Monday, March 23, 2015

Regarding (presumably pie-in-the-sky) discussions of radical tax reform, I find it helpful to focus on real resources instead of dollars.

For example, imagine a radical 100% tax on all personal wealth over $1M that is not charitably donated. Food is cheap, millions of people in the world are hungry, and there's a lot concentrated personal wealth we could throw at the problem. There exist Bill Gates, several other billionaires, and many millionaires. Yet, if all of Gates' wealth is redirected toward immediately feeding the hungry, where do all the bags of grain come from? The Gates mansion does not have that much food in it. The bags of grain come from a combination of many people and animals eating less grain and of farmers producing more grain (and of more people working on farms instead of elsewhere, and of more raw materials being used to build farm equipment, fertilizer, pesticides, and the like, instead of other things, and of more fuel, water, and electricity being used by farms, and...)

Generally speaking, taxes do not take away real resources from wealthy people, except to the extent that it reduces wealthy people's consumption of goods and services. What matters is consumption. Moreover, personal wealth taxes can be evaded by creating a corporation structured so that you tightly control it and "investing" your personal wealth in this corporation. If the government also heavily taxes corporate wealth, then (along with many other crazy changes) almost everything will end owned by "non-profits" that pay their executives fat salaries and "re-invest" most of their remaining net income in things like comfort, prestige, and power. Exhibit A is all the money universities and hospitals pour into their campus buildings and grounds.

As folks like Scott Sumner keep saying, let us tax consumption alone. Replacing all income taxes with a value-added tax (VAT) does this. Less radically (for the US), instead of taxing personal and corporate income as we do now, the Internal Revenue Service could tax personal income minus personal savings. Your capital gains, dividends, and interest income should not be taxed, but your negative savings, i.e., net withdrawals from their savings/brokerage/etc accounts should be taxed.

Morally speaking, if a rich man lives a modest lifestyle, why should he be more than modestly taxed? How is his net worth, his labor income, or his capital income morally relevant? If someday the rich man exercises his option to live lavishly, only then tax him lavishly.

From another angle, why tax my dividends at one rate and my wages at another? Tax $1K income saved at 0%, regardless of where it come from. Tax a person's Nth $1K of annual consumption spending at a progressive rate r(N). Yes, there will still be tax deductions and tax credits that complicating things, but equalizing tax rates across income sources is still a nontrivial simplification.

If my personal consumption includes lavish job perks from my employer (which might be myself), then how are these taxed? The Right Way to solve this problem is stop taxing income and go pure VAT. The inferior but less radical solution is a corporate/self-employed consumption tax with complicated rules, but no more complicated than the current income tax rules for corporations and the self-employed.

The Achilles heel of taxing income minus savings is imputed rent. If I own a house and live in it, that is consumption, but it is not obvious how valuable that consumption is. In effect, I am both landlord and tenant, paying myself some unknown rent. Is the IRS going to estimate and tax every home owner's imputed rent? The "estimate" part isn't a show-stopper; it wouldn't be any more difficult than what property tax assessors already do. The howler is the "tax" part, which would effectively be a federal home property tax. Again, the Right Way is a VAT. A bit closer to political reality would be the policy of just not taxing imputed rents and maybe not taxing housing rent of any kind.


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