Thursday, February 7, 2008

New Tax Scheme

As a sequel to my discussion of differential tax rates previously, I have devised a new taxing scheme. This taxing model has the advantages of simplicity and the removal of distortionary taxation effects. In other words, individuals’ decisions will not be influenced by tax rates (save the effect of choosing more leisure relative to work which all taxation will ensure).

In order to participate in society an individual must have money. In order to have money he must have income. Let’s assume all individuals work and, therefore, provide their income. Once the individual has provided himself with income, he has two options: spend or save—consume or invest. The function of these two options is exactly the same. In one case, he buys a coke and expects some utility (return) from the asset (in this case immediately). In the next case, he buys a stock and expects some utility (return) from the asset (greater quantities of the money in the future). But notice those are his only two real choices. Although, he can put it in a drawer, in which case the government has no claim to it.

The choices are essentially the same. Therefore, the taxation measures should be the same and the tax rates should be the same. There is no need to tax income (unless you are worried about money being spent in other countries, but that is trivial). Let’s just tax the only two things income can be used for: consumption or investment. And let’s tax them at the same rates at the same time. You want to buy a coke, pay 20% tax. You want to buy a stock—20% tax. The bank wants to buy your money (by your opening up a checking account)—20% tax (on the bank). Buy a boat—20% tax. Buy money (take out a loan)—20% tax. Up front, right in front of you. Wow, would this put the tax accountants in a tiffy. You wouldn’t be taxed when you received your investment income, because well, it is income remember.

Many will argue that this tax is not progressive—the poor have to pay the same percentage as the rich. It’s true. But the relevant question is: would the poor pay more or less tax than with the current system? Their income tax would be removed. The sales tax on goods may be set higher. The effect is uncertain, but the poor could be accommodated. Food stamps and no taxation on investments if you can prove your income is below a certain level. (This would be a hassle though, but don’t worry, there’s another route.)

I have never really been convinced that a progressive tax level is particularly valuable. Rich folks will still pay a huge percentage of the tax return. Also, they will be incentivized to spend more (on stocks or cokes). The government can do their re-distributions just as before (which of course are distortionary as well). If you want to retain the effects of a progressive tax structure, just give more benefits to the poor. It’s not how much money you make, but what you can afford with how much money you make. Collect evenly and distribute unevenly, the effects are exactly the same.

I’m not going to get into the cheating issue, which many cite as a criticism of greater sales tax levels. “There will become a black market to evade the sales tax. We will need a force to suppress it.” I think the IRS handles this already, and their job will probably be a bit easier with no income statements to mull over.

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