28 Jan 2015

Three Myths About Tax Reform

Shameless Self-Promotion, Tax policy 16 Comments

My latest FEE article. An excerpt:

The “correct” amount of saving, in terms of economic theory, is that which people choose in a free market. People have underlying preferences for present versus future consumption, and they engage in mutually advantageous trades — guided by interest rates — to rearrange the timing of their income and consumption.

It is true, as many critics complain, that the income tax imposes a “double tax” on labor income if it is saved and invested. However, the real problem here (from the point of view of resource allocation) is that a tax on dividend and interest income imposes an artificial penalty on future consumption versus present consumption. This is the sense in which a flat income tax of 10 percent will cause more economic inefficiency than a flat consumption tax of 10 percent, and it is the basis of many proposals to reform the tax code.

Yet, the problem here isn’t the government’s failure to reward (or encourage) saving; the problem is that the income tax artificially punishes deferred consumption relative to immediate consumption.

16 Responses to “Three Myths About Tax Reform”

  1. Andrew says:

    Would abolishing the income tax in favor of a consumption tax have the opposite negative effect? Would we then have a problem with people saving and investing too much and consuming too little? Would the economically optimal way for the government to raise tax money be a 5% flat tax on income and a 5% flat tax on consumption? Or 3% income and 6% consumption? I.e., some combination of the two rather than one or the other.

  2. Andrew_FL says:

    Ah I’d say the “optimal” way of raising revenue is the way that makes it most difficult to increase the amount raised. I’d think the most difficult way would be, when the government has to come to every single person and demand a lump sum regardless of their income ie a “head tax.”

    Difficult, in the sense that the political pressure against increasing the amount demanded, comes from all citizens, who have an equal interest in seeing the amount lowered.

    Additional benefit: the payer decides whether what they pay comes out of present consumption or future consumption.

    But mainly the appeal is just, you couldn’t raise trillions of dollars in revenue that way from a population in the hundreds of millions. Well, I suppose you could, if everyone is affluent enough, but, aforementioned political power works against it.

    • Andrew says:

      So you would charge every man, woman, and child $12,337.87? I don’t think this would be economically optimal in the way I was meaning. For the purpose of this discussion, assume that everyone agrees that the government is a valuable institution and requires $X to operate. What is the least economically disruptive way for the government to raise $X through taxes?

      • Andrew_FL says:

        My well named friend: I specifically said that the point of the head tax is you couldn’t collect as much revenue as you presently do without taxing every person an unreasonable amount. And therefore we’d have revenue actually cut, forcing the government to shrink. Well, provided you also require they cannot just borrow or paper over the difference.

        Actually I could make a case that they should be required to run an indefinite surplus, only spending in excess of revenue by dipping into accumulated funds in times of foreign invasion.

        Your question is I guess an interesting one. If we assume everyone is wrong, what is the least bad way to do something wrong? It’s not a question I like to think about particularly.

        • Andrew says:

          It appears that it is your opinion that government is always a bad thing, even when it is entered into voluntarily by consenting parties.

          • Andrew_FL says:

            Whether or not I think that is true, could not be derived, except by misunderstanding, from the point I made.

            If X is sufficiently small, the people who all agree that we need a government X dollars in size might not necessarily be wrong. Conceding that for the sake of argument, if X is sufficiently small, X amount of dollars can be raised by a head tax.

            The way you phrased your question, X was on the same order of magnitude that the actual level of Government spending actually is-or that’s what I took you to mean, anyway. My contention was “assume everyone agrees we need a government of X size” where X ~ G ca. the present day, then that assumption is equivalent to “assume everyone has a wrong opinion. How do we accomplish this bad thing everyone wants?”

            I’m actually probably less of an anarchist than most people here, although I come here because I respect and want to learn from their point of view (and I have).

