August 24, 2004
Blood From a Stone
Note: this is a post recovered from my old blog, before it died of an insufficient backup. Any comments/trackbacks on it have not been brought over, but can be seen with the original. The date is that of the original posting.\"\;
They say that strength and fortitude keeps a man from getting screwed; but the future raises so many doubts when you put it in but you can't get it out.Dennis Hastert, Speaker of the House of Representatives, is calling for replacing the income tax with some other system, probably the "fair tax", and in the process potentially eliminating the IRS.
- The Hooters, Blood From a Stone
Before I get to the specific possibilities of different types of alternative taxation, I'd like to approach this in a roundabout way (hey! if you've read this site for any time, you should have expected this!) and start with why we have an income tax in the first place, and why it's so horrible.
There are five characteristics that make the income tax horrible: it is intrusive, and breeds tyranny; it provides for unlimited Federal power; it cannot be avoided by reasonable changes in behavior; it spawns corruption and political favoritism; it distorts the economy and inhibits growth.
The income tax is not horrible because of the amount of money that is taken. The amount of money take is horrible, but it would be horrible to take that amount of money regardless of the system for extracting the money.
One problem with having an income tax is that it leads to extraordinary amounts of tyranny. Consider the following powers that the government has only because of the need to accurately collect income tax:
- The power to compel you and companies that may employ you to disclose the arrangements under which and the amounts which you are paid.
- The power to take money from you without your active participation.
- The power to fine you for not paying enough at the right times, even if you followed their rules on what to pay and when.
- The power to restrict the ways in which you spend your money, and the power to demand proof of how you've spent your money.
- The power to examine your financial records at will and without your knowledge, and frequently without any court order (such as going through your bank accounts).
- The power to charge you with a crime with no actual evidence, and compel you to prove your innocence.
- The power to compel you to participate in programs (such as Social Security) "for your benefit".
- The power to require you to identify yourself in virtually all major financial transactions, even those conducted in cash, using a national id number (your SSN).
- The power to control what benefits a company may offer and how it may fund them.
- The power to prevent you from moving your money overseas.
- The power to control ownership of publicly-traded companies.
All of these powers (and many others, equally as odious) are arrogated to the government because of the need to accurately collect a (very complicated) income tax. In sum, the government claims the right to control your finances in many, many particulars. Other forms of taxation could generate the same revenue for the government without the associated tyranny. Note that none of these factors changes with a flat tax, though it would be easier and cheaper to prepare tax returns.
Another problem with the income tax is the removal of limitations on Federal government action. I tend to date the end of the American Republic, and the beginning of the US as a Social Democratic nation, with the 16th and 17th Amendments to the Constitution, which destroyed two of the three primary practical limits on government power: limited income and limited political power (because the States, when they selected the Senators, jealously guarded their own interests). The third limit, by the way, was judicial conservatism, which was destroyed soon afterwards with the activists courts of the Depression and afterwards, and the willingness of the Congress and the people to allow their arrogations of power to stand.
With no ability for the States to check Federal spending, and with no ability for the people to avoid taxes (see below), the Federal government was suddenly able to intrude into virtually every aspect of individual life and of government at any level. Take roadbuilding and education as two examples: the Federal government can raise unlimited money, and can then use it to blackmail the States: either do such and so, or lose the money we are providing you for education or for road building. Thus was the national drinking age instituted. Thus have many dreadful changes in education been instituted. Thus, in short, has power been centralized and individual and State initiative stifled.
It used to be that taxation could be avoided. Assume the government were to put a tax on imports. Should that tax be oppressive, one could use domestic goods as a substitute, and thus avoid the tax. Non-direct taxes tend to be that way: you can avoid them by changing your behavior. With direct taxation, though, this is not possible, unless you choose to starve. (You can't even get out of this by growing your own food, because of property taxes on the land you would have to use to do so.) Since the tax is universal and unavoidable, government has no incentive to keep taxes reasonable. This is why taxation could grow to such levels, which is why in turn the Federal government could afford such massive and wasteful programs, which in turn demand higher tax rates.
