The immediate stimulus for this post is this article, though it outlines ideas I've been mulling over for a while. It will strike many as quite a dry topic, though it is in fact fundamental to any discussion of inequality and redistribution. My ideas are informed by "Econ 101"-level understanding, backed up largely by Wikipedia articles, and so will no doubt be incomplete and lacking in sophistication. The idea at present is to throw out some broad proposals, allow with potential complications, and see what people think. I hope to write a follow-up once I've thought through the details a bit more.
Before giving specific proposals, I should outline some general principles:
1) Tax policy should implicitly or explicitly specify a minimal expected standard of living per person. Income up to this level should not be taxed, and arguably income below this level should be "topped up" by a negative income tax or basic income. My personal view is that the level of this minimum income should be set as a fraction of per capita GDP and updated accordingly. Obviously there will be political disputes about how large a fraction this should be, which I won't get into here.
2) Taxation should be minimally distorting. That is, it should avoid, insofar as possible, encouraging people to behave economically in ways that they wouldn't have otherwise. However...
3) Some distortion is inevitable and should be targeted at reducing undesirable behaviour and increasing desirable behaviour. What behaviours are so classified will inevitably also be subject to political contestation.
4) Taxation should reduce inequalities that come about in market economies. That is, it should be broadly progressive, with the well-off bearing a disproportionate burden of taxation, and the worse-off bearing a lesser burden or actually benefiting (through negative taxation).
5) It should not be easy to avoid taxation by classifying economic activity differently, by moving it slightly backwards or forwards in time by trivial amounts, by changing the legal owner of assets, etc.
Here, then, are some proposals:
1) Taxation on individuals should be progressive with respect to annual consumption, as opposed to gross income. The basic motivation for this is that consumption is what actually contributes to human well-being (you can't eat bank deposits) and that inequality in well-being is what we find truly odious. The simplest way to calculate consumption, it seems, would be to simply subtract the value of certified savings and investments from gross income (including adding the value of withdrawals from savings). Such a "consumption tax" has several nice features. Firstly, as emphasised, it seems to target the inequality that we're really worried about. Secondly, it is "time neutral" with respect to consumption - if I sock away income, I only pay tax on it when I actually spend it. The attractiveness of this feature is already recognised in the tax-exempt status that many governments grant to vehicles for pension savings. The current proposal would simply extend the basic principle to all savings. Thirdly, it encourages saving and investment.
As an aside, another nice feature of this proposal is that savings could still be taxed, though at a lower rate than consumption. Varying this rate would allow "tuning" of real interest rates and so give another macroeconomic tool to governments to prevent economic stability. The classic Keynesian explanation of depressions is that uncertainty increases the propensity of people to save, beyond the capacity of the economy to absorb the ensuing quantity of investment capital. Under such circumstances the "market clearing" return on capital is negative, i.e. money that is saved should decline in real purchasing power. Central banks can bring actual returns partly in line with market clearing rates by ensuring that inflation rates exceed interest rates, thus eroding the value of savings. The point I'm making here is that explicitly taxing savings gives another means of reducing the real value of savings.
2) Sources of income from various sources should, insofar as possible, be treated identically. Ideally, income from wages, withdrawal of savings (construed broadly, so as to include capital gains and dividends), gifts, inheritance, entrepreneurial activity, etc. should all go in one "pot" and then taxed according to what proportion of it is consumed by the individual concerned in the relevant time period. The idea behind this is to reduce incentives for tax avoidance and distortions that may result from favouring some activities over others.
A corollary of this is that...
3) There shouldn't be taxes on corporate profits. Corporations are owned by individuals, and all economic benefits eventually accrue to those individuals; this is where those benefits should be taxed. Another factor behind this proposal is that what counts as "profit" is notoriously elastic, and this is a major avenue for tax avoidance. I am sensitive to the argument that corporations should make some contribution towards public infrastructure that they use, over-and-above what individual shareholders would use. But then they should be taxed on economic activity, perhaps as determined by revenue or payroll.
