Tax Reform Liberation

November 9th, 2011 at 1:16 pm

I’ve been thinking about tax reform lately (who hasn’t?), as in a major restructuring of our tax system.  And I’ve concluded that it’s a big waste of time.  Yes, the current system needs repair, and more to come on this, but here’s the core of the argument:

We need a system that raises adequate revenue with the least distortions.  Those distortions, however, do not come from the rate structure, so all this junk about lower rates unleashing a growth tsunami is at its core trickle-down propaganda.

The distortions come from the loopholes, exemptions, and most of all, from all the myriad ways different types of income are defined and treated.

It should also be a system that does not amplify pretax income inequalities—i.e., it should be progressive (the CBO inequality study finds that after-tax inequality has grown faster than pretax, implying diminished progressivity of the Federal tax system).

Once you accept these simple truths, you’re free from all the mishegas about flat taxes, corporate reforms, VATs, territorial systems, etc.  Nothing against all of those—many embed smart policy thinking. 

But we can have an efficient system that serves us well if we simplify the current code by treating all income the same, regardless of its source, close distortionary loopholes (and yes, defining what’s distortionary implies an argument, but there’s actually more agreement here than you might think), and sticking with—I’d say expanding—the progressivity of the current rate structure.

So, join me on path of tax policy enlightenment, and you too will experience the bliss of liberation from all the angst of this highly fractious debate.

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12 comments in reply to "Tax Reform Liberation"

  1. Ron E. says:

    I’d add one more principle: as much as possible any new revenues should come from taxing activities we want to discourage anyway such as carbon pollution, cigarettes, economy-destabilizing financial transactions, etc. Obviously there would big fights over what exact activities to tax, but that’s why we have democracy.


  2. Steve Roth says:

    To treat corporate profits the same, I say we adopt Milton Friedman’s suggestion: tax all corp profits like s-corp profits.

    Tax them once, with shareholders paying whether the profits are distributed or not, and tax them at the same rate as all other income.


  3. Steve Roth says:

    Also remove the business interest deduction, cause it’s distortionary and we want to encourage equity equally with debt financing.


  4. David says:

    @Steve Roth – I always attributed that idea (tax all profits to the shareholder whether distributed or not) to Lester Thurow (he discussed it in the book Zero Sum Society without credit to Friedman, as I recall), and it has a lot to recommend it. I always wondered why it dropped from sight. Except that you know it would be decried as a giveaway to corporations, when in fact it would ever so much fairer and efficient, and would highlight exactly those taxpayers we choose to exempt from taxation.


  5. Chigliakus says:

    The other day I was talking (arguing?) taxes with a wealthy friend from a wealthy family. He admitted that there should be higher tax brackets that extract a higher percentage from extremely high incomes, like over a million a year for example. Where he disagreed was when I suggested raising the capital gains tax, I suggested that all income should be taxed the same and not favor money making more money over income from actual labor. We never saw eye to eye on capital gains, he insisted he was being taxed twice when money that had already been taxed was used to make more money, and that the 15% rate was already too much. I attempted to explain, in a variety of ways, that he wasn’t being taxed on the money that had already been taxed, that his capital gains were new income.

    Anyway, there was one interesting point that was brought up during the discussion that perhaps you could comment on. If we raised the capital gains tax in the US, would that discourage foreign investment in our stock market? He was arguing that it would discourage all investment, domestic and foreign, but when I did some googling later it doesn’t appear that non-resident aliens have to pay US capital gains tax. Are there any legitimate downsides to giving the capital gains tax the same progressive structure and rates as the rest of our personal income taxes?


  6. Bud Meyers says:

    “We can have an efficient system that serves us well if we simplify the current code by treating all income the same, regardless of its source, close distortionary loopholes [on both personal income and corporate revenues]…and sticking with—I’d say expanding—the progressivity of the current rate structure.” PERFECT!


  7. perplexed says:

    We need more specifics on what the goals of our tax policies are and objective measures of whether or not these goals are being accomplished. Obviously we need revenue but what else are we trying to accomplish and are we getting there? We want to “internalize” externalities as RonE. points out above. These should offset the costs that businesses transfer to the public at large and make sure that business profits aren’t simply the results of having the public absorb transferable costs so investors can profit while competing technologies that don’t impose public costs are at a “market” disadvantage.

