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February 07, 2009 06:40 PM UTC

Dr. Spendright or: How I Learned to Stop Worrying and Love Taxes

  • 34 Comments
  • by: Bondo

( – promoted by Colorado Pols)

The discussion of taxing and spending in American politics, and especially Colorado politics, leaves much to be desired. The Republican Party’s position can pretty well be summed up as “taxes bad, spending…well, it depends” while the Democrats are a bit more like “alright, I guess taxes must be bad, but we sure think this spending would be nice.” There is nothing inherently good or bad about taxes or about governmental spending, either can be good or bad depending on how it is done. Thus, instead of demogauging about taxes and government spending, we need to do a better job discussing these issues to identify how we should tax and how we should spend, since ultimately, we will have to do both.

Not all taxes are created the same. Economic principle states that what you tax, you will get less of, which is useful to keep in mind when building a tax policy. Another sound economic principle is that a flat tax causes the least market distortion, as the marginal benefit remains consistent. However, there is good reason not to put all our focus on one area for taxes. For reasons we can tie to diminishing marginal returns, there is also a benefit to having a tax system that targets multiple areas. Conservatives often complain about “double taxation,” as if it should be forbidden to tax a particular dollar of work more than once. This of course, is a bit inane, as if one isn’t going to tax it a second time, they’ll just have to tax it more the first time.

Our current tax system is a complete mess. The federal government has loophole ridden personal and business income taxes that often allow the highest earners to pay a lower rate than middle income Americans. It has payroll taxes that are regressive relevant to payroll, and more regressive relative to total earnings. The state and local governments vary from place to place, but tend to include income, sales, and property taxes as well as any manner of fees for services. Combined, government taxes and spends about 30% of the GDP.

Another important caveat; based on my perception, it is easier for the federal government to tax than state and local governments. This means that an efficient tax system may include the federal government taxing more and distributing significant portions to the states rather than the states generating the revenues directly. This system has a second major benefit, and that is of the federal government’s ability to run a deficit and provide countercyclical actions, running deficits in recessions and paying off debt in the crests.

So how should we tax? Generally speaking, we would like to tamp down consumption, to promote national saving in the long run (though this certainly applies less during a recession). As such, there should be a 15% consumption tax (or VAT). Though we should be less anxious to tax investment or income, an income tax is a necessary component of a tax system. However, it should have no deductions or credits, include income both from labor and investment, and be flat, again, 15%. For a reason I will explain when I get to spending, I actually feel there is a justification to build in what we would now conceive of as the standard deduction, only to be more effective and provide a slight progressive tilt, it should be a refundable tax credit, not a deduction. Business taxes generally should be avoided as they are fairly ineffective (they end up being passed on to consumers or taken out of salaries) and can stifle economic productivity. Ultimately, all money businesses make will end up in the hands off individuals where it will be taxable. However, we can certainly feel free to have a modest business tax if we desire. Now, we must understand that these two 15% taxes do not actually add up to 30% of the GDP due to the manner in which taxing works, so we are not done yet. Additionally, due to the argument to be made related to spending, I will actually suggest government taxation closer to 40%.

Moving beyond these two main forms of taxation, we get into more targeted forms of taxation. One particularly economically sound area of taxation relates to externalities. Taxes can be used to expose individuals to costs related to their actions that they will not face naturally, causing them to overconsume the equilibrium. The most notable area for this is in addressing climate change. A tax on carbon and other forms of pollution is entirely justified, and can be used directly to fund programs that deal with the costs of that pollution. Similarly, tobacco, alcohol, and drugs to be legalized later merit special tax treatment due to the social costs they incur. One might even go so far as to tax unhealthy foods. Either way, through these other forms of taxes, we can reach our goal of 40% of GDP.

Now, the system I’ve laid out is largely flat. Like I said, this is good because it provides no disincentive towards increased production. This does however pose a problem in that 40% is a much greater burden to poorer individuals than wealthier ones. Rather than make the tax system more progressive, but less efficient, we can address this concern of redistributive justice through our choice of spending.

One of the major goals of the government is to provide for a foundational quality of life for all of its citizens, and it can do this quite efficiently by quickly putting a significant portion of its revenues right back to the taxpayers. The key though, is that this spending be universal and pay out the same value in benefits. This is important because frequently, benefits have been tied to income level. In some cases, earning more makes you worse off because of the lost value in benefits, thus acting as a disincentive to work. Additionally, particularized benefits tend to provoke resentment, while universal benefits draw broader support. The graph below (click to enlarge) compares the cost (taxes) and benefit as a percentage of income assuming all government revenues were distributed equally.



