The Burton Theory of Taxation
All taxes hurt. Even a billionaire is hurt (at least theoretically) by a $1 tax. So there's not way we can raise money for the government without hurting someone at least a little. Unfortunately, we still need to raise money for the government to operate. Therefore it comes down to the question of
who do we hurt and how much.
In my (modestly named) theory,
taxes should be based on causing the least pain possible while distorting incentives as little as possible (with one exception to be mentioned later).
I don't think issues of "fairness" should enter into the equation much at all, for the simple reason that we don't have an easy way to determine someone's "fair" share of taxes. One person may make money in way that depends greatly on the government (as, perhaps, an employee of a defense contractor); someone else may make money in a way that has little to do with the government (as a gardener, perhaps). Is it "fair" to charge them the same in taxes? Who knows? Should someone who is more likely to be mugged pay more for police protection? There are just too many variables to ever determine anyone's "fair" tax burden, so I'm not even going to try.
Nor am I going to try to base taxes on moral or economic "worth" (an argument with which many other people put great stock). An argument that
They earned it isn't going to carry much weight with me, since the alternative is taxing someone who also presumably
earned it (with one notable exception).
All taxes have to come from someone who otherwise has legal right to the money involved, and I don't think that the government should be in the business of ranking relative merit to determine who gets to pay the next dollar in taxes needed. Again, it's just not something that lends itself to quantification. Was Dick Cheney so worthy at Halliburton that he merited the pay of 1 million minumum wage employees? What about Larry Flynt? Probably not (to either), but I don't think there's any way to decided that question fairly. I'm fine with letting the market decide compensation (with a floor below which it can't go), but that's not the same as letting the market decide taxation. Just because the market rewards Larry Flynt with millions more than it rewards a bricklayer, doesn't mean that he shouldn't pay more in taxes (nor does it, in itself, mean he
should pay more).
By "least pain", I don't intend to guess the amount of personal psychic trauma caused by paying taxes. I mean this to measure the
greatest disruption in buying power and in lifestyle. By this measure, taxing a billionaire $1 million would be far less painful than taxing 1000 people barely scraping by $1000/each. While the billionaire may not like paying $1 million in taxes, it won't affect his buying power as much as a $1000 tax would to someone barely scraping by (even a $500 million tax wouldn't have the same real day-to-day effect on a billionaire's life as a small tax would on someone in poverty).
If causing the
least pain were the only measure worth consideration, we could simply slap a 100% marginal tax on high incomes until they were broght down to everyone else's level or until the government were fully funded. But that's not the only issue. We also need to take into account how taxes will affect the incentive to work, save, and invest. Obviously, a 100% marginal tax bracket gives no incentive to do anything but sit around all day. Just as obviously (to anyone not in the current administration), the difference between a 39% marginal tax rate and a 36% marginal tax rate probably isn't enough to change anyone's motivation. But there is an obvious difference between the motivation provided by a 90% marginal tax bracket and a 30% one. [Remember: For the purpose of motivation, what matters is the
marginal tax bracket (that is, the tax on the
next dollar earned) not the overall tax bracket. If all your income up to now is tax free, but any income above it is taxed at 100%, then there's no incentive to work overtime or get a raise even though your overall rate of taxation may still be very low.]
There is another way in which taxes can distort things other than simply placing a brake on motivation, they can cause people to change their behavior. If the government declared tomorrow that all people named
William didn't have to pay taxes, there would be a mad rush as people changed their names and almost all new babies would be named William. This wouldn't have anything to do with the intrinsic goodness of the name, just a reaction to tax incentives. There are real life examples of this all around us. Property taxes in Charleston used to based on the amount on streetfront taken up by a house, so most old houses in Charleston are very narrow and go far back from the street. There's nothing that made this design more desirable in Charleston than here in Nashville, but the tax structure gave people an incentive to build those houses in Charleston and not in Nashville. Currently, Federal income taxes are lower on
capital gains on investments and real estate than they are for
earned income. In addition, earned income is assessed payroll taxes to pay for Social Security and Medicare and capital gains aren't. This serves to distort incentives, making capital gains more attractive than earned income.
If we put all this together, we come up with the outline of an ideal tax code. It should
cause as little pain as possible, so it should take very little (if anything) from those on the low end of the economic spectrum who would suffer the most harm from any loss of income. It should also
cause the least disincentive as possible, so at no place on the income scale should marginal rates be high enough completely discourage economic activity.
Nor should an ideal tax code distort economic and noneconomic choices without good reason*. I would also add that an ideal tax code would be
as simple as possible, because I consider having to hire an accountant or tax preparer to be a distortion of behavior (and an economic inefficiency).
People may disagree, but this is what an ideal income tax structure would look like for me:
1)
All income treated the same, whether it came through labor, through investments, or even through inheritance**. That means no payroll taxes and no lower rates for capital gains. This will cause the least distortion of economic behavior.