With the large amount of income, and the utter intrusiveness, generated by the income tax, it became far more possible for the government to grant and revoke political favors. Consider as one example the wrangling each year over which tax benefits to grant to favored groups (buying their votes with our money), such as subsidies for farmers (which mostly go to large corporations). This is not really corruption, per se, though in certain cases it is corruption, for example where there is trading of subsidy or relief for campaign funds; but generally the problem is just that the public at large is taxed to favor particular groups.
On top of all of this, the income tax is bad for the economy. Again ignoring the size of the tax to be collected, the amount of money required to comply with the income tax is huge. I've seen estimates of $200 billion a year across the economy. Most of that is actually borne by companies; an individual's $60 tax prep program is minor, but companies can spend millions of dollars to avoid even larger amounts spent to pay fines. These corporate costs are passed on in the cost of goods and services, along with the actual tax paid. Merely reducing the cost of compliance with the code by simplification of the code adds huge amounts of "free" money back into the productive economy.
But not only is the economy dragged down somewhat by the costs of compliance, the remainder of the economy is distorted. Consider the subsidies: if a person is given money to produce, say, dairy products, wouldn't they produce more dairy products? Of course, which means that the supply of dairy products exceeds the natural demand, and the government is forced to allow prices to drop (thus resulting in no net gain to the dairy farmers), or to buy up the surplus product and warehouse it. Don't laugh, it happens.
So, if we are to eliminate the income tax, we have to have a system which eliminates or reduces these five effects (tyranny, unlimited Federal income/power, inability to avoid the tax, favoritism and economic drag) without adding offsetting bad effects.
I don't want to get too much into what is "politically possible," because if you don't ask, the answer's always no: I've seen too many "impossible" things done to credit that argument. (It's at about the same level of credibility as who is "electable" and who is not.) There is one argument, though, which I think is fairly incontrovertible: any system which puts a large burden on the poor - or can be made to appear as if it does to a person who is not paying attention - will fail politically: most Americans would not accept shifting the burden to the poor, and any plan which appears to do that would be rejected, along with the person who proposed it.
Another characteristic required of any replacement for income tax is that it must either be revenue-neutral, or must provide explicitly for the elimination of spending/programs. Given that the latter is unlikely as long as politicians seek power and bureaucrats seek to protect their "kingdoms", it's reasonable to only look at plans which are revenue-neutral.
So, that said, what are the options? Basically, you can only reasonably tax stores of value, or transactions involving stores of value. This means that you can tax things or events like physical property and other tangible assets, payment for services (including salary), sales and rentals, use of government-owned assets, use of government services, transfers of goods, and ownership or transfer of intellectual property grants. Taxing other things, at best, does no good, because the taxes are avoidable by using cash and not keeping records. Assuming you don't want to create tyranny, you want to avoid persecuting people over whether or not they've avoided reporting cash transactions.
Taking each of those items in turn:
- Physical property and tangible assets: Put simply, this is property tax. It taxes the value of physical goods and titles held by a person, more or less in return for the government's protections of one's rights to those goods and titles.
Little tyranny is involved, because the government has to know what you possess in order to protect your property rights in any case. However, the government could easily become excessively intrusive about how property is registered, used and transferred. Any such tendency would have to be kept carefully in check, perhaps by allowing Federal governments to tax the States based on their total property valuation, and having the States collect the tax as appropriate.
The tax is avoidable, because property can be sold or abandoned if the taxes exceed the value of the property or goods. Because it can be avoided, Federal power is limited (since raising the tax too high would result in people avoiding the tax, and thus lessening the government's revenue).
Favoritism is possible, because property could be taxed differentially by such selectors as who owns the property (look, for example, at the local property tax breaks given to large corporations) or what the property is used for. However, the ability of people to avoid the tax (for example, by incorporating or divesting themselves of the property) would limit this in comparison to the income tax.
