Wednesday, 14 March 2012

TAXES: HERE COMES THE GRIM REAPER! , PART 1


Introduction


This is going to be another serialised article and not just because I think it suits the blog-format better than a long winded newspaper length article. The truth is that I am not a fiscal expert by any stretch of the imagination and that, while I got a good idea of what I want an ideal/utopian tax system to look like and achieve, I am quite open as to how we achieve it and, even more, I am not entirely sure as to how best translate some of that utopian vision into practice (even just theoretically. I have no delusion as to the likelihood of achieving any of it in reality).


The Objective


The whole point of taxation is for the government to collect money to then spend on the purchase of public goods. We might spend endless amount of time on what ought to be publicly purchased and how much ought to be spent on any particular item or public good (or even what is and isn't a public good in the first place). However, that's a discussion best left for later/a different article. The question here is how to collect and from whom.


Lots of people have proposed different systems - John Mauldin (website on the side) has recently written an article on the subject, there's been several pieces on Bloomberg and, in the USA, we've had the hilarious 9-9-9 plan from Herman Cain etc.


My own reflections on the subject are as follow: First and foremost, I want taxes to be strongly progressive. Flat taxes, a popular idea with quite a few people, have the inconvenience of re-creating an aristocracy more or less within a generation - unless accompanied by confiscatory inheritance taxes (death taxes, to the Republicans, if any ever read this blog). I hope I don't have to expand on why an aristocratic society is not a good idea for the rest of us peons.


A secondary objective is that I do not want taxes to unduly modify behaviours, discourage savings/investments (or consumption for that matter) and, in general, mess with economic incentives and the utility maximisation behaviour of the various agents. I would not go as far as saying that I disagree with taxes being used for social engineering as a matter of theological belief but, in practice, I am unlikely to find a tax break I like - even for marriage or kids or other 'worthy' causes such as 'green energy'... If you want the government to incentivise behaviours, it ought to do so via targeted spending, not forgoing tax collection.


The Reality


When it comes to making taxes progressive, many people disagree violently at the idea of high level of taxation on rich people. Several reasons are given - from "this will dis-incentivise high earners to work" to "this is robbery, pure and simple" to the instant classic "why do you hate success?". I will probably expand later on why those arguments are wrong in various ways but the first thing I wanted to do in this stream-of-consciousness post (I am tired, sorry...) is post the following graph.




For some reason, Paul Krugman (of NYT blogging and Nobel fame) prefers the log-variant of the same. See below. I don't. I like the outrageous jump in remuneration at the extreme right hand of the graph to be perfectly clear.









The log effect kind of kill that graphic, visceral evidence that you have to go to the very top of the tippy-top of the pyramid to see income levels increasing vastly out of proportion with the bottom, well, 99% at the least. So it might be easier to read but it defeats the purpose - or my purpose anyhow.


Because, if you're arguing for taxes to be flat beyond, say, $250,000 a year, you are basically arguing for flat taxes.


It makes no sense to have tax rates, meant to be progressive, to increase from 0% to, whatever, 35 or 40 or 45 or 55% (depending on the country you're in) for the bottom 99% and then let the tax rate go flat. The whole of the income acceleration is occurring at the very extreme.


It would be a lot more logical to argue for the rate to be flat (and low) till you reach $250,000 (although I find that cut-off point a bit low, to be honest) and then let the tax rate appreciates exponentially as the income increases.


Basically, my opinion is that the tax rate ought to follow the income distribution curve - i.e. it ought to be exponentially shaped. On top, a logarithmic function would have the advantage of having no "steps" - no single incremental $ would trigger a different rate thus there would be no change of behaviour around specific levels.


We will explore in another post the classic objections to such confiscatory taxation.