A Bad Idea for Tax Reform
Social Ends and Taxing Means
Examples of how tax policy promotes cultural values are far too many to list. They span the spectrum of life at the personal, group, and society levels. It is enough to point to several that have had enormous, if in some cases wholly subtle, influence.
A quick number for one of these social tuning knobs can be found in the tax consequences of marriages, and never mind the intricate details of "marriage penalty taxes" and abatements of such burdens. The reality is that two people who are married do not have to pay as much on their combined income as one person making that much, even though those two people living together will experience scale economies impossible for the one person to achieve.
The argument goes, of course, that because our tax system is progressive, the combined incomes would be unfairly exposed to a higher marginal tax rate than each individual's income would have been; but this argument is entirely fallacious: the two people have a combined income that is used by the household in exactly the same manner as the income of the single person would be.
That the federal government is doing everything in its power to prevent gay marriages is an exercise in preventing the huge marriage tax shield from accruing to a life-style the government does not want to promote. Effectively, the tax code's benefits are for intended recipients only, and not for those whose behaviors, actions, and beliefs are contrary to what is government approved. "Fairness" in tax policy is a specious concept when it comes to marriage benefits: the shields exist for those whose lifestyles comport with specific beliefs that arguably have narrowly religious backdrops. This same motive force of specific tax policies associated with specific religious doctrines comes into play in an unspoken and subtle way in the later part of this article; but first, as a primer for the pump, a glaring example of tax policy being used to shape society is in order.
A remarkable success story of how tax policy can promote a desired social policy can be found in the treatment of owner-occupied housing in the U.S. tax code. The deductibility of the interest on mortgage loans is a compelling incentive for households to allocate a disproportionate share of income toward investment in the physical asset of a house; but mortgage interest deductibility is only one of several incentives the tax code provides for owner-occupied housing. The result of this deliberate policy by the government has been a massive over-production of single-family houses with attendant distortions of physical and financial capital flows. Whether or not this has been "good" policy is for social and economics commentators; but the long-term and profound effects upon how the consumers have shaped the way resources are used in the United States is beyond any dispute.
A Digression for Some Arithmetic
Before proceeding with the main point of this article, some terminology and associated math should be set forth, just in case some readers don't spend serious time studying and remembering how different types of taxes work.
It is not an oversimplification to state that a tax system can operate one of four ways:
Flat tax: This is a tax of the same dollar amount upon everyone. It would be the ultimate in simplicity as a federal revenue generator. Every citizen pays the same amount of money every year. Let's say the flat tax was $2,000 per head. With about 285 million citizens, that would come out to be around $570 billion in federal tax revenue. Although the love child of a few economists who admire its lack of distorting effects on an economy, the flat tax suffers from the fatal flaw that it would too obviously hurt people of limited means far more than it would those with lots of money.
Proportional tax: This tax is occasionally misnamed a "flat tax," but a proportional tax applies the same percentage tax rate to all people, regardless of how much they make. Variations on the theme are plentiful, and below, several of them will be investigated a bit more deeply because it appears that some version of a proportional tax is going to be recommended by the President's Commission on Tax Reform. Suffice it to note that sales taxes are almost always proportional taxes on retail prices of goods. Value added taxes (VATs) are proportional taxes on the wholesale prices at various stages of production, but this just means that the sales tax is going to be buried in the final prices of goods instead of being on direct display at the checkout register. As a rough estimate of the tax revenue generated by a national sales tax, suppose a tax of 15% were to be assessed on the final output of all new goods and services produced in the United States, as measured by the gross domestic product for 2004. According to the 2004 CIA World Factbook, the GDP for 2004 for the United States was $10.98 trillion, so a 15% tax on this amount would generate federal tax revenues totaling $1.65 trillion.
Regressive tax: Every now and then, some hard-core, Right-wing economist brings up the idea of making taxes higher for people who make less money. The idea is that, if folks know they'll pay more if they earn less, they'll have a whole lot of incentive to work harder so they don't have to pay as much in tax on the last dollar they earn. And, yes, there really are economists who think a regressive tax would be a great idea, even though the whole idea is so obviously unfair on its face that it could never happen... at least, not if it was too obvious.
Progressive tax: Income taxes based on a progressivity principle are the most common type in the world. Progressive taxes assess a higher tax rate to income at higher and higher levels. Consider a relatively simple, three-tier structure:
For income of $15,000 or less, a 10% tax rate is applied.
For income between $15,001 and $40,000, a 20% tax rate is applied.
For income greater than $40,000, a 30% tax rate is applied.
So, for a person making, say, $12,000, the total income tax bill would be
10%×$12,000 = $1,200.
For a person making, say, $25,000, the total income tax bill would be
10%×$15,000 20%×$10,000 = $3,500.
And for a person making, say, $70,000, the total income tax bill would be
10%×$15,000 20%×$25,000 30%×$35,000 = $17,000
Notice several features of progressive taxes. First, not all income is taxed at the highest rate; only the income that falls in a given tax bracket gets hit at the so-called "marginal rate." Second, progressive taxes are annoyingly complicated little suckers. It's not all that easy to predict how much income tax will have to be paid in a given year, and this is made worse by Congress constantly tinkering with both the rates in the different levels and by where each level begins and ends. Most people fill out a W-4 form, which is supposed to give an employer a rough idea of where an employee's income will fall in the tax tables and therefore give a decent idea of how much to withhold for the employee; but this doesn't always work very well, especially for people who work multiple, part-time jobs that cause income to stack in a way that kicks them into higher marginal tax brackets than the W-4 can properly predict.
