Election day quickly approaches. Ironically here in their 250th year, Americans are faced with the dual burdens of no representation while being taxed. Our governance is pitiful when not deplorable. Yet the true tax burden grows ever larger—exceeding $8,000,000,000,000 per year or about 24% of GDP.
Adding insult to injury, our method of taxation is very burdensome in terms of compliance and more importantly long-term economic impact. On the former point, J.D. Tuccille points out that just filing taxes this year will cost Americans $544 billion. On the latter point, the cost to economic growth (future wealth) dwarfs this figure.
Make no mistake in reading my title. I certainly take issue with the level of taxation—explicit (the amount we currently pay) and implicit (Milton Friedman’s point in the video linked above). And do not be confused in reading my prior admonishments on this topic. Certainly if the American people want this size and scope of government, they should damn well pay for it good and hard (with apologies to Mencken).
Yet a bad method of taxing is costly regardless of the amount of taxation, and given the necessary size of taxation to fund a large government, this issue becomes more and more pressing. Fortunately, we have great thinkers like John Cochrane to show the way.
In a three-part series he gives us the road map to the promised land of a much better federal tax system.
From part one “How Should We Reform the Tax Code?”,
So let’s start with this question: How should the government raise revenue while doing the least amount of long-run economic damage?
My answer: The government should eliminate income, corporate, estate, excise, and all other taxes. It should tax consumption instead. It should tax every good at the same rate, with no special deals. Fighting the special-deal Swiss cheese is, in fact, the most crucial aspect of tax reform.
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If you tax investment, you get less investment and, eventually, less capital, less income, and no more tax revenue. People board up all of those windows.
“Why do governments do it?” you might ask. Ah, well, taxing capital is an eternal temptation because the government makes money in the short run—until the capital’s all gone.
Income just isn’t a meaningful economic concept. We tax income because that was easier to implement in 1913, not because it makes any economic sense.
A consumption tax can be really simple. It can raise stupendous amounts of money. You can’t avoid consuming. There’s little real way to game it, so it’s actually more clearly fair.
From part two “Replace the Tax Code, Don’t Repair It”,
Too many businesses pay more attention to avoiding taxes than to making products. Nonprofits, which employ about one in 10 workers and include most hospitals and educational institutions, pay no taxes at all.
Our taxes on investment are particularly dysfunctional. The government sort of recognizes that taxing saving and investment is a bad idea, but rather than reduce the high rates, it offers a smorgasbord of tax-sheltered investments, each with its own complicated rules. The 401, the 526B, the IRA, the Roth IRA, life insurance carve-outs, and so on and so forth.
From part three “Progressive Taxes Without a Complex Tax Code”,
So, in fact, the tax code does try to do three things: raise revenue for general spending, transfer income, and subsidize a whole range of activities and people.
So last week, I advocated that Congress subsidize whatever it wants to with on-budget, authorized, and visible spending rather than hide it in the tax code. Let’s think in the same way about redistribution.
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And all of us should think clearly about whether pure forced redistribution is a government goal rather than ensuring opportunity and prosperity for all Americans.
Now, I emphasized also that we should think about the effect of all taxes taken together. In the same way, if you want redistribution, it only makes sense to think of the redistributive effect of the government as a whole, uniting taxing, spending, transfers, social programs, and services rather than each one in isolation.
If a flat tax efficiently raises lots of revenue that Congress hands out to needy people, then the government as a whole redistributes a lot of resources, even though the flat tax system doesn’t. If the flat tax and consequent economic growth raise even more resources, the poor can get even more even if they get a lower share.
Do you really want redistribution or do you care about prosperity? Do you really care about shares or about everyone’s level?
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But still, if you must, it’s easy enough to make a consumption tax progressive all on its own. You can make a VAT or a sales tax progressive by simply exempting the first, I don’t know, $20,000 of purchases or whatever number you want.
Give people a credit card, as cash benefits do, that pays for those taxes. You can also make high consumers pay more by retaining the income tax enforcement mechanism.
