Tuesday, February 18, 2014
NOTE: I am reproducing a number of essays on taxes which originally appeared in my now defunct blog Random Notes. I will also be reproducing articles on the FairTax in the next few days. I hope these essays will provide a good background for my planned essay examining the current state of the FairTax, as well as summarizing all my objections to it, those which have been answered and those which were not. Those interested in the topic may also find useful material in a number of essays printed in this blog (many reproduced from Random Notes), including: "Passing Thoughts on Taxes", "Two Thoughts on Taxation", "Government by Emotion", "Minimal Reforms", "Simplicity", "Reframing the Debate", "A Partial Reply to yt_knight", "Another Reply to yt_knight", "The Runaway Stagecoach", "The VAT Versus the FairTax", "Ch-Ch-Changes", "Gardasil and Logical Errors", "What is Wrong with a Prebate?", "Making Taxes Hurt", "Reply to FairTax Comments", "Reply to FairTax Comment II", "Reply to FairTax Comment III", "Short Reply to Doctor Adams", "Revisiting the FairTax", "If we must...", "What We Need", "The Consequences of Bad Laws" and "Truths About Taxation".
I mentioned before that I have recently had a run in with the IRS("Your Tax Dollars Hard At Work"), and as a result I have recently been thinking once more about capital gains taxes. And not just capital gains taxes, but all taxation, individual and corporate, as well as fees, duties and the rest. Basically, as I thought of the problems with capital gains taxation, it struck me that almost everything about our tax system is designed to produce incentives to act in ways we would not desire, but that few seem to recognize this. Worse, the few systems of taxation that are fair, or would produce fair outcomes, are often declared off limits for one reason or another.
Let us start with capital gains. There are any number of problems with this system, but let us point out the most obvious. When you earn money on investments, it is not just income, but income treated with an additional tax. However, when you lose money, it is simply an offset against income (if it can be claimed at all). In other words, you receive for a loss much less of a write off than you are penalized for earning. And that is doubly foolish, as we constantly hear how Americans do not save or invest enough (though I sometimes argue with this perception -- "Debt", "To Correct Debra Saunders", "Nation of Debtors", "Morris Gets His Economics Wrong Again" [Language filters once allowed his first name, but now I must delete it]), yet this tax scheme is designed precisely to discourage investment and savings, by penalizing those who do so successfully.
Then again, the entire system seems designed to penalize success. The progressive income tax, for example, is designed in such a way that increasing one's earning can produce much less proportional increases in income, and, at some points, can even produce a net loss. In the long run, this serves as an incentive against increasing earnings at certain points, and generally discourages people from putting in effort to obtain additional income, or at least putting in as much effort as they would were they to be taxed at a flat rate.
Of course, the problem becomes more severe at the other end. With progressive tax, deductions and the like, many people end up paying no tax, which means there are a significant number of voters who have no reason to oppose any government spending or taxes, as they know they will not be touched. (Actually, the economic consequences will touch them, but our general lack of economic understanding means most of us never consider that effect of taxes.)
A similar problem to capital gains is brought about by death taxes. Of course, for those with even a modest estate, the subterfuge of a trust is always available, as is the option of giving away one's assets while alive. But, for those unwilling or unable to avail themselves of this option, the death duties end up doing little more than confiscating accumulations of wealth, breaking up family businesses, and depriving some of money that could be invested or saved, and thus used to fund business expansion or new ventures. ("The Benefits of Inequalities of Wealth", "A Great Quote", "Envy Kills II", "The "Lucky" Rich")
Then there are corporate taxes, which are quite pleasing to populists as they strike at evil corporations. However, when viewed realistically, they do nothing of the kind. Corporations are, despite the legal claims, not people, and do not pay taxes. The taxes are paid, not by corporations, but by the customers, in terms of increased prices, and by the owners, who, often, are not "fat cats" and "plutocrats", but those owning 401ks, or life insurance, or union pension funds, or bond holders. They end up paying much of the tax. But not just them, and not just customers. by taking away profits that could expand ventures, corporate taxes also end up stopping investment and decreasing pay, meaning that current workers, and potential new hires also suffer. The taxes strike all across the board. And worse still, they strike in random and unpredictable ways. By applying a tax which is then distributed by uncontrolled processes, we effectively apply a tax randomly.
And that is my complaint with the many fees , duties, fines and the like used as substitute taxes. They too often end up being passed along by those who supposedly pay, and thus become random taxes as well, being passe don to customers, to employees, to investors and others, all in an unpredictable manner.
