Wednesday, January 1, 2014

Progressive taxes with a flat marginal rate

Some of my proposals on this blog are completely serious (like Replace bad taxes with useful taxes); some are purely silly (like Covering the alphabet with states).  This is half way in between.  It would probably be a good idea, but there are lots of complications, and it will probably not be worth the disruption of the transition.  Still, it appeals to me.


William F. Buckley argued for a flat marginal income tax rate from a fairness position: we get benefits from society proportional to our income, so we should contribute to the maintenance of society proportional to our income.  A flat rate is simpler, and supports other tax simplification.

A flat marginal rate doesn't require everybody pays the same net rate, but the only way to get progressive taxes with a constant marginal rate is to have the government giving individuals money at the bottom rung.  I had this idea long ago, but thought the payments at the bottom would be too radical.  Apparently the "Basic Income" idea is catching on, so it's time to publish!


This is more clear with an example.  I'll chose a marginal rate of 39.6% (the current US top marginal rate), a payment of $11,490 (the US individual poverty line), and no individual exemption (vs the current US $6100).  Individuals earning up to $29,015 get more back than they pay in.  Somebody earning $50,000 would pay $19,800 in taxes and get $11,490 back, for a net payment of $7,310, a bit more than the current $6,986.  Somebody earning $100,000 pays a net $28,110, somewhat more than the current $19,760.

The specific value for the basic subsidy can be set lower or higher depending on how progressive we want the taxes to be; the tax rate should be adjusted to keep be revenue neutral.  My example (starting with the poverty line) allows us to replace basic welfare entirely, but the opposite extreme of no basic income is obviously less progressive than our current system.

Advantage of a fixed rate to tax collecting

Here's another radical idea that's enabled by a flat tax rate: put banks (instead of employers) in charge of collecting income taxes.  We'd have two kinds of accounts: pre-tax and post-tax.  Paychecks go into pre-tax accounts; taxes are withdrawn when the money is transferred to a post-tax account.  Checks (or other debits) drawn against a pre-tax account can be deposited in other pre-tax accounts, e.g. long-term investments; this allows all savings to enjoy tax-free growth, like IRAs and 401Ks do today. Checks from a pre-tax account can be cashed by registered charities and anybody else we want to designate as able to receive tax-free payments.

We could require checks for services to be marked as such, and thus only legally depositable in a pre-tax account.  That doesn't eliminate the underground, untaxed economy, but it requires both parties to participate in the cheating.

The net effect of this, besides further simplification, is to switch taxes from earning to spending, which is also a good thing.

Arguments for Basic Income

Since Basic Income is already a thing, there are already plenty of arguments out there for it.  See for instance the current campaign to pass it in Switzerland.  For me, it comes down to each of us deserving basics of life such has food, shelter, and clothing.  We can give those out directly, e.g. with food stamps and subsidized housing, but it's much more respectful and efficient to give people the resources to get those things themselves.

So, why do we give any money to those who already earn enough for the basics?  From an economic standpoint, it's to give people "on support" incentive to go out and earn whatever they're capable of.  From a moral standpoint, it's because the poor deserve the extra luxuries that their extra income buys them as much as the rich do!


Ron Morrell said...

I like this idea. Seems much simpler than the current approach.
A component of the current system missing in this approach is that much of the Loophole problem is governmental attempts at social engineering.
For example: the government wants to encourage solar power. To encourage people to meet this desire, the money spent on installing solar power is exempted from taxation.
I installed a $24,000 solar panel. When I filed income tax, I got back several thousand dollars. Without the governmental encouragement, I wouldn't have participated in meeting the government's desires.
I bought an electric car to use the electricity from the government desired solar panel. Again, it would have been an even less economically viable activity without the tax reduction incentive (I have 20,000 miles on it, and already the battery capacity meter is showing 11 bars rather than the 12 bars of capacity when new--I keep my cars to well over 150,000 miles. Not looking good for this one).
The government wants people to own homes. To make this more affordable, interest on mortgages is exempt from taxes.
The government wants to encourage innovation of start-up companies and expansion of productive companies. Should the companies become profitable, the capital gains are taxed at a lower rate than other money. Long term investment in the companies is at the low rate; short term investment as in day-trading is taxed as would be any other income.
Whether the government should be using tax exemption to foster its desire is a topic for discussion. This simple system with your bank automatically deducting your taxes (similar to the UK) seems to prevent use of this tool.
Also, think of all the unemployed IRS workers and tax preparers relegated to panhandling.

Ethan Bradford said...

Thanks for the note, Ron! You make a good point, but my system actually simplifies encouraging things by not taxing them. The extra paper work is done by the entity to allow them to cash pre-tax checks; after that, you just write them a check from your pre-tax account and fill out no additional forms.