The reason capitalism is a superior economic system to socialism is because the reward of getting to keep what one earns provides sufficient incentive to take the risk of starting a business and working hard enough to provide a service to one’s fellow citizens, a service for which the citizens will, in turn, pay a fair price.
To the contrary, when the fruits of one’s labor are pooled such that those who gave half the effort as one’s neighbor are entitled to the same resulting benefit, the hard worker has no incentive to continue to work harder than his neighbor, and a decrease in overall productivity is the result.
So, the policies which define the system provide the incentive necessary for economic growth.
Keep this in mind as we turn our attention to our tax structure.
History of the Income Tax
The income tax in its current form was created by the passage of the sixteenth amendment in 1913. Prior to this, the federal government raised revenue through tariffs applied to imported goods.
(For more on the history of income tax percentages, see our previous entry on the subject here.)
Problems with the Incentives of the Income Tax
The income tax is a progressive tax, meaning that the greater one’s income, the higher percentage of tax he or she pays.
(This has led many to believe the narrative that the rich are not paying their fair share. Our thoughts on that can be found here.)
While it may appear on the surface that the progressive nature of our tax code is fair, it appears so for many of the same reasons socialism is attractive to so many.
The problem is with the incentive, or in this case, disincentive.
By taxing the higher wage earners at a higher rate, this effectively punishes productivity. The result, on a macro scale, of punishing productivity is a reduction of it.
This is why, for the opposite reason, large across the board tax cuts have historically spurred economic growth. Tax cuts create an incentive to earn more because the earners are allowed to keep more of their own income.
(See the history of tax cuts and economic growth here.)
So much in life can be traced back to dollars and cents. Just follow the money.
Tomorrow, we’ll look at more problems with the income tax and a better solution for generating federal revenue.
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