  3. Bitter Clinger says:

    Since income is a measure of productivity, isn’t taxing income the problem? You are punishing the people with INCOME to finance government instead of the people with wealth. According to the Federal Reserve, the top 20% of the population controls 85% of the wealth. This same group earns only 47% (2008) of the income. Obviously the remaining 80% of the population earns 53% of the income while controlling only 15% of the wealth. As a measure of productivity of wealth, the bottom 80% is six times more productive. To clarify; Bill Gates, a real rich guy, a few years ago paid $19 million income tax on $59 million of earnings but at the same times had a net worth of $5.8 BILLION. He paid .03 percent of his net worth in income tax. (I saw someplace he was worth 80 billion today?) Theresa Heinz Kerry in 2004 paid $660,000 in income tax on a net worth of $200 million or .3 percent. I am a Bitter Clinger who owns his own home and has a 401k and last year I paid 3% of my net worth in income taxes. My daughter and her husband, who are just starting out, paid a stunning 30% of their net worth in income taxes and my son in LA is underwater and has a negative net worth. The question is morally speaking who should pay to support the status quo? Since my son has nothing, no net worth, why should he be forced to pay anything? For the last hundred years the government has tinkered with the tax rates in the income tax to get the wealthy to pay more but as I have pointed it just can’t be done. All you can do when you raise rates on high-income earners is essentially destroy the ability for people to move from class to class. Both the Tea Party and OWS see the problem but because they cannot discriminate between income (actually better termed ‘productivity’) and wealth they are unable to see any feasible solutions. Let us do a quick calculation of what the wealth tax to replace the income tax and corporate tax would be. If all wealth (based upon the Federal Reserve’s 2008 estimate) were taxed, the rate would be 1.2%; amazingly similar to property taxes I pay on my home. But let us say since 95% of the population has assets (home and 401K) less than half a million dollars you only tax above the half million. Then the rate has to be 1.5% per year. Less than the management fees on many mutual funds. If you were allowed to deduct a million dollars (my preferred), the tax rate would only have to be 1.8% and only paid by the hated 1%. If a corporation’s stock (even if owned by people with net worth less than a million) on average is worth more than the stockholder equity and the good will of the corporation, then the corporation would not have to pay any taxes. If it were worth less, the corporation would have to make up the difference, promoting bankruptcy of marginal corporations, I believe a good thing. People who “forget” to declare their assets would be subject to the forfeiture of the asset plus a fine of five times the value of the asset; i.e. if the IRS finds a million dollar account in Morocco, they say “Who is paying the wealth tax on this?” If no one steps up, they take it. If in the future they find out who owned it, they fine them five million dollars on top. I read where someone asked Bruce Bartlett about this concept and he said, as a paid shill of the establishment banksters, that assets are too hard to track. What a bunch of crap, the IRS tracks the “flows” of money, you don’t think they can’t track the money? Good Luck Guys. Dr. Murphy, I got my numbers from the book, Social Problems by John J. Macionis, Prentice Hall, 2010. You (or your readers) probably have much better numbers to calculate the required “Wealth Tax” If you get a second could you calculate what you think it has to be on wealth over a million dollars? Thank You, BC

    • Andrew_FL says:

      Top 20% of income earners are not necessarily the same top 20% of wealth holders. So “This same group earns only 47% (2008) of the income.” is an error.

      Some high income earners would be in lower quintiles of wealth holders, simply because they only recently, and briefly, started to earn a high income. And if they spend most of their income on immediate consumption goods, they may in fact be very low on the wealth ladder indeed. Similarly, someone in the top wealth holding quintile may be a low earner, simply because they may have finished accumulating their large fortune long ago, and now no longer work to building it up, but instead slowly consume it in retirement.

  4. guest says:

    A little off topic. Bob Murphy says:

    “However, the real problem here (from the point of view of resource allocation) is that a tax on dividend and interest income imposes an artificial penalty on future consumption versus present consumption. This is the sense in which a flat income tax of 10 percent will cause more economic inefficiency than a flat consumption tax of 10 percent, and it is the basis of many proposals to reform the tax code.”

    Let me preface by saying that I am not in favor of any taxation. Taxation is theft.

    Now, I keep seeing Austrians try and make the case that a flat income tax is worse than a progressive income tax because it hurts the poor more than the rich, as if “poor” was a legitimate class. Also, I’ve read that Ayn Rand disfavored a flat income tax on the basis that it hurts laborers disproportionately to capital owners, as if “laborers” were a legitimate class.

    When I was a Neocon and bought into the notion that taxes were at least a necessary evil, I always favored a flat percentage versus a “progressive” tax on whatever was taxed (I didn’t have an opinion on income versus consumption tax, at the time).

    The reason is that it burdens everyone relative to their capacity to produce. That’s fair.