From the perspective of a particular country, we may also have to think about repatriation of profits by foreign corporations, and those profits will eventually be enjoyed by foreign individuals who are not subject to the tax regime of the country in question. Another complication to think about is retention of corporate earnings - in times of economic uncertainty, corporations may also have a propensity to save that exceeds what is socially optimal. Moreover, individual shareholders of corporations may be able to avoid taxation on personal savings by holding shares. It is already a problem that employees or shareholders of corporations attempt to avoid declaring personal consumption by classifying them as corporate expenses, but incentives for this might be increased under the current proposals.
4) There should be a tax on the unimproved value of land. The wiki article explains this in detail, but I'm emphasise a few nice features. Firstly, a land tax is non-distorting, since the legal framework in most countries means someone has to own every patch of land, and the amount of land (barring exceptional circumstances) neither increases nor decreases. You can only avoid the tax by passing on the land to someone else, in which case that person has to pay the tax. Secondly, since you'll pay the same tax however you use the land, it provides incentives to use it more efficiently. So, for instance, if the area in which your land sits increases in desirability, you should build more or better-quality accommodation. If you aren't able to improve the land, you have an incentive to sell it on to someone who is able to.
5) There should be a tax on carbon, environmental pollutants, the sale and production of alcohol and other economic activities with significant negative externalities. I take it that the case for such taxes is obvious. Although such taxes may tend to be overall regressive, the progressive tax on consumption and the land tax would both be progressive, leading to an overall progressive system of taxation.
Before giving specific proposals, I should outline some general principles:
1) Tax policy should implicitly or explicitly specify a minimal expected standard of living per person. Income up to this level should not be taxed, and arguably income below this level should be "topped up" by a negative income tax or basic income. My personal view is that the level of this minimum income should be set as a fraction of per capita GDP and updated accordingly. Obviously there will be political disputes about how large a fraction this should be, which I won't get into here.
2) Taxation should be minimally distorting. That is, it should avoid, insofar as possible, encouraging people to behave economically in ways that they wouldn't have otherwise. However...
3) Some distortion is inevitable and should be targeted at reducing undesirable behaviour and increasing desirable behaviour. What behaviours are so classified will inevitably also be subject to political contestation.
4) Taxation should reduce inequalities that come about in market economies. That is, it should be broadly progressive, with the well-off bearing a disproportionate burden of taxation, and the worse-off bearing a lesser burden or actually benefiting (through negative taxation).
5) It should not be easy to avoid taxation by classifying economic activity differently, by moving it slightly backwards or forwards in time by trivial amounts, by changing the legal owner of assets, etc.
Here, then, are some proposals:
1) Taxation on individuals should be progressive with respect to annual consumption, as opposed to gross income. The basic motivation for this is that consumption is what actually contributes to human well-being (you can't eat bank deposits) and that inequality in well-being is what we find truly odious. The simplest way to calculate consumption, it seems, would be to simply subtract the value of certified savings and investments from gross income (including adding the value of withdrawals from savings). Such a "consumption tax" has several nice features. Firstly, as emphasised, it seems to target the inequality that we're really worried about. Secondly, it is "time neutral" with respect to consumption - if I sock away income, I only pay tax on it when I actually spend it. The attractiveness of this feature is already recognised in the tax-exempt status that many governments grant to vehicles for pension savings. The current proposal would simply extend the basic principle to all savings. Thirdly, it encourages saving and investment.
As an aside, another nice feature of this proposal is that savings could still be taxed, though at a lower rate than consumption. Varying this rate would allow "tuning" of real interest rates and so give another macroeconomic tool to governments to prevent economic stability. The classic Keynesian explanation of depressions is that uncertainty increases the propensity of people to save, beyond the capacity of the economy to absorb the ensuing quantity of investment capital. Under such circumstances the "market clearing" return on capital is negative, i.e. money that is saved should decline in real purchasing power. Central banks can bring actual returns partly in line with market clearing rates by ensuring that inflation rates exceed interest rates, thus eroding the value of savings. The point I'm making here is that explicitly taxing savings gives another means of reducing the real value of savings.