    Why progressive taxes? What’s the goal? How do measure it? How much progressiveness is enough? How much is too much? Progressive taxation is the only tool we have for controlling wealth and income concentration. http://nontrivialpursuits.org/Tax_Policy.htm Do we want to control it or not? If so how do we know if our “system” accomplishes our goals if we don’t have any explicit measurable goals? We want a “progressive” system that we have no way to measure? Why, what’s the point? Is it so we have something to argue about while our wealth Gini exceeds that of most third world countries and 23% of our national income goes to the top 1%? We have to get off this emotional roller coaster and make some decisions about how much income & wealth inequality we’re going to allow. Our lack of willingness to discuss this explicitly has allowed ideologies to take over our tax system and turn us into a banana republic because we refuse to have the discussion of what level of inequality is too high and too damaging to tolerate.

    What is the reason to use tax policy to “incent” investments we wish to support other than obfuscation? Is there a good reason not to get it 100% back in the budget where it belongs and doesn’t obscure where our revenues are coming from?

    If we can’t articulate our goals and choose the best policy with which to achieve them, the entire “system” becomes arbitrary and also becomes the object of profit for special interests groups who can sways things to their advantage. How else do you decide what marginal tax rates should be without considering their impact on redistribution and inequality? If we don’t spell it it out explicitly and discuss it, we relegate our children, grandchildren, & great grandchildren, etc. to live in a highly unequal society with all of the costs it imposes http://www.ted.com/talks/richard_wilkinson.html.

    This won’t change on its own; we have to do it, measure it, and make sure it happens if we’re at all serious about having successive generations of Americans live in the “land of opportunity.”


  8. Steve Roth says:

    The idea that taxing “investment” income discourages “investment” is based on a fundamental fallacy.

    Demand curves work via substitution. If the price goes up for something (or the it’s taxed), you buy more of something else (or don’t spend, IOW save).

    But if you have a pile of money that you don’t want to spend on food or Lamborghinis, there is no substitute for financial investment (which *is* saving).

    Except: real investment — in fixed assets, and in the vast pool of unmeasured intangible assets like organizational capital, knowledge (via education), skills (via training), ideas (via R&D), etc.

    So taxes on income from financial investments — at least such investments made by businesses — actually incentivize businesses to choose real investment as a substitute.

    Which is directly contrary to the false meme that moneyed interests/rentiers seek to promulgate.


  9. Steve Roth says:

    @David Yeah: the double-taxation argument against corporate+personal tax on dividends has legs, in my opinion. It certainly has rhetorical legs.

    I’m not sure why that idea has never gotten any traction. Both the left and the right have reasons to dislike it, I guess. All misplaced reasons, IMHO…


  10. stuhlmann says:

    You argue for closing loopholes and exemptions and all the different ways different types of income are taxed, yet you don’t seem to like flat taxes. Doesn’t a flat tax do most of what you want? Couldn’t a variant of a flat tax work very well, with the tax rate set at the right percentage and maybe the first X-amount of income tax free?

    I would like the tax code to require that corporations use the same definitions of revenues, costs, and profit when filling out their tax returns as they do when filling out their shareholder reports.


  11. Tom Cantlon says:

    I agree. Of the “big ideas” I favor the progressive consumption tax most, but just in terms of federal taxes we could well achieve most of what needs to be done by fixing what we have. The “it can’t be fixed” drone is just an excuse to change it all to something that favors those who think it can’t be fixed. P.S. Absurdly regressive state taxes are a different story.


  12. Auros Harman says:

    Steve, the problem with taxing all corporate income like S-Corps — which is pretty similar to how we tax partnerships, i.e. with the income of the business entity being treated as directly passed-through into the income of its owners — is that ownership in C-corps changes so rapidly, and the interactions between different classes of income and expense would be unique to every individual stockholder.

    It is much simpler to just regard the tax on C-corps as the cost of the liability shield. I’d be fine with lowering the rate somewhat while wiping out a lot of the loopholes. But limited liability, by itself, carries a moral hazard cost. We should demand a price for that.


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