Arnold Kling  

One-Sentence Tax Reform

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Richard Green writes,


Let's just start by designing a code that requires that as adjusted gross income rises, the effective tax rate may not fall. That way taxpayers would be able to look at their own effective rate, and know that everyone with higher incomes would pay at least as high a rate.

Pointer from Mark Thoma.

Here is my own one-sentence proposal:


If A and B earn the same income, but A saves and B spends more, then A should not have to pay higher lifetime taxes.

Note that Green's principle sounds attractive, my principle sounds attractive, and they contradict each other. Consider A and B in my example. Because of higher saving, A's income will be higher, and according to Green this means that A should face a higher tax rate.

If the tax code is focused on reducing income inequality, it will have to punish saving. If the tax code is focused on not punishing saving, it will have to enhance income inequality. (Those of us who oppose punishing saving tend to view consumption inequality is a better measure than income inequality.) I see no way to reconcile that conflict.

Politicians do not want to surface and deal with this conflict in a coherent way. Instead, individual provisions in the tax code lean one direction or the other. Thus, it is easy for both Green and me to complain that the tax code violates our "simple" principles.


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CATEGORIES: Tax Reform



COMMENTS (20 to date)
Jack writes:

I suspect folk Keynesianism contributes to the problem: When you say "A saves while B spends", folk Keynesians tell us: A's behavior hurts the economy, B's is good for the economy. E.g., the Rutgers historian who, incredibly, claimed investment does nothing for economic growth, and that it is all consumer spending.

I agree, however: fairness would be that a dollar is taxed at the same level, however many channels it goes through (for a given income level, of course). Since calculating such effective tax rates might be too tricky for politicians, it would be best to simply have a one-stop tax. E.g., get rid of corporate taxes and dividend taxes, but increase the higher brackets on income taxes. Or, per Bob Frank's suggestion, create a consumption tax to discourage conspicuous consumption and encourage saving and investment. This would also allow income tax rates to be lowered.

Bostonian writes:

A simple principle is that the marginal tax rate should never be higher than a certain level, say 30%. Obama has proposed that people earning $1mil or more pay at least 30% of income. If this is adopted, the marginal tax rate for someone earning just under $1mil through long-term capital gains is enormous, because a tax bill of $150K jumps suddenly to $300K with only slightly more income.

Shayne Cook writes:

If I may, I'd like to interject a history lesson here.

Back in early 1992, the exact same "Tax the Rich" political rhetoric was in full vigor. At that time, the popular-sentiment remedy was to impose a 10% "Luxury Tax" on all goods that only rich folks could afford to buy - Yachts, private airplanes, and "luxury" items.

It passed. And it had exactly the desired effect - it obliterated George Bush's (the elder) stellar popularity ratings (that he'd gained from the success of the First Desert War) due to changing his "read my lips ..." message from "No New Taxes" to "Know New Taxes", and got Bill Clinton elected.

That "Luxury Tax" also had economic detrimental effects - it obliterated the Yacht, private airplane and other "luxury" product industries in the United States. And it was repealed shortly after Bill Clinton was elected - courtesy of the Democrat-majority Congress he had prior to the Gingrich-led Republican takeover.

Bill Clinton survived (so did the "penalized" U.S. rich folks). George Bush (the elder) did not. The intended purpose of the "Tax the Rich" rhetoric worked! Unfortunately for the U.S. economy, those "luxury" industries (at least in the United States) also did not survive.

From an economics standpoint, it seems Pigovian taxes really do work - to get the desired candidates elected!

Grant Gould writes:

Even if we simply required that one or the other of those two sentences hold, we'd still be better off than we are today.

diz writes:

My one sentence:

"Everyone who is not poor should pay the expected cost of his own government benefits."

Andrew writes:

While I agree with what has been written and commented, there remains one issue.

Because person A saved/invested a portion of the fruits of his initial labor, his compensation from that initial labor is actually greater than person B.

This seems to be reflected in your concern for consumption inequality over income inequality. The saver/investor is trading consumption today for greater consumption tomorrow.

David W writes:
"Everyone who is not poor should pay the expected cost of his own government benefits."

How the heck would you go about calculating that? At one extreme, you're paying prisoners for their trouble; at the other you're billing the family of someone executed for the bullets needed to do the job.

Simonini writes:

If I invest in my own human capital, the dividends are paid in the form of higher future wages. These are taxed at my marginal income rates.

diz writes:
How the heck would you go about calculating that? At one extreme, you're paying prisoners for their trouble; at the other you're billing the family of someone executed for the bullets needed to do the job.

The goal would not be perfection, but a broad level of correlation with the principle.

For example, I can using basic actuarial and financial principles calculate what it would cost to provide you your own defined social security benefits.

The tax should be set so that (on average) non-poor people pay enough to cover their own (expected) benefits.

Some will win, some will lose, but no one would have an ex ante expectation of winning or losing. (Unless of course they believe the governemnt is particularly good at providing the service versus the other possible providors) And if the government added some new SS benefit, everyone would see their SS taxes go up by the amount required to pay for it.

The point is to establish a linkage between the consumption decision and the spending.

roystgnr writes:

Simonini hits it on the nose. Investing in yourself is often the most economically productive way to save; it's pretty hard to avoid penalizing that with higher taxes though, no?

Consumption taxes have hidden problems, too. If you spend 56 hours a week sleeping, 40 hours a week at work, 30 hours a week on commuting/chores/errands/etc, then you have 42 hours a week left for leisure. If you spend 60 hours a week at work instead, then you have 22 hours a week left for leisure. That's a huge difference in quality of life! Do we tax it? If we tax the consumption of dollars produced by working and we don't tax the consumption of leisure time produced by not working, then people are given an artificial incentive toward inefficient overconsumption of leisure. But how do you even begin to design a fix for that?

