Principled Taxation

Having dealt with the principles underlying spending, let's turn to the topic of taxation.  Again, in my opinion, three principles are sufficient to help us design our tax code.

1. The tax code should pay for the spending we do.  This is particularly true of what we call the "base" spending.  A tax code that does not cover the spending we do is of no use from a budgetary perspective.
2. The tax code should be as simple as possible.  There is no reason for the extremely large numbers of exceptions, rate, alternative rates and so forth in the tax code.  This type of behavior is simply a giveaway by legislators to preferred constituencies of all types.
3. Income below a certain threshold should not be subject to tax.  It is entirely true that some income should be shielded from taxation since that income is necessary for subsistence.

In following these three principles, what type of tax code would we get?  Basically, we would wind up with a tax code that exempts income below a certain threshold, say 1.5 times the poverty level and has a single rate above that threshold.  This rate would apply to all income and would replace all personal income taxes, including the current FICA tax.

Some might object to taxing capital income at the same rate as wage income.  To me, there is an interesting debate to be had on this topic but that debate should occur on the corporate income tax side of the ledger.  Making the personal code more complex because of an argument about the corporate tax code to me makes relatively little sense.  Furthermore, the notion that capital income requires preferential treatment seems to me out of keeping with the current environment for capital (e.g., a very fluid, global, capital system).

Others might object that this system is not "progressive" because there is only one tax rate.  Of course, the outcomes are progressive (meaning the effective tax rates are progressive) despite the fact that the rate table is not.  

Finally, some would object that this type of a system would eliminate refundable credits, basically payments made through the tax code.  My argument is that these payments, should they be necessary, should simply be made through expenditures rather than through the manipulation of the tax code.

What would the rate need to be to make this type of a tax code work?  More on that in the next post when we run the numbers.

Principled Spending

Well, it took me a lot longer than I had thought it would to come back to this but I did want to return to the principled view on taxes and spending.  As I said I would, let's start with spending and what the principles are that we might use and what they might mean.

So what are the principles we could use for spending?  I'd say there are really only 3.

1.  Government spending should grow no faster than the historical rate of inflation plus “relevant population growth.”  It is critically important to argue that government should be on a COLA the same way that our seniors are.  Why should government be able to expand its budget faster than anyone else simply because it perpetually borrows the difference?
2. Government may still institute “emergency” spending during recessions but this spending will be accounted for separately and brought to zero as the economy improves.  Explicit countercyclical spending should in fact be accounted for separately.  Failure to do this is what has allowed the budget to expand under President Obama.  The stimulus was baked into the baseline, a terrible mistake from the standpoint of fiscal responsibility.
3. This COLA approach (excluding any emergency spending) will form the new baseline for government spending from which we will attempt to drive even greater efficiency.  In other words, the COLA approach serves as a ceiling rather than a floor for spending (ex-emergencies).

Let's explore these a bit more in depth.  As to the first, we should ask our politicians to set some threshold that isn't a baseline for how fast government should grow.  As a cost center, government shouldn't need to grow faster than the population it serves plus the rate of inflation.  In fact, growth at inflation plus population more or less assumes no positive returns to scale.

Principle 2 is equally important for fiscal sustainability.  The government should differentiate emergency spending from baseline spending with the assumption that emergency spending will be reduced to zero once the emergency has ended.  Overseas Contingency Operations (the wars) are a good example of this but so are automatic stabilizers (like extended unemployment insurance).  Without an assumption that these emergencies go to zero, we never can differentiate whats "in the base" from what's "temporary."  Putting things in the temporary bucket ties them to external events.

Finally, the third principle is what we the people ultimately ask government to do on our behalf.  The more efficiency we demand from government (or the more economies of scale we believe exist), the more we should ask for a rate of growth below the "COLA baseline."

These principles may seem small but in point of fact their application would dramatically improve our fiscal position, a point I will cover after we cover tax principles in the next post.

Another False Choice

Here's a great new false choice that is being bandied about.  From Reuters reporting a Reuters/Ipsos poll:

The online poll found Americans split over the right course for government, with 51 percent of respondents saying they support dramatic cuts in government spending and 49 percent saying that increased infrastructure spending would improve the economy.

Let's take a quick look at why this is such a false choice.  Let's say you wanted to dramatically, say by 20 percent or so, increase infrastructure spending while simultaneously cutting government spending.  Would that actually be possible?

Well, helpfully, the government publishes statistics on infrastructure spending.  From the BEA National Income and Product Accounts, we can see that infrastructure spending in 2010 was $505 billion including state and local governments.  Meanwhile, total government outlays in the same period from the same source were $5.26 trillion.

So let's see, a 20% increase in infrastructure spending would be $100 billion or a 2% decrease in government spending somewhere else.

Let's face it, the issue with infrastructure spending has nothing to do with how much money the government has to spend, it's all about what the government chooses to spend the money on.

If you're complaining about your roof leaking while taking a $100,000 vacation, there aren't a whole lot of people who are going to have sympathy for your plight.