    Progressive taxes treat people as if they belong to different classes, when there’s really no difference between laborers and capital owners, except that some people have more labor saving devices than others. That’s not a class, that’s a state of being that applies to the individual; You can enter the capital-owning “class” by simply acquiring capital. “Labor” and “capital-owning” are not classes.

    It bugs me that a significant amount of libertarians favor a progressive tax over a flat one. It makes them seem like Leftists, if it matters to any of them that they’re not reaching the Conservatives. Leftist equals anti free market to Conservatives / Neocons.

    We already believe in free markets. We either just don’t know that we’re inconsistent, or we see the government as a necessary evil that maximizes individual liberty.

    On the issue of a consumption tax, what’s to stop people from consuming an alternative? Or if by consumption tax, you mean a tax on all purchases (not just specific items), then you have the problem that Major Freedom has raised a number of times that both parties to a transaction are buyers and both are sellers.

    So, in order to be consistent, you’d have to tax both the guy who buys goods with money and the guy who buys money with goods.

    • Bob Murphy says:

      Guest, I am not aware of a single Austrian who favors a progressive income tax over a flat income tax. I’m not “daring” you, I’m genuinely asking out of curiosity: Can you point me to some?

      • aby says:

        There are quite a few Austrian economists who have made that claim. (Rothbard, salerno, garrison,…) HOWEVER, they made statements like: “I favor a progressive income tax (2% for the poor and 5% for the rich) over a 20% flat tax.
        Mark Thornton is the only one I can think of who has made a statement like guest makes. He said the government should first cut taxes for the poor before they should cut taxes for the rich, but he said that in an interview on some left wing radio station. I think that was more of a strategic point though.

        • Bob Murphy says:

          OK aby if the claim is that Austrian economists would rather lower taxes on some people, rather than retain a uniformly higher rate on everyone, then of course that is true. But I thought guest was claiming that Austrians actually like a progressive income tax, as far as taxes go.

      • guest says:

        Sure. Here’s one example by Lew Rockwell:

        The Return of Supply Side

        “Neglecting the overall tax rate leads to other errors. The supply-siders back flatter taxes, on grounds that progressive rates penalize wealth accumulation. But if these flatter taxes end up as higher taxes (as they do in most proposed reform packages), it would be for the worse. It’s better to have three progressive rates of 15%, 28%, and 33 % than a flat rate of 30%. It’s not the flatness that counts so much as the overall level.”

        This is true as far as it goes, but when everyone feels a 30% tax, the poor do not disengage from the burden their vote places on their neighbor whose crime is having more than them, and everyone is more likely to favor a reduction of the flat rate.

        It *is* the flatness that counts if you’re going to claim that a particular government program is for the benefit of everyone.

        As for whether cutting taxes for the poor or the rich makes more economic sense, wealth creation comes from production, not from having more relative to someone else. It doesn’t matter what the other guy has; It only matters what you have relative to what you had before. The concern over wealth inequality is just envy.

        It is the capitalist who has the means to produce more abundantly, and therefore the capitalist can better compete for labor with higher wages than the laborer would otherwise have opportunity to earn.

        A reduction of taxes on the rich leads to greater production and a greater “pie” of wealth, so the more economical of the two positions would be to reduce the burden on the rich, first.

        • guest says:

          That was a great article, over all, I’d like to add.

          It shows how the Right can be awfully Leftist in their policies.

  5. Innocent says:

    Taxation is a tough one. I honestly agree that there is no good tax. All taxation is a method of wealth destruction and cronyism. I fail to see to this day the difference between ‘protection’ money and taxation. I lived in Italy for a while and have to say that the Mafia seemed to care more than the Government did at times about the people. The Government was simply in it to embezzle as much money as possible. At least the Mafia was honest about what it was doing.

    Anyway, If you are going to go down the road of taxation, I would suggest you make it as even as possible. So you are going to want to tax future and current consumption as evenly as possible, however that comes out.

    Finally there is no such thing as a fair tax. No matter what you do someone will gripe about it because fair is a perception. To one person it is fair if someone is taxed 80% of their income because ‘they have enough’. So stop trying to create something that is fair and rather create something simple and even. Not fair. I do not want something fair.

  6. Harold says:

    “The “correct” amount of saving, in terms of economic theory, is that which people choose in a free market.”
    Is it not that which people would choose in a perfect market? This is a significant distinction. Or you could say according to a particular economic theory, rather than “economic theory” generally. That is if free market is defined as one wfree of Government intervention.

Leave a Reply