Ideal World

Yesterday we dealt with areas I thought were ripe for easy to implement tax reform that could both increase revenues and improve our competitiveness for international businesses. One of the caveats I put on my advice was that this was aimed at something I thought could be accepted at a bipartisan level, not what I thought was the ideal outcome for America. So, the subject of today's post is what is an ideal system?

First off the term "ideal" is loaded. Like "fairness" and so many other terms thrown around in politics, its meaning greatly depends on the perspective of the person using it. However, since this is my blog, the perspective that I view as "ideal" is really my own, namely that of a limited federal government limited to its enumerated powers. So understand that my ideal may well greatly diverge from your own ideal.

Also, a word of caution. Many well intentioned thinkers over the years have set out to form more perfect political systems. Frequently this ends in abject failure (think Soviet Union), or in untenable positions never tested in real life (the Plato's Republic). One man's ideal can well become a society's totalitarian dictatorship or oligarchical nightmare. So some attention has to be paid to not only what I want, but what I think is actually in the best interests of everyone involved. This is especially true in the modern era where the ability to leave your country, find unclaimed land and start your own society is not an option (this may sound laughable, but a central theme in post Renaissance social contract theories was that anyone could choose not to participate in society, leave, and start their own).

First and foremost, since this is largely going to be a discussion focused on tax policy and not the form of government, I am going to posit the US model of government with three coequal branches of government kept in line with checks and balances on their powers. Why not a parliamentary democracy you ask? Because while they are more able to react to changes with coalition governments and are less affected by polarizing politics (since the nature of parliamentary democracy makes third parties more viable), they are also less held back by checks and balances. This level of power in a government gives it carte blanche to seize and hold political power, rig elections and marginalize groups that make up large portions of the population simply because they are not part of the coalition. So in short, I like a little partisan gridlock as a way to keep government from becoming too powerful.

So, onward to tax policy. While I personally favor a simple flat tax system as the easiest to implement and organize from a governmental administration perspective and easiest to understand from an individual perspective, it is not a popular form of taxation because it is viewed as overly burdensome on the poor. This is because they are seen as "less able to pay" the same percentage of their incomes as the rich (the poor tend to be forced to consume all of their income to meet daily life needs, unlike the rich and middle class who have enough discretionary income to save and economize). So some degree of progressivity is necessary to help alleviate the burdens to the under classes that are endemic in all modern societies.

I also like, from an administrative perspective, an income based tax system with a broad definition of income. This is because it's much easier for a government to take money from people before they have possession of it, than it is to ask them to give it to them after they have it (money tends to disappear in private hands). Instead, they get to file tax returns for the government to pay them back any over charges. Some of the biggest problems of any tax collection system are those of administration and fraud. So a system that automatically deducts the taxes from wages, lowers administrative costs and makes tax fraud more difficult, is a system to be preferred.

Also, I like, from an ease of administrative perspective, treating all money received by a person as income. This is the broad definition of income I mentioned earlier. Whether you get it from investing, cash payments, in kind service for service arrangements, or even inheritance, it should all be viewed as income and the government should be due its share. This makes it easy for people to figure out what is taxable income. All money, profits and things of monetary value that you receive qualifies.

Also, another principle I would like to put forward is that of personal benefit. We should all be in a position to receive the majority of the value of our labors after taxes. What this means is that I think total tax burdens that meet or exceed 50% are not justifiable. At the 50% threshold we reach a point where government is benefiting more from your labors than you are. This makes the tax payer more of a serf plowing the governments' fields than an independent entity working for his or her own good. This is an important point, because in modern America, between federal, state and local taxes, it is entirely possible for a person's tax burden to exceed this amount. This creates a disincentive to further work for the nations most productive tax payers (assuming a progressive tax rate where by earning more you can move into a bracket whose total burden meets or exceeds 50%). In our history, such high rates have been associated with poor economic outcomes and bad recessions. Most recently during the 70's when stagflation was rampant and the nation was in the grip of persistent recession and economic stagnation. A country that exceeds 50% total tax burden does so at its own peril.

So what do we have now? A tricameral government kept in check by democratic voting and checks and balances between its three branches as well as a progressive tax system that taxes only income. But what about luxury or wealth taxes you ask? Well, I am not a big fan of these additional taxes because they create additional disincentives to saving and wealth accumulation. The reason this is bad is that it is in saving and wealth accumulation that a populace is able to look after itself in bad times without government help. Also that the wealth people accumulate is usually then reinvested in the economy to pay great dividends in added economic growth and job creation. So creating such disincentives is counterproductive to long term growth rates and is why they are not included in my ideal tax system.

The one form of non-income based taxes that I do approve of are the so called "sin" taxes. What this usually refers to are additional taxes on alcohol, tobacco and recreational drugs. These are the sort of things that create additional societal burdens whose costs are usually born by government. The reason I do favor them is two fold: one, it creates an economic disincentive to partaking in these activities; and two, it makes government invested in not simply outright banning these vices. If we look at such bans historically, prohibition and the US war on drugs, what we see are increased violence, increased criminality and huge, largely wasted, government outlays on policing the bans and their negative externalities. Governments would be wise to tolerate such vices, tax them, and use the proceeds to negate some of these negative externalities. The alternative approach has been a failure at enormous societal cost.

So, in conclusion, I am most in favor of a simple progressive income tax system that treats all money and services received by a tax payer as income, with additional taxes on the sale of certain goods and services that are viewed by society as vices. In a later post I will explain why it is I prefer a smaller limited government instead of a larger centralized power that influences all aspects of the life of its citizens.