Of course Warren Buffet's op-ed in Sunday's New York Times caused a lot of brouhaha. I tend to be surprised at how charged the debate about taxing the very richest income strata gets. Buffett is not talking about the rich in the sense that Obama has talked about them, i.e. anyone making more than $250,000 per year. While $250,000 is a lot it is not totally unheard of. A lawyer, accountant, doctor, financial analyst, consultant at an advanced point in a successful career could well make that much money. Making $1 million every year is a different league. The majority of us don't know anyone making that much money. Yet I know many people who get upset at the proposal. It can't be a matter of self-interest that makes people feel this way so it must be a matter of principle. Yet the degree to which people feel this way seems incommensurate with other matters of principle. Whether it is incommensurate or not, here's why you would want a progressive tax system:
The main theoretical advantage of capitalism is that it allocates resources, goods, and services efficiently, meaning that those who are best at producing something make it and those who want it the most get it. In economic theory this is done via the price. Via supply and demand you arrive at the equilibrium price. Everyone who can produce a good cheaper than that price will stand to make a profit and produce it. Everyone who wants the good badly enough that they are willing to pay the prevailing price gets one. In that way the people who can produce things the cheapest end up producing them and the people who want something the most end up getting them.
The problem is that money (or anything material) is only a proxy for how much we value something. It is obviously true that if I am willing to pay $100 for something then I must be valuing it more than if I am willing to pay only $90 for it. But it is not true that someone who is willing to pay $100 for something values that good more than I do even if I am only ready to spend $90 on it. If we had some sort of General Happiness Unit then we could claim that someone who is willing to give up 100 of his happiness units to get something must derive more pleasure from it (namely either 100 happiness units or more) than someone who is willing to only give up 90 GHUs. But we don't have those, we only have money. And for a lot of things that works as a fine proxy. We all had to go to work, give up the happiness of lounging at the coffee shop in the morning and reading The Economist or the FT Weekend Edition, in order to get paid. And if my friend and I go out and get a drink and I'm willing to pay $5 for a Guinness but he's only willing to spend $4 for it we're usually not wrong if we claim that I value the Guinness more than he does.
The reason that money doesn't work perfectly as a proxy is because of the law of diminishing returns. The more you have of something the less the additional unit of it gets you in terms of happiness. We can argue back and forth about the theoretical aspects here but obviously a beggar will value five bucks more than Lloyd Blankfein. (Meaning "the beggar will value five bucks more than Lloyd Blankfein would value them" not "... value five bucks more than he would value Lloyd Blankfein" although the latter may also be true.)
So the great thing about capitalism--that it allocates resources efficiently to those who most desire them--relies heavily on people having somewhat equal amounts of money. That pits you at a delicate balance. If you want to ensure a well-working capitalist system you need to make sure people have incentives to work and produce, i.e. people need to be rewarded for their efforts. You can't expect people to do their very best if they aren't rewarded for it; that is the fallacy of Marxism (well, one fallacy.) At the same time you need to make sure that people have similar material endowments so that the price mechanism works well. This means that for capitalism to work well you have to have a progressive tax system where those with more money get taxed more and those with little money receive the benefits of those transfers--painful as that may be for the individual.
This logic ultimately leads you to conclude that the estate tax is essential for a capitalist society. Otherwise the richest people's children inherit their wealth and not the most hard-working people gain entrance to the best universities and get the best jobs but those who can pay the most. The wider the wealth gap opens the less well the "invisible hand" of the price mechanism works to efficiently allocate resources such that the main advantage of capitalism is not given anymore.
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