Why You Should Pay More Taxes: A Marginal Utility Perspective on Progressive Taxation

By David Metcalfe

July 26, 2019

The Best Hamburger I’ve Ever Had

When I was 16, my sister was going on a trip to Jamaica, with all of the expenses paid by a local church. I was instantly jealous, and to my good fortune, she mentioned that they needed a couple more people, and I was able to join her. But there wasn’t as much vacationing as I had hoped for. It was a lot of work; carrying sand and cement to construct what was to become an orphanage. It got up to 45 degrees celsius at times in the afternoon. We slept on one inch mattresses on cement floors. To travel anywhere, we either had to walk or squish 10 people into a van (with no air conditioning).

But the worst thing, by far, was the food.

Apparently the flies got served the food before us, because it was not uncommon to see several of them crawling around on the dishes. I recalled my science teacher from junior high once saying that flies vomit on the food before eating it, and if they get interrupted, will simply vomit on the food and leave, and even if they do eat it, always leave some vomit. But even without the fly vomit, the dishes just tasted really weird. Washing it down with water didn’t help; the water tasted weird too.

But after over a week of that, we got a vacation day. We went to a place called Dunn’s River Falls, and we stopped at a Wendy’s fast-food restaurant. I had been to Wendy’s in Canada probably 100 times, and, in every objective respect, this Wendy’s was no different. But to me, the whole experience was surreal. It was 8 years ago, and yet I still remember exactly what I ordered: double baconator, large coke, large fries, and a medium chocolate frosty. My first bite of that baconator was the best bite of anything I’ve ever had in my life.

Now, you might say, “well, David, you must really love baconators!” Nope; I don’t really care for them. Here in Edmonton, I have a Wendy’s 500 metres from my house, and I’ve been there twice in the last year- neither time did I get a baconator, by the way. But 16 year old David in Jamaica, after eating terrible food for several days- that guy loves baconators!

So what’s the difference between “16 year old Jamaica David” and “current David”? It’s simple: 16 year old Jamaica David was essentially impoverished- he ate terribly. Current David, on the other hand, is rich- he regularly eats great food. It has nothing to do with the baconator itself, and everything to do with my circumstances and perceptions.

Goods and services do not have an objective value. After all, what standard would you use? The amount of labor that produced it? Well, what if it takes several people a month to mine some coal but then someone happens to be walking in the forest and finds some gold? Or perhaps we could say it’s the societal usefulness of the good. But water is much more useful to society than diamonds, and yet diamonds are way more valuable. Or perhaps we could say it’s the rarity of the item. But a black and white television may be a rare item in modern days, but that doesn’t make it valuable.

How Money Buys Happiness

This is why economists, social scientists, and philosophers refer to a concept called “marginal utility”. Marginal utility looks at the subjective value that individuals and society place on certain goods and services. Utility is basically the happiness a certain good or service gives us. Because happiness is very personally subjective, the value of any good or service is how much utility we perceive it to have.

Now, there might be people who say, “but money doesn’t buy happiness!”, to which I would refer them to children at Christmas, a teenager getting their first car, a hard worker getting a promotion, or a poor person winning the lottery. If you want to look at their smiling face and tell them, “this money has nothing to do with the happiness you are experiencing right now.”, then you can go ahead and try.

But even if you want to say that money can only buy a very superficial kind of happiness, and it’s only through relationships or altruism or whatever that deep and fulfilling happiness is achieved, then you would still be forced to agree that relationships and altruism are not possible without money involved. Money is just the metric we assign to goods and services. Everyone needs goods and services- to survive and to enjoy life.

The definition of happiness, in its economic terms, is a fairly superficial one; it’s both positive and negative. Positive happiness is the fulfillment of certain desires, and the accompanying pleasure from them. Negative happiness is the alleviation of suffering, and the accompanying relief from that. Any good or service necessary for the fulfillment of desire or relief from suffering is therefore synonymous with the amount of money spent on it.

Supply and Demand In Marginal Utility

In considering the role of “supply and demand” in marginal utility theory, we need to appreciate the larger concept that drives demand: utility, or “perceived happiness function”.

In simple “supply and demand theory”, value is increased by increase in demand and decrease in supply, and value is decreased by decrease in demand and increase in supply. If we assume demand to be synonymous with utility, and supply to have a direct relationship with utility (in the same way it would with demand), then we can explain this relationship in three main ways:

1) Increased demand is a result of people believing their happiness will be increased in a greater amount from the product, and with decreased demand, that happiness will increase by a lesser amount.

2) Increase in supply results in decreased desperation to have the happiness the product would create, and because happiness decreases with decreased desperation alleviation, would result in less demand.

3) Decrease in supply results in increased desperation to have the happiness the product would create, and because happiness increases with increased desperation alleviation, would result in greater demand.

