A Would-Be Philosopher-King Offers His Optimal Tax Policy

If I had any real power I would tax you all in the following manner:

First, I’d impose a consumption tax such as a VAT on traded goods and services. The consumption tax will have to be progressive, for example by way of a 0% tax on food and other basic necessities and a rate close to 100% for luxuries. A consumption tax encourages savings and investment and does away with the disincentives of income and payroll taxes which it will replace (disincentives to work, earn and hire). It also puts a stop to wasteful conspicuous consumption and status competition, at least at the top end. The sharply decreasing marginal utility at high levels of consumption means that the tax can indeed be strongly progressive, with close to 100% rates at very high levels of consumption. Such a strongly progressive consumption tax will leave incentives in place: a $1 million dollar home motivates just as well as a $200 million home, because people mostly care about how they are doing relative to similar others and all similar others will be subject to the same taxes.

Second: add an inheritance or estate tax because the wealthy, who will save more as a consequence of the consumption tax, will die with larger estates than before. Inheritance is inherently unfair because undeserved. A tax on inheritance not only reduces this unfairness, but does so without distorting incentives. Most other types of taxes have disincentive effects: when an activity such as consumption, investment, employment or pollution is taxed, the activity becomes more expensive. Hence, people will to some extent disengage from the activity (consume less, hire less employees, invest less, pollute less) or find ways to reduce their tax burden (offshore profits or assets, fail to declare income etc.). Disengagement is good in the case of pollution and consumption, but not for investment and employment. An inheritance tax is one that doesn’t have disincentive effects. People will not die less when wealth and assets are taxed after death. This tax is therefore sustainable, in addition to being moral.

It’s a kind of wealth tax. Wealth taxes, including an inheritance tax, promote consumption and are in conflict with the stated aims of a consumption tax (see above). But in the case of inheritance tax that’s a reasonable price to pay. Other wealth taxes – with one exception (see below) – will have to go, precisely for this reason, as well as other reasons: wealth taxes are difficult (they are a percentage of the taxpayer’s calculated net worth – total assets including cash deposits, real estate holdings, investments, trusts and shares in businesses, minus debt – and this net worth is difficult to valuate and easy to offshore); and they raise liquidity problems (the taxpayer may have to sell part of her assets in order to pay the tax, which will increase the supply of assets and drive down their prices, making wealth creation less attractive and possibly undermining the wealth tax). So, although a wealth tax is perhaps a fair tax – wealth is more concentrated in the hands of a very small elite, compared to income – it’s not necessarily a good idea.

Third: add a land value tax. This is a wealth tax, but not really a real estate tax, because the largest part of the value of real estate is the value of the land, not the value of the buildings. It doesn’t cost much more to build a house in Manhattan than to build an identical one in the Midwest. The house in Manhattan is much more expensive because it’s on Manhattan land. A land tax is similar to an inheritance tax: no one built the land, so people will not have less land when it’s taxed. And because no one built it, no one can be said to deserve it. So no incentives arguments against a land tax, and a strong moral argument in favor of it. Just as with inheritance.

Fourth: add some pigovian taxes (taxes on carbon and other externalities such as pollution, congestion etc.).

Fifth: abolish all other taxes, including taxes on investment income or normal income, on corporate profits, on labor/employment etc.

This system yields our tax revenues. A tax system can be justified on different grounds, and I’ve already mentioned a few, namely fairness, incentives (incentives to consume less, to save and invest more, to avoid pollution…) and efficiency (ease of tax collection and tax calculation). But an important justification of a tax system is its general purpose. What do we want to do with the tax revenue? Apart from the obvious goals – public goods such as a police force, a judiciary, a national defense, infrastructure, some regulatory agencies, public education, healthcare etc. – my main concern is welfare, or social security as they say in Europe. And like an increasing number of people I want to propose that we use our tax revenues to fund a universal basic income system which will replace all or most of the existing government support measures such as unemployment benefits, pensions, food stamps etc. I’ve defended the UBI in more detail before so I won’t burden this already longish post any more than necessary.

Now tell me why I’m wrong.