The economy would still be distorted, to the extent that private property ownership would be discouraged in relation to other stores of value (like stocks or cash); on the other hand, this distortion is considerably less than that of income tax, because it touches fewer economic activities. In addition, the cost of compliance is relatively small: the property value must be assessed, and the appropriate tax rate applied, and that's it (as long as the Congress resists the power to make the rate schedule Byzantine).
The tax is not regressive, and couldn't easily be portrayed as such, because inherently poorer people wouldn't own property with valuations as high as those of richer people. Finally, given the large amounts of property and their values, it would be fairly simple to keep the plan revenue neutral without taxing private property ownership out of reach.
- Payment for services (including salary): This is the income tax; it's what we are trying to avoid, for the reasons discussed above.
- Sales and rentals: Retail sales taxes are commonly used by local governments. The VAT (Value Added Tax), added at each stage of production, is somewhat like a sales tax, but takes place not only at the retail level, but whenever the good or service is transferred. VAT is much used in Europe.
Sales taxes and VAT are not terribly intrusive, because they are anonymous. It's hard to tyrannize people when you don't know who they are.
Sales taxes are self-limiting, because excessive rates cause reduced purchasing or switching to tax-preferred alternatives (such as used goods).
Corruption is still possible in subsidies, but it's very difficult to give tax breaks to specific groups on sales taxes, so favoritism is much less of an issue.
The economic distortion in this case would be to encourage savings and discourage consumption. I don't know enough about economics to determine how damaging this would be in comparison to the income tax. To some degree, this would be offset by the higher immediate incomes, which allows people to determine how to use their money, and thus how they will pay the tax. This is therefore likely to be less of a drag on the economy than the income tax currently is.
The biggest argument against sales taxes and VATs are that they are regressive. Attempting to craft them as taxes on luxury goods has the effect of killing the market in that luxury good (they are purchased abroad and imported instead) while not bringing in net revenue. In general, it is likely that a VAT could be implemented over this objection, so long as it excludes food and fabric and is not charged at the retail level.
It would be possible to make this tax revenue neutral, though it would require adjustments for several years as people's behavior changed in response to the initial implementations of the tax.
- Use of government-owned assets: These are generally called user fees. They are at best a very small part of the government's revenue stream. While these are, and will continue to be, employed, they do not form a part of the solution to eliminating the income tax.
- Use of government services: The Post Office charges for its services, as does the Fed, as does the Patent Office. However, this is at best an offset of the operating expenses of that particular service: how do you charge for, say, the Army as a part of fees on government services, when private-sector services could be procured instead at a much lower cost? Again, this is not part of a solution to eliminating the income tax.
- Transfers of goods: Import and export duties fall into this category. Otherwise, this doesn't differ markedly from sales taxes if you include VAT as a sales tax. I don't see this as being a major contributor to government revenue, though these taxes will continue to be imposed.
- Ownership or transfer of intellectual property grants: This amounts to a property tax, but with the problem that valuation is extraordinarily difficult. How much is Micky Mouse's copyright worth? How about the patent for a drug, when the patent will expire next year? Certainly, this kind of property could be taxed, but it would be a lot easier to tax this as sales, rather than valuation of the grant of the monopoly.
I know I treated some of those a little briefly, but really, the only two options to taxation of income which would potentially be revenue neutral would be taxation of property values and sales. Some combination of these two would have to be used to replace the income tax.
Perhaps the best thing to do would be to tax the States relative to their GDP, and let them figure out how to raise money from their citizens. Of course, then the States would need Congressional representation, so they would have to regain the right to select their Senators. Hmmm...perhaps the real solution is to simply repeal the 16th and 17th Amendments, and let the government raise revenue by taxing the States proportionate to their population, GDP or some other meaningful measure.
Frankly, I'd be happy with some combination of property and sales taxes even if administered by the Federal government, as opposed to the income tax. If President Bush supports this, it won't change my vote for President, but it might change my vote for down-ballot elections.