxes

Progressive taxes favor the poor. The rich must pay a higher percentage of their income than the poor in a progressive taxation system. For example, U.S. federal income taxes charge lower income groups about 10 percent of their income, whereas richer people must pay substantially more (more than 20 percent in some cases). People who favor these taxes argue that because the rich can afford to pay more, they should pay more. Progressive taxes attempt to create economic equality. Such policies are sometimes called redistributive because they shift money from one group to another.

Regressive Taxes

Regressive taxes cost the poor a larger portion of their income than they do the rich. Social security taxes are an example of regressive taxes because everyone who earns a paycheck must pay based on their earnings. Wage earners are taxed at a set rate but only on the first $90,000 (approximately). So someone who earns $90,000 pays the same dollar amount as someone who makes $30,000, but the person who earns $30,000 shells out a far bigger percentage of his or her income than the person who earns $90,000. Like progressive taxes, regressive taxes are redistributive, but regressive taxes shift money toward the rich rather than toward the poor.

Flat Taxes

Flat taxes charge everyone the same rate, regardless of income. In practice, there are not many flat taxes in the United States. Even some of the flat tax proposals put forward are not truly flat.

Example: Although the United States may not have many flat taxes, other countries do. In fact, during the last ten years, many countries in Eastern Europe (including Russia, Ukraine, Romania, and Georgia) have adopted flat taxes ranging between roughly 10 and 30 percent of income. The governments of these countries instituted the flat tax with the hope that a simpler tax system with fewer loopholes and opportunities for tax shelters would actually increase the amount of taxes they collected from wealthier individuals and corporations.