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11 thoughts on “A Would-Be Philosopher-King Offers His Optimal Tax Policy

  1. Don’t wish to be a party-pooper, but I disagree on the basic income front. You already note one downside of the basic income philosophy in your other post, i.e. it may fail to cover health-care costs from some “catastrophic” event. Beside this specific fact (which would especially badly impact those at the lower levels of the income ladder and increase inequality in this sense), I disagree as this analysis fails to take into account the existence of certain market failures. It inherently assumes that the private sector is better in organizing all activities and government involvement is hence uncalled for. Yet, health care is not necessarily organized more efficiently by the private sector. Hence, your final conclusion has a significant libertarian bias, without taking into account the fact that sometimes government is better equipped to organize certain activities than the private market. The discussion thus reverts to the basic question, normally answered with a significant ideological bias : What is it that government should focus on, i.e. where does government involvement improve the situation due to significant economies of scale or the solution to market failures?

    1. I don’t disagree. Catastrophic healthcare coverage may have to be added to the UBI. Doesn’t mean however that UBI has to come on top of all existing welfare measures.

  2. Inheritance tax should be related to the size of the bequest. Spread the wealth and you escape the tax. Concentrate and you pay a lot.
    There is a macro problem in replacing income taxes with VAT. Spending is more unstable and procyclical than income. It would require far stronger stabilisation policies.

  3. To my way of thinking, virtually all economic activity stems from consumption and the desire to consume. Even investment and savings are driven by consumption (if you don’t want to consume anything, you have no reason to save money, and if nobody is consuming anything, you have no reason to invest in production). Jobs and therefore most individual income also flow from consumption. Taxing consumption in the way you propose would, I believe, have your intended consequence of reducing consumption, and the large unintended consequence of reducing personal income and jobs, overall. Moreover, since production costs for producers are a combination of fixed and variable costs, relatively small reductions in consumption (their sales) can quickly turn a profitable producer unprofitable, at least in the short run.

    I do like how you’ve made the consumption taxes you propose progressive so that they fall easiest on the poorest among us, and I dislike the income tax and its complexity and difficulty in collection vs. a consumption tax. But overall, in my opinion, shifting from income to a consumption tax would would shrink the overall economy and therefore the overall welfare by–probably–an unacceptable amount.

    Having said all of that, I think your implied social welfare goals are laudable, and I would like to see the US do better in that regard. I’m just not convinced that this would be the way to do it.

  4. We already have a land value tax, AKA property taxes. Farmers pay taxes on their fields. These taxes fund schools and county governments, and their levels are set by the voters who are directly affected. Other than locality sales taxes, this is the main source of revenue for smaller cities, towns and school districts.

    1. … and that’s me missing the point, sorry. You’re laying out the taxes you would impose, not commenting on taxes that should be imposed but are not yet in force.

      You do, however, imply that all these taxes will be federal taxes. How will states, counties and townships/cities raise money?

  5. Why are you wrong? To the (limited) extent that you are, it’s because your model world diverges from the real one.

    The biggest problem this causes is your rejection of income taxes. Your rationale for this is that you don’t want to discourage savings and work effort. However, at least at the moment there is no shortage of savings. Rather the reverse; we’re awash in unused capital. Under those conditions encouraging saving is counterproductive. What’s needed to employ idle resources is demand; i.e. consumption.

    (I note in passing that income taxes don’t discourage hiring. The decision to hire is based on anticipated profit, not on the tax rate faced either on the profit or on the person making the decision. Another en passant is that you’re ignoring the income effect on work incentive.)

    Also, IMHO the effect on work effort on reducing an income of, say, 2.5 billion to, say, 25 million would be zero. And considering what the financial types who make that kind of money do reducing effort would probably be a net plus.

    In a general way discouraging consumption is perverse. The reason for an economy to exist is to produce things people need or wish to consume. Favoring savings is presumably pro-growth. But growth is just a way to consume more in the future. Considering the declining marginal utility of consumption perhaps substituting leisure is preferable. Also, leisure is less capital-intensive than production (modulo the obvious counterexamples).

    Another downside to favoring growth is that growth benefits a tiny minority at the top of the income pyramid. Your model world doesn’t have that characteristic. You may argue that this isn’t inevitable, but it’s been the rule for about the last forty years. No doubt the first welfare-enhancing thing to do is change that situation. Until it does change socially optimal taxation policy is to tax the wealthy heavily, including taxes on top incomes. I wish policy to be optimal in the actual world. And I realize that parts of your proposed policy mix do tax the wealthy.

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