In his recent post on proposals for a flat tax, Tyler Cowen cites this op-ed from The New York Times:
In 1940 the instructions to the Form 1040 were about four pages. Today they are more than 100 pages, and the form itself contains more than 10 schedules and more than 20 worksheets. The complete tax code totals about 2.8 million words – about four times longer than “War and Peace” (and considerably harder to parse).
Look at the bright side, Tyler. They could be in Russian.
My own feeling on the subject of taxes is that marginal tax rates are largely beside the point. The critical issue is how income is calculated. Differences in how different kinds of income are taxed, various different deductions, and varying levels of fringe benefits that aren’t subject to personal income tax, are all methods of altering the progressivity of the tax system.
That’s why the Fair Tax is so appealing. It’s not regressive and it cuts the Gordian Knot of the calculation of income
I haven’t done a lot of research, but my instincts tell me that people with resources will figure out how to avoid paying taxes for large purchases, thus sheltering themselves from the tax. They will purchase online or purchase overseas. Up until now, many people have avoided paying sales tax by using those strategies. Witness the proliferation of e-commerce. Adding an additional “fair” tax to sales to substitute for income tax would in essence result in those people avoiding not just sales taxes, but also income taxes. In my opinion it would be a disaster. I think the first thing we need to do is figure out how to capture taxes on all e-commerce.
The Far Tax has problems, as above, although those can be solved. However, the rate it would have to be at would lead to a huge underground economy. How do you make sure that a roadside fruit stand collects it? How do you then make sure that all purchases don’t migrate to such places?
At the rate proposed (around the 20% mark I think ) it is simply a non-starter.
The advantage of VAT systems is that it is charged on the margin of each stage of production. While the final rate to the consumer is the same each stage in the production process has a much much lower incentive to cheat, thus lessening cheating overall.
I agree that the definition of income is important. The wider any tax base the lower the rate can be. Fewer exemptions, fewer special rates. Economists like this precisely because they do think that marginal rates matter. The higher the marginal (not absolute) rate, the more the tax changes people’s behaviour at that margin.
My preferred solution is a consumption tax. This is collected in the same way as the income tax, but all savings are deducted from income. All spending from savings are treated as income. Very similar to the idea that everyone has a giant IRA or something, one which is inheritable etc. What you put in is tax free, what you earn in it is tax free, what you take out of it pays the standard rate of consumption tax.
Combine it with a flat tax and I think you’ve got the best you’re going to get. Encouragement for savings, no double taxation of the returns to saving, low marginal rates, easy to collect, easy to understand, combine it with a high exemption and you could even call it progressive. What a great idea!