Diminishing Marginal Utility in Taxation

Once you appreciate that demand is synonymous with utility, and supply has a direct relationship to it, we can then look at some practical effects of supply and “demand as utility function”.

Let’s go back to my Jamaican baconator. Supply of good food was extremely low, and I became desperate for good food. This made my demand very high, and thus the utility of product acquisition (aka value) very high. When in Edmonton, my supply of good food is very high, so I have no desperation, and thus the utility of the same product acquisition becomes much lower, and it has less value to me. I was more than willing to pay $50 for that baconator when in Jamaica (if it had been that expensive), but in Edmonton, I won’t even pay $8.

Let’s apply this to other things. For example, children are often very happy on Christmas. But you know how to make a child not happy on Christmas? Give them presents every day of the year. Suddenly, they won’t appreciate it. The supply is too high, and the utility function is reduced. How happy would Bill Gates be if he won a $20 million lottery? Probably not at all. How happy would a struggling family be if they won that same $20 million? Probably extremely happy.

In considering taxation, then, we can evaluate effective taxation by the resulting utility function. If someone makes $1 million per year, and is taxed at 1% of their income, they will only give away $10,000 per year. How much do they care about losing $10,000? Probably not at all. How much would 5 poor people care about receiving $2,000 each? Probably very happy. So, if our goal is to maximize overall happiness, we can then say that it is beneficial for the wealthy person to give to the 5 poor people.

We would also say that the wealthy person giving more money would result in a higher overall utility function. So, let’s say the wealthy person is now taxed at 10%. He cares a little more about $100,000 than he did about $10,000. But the 5 poor people who now receive $20,000 each are much happier proportionally. Or, we could distribute $2,000 to 50 people, thus increasing the happiness for 50 people. Furthermore, why not tax the wealthy person at 50%, or 90%?

In terms of the theoretical numbers alone, the maximal utility function will be pure economic equality. Because, even if someone only makes 1% more than another person, they will still value the same amount of money slightly less.

Why Can’t We Just Pay Everyone The Same Income?

There are a number of troubles with an attempt to maximize utility function based on pure economic equality. The first important one is that not all people feel the same utility that money brings. For example, if someone’s favourite hobby in the world is playing video games, it maybe costs $1000 over 5 years for the console and games. But if another person’s favourite hobby is skiing, it may cost $10,000 over 5 years. If another person’s favourite hobby is collecting antique cars, it may cost them $10 million over 5 years. All of these people are getting the same utility function, but it is worth dramatically different monetary values.

The second important consideration is that certain people work harder than others, and therefore expend more utility in terms of their time and effort, and thus are less happy than someone who works less time and with less effort. This means that we would need to pay harder working people more money than less hard working people to maximize the utility function. For example, someone who works 10 hours per week at an easy job is going to be much happier to receive $50,000 per year than someone who works 80 hours per week at a difficult job. This means we would need to consider some kind of correlate for work time and difficulty.

The third important consideration is the economic production that one’s time and effort brings through their work. If we are thinking of money as utility function, a successful business owner is creating a lot more utility for society than a random employee. So, then, we may wish to incentivize the development of more utility function through rewarding greater utility to those who create utility for others. Taking the successful business owner’s money through taxation disincentivizes him to continue creating more utility function, and may even limit his ability to do so, through a lack of capital means.

How Do We Develop a Taxation System That Maximizes Utility Function?

A system that maximizes utility function is one that appreciates the many factors that go into economic production and the relative happiness and value that goods or services bring to individuals.

Because the immense suffering of disease and death cannot be matched by any amount of positive happiness, it would need to be a society that is ok with taxing any amount necessary to guarantee none of its citizens lack access to basic healthcare, food, water, or shelter.

Because different individuals are willing to expend different amounts of utility in attaining monetary utility, it would need to be a society that pays people different amounts, correlated to how much work they do. But because different individual’s work will create different amounts of utility for others, it would need to be a society that correlates economic production to the individual’s pay.

The reason Americans need to pay more taxes is because utility function is clearly not being maximized. As long as there are people who go without basic healthcare, food, water, and shelter, and there are others who have so much money they could easily cover the cost of someone receiving that, but are not taxed in accordance with that, then there is severely lacking utility function. In addition, if there are people who are buying a 5th mansion or 3rd private plane, that they aren’t even that happy about, and there are other people who would greatly benefit from that same amount of money, then there is also severely lacking utility function.

Conclusion

Social welfare doesn’t need to be at odds with capitalism; it simply needs to be incorporated into it as the principle measure of a successful society. Money doesn’t really exist- it’s just a number we assign to something that really does exist: the happiness of people. Using and applying our money in such a way that maximizes the real benefit- the well being of all people- is vital to a prosperous and just society.