Stop taxing happiness: A new perspective on progressive taxation

The tax debate has again erupted. In March, the Commonwealth Parliamentary Committee on Employment, Workplace Relations and Workplace Participation released a report calling for the $6,000 tax-free threshold to be lifted, and for there to be a softening of high effective marginal tax rates. Furthermore, recently prominent Liberal MP Malcolm Turnbull has spoken out that the poor are paying too much tax and the rich not enough tax due to the operation of tax avoidance schemes. Billionaire Steve Forbes (of Forbes Magazine) has suggested that Australia should replace the existing progressive tax system with a 17 per cent flat tax. In other words, tax reform is again front page news.

Tax policy bashing and attempted reform is a cyclical activity. It is driven by the patent unfairness of the tax system, where PAYE income earners (who represent mainly the lower to middle income earners) pay a grossly disproportionate share of taxation. Business people (mainly the rich) manage to find ways to pay far less tax. This is made possible by a plethora of different ways that people who are not taxed at the point of receipt of personal income avoid their tax obligations.

The development of taxation law and policy has been driven largely by economic considerations and economic theory. Underlying this is the assumption that money is important to human well-being and is in fact the most important thing in this regard. Recent empirical studies of human well-being disprove this assumption. Money has only a limited bearing on happiness. The results of the recent studies have significant implications for the manner in which we should raise tax.

In a paper which is shortly to be published in the Pittsburgh Tax Review, we contend that a wholesale reform to tax law and policy is necessary. We base our proposal on emerging empirical evidence on what makes individuals happy (the new “happiness movement” was the subject of a special issue of Time magazine in January 2005). This evidence highlights that there are common factors that have emerged about what contributes to (or detracts from) the happiness of individuals - which is important given that happiness is the ultimate human objective. While noting the diversity in the range of activities through which people choose to express themselves, the studies show that at the base we are not that different after all.

We can now confidently identify the things that make people happy. These include enjoying a high degree of liberty, so that people are free to pursue their individual goals, a sense of participation and control in the activities that one engages in, close personal relationships and good health. We also know some things that do not make us happy. One of these, generally speaking, is money.

The extent to which money impacts on human happiness is as follows:

• People that are very poor are unhappy because they cannot afford the basic necessities of life;
• Extra money in excess of that which is necessary for a person to have an average standard of life has no meaningful impact on happiness;
• Large wealth disparities cause unhappiness for the less well off (due to what psychologists refer to as “reference anxiety”- or more commonly, “Keeping up with the Joneses”); and
• The unbridled pursuit of wealth is detrimental to happiness.

These premises have telling implications for the manner in which taxation is raised and also some implications concerning taxation expenditure. First, it is important that every citizen in the community has means that are sufficient for them to afford the essentials of life. Thus, we must continue to raise taxation.

Second, the rich should pay more tax. A lot more. Why? Simply because they can and they derive no actual advantage (in happiness terms) from their wealth - which can be used far more effectively to support the poor. The rich might think that money is important to them, but this is misguided and as a community we should not let such delusions guide important social policy.

This approach may have the effect of discouraging people to earn vast sums of money and thereby diminish the economic output of a nation. There is some evidence that the rich vote with their feet and avoid high taxing nations. However, this risk should not weigh so heavily as to play an influential role in taxation policy. As is now evident, a few dollars less in a community will not diminish net happiness. Moreover, less “mega-wealthy” individuals in a community will mean less scope for unhappiness stemming from wealth disparity and the materialist pursuit of more wealth by the already wealthy. Thus, encouraging the mega wealthy to earn less or leave the jurisdiction is probably a good thing for the community in question.