Sunday, June 24, 2012

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.

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