This next graph displays the net benefit as one moves up in income, showing the redistributive effects of combining a flat tax with equal spending.



A key point under this system is that everyone under the mean income benefits while everyone over the mean income has a net negative benefit that grows as they go up the income scale. But this is how we ultimately expect our system to work, we expect the richer individuals to support the poorer. And, because of the nature of income distribution, the mean is actually skewed, so that a majority of Americans would benefit under this system.

So what kind of policies do we structure to create this equal benefit? One example, as I discussed in my post on health reform, is a health savings account for each individual worth $4,000 per year. Similar accounts could be established for full-life education (funding early childhood education through college and even continuing education or job retraining), housing vouchers, and food vouchers. These universal programs would be easy to administer because everyone would qualify, could be tied to a smart ID card used to pay directly to a health provider, school, apartment complex or grocery store. This would provide the essentials for a basic quality of life for each American and would quickly use up 2/3 of the government pot, without any massive bureaucracy, because it would be released back into the private market. The key is that this brief time spent in government hands would have allowed for a redistribution to provide that minimum standard of living, and guaranteed that funding would be spent on these essential items. Naturally, those with greater wealth would combine their vouchers with private funds to purchase more expensive homes or nicer food. Unspent funds would roll into future years, providing security, and eventually a retirement fund (supplanting Social Security).

This form of social spending is a majority of what government does. These social expenditures make up well over half of governmental budgets. The additional funding would go towards public goods such as national defense as well as collective liabilities, which is to say, paying down the debt. In many ways, the benefits of some of these are not actually equal. The rich man benefits more from law and order than the poor man, if only because he has more to lose from chaos. This is why it seems justifiable to add some subtle progressive elements to the tax system such as the standard refundable tax credit on the income tax.

Now, I can only expect that Republicans will complain about the strong increase in taxes and spending that result under this system, but it is important to consider how much of the funds pass through with minimal administration costs. Additionally, the movement towards a flat tax and eliminating particularized welfare benefits should be considered a plus. Between the more efficient manner of this, and the stronger safety net, the American economy could be more vigorous and entrepreneurial, strengthening our position in the world economy going forward. Yet, Democrats can hardly complain about the redistributive power of the system and the strength of the safety net. It is a system that combines values from both liberals and conservatives not as compromise, but as mutual interest. And that is how one can effectively tax and spend.

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34 thoughts on “Dr. Spendright or: How I Learned to Stop Worrying and Love Taxes”

    1. Ok, read your post over there (however comments were disabled so I’ll reply here). What you propose is basically neo-Hooverism. I know, I know, you don’t believe in Keynesian economics, but Keynes was right. You don’t cut spending in a recession. Short term deficits don’t really matter considering the interest rate is effectively zero.

      Secondly, there is no good reason to think that luxury spending creates jobs any better than ordinary spending. What’s more, those who tend to buy ordinary things are more likely to spend each marginal dollar rather than save it. Thus, getting money to those individuals is better stimulus than getting it to those who would even think about buying a luxury car at the present time.

              1. I was making a joke.  I apologize if it didn’t meet your impossibly “high standards;” please feel free to begin to dazzle us by applying them to your posts in the future.

  2. I understand people are less likely to like wonkish 1500 word posts, but hey, it is there for those who like that sort of thing.

    But I think you misstate the dynamic of taxes. It is true that people will spend less on the specific item taxed than they would otherwise, but it isn’t like taxes are just sucked into a black hole. They are spent on things, and thus jobs are created.

    Beside the long-term argument that we SHOULD spend less while saving more, at least in terms of my plan, people will actually be as likely to spend more in some areas because they’ll be spending less in others. Namely, if we make health care more efficient (higher taxes, yes, but lower spending overall) we free up more money for discretionary spending.

    My post was sprawling enough that I didn’t cover everything, but too many people simply don’t understand how taxes affect people, and they fall into badly mistaken myths of subsequent behavior.

    1. …is if people spend less, then less needs to be produced, and then there are fewer jobs. This is a large part of what caused the depression – less demand than required for full employment and it went into a downward spiral.

      1. This is not a stimulus proposal. This is not something that would be enacted in full in the next year. This is a long-term ideal for righting of the economic trajection of the country. While in the short term we would like a bit more consumption (and certainly not raise taxes), eventually we will have to consume less since we were doing it beyond our means, and that cannot continue forever.

