The Pareto principle states that, in general, 80% of the effects are derived from 20% of
the causes. Far from being a glib observation, this distribution actually comes up time
and time again, in everything from pea pods to software debugging. There are
complicated mathematical explanations for
why this should be true, but suffice it to say
that it's practically a law of the Universe.
One place where the Pareto principle holds true is in wealth distribution—roughly 80%
of the world's wealth is controlled by 20% of the population. Interestingly, this seems
to hold true no matter what subset of wealth holders you look at. Whether you
examine the top 2% or the bottom 40%, it still tends to follow the 80/20 rule within that
subset.
It therefore would seem that that the natural distribution for wealth should roughly
follow a Pareto curve, and that this is a sign of a healthy economy. It also follows that
when wealth in a society is out of alignment with this distribution, it's a sign of a
troubled economy. Accordingly, the idea would be to tax income according to the
Pareto principle.
The tax level for the 80th percentile earner would be fixed at a given rate. Then,
taxes for the year would be calculated so that tax revenue perfectly follows a Pareto
curve—80% of tax revenue comes from the top 20% of earners, 64% of revenue comes
from the top 4% of earners, and so on. All taxes would be on net income, after income
deductions. Tax payments would be approximated for the year based on last year's
returns, and after all of the returns are in revenues would be adjusted as necessary, by
either billing for additional tax or distributing refunds.
There are several advantages to this system of taxation. Perhaps most importantly, it's
fundamentally fair: If income perfectly follows a Pareto curve, this is effectively a flat
tax on everyone. It's also self-correcting, in that if the income distribution starts to
slide out of alignment, the tax system automatically adjusts as necessary to help bring
it back towards where it should be. It's also based on a strict mathematical principle,
so there can be no claims of bias towards the rich or the poor.
If necessary, however, the tax burden can be shifted upwards or downwards predictably
by simply changing the standard deduction and the 80th percentile tax rate. Adjusting
the standard deduction will have a significant effect on the tax rate (relative to gross
income) for low earners, while having a negligible effect on high earners. Adjusting
the 80th percentile rate will have roughly the same effect on all earners. Between
these two numbers, an optimum tax rate can be found that meets the needs of the
government without excessively burdening any segment of society.