Then have a separate redistribution code walled off from the tax code.
I’d rather not, as it risks keeping all the rot of the current code, but at least it’s possible.
Bottom line: The right answer is a clean, simple tax code that raises revenue without economic distortion, a separate messy subsidy code, but via on-budget, authorized, visible spending, and an integrated set of social programs that provide support for the needy while controlling their disincentives.
He summarizes and goes a bit further in this essay. His clear-headed approach to changing our unclear (to say the least) tax system begins, as he stresses, by asking the right questions and determining what question you are trying to answer.
The damage is not just economic. People have a sense that the wealthy with fancy lawyers and lobbyists get away with a lot, a politically corrosive reality. Getting rid of the monstrous, complex, and cronyist tax code in favor of a simple and fair tax system is, in my view, even more important than getting the headline rates right.
So, the answer is simple: Eliminate the income, corporate, estate, excise, tariff, wealth, and all other taxes. Tax consumption instead. (Payroll taxes for social programs are almost the same as a consumption tax, so can remain if one wishes.)
When you tax something, you get less of it. So, tax things that people will buy or produce even if they have to pay taxes. Consumption is fairly unavoidable. By contrast, if you tax the returns to investment, people save less, and you end up with a lot less capital: fewer businesses, less equipment, fewer factories.
More deeply, if people invest and reinvest their income in businesses, directly or indirectly by holding stocks and bonds, and those businesses hire others and make great products for the rest of us, why is this a problem? Wealth and income are ways of providing for future consumption. Be patient. Tax the final consumption, not the work and investment that made it possible.
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Crucially, the consumption tax must be one rate on everything, and for everyone. No lower tax on tacos than on steaks, on food and medicine than on yachts, for domestic vs. foreign goods. No lower taxes for nonprofits, universities, strategic industries, and so on. No more transferring income by distorting prices.
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You may object, won’t that consumption tax need a high rate? Well, yes. If the government spends 40 percent of GDP, in the end the average tax rate must be 40 percent. And the less some people and activities pay, the more the rest must pay. But whatever the rate, that’s what you’re paying now. Putting it in one place is healthier, as we can see it.
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You may object that a consumption tax is “regressive.” Everyone pays the same share of their consumption. I answer, wait: Now you’re asking a different question. We were raising revenue for the government. Now you’re asking how to transfer income.
Well, again, if we wish to answer that question, we must look at the whole system, not each element in isolation. If a flat tax funds Bernie Sanders’ spending, the whole government can be as progressive as you like. Also, if you believe the trope that rich people don’t pay income taxes, then you have to admit they will pay more with a consumption tax. You’ll get them at the yacht dealer, not the tax accountant’s office.
But if we must, a consumption tax can be progressive. Most proposals to shift the income tax system to a consumption tax maintain the income tax’s progressivity—along with its Swiss cheese. A VAT or sales tax can also be progressive. For instance, if everyone gets a card that pays the first $10,000 of VAT or sales taxes.
However, you cannot escape basic math. For every person who pays a lower rate, someone else must pay a higher rate, and thereby worsen the economy. (The damage of taxation is roughly proportional to the square of the tax rate.)
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Don’t hide a subsidy in the tax code or with a regulation. Charge taxes, spend money, on budget. Taxing and spending are damaging, yes, but visible and politically accountable taxing and spending are far better than the same thing hiding in economic regulation and complex tax deductions and credits.
The size of government is a separate though related issue from the problem of how to fund it. Political compromise on the method of taxation is a long shot—always has been and especially is today in our current dysfunctional environment. However, it is much more likely if we can set aside the “how big” issue from the “how funded” issue.
Neither party is interested in reducing the size of government. Small government folks like me truly have no representation here. However, I do hold out hope that with the right leadership we might find a way to tackle the problem of our bad method of taxation. . . . then I see things like wealth taxes on ballots, and my hopes again get dashed. . . sigh.