        2. How about a flat federal tax with the first $25,000 earned tax free. Absolutely no loopholes, credits or deductions. Also, is your consumption tax a federal tax or a local, county and state sales tax? After reading your post it appears to be a federal consumption tax and there would still be state and local sales tax? Why not have a higher flat tax after the first 25K tax free and a smaller consumption tax with no taxes on food.  

          2. I feel like part of the goal of my plan is that the poorest still pay their share of taxes and feel equally vested in the system, but due to the benefit structure, they still are helped rather than burdened. If you incorporate a blanket income disregard, a quarter of the public would not be buying in the same way. 25k strikes me as a bit high for an income disregard. I’d have to see the actuarial workup on such a plan, but it would seem to force a higher than desirable tax rate on the rest.

            Regarding the consumption tax, which would be federal, I feel there is a strong argument that it is preferable to an income tax, so reducing it is not really a fitting goal in my mind. I should say that items bought using the vouchers (including food) would not be taxed, thus helping avoid regressive tendencies for consumption taxes.

              1. One of the major points of the system I lay out is that the progressive element is introduced through spending rather than taxation. Your proposal distinctly throws it back into the taxation element.

                That said, our major dispute is probably more around the level. My proposal included a standard deduction of sorts. Right now the standard deduction (again, I would propose it be a refundable tax credit) is about $5k per person. What you are proposing is in essence a $25k standard deduction (non-refundable). My plan is actually better for the very, very poor (those who make less than the standard deduction) than yours is, due to the refundable nature.

                Also, the thing to consider is whether we talk about individual or household. Everything I was discussing was on an individual level. While each individual would have a $4000 health savings account, a family of four would have in effect $20,000. And the standard tax credit would be $20,000 off household income for that family of four.

                Having a blanket $25k income exclusion for a household makes little sense because it would be excessive for a household of one and potentially not enough for particularly large households. Similarly, having that exclusion be for each person (or each income earner) would clearly make it too generous.

                1. I understand your proposal. And certainly agree that we need to restructure our tax code. I still feel like the first 25K federal tax free plan is most equitable and saleable to everyone. I’m not sure what the bottom line gain or loss might be in federal tax revenue. If federal tax revenue decreases significantly under this model then the figure could be lowered to 20K. The simplicity of this plan would be appealing to many.  

                  1. I’m willing to accept a more progressive income tax on one condition, flat (consumption) taxes should be used to raise the revenue tied to the specific spending aspects that distribute funding to individuals on an equal per capita basis. I think it is vital for this element to be structured as such (flat tax, universal benefit).

                    I would accept (and even allowed a degree of) progressive tax (again, what level of income is excluded would be up for actuarial negotiation) to fund the rest of government that is not as tidy in being able to determine who benefits at what amount.

                    1. then the plan would probably not pass. The beauty of the first 25k or 20k federal tax free is that everyone benefits. Personally would be fine with excluding 200K and above, but. If this discussion gets any more sophisticated than you will lose me. I have a B.A. in Sociology not tax policy 🙂

                    2. When I say income exclusion, it is the same thing as saying it is tax-free for that amount. Basically the calculation would be Gross Income-Exclusion*Tax Rate=Income Tax.

                      Exclusions are used by some Medicaid/SCHIP programs to make the effective coverage level higher (more generous).

                    3. were going to go over my head. Bondo, I can tell you are a reasonable moderate. Now, I need to get back to more exciting stuff like all the scuttle butt about who is going to primary who.  

  3. Seems there was a meeting yesterday of residents of Casey Key, an enclave of the rich.  They have been talking about incorporating, which would need more taxes, of course.  Another layer of government.

    Being rich, therefore probably a Republican and a conservative says, “I’m against taxes, any tax.”

    He failed to note that the meeting was being held in the local, tax supported, firehouse.  

  4. I’m no tax expert.  I like what Bondo says, even if I disagree on several points.

    Here are two points of comparison:

    About four years ago daughter and hubby spent the summer in Belgium so that he could get more experience in his bicycle racing.  They had to ask family and friends to stop sending things because the VAT ate up their budget.  Send a pack of corn tortillas, it got taxed.  Heavily.

    Now, has anyone else noticed the new eBay seller category out of China?  They sell computer and electronic parts at prices that are ridiculous.  A buck or five for real stuff, all coming from Hong Kong. I’ve yet to be disappointed.  I don’t know how they do it, but there is never a charge on this end.  

    Frankly, that shouldn’t be the case.  Nor should the heavy VAT EU tax.  Is there something in the middle?  

