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.
-- ytk, Oct 12 2012

*For the record, I actually think all taxation on income is nothing more than legalized extortion and should be eliminated entirely. I also think using the tax rate as a tool to affect the economy is immoral. I'm just speaking theoretically with this idea.
-- ytk, Oct 12 2012


Sounds good to me.
-- MaxwellBuchanan, Oct 12 2012


Wealth distribution is not actually the same as income distribution, and wealthy people use that fact to avoid income taxes.
-- pocmloc, Oct 12 2012


[+] for the concept, but I think the implementation is wrong. If the top 20th percentile pays 80% of the taxes, when income disaprity increases, the tax rate will decrease on the top earners and increase on the low earners.

In the absurd case: there are 80 people earning $1 per year net and 20 people earning $1000 per year. If the top 20 people have a tax rate of 10%, ($100 each), there is $2000 in taxes from them. You're going to have a very hard time extracting $500 (20% of total tax revenue) from the 80 people who only have $1 income.

I assume there would be some way to rework the formulas so that when the 80-20 rule was true the tax would be a flat percentage and when the rich received more than 80% of the income, they would pay a higher rate, but how much negative feedback to put into that equation would still be a lively debate. Also I asume peopel woudl argue for some conditional so that if income was 70-30 you wouldn't be taxing those with low income at a higher rate in an attempt to reach the "ideal" 80-20 distribution.

I also don't like the complexity and the inability to predict the tax rate. I admit that I've never actually succeeded in predicting my taxes before the end of the year, but I like the fact that it is sometimes theoretically possible. It really annoys me that I can't predict early in the year because they always seem to wait until the end of the year to extend various tax breaks.
-- scad mientist, Oct 12 2012



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