For better or worse, though, the United States and most of the civilized world have some form of progressivity in their personal and corporate income tax structures, although the U.S. has been on a path over the past several decades of "flattening" the structure by reducing the number of tiers. The President's tax commission might very well finish the job by entirely dispensing with the tiers; but converting the federal income tax structure into a proportional income tax would be too obviously a windfall to those with high incomes because it would clearly relieve them of the burden of facing progressively higher marginal tax rates on the upper reaches of their income.
This means the tax must come in a better-looking package, one that promotes some apparently important ideal within the American psyche. Imagine a tax that is at once simple and promotes old-fashioned Protestant frugality.
Tax Structures to Promote Savings: Slapping the Consumers
A proportional tax fills the bill, particularly if the tax is only on consumption because everyone knows that Americans don't save enough of their income, and everyone knows that saving money is a good thing. Actually, the importance of increasing the savings rate among Americans is dubious on its face, especially when the clarion call for more savings comes from pro-business interests, which have great incentive to see Americans save lots of money. The reason is that, if people save more, this increases the supply of lendable funds available for banks and other financial institutions to lend. But when the supply of anything increases, its price decreases; and the price of lendable funds is the interest rate charged on the loans. That means, if Americans save lots more money, interest rates for businesses will go down, making leveraged investments in plant and equipment (as well as leveraged take-overs and buy-outs) cheaper.
But this would be good for regular people, too, one might argue. Not really: first, a consumption tax would be punishing people for trying to take advantage of lower interest rates on anything that had to do with consumption; and second, business investment in plant and equipment has had a marked tendency to be used to replace human capital, not to supplement it. In other words, the modern American business model has had as one of its clear goals the use of physical capital as a "substitute," not a "complement," for labor, meaning that Americans pouring money into savings accounts are going to accelerate the industrial shift that has for years been progressively and deliberately degrading and diminishing the jobs market in the U.S.
And if that weren't enough, recall that interest rates will be falling as more money is saved, so those average Americans, who used to spend their money, now will be saving much of that money at lower and lower rates.
And One Last Whack, Just for Good Measure
A quick look at two hypothetical Americans will drive home another, compelling downside of a national sales tax. Consider the case of Byron and Barton Binkwater, brothers whose lives diverged early on and who now live on opposite sides of the tracks.
Byron Binkwater works like a dog at the EZ-Lube on the south-east side of town, out by the Snarf-n-Barf. He earns total income of $20,000 a year.
Barton Binkwater hit the big time, rising up the corporate ladder at Purcell's Parts down on River Street right by where the Steak Sandwich Outlet used to have its corporate offices. Barton earns $80,000 a year.
Byron and Barton are still a lot alike in many ways. Most importantly, they have the same essential needs in life, even though both of them would say that isn't so. Being of similar builds and health, there is no difference in what they need to stay alive and healthy underneath their quite different outward lifestyles. What they want might be worlds apart, but what they need just to keep going from one day to the next is pretty much the same: roughly the same number of calories, about the same amount of shelter, 'round about the same amount of heat and air conditioning, somewhere near the same medicines. In economics, this "same" aggregate amount is called "autonomous consumption": the amount of money that is necessary regardless of whether there's any income or not. It's not something that varies with lifestyle, it's not something that varies with who a person is and where that person's station in life happens to be. When people are better off, they almost always think they simply must have more just to keep body and soul together, but that's just a mark of their changing wants, not their changing needs.
After all is said and done, Byron and Barton both need $8,000 just to stay alive. That's the basic amount of money each must spend, and anything either of them spends above and beyond that amount is discretionary, whether either of them wants to admit it or not.
Now, if each of them actually only spent what was absolutely necessary and put the rest away in savings, a consumption tax of 15% would hit each of them like this:
Byron spends $8,000 that is exposed to a 15% tax; so his tax bill is
15%×$8,000 = $1,200.
Barton spends $8,000 that is exposed to a 15% tax; so his tax bill is the same
15%×$8,000 = $1,200.
What could be more fair? They both pay the same amount of tax!
Ah, but look more closely at the tax rate each of these fellows faces on income:
Byron pays consumption tax of $1,200 on income of $20,000, so his income tax rate is
$1,200÷$20,000 = 6%.
Barton pays consumption tax of $1,200 on income of $80,000, so his income tax rate is
$1,200÷$80,000 = 1.5%.
Holy Moses! So this is why there's an old saying in macroeconomics:
A proportional tax on sales is a regressive tax on income.
In fact, Barton could spend a whole lot more than $8,000 on consumption and still have an income tax rate below Byron's. Doing a little bit of algebra, Barton would have to spend $32,000 on consumption before he'd pay the same, 6% income tax rate Byron is paying just to buy enough to stay alive.
Oh, the Feds Wouldn't Let That Happen... Would They?
Surely, any such tax would be lower on food and medicines than it would on luxury items, the argument might go. Perhaps it would be, but any tax whatsoever on essentials would have the same result: it would be a regressive tax on income. It wouldn't matter what the tax rate was, it would still apply to both Barton and Byron the same way on their purchases of essentials, so it would create the same regressivity when looked at as an income tax. Unless the tax commission proposes that essentials of life be exempt from a national sales tax, the poor will be punished more than the rich, based upon income.
So the only way to take away the regressivity feature of a national sales tax would be to exempt all basic foods and medicines; but that poses a major problem for tax planners: those essentials comprise a huge amount of the consumption expenditures in the U.S.: exempting all of the basics people need leaves a much thinner tax base from which to draw federal revenues. One way or the other, at least some positive sales tax rate would have to be applied to at least some consumption items that are essential to people. And once that requirement of a national sales tax is acknowledged, at its core, the tax becomes regressive.
But that just means the federal tax system will continue to be used to promote social and economic goals of those who manage its details.
The Dark Wraith has spoken.