        1. they pay, copy right violations, single shot executions, mobile execution chambers, Tibet, blocking of certain internet content (and no I’m not talking porn here).

          Yeah so I totally disagree that 95% is not copy … more like 95% is copy made with slave labor wages.

          When China implodes and nears civil war … you’ll be there professing how Obama needs join with the communists to hold it together.

    2. Regarding the VAT, I cannot claim to have a perfect understanding of it. But what I’ve heard is that it is a more effective way of doing a consumption tax than our own sales tax. The thing about a VAT is that it is not anti-trade in the same way that a tariff is. It does not target import goods specifically. Rather, in the EU, the VAT applies to domestic goods as well, and to not also apply it to import goods would destroy domestic competition. I guess the concern is that if you buy something in one place, paying a VAT, and then send it elsewhere, paying that VAT, you will have made the product much more expensive and disincentivize trade. These are certainly issues to ponder when crafting the consumption tax element.

  5. Thats right big boy. Lets look at CA, $40 billion is shovel ready debt, who can’t pay their current obligations because there is no additional capacity to tax without causing housing values to crater or economic transactions to curtail.

    My guess is by @2010 you’ll be here blogging about the same tired approaches to more big government.

    1. My plan has the vast majority of spending going right back to individuals with essentially no bureaucracy. It seems a bit inane to use “big government” to refer specifically to tax rate rather than bureaucracy size and reach.

      That said, you are mistaken about California. Their inability to deal with their deficit is because of political institutions that prevent raising taxes. They have the capacity to tax, just that the means. That said, all states are in a bad situation because they are forced to make cuts when it is worst for the economy. That again, is tied to political institutions rather than economic reasons.

      P.S. The US tax burden is far from hitting the point on the Laffer curve that it would be counterproductive, which is typically placed in the mid-40s% range.

      1. passes the IRS has my address. I’ll expect a $30,000 check.

        You know, my ‘fair share’. Because if the spending is going right back to individuals then here I am awaintin’ me check.

        1. but I did stay at a Holiday Inn Express last night.

          Seriously, how is it that you are talking about the stimulus package in response to me talking about my hypothetical proposal for the structure of federal taxation and spending? They are not the same thing in any sense of the word.

  6. but someone has to point out how crazy this is, whether you’re a Democrat or a Republican.

    Look, I like the idea of figuring out a way to make our tax system more efficient and more equitable, but this scenario is in no way plausible.

    First, this plan would call for an absolutely massive increase in government spending (not necessarily something I’m opposed to, but…) while decreasing total government revenue. From reading the comments I take it that you’re alright with short-run deficit spending. Fine, me too. However, your tax plan would (roughly) double the consumption tax (generally from 6-8% now), while more than halving the income tax revenue. In the status quo, most people who pay significant amounts of income tax pay above the 15% that your plan would call for. The wealthiest pay 33%, middle-class in the low to mid twenties, etc. Currently this revenue from the middle and upper class accounts for nearly all of the government’s earnings. The poor have virtually no tax liability (excluding the regressive taxes that your plan champions), so at the point that you are drastically cutting the main source of government funding (income tax on wealthy people). Your VAT cannot possibly make up for it since, as you said, it is a tax that encourages savings which decreases overall consumption and thus decreases the money taxed on consumption. The only people who will continue spending are the poor, who have to, which means that your plan forces the poorest people to make up the slack in government revenue — wiping out any distributive benefits your spending idea gets. In addition to being bad policy, it’s actually unsustainable, as financing your spending requests would require a massive permanent increase in annual deficits, which is a problem for another point and time.

    Second, ok, let’s get this straight, you want to make our country more efficient by having the federal government take over feeding, housing, clothing, paying, educating, and generally taking care of the vast majority of the country? And you think this will somehow create an incentive to work? Look, the federal government has a key, absolutely crucial role to play in filling in the gaps, and providing assistance to those the market shuts out. But to suggest that the government should take care of everything for everyone is a bit ridiculous. You’re asking for one boon-dogle of an institution there with no competition to make it perform efficiently.

    Finally, hopefully the shortest point, you’re entire argument is predicated on the assumption that we should be encouraging savings, and that progressive taxes create disincentives to work. Really? You’re really going with that? We’ve had a (more or less) progressive tax system in America for over 100 years now, do we seem to be lacking in people who are or want to be ga-jillion-aires? Any warrant as to why we should be increasing savings when our most recent encounter with increased investment (remember all savings is investment) has been a sub-prime mortgage nightmare?

    Yeah, didn’t really think so.

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