David W writes:
The point is to establish a linkage between the consumption decision and the spending.

Although I see where you're going with this, I think it only applies to those portions of government that would be better off privatized. You're basically assuming away the problem; if we can get a service fee style of taxation by hypothesis, I don't see why we can't simply go one step further and hypothetically actually privatize.

mark writes:

Ay yi yi. In grade school, one learns the difference between "greater than" and "greater than or equal to". This guy Green seems not to retained that. If you look at the quote, the first sentence, "Let's just start by designing a code that requires that as adjusted gross income rises, the effective tax rate may not fall" is satsified as by a flat rate tax as a progressive one.

Thus the second sentence "That way taxpayers would be able to look at their own effective rate, and know that everyone with higher incomes would pay at least as high a rate" is false or a nonsequitur.

Is it too much to ask that someone who purports to be tell us how to run things actually be able to tell the difference between "greater than" and "greater than or equal to".

Floccina writes:

We should all have an investment account like an IRA that all our earning go into. We can then be taxed on withdrawals from that account with some special treatment for the purchase of a home or car.

Floccina writes:

My one sentence on government spending:

You cannot subsidize the middle class and so you should not try.

GIVCO writes:

The Code should be a progressive, self-reported consumption tax. Your tax base is Total Savings On January 1 plus Current Year Income minus Total Savings on 12/31. Tax that base with progressive rates.

That tax code enhances saving and does not enhance consumption inequality.

Joe Eagar writes:

I'm confused. Why must encouraging saving lead to inequality? If the personal savings rate shot up to 15%, wouldn't much of it come from the middle class?

Lower capital gains and dividend rates has not increased the personal savings rate, which has plummeted over the past two decades. My understanding is that lower investment taxes are supposed to increase productivity, not the aggregate level of savings per se.

Isn't the traditional incentive for savings a value-added tax?

diz writes:
Although I see where you're going with this, I think it only applies to those portions of government that would be better off privatized. You're basically assuming away the problem; if we can get a service fee style of taxation by hypothesis, I don't see why we can't simply go one step further and hypothetically actually privatize

I am attempting to be agnostic with respect to what should and should not be done by government.

However, I am trying to set up a system wherein a a middle class person has the correct incentives to think about that before requesting government services. If the government is proposing a service that costs them $5000 to provide me, I should get charged $5000 for it. If I am told Mitt Romney is going to pay for it or it will be borrowed from China (or no mention is made how it will be paid for at all), then I do not have the right incentive. The benefit should not be detached from the cost. Certainly as a greater share of government becomes payments to specific individuals.

Also, as a general principle, I don't see any "fairness" in a system in which non-poor people don't pay for what they consume.

diz writes:

Although I see where you're going with this, I think it only applies to those portions of government that would be better off privatized. You're basically assuming away the problem; if we can get a service fee style of taxation by hypothesis, I don't see why we can't simply go one step further and hypothetically actually privatize.

My intent is to be agnostic with respect to what is and isn't done by government.

However, my intent is also to create proper incentives for middle class citizens to make these decisions in the best way. If someone wants to order up a new social security or medicare benefit that costs $5000 per year to provide, I think their taxes should go up $5000. They shouldn't want it because they have been led to believe that Mitt Romney or Chinese borrowing is going to pay for it. That leads to poor decisions at a societal level. If the reason the government is going to provide something is that the government is great at it, people shouldn't mind paying their own cost.

Also, as a basic principle of "fairness" it seems to me that people who have the resources to pay their own way should not use force to live at the expense of others.

It's strange to me that people of reasonable wealth and responsibility blindly accept that Mitt Romney is supposed to buy them things. Most of lour lives are not ordered this way. I go to lunch, I expect to pay for my lunch. I buy gas from my car, I expect to pay for the gas. If the government started providing lunches what magically happens to make it Mitt Romney's responsibility to buy me lunch when I have the money myself?

[diz: You submitted two versions of this comment. Email me at webmaster@econlib.org if you prefer the first version.--Econlib Ed.]

Chris Koresko writes:

Bostonian: A simple principle is that the marginal tax rate should never be higher than a certain level, say 30%.

I second this idea, with the proviso that the marginal tax rate should be calculated in a way that includes payments from the government to the taxpayer, such as housing subsidies, food subsidies, etc. With that modification, Bostonian's idea eliminates the poverty trap, i.e., the very high (~100%) effective marginal tax rate for typical lower middle-class incomes.

I am coming to suspect very strongly that this poverty trap is the root cause of a lot of our modern social maladies.

kharris writes:

OK, there is a problem with the presentation here:

"Note that Green's principle sounds attractive, my principle sounds attractive,..."

Since you aren't Green, your view that his principle sounds attractive has some chance of being objective, especially since, as you note, the principles the two of you state are contradictory. You really have no standing in declaring your own principle "attractive". We already know you like it, given that you proposed it. You've simply repeated that it's your favored view, using other words.

I also think you are mistaken in saying that there is nothing that can bridge the gap between the two points of view. You are essentially arguing that middle ground is unavailable. That's silly. Taxing inherited money at less than a 100% rate would address a social injustice without taxing saving in the first instance. Taxing wealth, instead of savings, would do very little to discourage savings at lower earnings levels, where it serves a welfare function beyond capital accumulation.

An argument based on praising your own view, leaving out alternative policies that weaken your argument - this ain't how it's done.

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