2)
A personal exemption from taxes for all income to well above the poverty line. The amount of this exemption would be higher for those with children, just as the poverty line is higher for those with children. The harm caused by the loss of any income to someone living in poverty or close to it is far greater than the harm caused to others by loss of income. This would make sure those most vulnerable didn't get hurt.
3)
No other exemptions or deductions for anything other than charitable contributions***. Nothing. No deductions for interest paid on mortgages, no deductions for childcare or health care, nothing. You want a simple tax code, this is your baby. Once you start introducing complications, things go downhill fast. This would keep the tax code easy and simple to understand, and would eliminate distortions. The fewer the exemptions, the lower rates can be for everybody.
4)
A steeply progressive tax code, with brackets starting at 5% for income just above the personal exemption, going up at 5% intervals from there. I'd probably cap the brackets at 45% for income over $1 million and 50% for incomes over $5 or 10$ million, maybe with another 5% tacked over $50 million, but these are pretty much arbitrary numbers (I've never understood why someone making $200 million is in the same bracket as someone making $200 thousand). At no point would there be a huge disincentive to earning more, except perhaps at the top end (and that would still be a mild disincentive). Even with so many brackets, you could still look up the exact amount owed in the back of the instruction booklet.
5)
Corporations and LLCs would be subject to taxation as if they were people, same rates and everything. If income was distributed as dividends, it would be taxable at the individuals rate but the corporation wouldn't have to pay taxes on that portion of income. Stock owned by overseas investors would still be subject to taxation in America and so would income earned in America by overseas corporations. This would eliminate the weird distortion we have now in which a corporation competing against an individual is at a competitive advantage since it pays less in taxes. If would also eliminate the situation in many companies in which profits aren't distributed as dividends because major shareholders don't want to pay taxes on all that income. Of course, it would completely eliminate the incentive to incorporate offshore to avoid federal taxes. This added tax burden would be partially offset by corporations no longer having to pay payroll taxes on their employees, and perhaps even by savings on tax preparation and accounting (should they choose not to try dodging their share of taxes).
That's it! A five-step tax code. Of course, there would still be reams of fine print defining what was and was not income and making it hard to shield income from taxation, but
it would make things better for the vast majority of Americans. It would also shift a large part of the tax burden to corporations, and away from individuals (one of the great unnoticed stories of the last twenty years is that corporations pay less than half the tax burden they did in 1980).
This is also, needless to say, impossible in today's political climate. There hasn't been a move towards a simpler tax code since '86, and it made the code considerable less progressive. Bush's tax bill not only make the code more complex, but it also made it far less progressive. Too many special interests have too much invested in the current structure to want it to go away completely. Of course, we're also unlikely to see many politicians falling all over themselves to raise taxes on their donor base even if it meant lowering taxes for the people in greatest need.
Even if a tax structure like this is impossible to implement politically,
we can still work towards one like it incrementally. The easiest place to start would be to insist that
all future tax cuts come out of the lowest bracket (which we all pay), rather than out of the highest (which most of us don't). We could also do something to reduce the burden of payroll taxes on the working poor and to eliminate tax dodges at the high end of the spectrum.
* Some taxes that distort or discourage behavior would be worth keeping around, because the behavior in question is worth discouraging but shouldn't be made illegal. I'd include tobacco, gasoline, and alcohol taxes in this category. I don't want the government telling people they can't smoke, they can't drink, or they can't drive around all guzzling gas; but I think these activities are harmful enough to discourage through the tax code. The taxes raised, of course, could be easily earmarked to ameliorate the damage caused by the activitt in the first place. I realize that taxes on this activity would hit the low income harder than the high income, but it would still be worth it.
**There are "fairness" questions to be raised on both sides of the inheritance tax debate, depending on whether you focus on the dead guy who is leaving the estate or the live guy who's getting it without having done any work. I think it's easiest to sidestep this by simply declaring inheritances to be taxable income. It would be easy to make personal effects below a certain monetary value exempt, as well as to make very low interest loans available to those who inherit one major asset (a home, a business, or a farm) so that taxes can be paid over time without selling the asset.
***Charities would be the flip side of taxes on tobacco, etc. Charitable giving is an activity that we want to encourage and it's fairly simple do so. Even though we want to encourage home ownership, a deduction for mortgage interest really acts as a subsidy of those who can afford to buy homes by those who can't (especially since someone with a large mortgage and a high tax bracket saves considerably more than someone with a small mortgage and a low tax bracket). It's better to make tax rates as low as possible and allow people to buy homes or not as they wish.
Clarification: Corporations and self-employed individuals would still be able to write off legitimate business expenses, as income taxes would only apply to net
profits, not to every penny taken in. There would, however, be strict oversight to make sure only actual cash out-of-pocket expenses were used. I'd probably disallow the practice of applying previous year's losses against this year's taxes (and I'd definitely discontinue the practice of corporations aquiring defunct companies with huge previous losses just to cut taxes in future years).