Wednesday, November 17, 2010

Some Thoughts on Taxation

I was intending to take this up later when I was able to take the time to assemble some data but this post today on the Economist DiA blog meant I had to address it.

Dr. Robert Frank has an interesting proposal to to tax consumption instead of income by making savings deductible.  I largely like this but with some caveats.

First, it's not distortion free because this will favor whatever type of savings are allowed under the plan.  Small but still there and worth mentioning.  I think this would be most noticeable in the case of financial assets vs. other kinds of investments meant to increase personal productivity.   Probably surmountable, this would have to be done in regards to small businesses that pay on individual income taxes anyway (and ideally should include education as a form of savings), but this is going to make it more complex.

Second, it can be argued that this favors wealth inequality, which I agree is a significant problem.  I think there are a few ways to lessen this.  My views on inequality are slightly odd though so a brief aside on that first.

I'm not really worried about inequality if it is all money tied up in businesses rather than money that is being used to create a real perceived gap in lifestyle or is used in the exercise of power (donating to political campaigns should not be counted as savings).  I do worry about inequality if it is simply inflating asset values, particularly in goods that can't be produced (in reasonable amounts or at reasonable cost) such as land.  This is too big of a subject to take up here, I'll do so in a later post.

Inequality is also a problem because it shapes outcomes.  While many want to deny this, there are too many historical examples of how the powerful have been able to shape social outcomes, both through the use of the state and simply by private economic power.  This isn't wholly avoidable and the costs of trying to correct it are too high and too uncertain to be worth trying to eliminate these advantages entirely, though trying to do so in part is worth doing.

So, we need to do something to make the tax even more progressive to help those with low incomes compete against those with high incomes who have a number of natural advantages.  With the goal in mind of increasing competition and presenting established fortunes with a constant flow of new challengers.  The first advantage to those trying to move up the ladder would be a fairly high standard exemption.  The second would be a standard income tax but only on very high earners and then at fairly low rates.  This is meant to equalize the playing field a bit, not predetermine the outcome.  These rates would ultimately be subject to actual budget analysis as to what the trade offs would be between a high consumption tax and the portion of it left to an income tax.  To give an idea what I have in mind, a ballpark figure would be 1% at $250K, 3% at $1M, 5% at $10M, and 10% at incomes over $10M.  Nothing scientific about it, but frankly, I think we know enough to say that high incomes distort the playing field but we don't know enough to say by how much in a way that amounts to more than pulling complicated sounding numbers out our rear ends.

Something will also have to be done about corporate taxes but since there are no recent news articles on the subject I can leave this for when I've done some real research on the subject.  Also taxes will have to be diversified further, a single revenue stream is always less than optimal and there are a few areas where positive goods can be achieved through the tax system, I will take this up later.

Of course, vast change in government always seems unlikely.  However, our revenue policies are so bad, and so widely recognized as being so, that this is the one policy area that I think there is a decent chance of having a revenue system 10 years from now that is completely different from today's.

[Update:  While this article got me to thinking, after considering it a little longer I think I may prefer to encourage people to keep money invested simply by slashing the corporate tax rate and simply treat all income equally.  This way, if you want to build up your vast fortune you're best off simply keeping the money invested and never realizing the gains.  You still get to be an uber-billionaire but most of the effects of inequality would be muted.  I'll take this up a little more when I treat corporate taxes later on.]

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