Many national governments are funded through a combination of income and broad based consumption taxes, usually in the form of a Value-Added-Tax (VAT). In the United States, consumption taxes (in the form of sales taxes) have been left to the states, while the federal government relies on a combination of income taxes, payroll taxes, excise taxes, and duties. Some economists wonder if the future demands on retiree benefits might make a federal consumption tax inevitable, while the proponents of the so-called ‘fair tax’ are advocating that nearly all federal taxes should be eliminated in favor of only a national sales tax, which they estimate would be about 23 percent.
Some basic truths are usually overlooked in the discussion:
- Nobody is going to come up with a tax structure that will be universally regarded as ‘fair’. Inevitably people will believe that ‘some people’ are being burdened unfairly and that ‘somebody else’ should be taxed more. Typically the ‘some people’ is you and the ‘somebody else’ is, well, somebody else.
- All taxes depress economic activity. Even the ‘non-tax’ of federal borrowing has negative consequences. The question is only a matter of (i) which form of economic activity and (ii) how significantly.
- As soon as taxes represent a significant portion of a transaction, then effort will be made to avoid them, either through lobbying for exceptions or subterfuge. So for example, currently sales taxes have a comparably high compliance and low complexity compared to the income tax. However, if the combined federal/state sales tax burden approaches thirty percent, the inestimable creativity of our nation’s lawyers and accountants will be unleashed upon the question of how to have things without ‘purchasing’ them. While a multi-entity leaseback through offshore shell corporations might not be worth it for a $20 shirt, the story is different for a $20 million plane.
So if there is no perfect tax, which it the least imperfect?
Income taxes, including payroll taxes, obviously hurt net spendable income. They are relatively easy to make progressive through tiered tax tables, but the definition of and reporting of all the various forms of income can take considerable effort. There are frequently complaints of ‘double taxation’ since any piece of income was first somebody else’s income.
Consumption taxes, such as sales and use taxes, hurt the value of net spendable income because the final price of everything is higher. They are harder to make progressive and are considered regressive since a greater portion of the income of highly compensated persons goes into wealth and not purchases. Since a value-added approach can be taken to their collection, there are fewer cases of ‘double taxation’.
Wealth taxes are relatively uncommon and have mostly been approached from an indirect standpoint such as property taxes. A comprehensive wealth tax could take the form of expecting citizens to create a balance sheet and paying a percentage of their net worth. While this would have a negative effect on invetment income, it would be progressive. Moreover, wealth might be able to be defined broadly enough to make evasion techniques difficult. There would be many complaints of ‘double taxation’ since, like income, all wealth was previously somebody else’s wealth.
Financial Transaction taxes are a relatively new idea that is being considered in some circles. The idea would be to place a tiny fee, say a tenth of a cent, on every financial transaction enacted through a bank, brokerage or other similar financial institution. This could raise substantial revenues and be relatively easy to administer since the number of financial institutions is much smaller than all of the nation’s income earners or businesses. The economic impact would be on both income and consumption and wealth, with particular impact on high-transaction rate activities like computerized trading. Some of those proposing financial transaction taxes are suggesting that it should be simultaneously agreed upon by all the major economic powers so as to avoid problems of financial markets relocating.
Import/Export Duties have fallen out of favor in the era of free trade but were previously both a significant financial tool and a route to promoting particular industries and exercising foreign policy. They have been promoted almost as a free lunch, both helping promote the local economy and raising money. Now duties are largely seen as a form of consumption tax, with the consumer paying more for both the imported commodity and its domestic form from reduced price competition.
Excise Taxes are frequently overlooked, but particularly in the case of ‘sin taxes’, are a not insignificant part of the whole tax picture. Excise taxes are targeted consumption taxes and are regressive unless specifically targeted at luxury goods. The more common approaches to excise taxes have been justified as balancing the social costs of private behaviors, like (i) paying for the public health costs of smoking or the environmental cost of greenhouse gas emissions, or (ii) taxing gas to build roads. Often the tax is justified by the efforts people will put to avoid it (like quitting smoking) but can just as well result in smuggling. It would be interesting to speculate as to what to impose an excise tax on, and how expensive it would have to be, in order to substantially replace the federal income tax. Gas at $20 a gallon but no income tax anyone?