2) Sources of income from various sources should, insofar as possible, be treated identically. Ideally, income from wages, withdrawal of savings (construed broadly, so as to include capital gains and dividends), gifts, inheritance, entrepreneurial activity, etc. should all go in one "pot" and then taxed according to what proportion of it is consumed by the individual concerned in the relevant time period. The idea behind this is to reduce incentives for tax avoidance and distortions that may result from favouring some activities over others.
A corollary of this is that...
3) There shouldn't be taxes on corporate profits. Corporations are owned by individuals, and all economic benefits eventually accrue to those individuals; this is where those benefits should be taxed. Another factor behind this proposal is that what counts as "profit" is notoriously elastic, and this is a major avenue for tax avoidance. I am sensitive to the argument that corporations should make some contribution towards public infrastructure that they use, over-and-above what individual shareholders would use. But then they should be taxed on economic activity, perhaps as determined by revenue or payroll.
From the perspective of a particular country, we may also have to think about repatriation of profits by foreign corporations, and those profits will eventually be enjoyed by foreign individuals who are not subject to the tax regime of the country in question. Another complication to think about is retention of corporate earnings - in times of economic uncertainty, corporations may also have a propensity to save that exceeds what is socially optimal. Moreover, individual shareholders of corporations may be able to avoid taxation on personal savings by holding shares. It is already a problem that employees or shareholders of corporations attempt to avoid declaring personal consumption by classifying them as corporate expenses, but incentives for this might be increased under the current proposals.
4) There should be a tax on the unimproved value of land. The wiki article explains this in detail, but I'm emphasise a few nice features. Firstly, a land tax is non-distorting, since the legal framework in most countries means someone has to own every patch of land, and the amount of land (barring exceptional circumstances) neither increases nor decreases. You can only avoid the tax by passing on the land to someone else, in which case that person has to pay the tax. Secondly, since you'll pay the same tax however you use the land, it provides incentives to use it more efficiently. So, for instance, if the area in which your land sits increases in desirability, you should build more or better-quality accommodation. If you aren't able to improve the land, you have an incentive to sell it on to someone who is able to.
5) There should be a tax on carbon, environmental pollutants, the sale and production of alcohol and other economic activities with significant negative externalities. I take it that the case for such taxes is obvious. Although such taxes may tend to be overall regressive, the progressive tax on consumption and the land tax would both be progressive, leading to an overall progressive system of taxation.
Dean, I find we're in broad agreement. By the way, on carbon, you can also look for 'fee and dividend' type systems, see her: http://en.wikipedia.org/wiki/Fee_and_dividend These needn't be as regressive as you were concerned about. Also, if you haven't read it, I found some of the content of Robert Frank's 'The Darwin Economy' on positional competition and reasons for consumption taxes quite valuable (he goes on about consumption taxes all the time, but articulates why more comprehensively in his books, e.g. also in 'The winner-take all society' - http://www.amazon.com/The-Winner-Take-All-Society-Much-More/dp/0140259953). Certainly, some of his positions are more paternalistic than libertarian, but I find myself often agreeing with him especially e.g. about housing and schools relating to positional competition elsewhere in the economy and thus helping to perpetuate inequality. Also, you mentioned carbon, but there are a variety of other issues pertaining to climate change that need to be managed better - sulfur, methane, water. I don't know if you read Jeff Frankel's recent project syndicate piece, but it was worth reading: http://www.project-syndicate.org/commentary/jeffrey-frankel-examines-the-startling-decline-of-market-based-approaches-to-regulation
ReplyDeleteGood luck with the blogging.