Which brings me to sales taxes ("The Failings of Sales Taxes"). I know this plan enjoys new popularity thanks to the FairTax crowd, but I have many concerns with that scheme. ("The FairTax's Liberal Assumptions", "An Interesting Analogy, "Why I Dislike the FairTax ", "The Best Argument Against the FairTax ", "Truths About Taxation", "A Partial Reply to yt_knight", "The VAT Versus The FairTax", "What we need", "Making Taxes Hurt", "The FairTax's Liberal Assumptions") Even if I didn't, sales taxes are hardly a good system. While I complained about the progressive tax being a bad idea, the sales tax is a regressive tax, which is just a sbad. Because the poor consume a greater percentage of their income, they end up paying more taxes, per dollar earned, than other groups, which is unlikely to produce a happy electorate. I know the FairTax booster argue you can control spending and thus control your taxes, but that is like saying you can avoid income taxes by choosing not to work, a suggestion that shows how out of touch many of them are. When a tax is imposed that strikes the poor so much more than others, all such excuses will mean nothing, and a nationwide, substantial sales tax will be a polarizing, dangerous proposal.
So, what taxes make sense?
First, let me say ideally I would like to see taxes collected by states, which would then fund the federal government, as the constitution requires. This would allow for multiple systems of taxation, as well as making the states interested in decreasing federal spending to keep more tax money at home. ("What we need", "Minimal Reforms") However, that plan is unlikely to come about soon, and so, as a compromise, I will now look at federal systems that are improvements upon what we now have*.
The most obvious solution, because it would require the fewest changes and thus create the least disruption, would be moving to a flat tax, and, not only a flat tax, but a flat tax as the single source of income. Under this system, the government would estimate taxable income for the coming year, apply a small margin for error and failure to collect, and then describe expenditures as a percentage of that income. All individuals would have to pay that percentage of all they earned, from a nickel to a hundred billion dollars, all without exemptions, deduction, everything. The tax would be assessed against all income, and everyone, from the poorest to richest would have to pay their share.
This would be beneficial in two ways. First, it would mean no one would be exempt from taxes and thus uninterested in fiscal responsibility. Everyone would have to concern themselves with spending. Second, by eliminating all deductions, it would stop taxes from being a tool of social policy and, at the same time, simplify taxes considerably. Lastly, if we changed from a withholding system to demanding quarterly or yearly payment, as I often propose ("If we must...", "Making Taxes Hurt"), it would also make the amount of taxes we all pay quite obvious and may make fiscal responsibility a major election issue once more.
Another alternative strikes me as even more fair, though it is one alternative that is pretty much off limits in tax debate. Many suggest the flat tax is fair, but I beg to differ. The benefits we receive from government are not proportional to our income. We all get the same benefits from police and army and voting regardless of income And thus, a much more fair system would be to take the yearly costs and divide by the number of adult citizens, and then ask each to pay their share. Obviously, this might be a problem for the indigent, but then again, perhaps that would be an incentive for liberals to spend less, so as to put less of a burden on the working (and non-working) poor.
Of course, some will argue that the rich receive more benefit from police as they have more to protect, and thus say my proposal is still unfair. I would counter by arguing that a rich man suffers less from a burglary than a poor man, not to mention that the poor are more likely to suffer break ins and street crime, and thus the poor should actually pay somewhat more. But even with that argument, I think this per capita tax is unlikely to ever be proposed. Fair as it is, it is unlikely to win sufficient votes, mostly because of the problems of figuring out what to do with those unable to pay, as well as the many who would consider it heartless.
Which brings me back to the flat tax. If we are unable to return to state taxes, and cannot apply a tax per capita, the best alternative is the flat tax paid on a quarterly or yearly basis. Without other taxes, without deductions, it would both ensure everyone paid their share of taxes, and would make everyone feel the true burden of taxes. All without the additional negatives of most of our current tax schemes, or the even worse consequences of inflationary financing.
* Ideally, taxes would be voluntary, in one way or another, but that is a tricky proposal and has many risks. Since it would probably prove difficult, if not impossible, in practice, while I mention voluntary taxes as an ideal, I recognize that it is unlikely we will ever eliminate some form of involuntary taxation. (One possibility would be a yearly bill, presented to every citizen, payment of which would be required to vote, to file suit in civil court, and to otherwise make use of any government services besides police and military protection. But this idea would need to be examined in more detail, which I shall do in the near future in another post.)
This essay is meant to be nothing but a quick survey of a topic I hope to address in much greater detail very soon. I have long been thinking about examining the many issues surrounding taxation. Thus I wrote this to give a general outline to the essay I shall write in a few days.
Originally posted in Random Notes on 2012/05/21.