Sunday, February 12, 2012

Tax Code Revolution!

Taxes are tricky, messy, bastardized things. Their inherently mongreloid nature leaves them more misshapen than a Boris Karloff monster and more random than a platypus. So what happens when you start throwing different ideas around? My uncle pitched me his ideas for tax reform and asked for my opinion. We had the following exchange that I invite everyone to join in on.

(note: since my internet is down at the moment, copy pasta will have to do for now. I'll edit later for clarity, grammar, etc.)

(note the 2nd: though I am an analyst, I don't work with tax policy directly. Feel free to point out any errors, alternative theories, etc.)

Hi Isaac,
Listening to today's news, I realized that I have long been formulating my own ideas about taxes--so I decided to write them down. You're the economist in the family, so I'm sending you my tax plan. Are the attached ideas crazy?
Uncle Steve

Proposed Tax Code changes:
1. -cut payroll taxes to zero
2. -eliminate Bush tax cuts
3. -increase all tax rates by same proportion (i.e. everyone goes up by n% of their current rate)
until provisions 1 to 3 together are revenue-neutral. (Note: this does not include reducing
the earned-income tax credit for poor workers, since we want to keep incentives for working
instead of going on welfare.)
4. -eliminate housing deduction. Decrease tax rates for those earning under $250,000 yearly,
everyone’s by same proportion (n% of current rate) until the housing-deduction elimination
combined with lower tax rates is revenue-neutral
5. -Tax capital gains at the same rate as income. I have seen arguments on both sides about
whether this would reduce investment—but in the long run, folks will invest rather than let their
$$ sit idle. Plus, there is “moral hazard” in taxing me more for income that requires me to work,
and less for income that rolls in while I sit on my butt.
6. -eliminate the deduction for businesses paying for health insurance. Instead, certify insurance
plans as being acceptable if they meet the minimum of covering reasonable emergency and
preventive care, and if they do not cherry-pick by doing stuff like eliminating folks with prior-
existing conditions. Give each individual a voucher that can be used towards paying for certified
health insurance. An individual’s left-over $$ can be used towards tax payments (including
potential refund), or if the certified insurance individual selects costs more than the voucher,
the individual can pay the difference. Individuals without certified health insurance don’t get
the voucher. (Note: hopefully market forces under this plan will lead to reduced health care
costs over time. If this happens, then folks will in the long run be receiving a yearly rebate for
buying less-expensive insurance. ) (Also note: by “individual” I mean “individual tax payer”. The
voucher would be adjusted upwards to cover all dependents on your tax return, and to get it
you would need to purchase certified insurance that covers all of them.)
7. -eliminate all other tax deductions, even including charity, etc. This would mean for example
that the tax incentives Obama proposed in his state-of-the-union would not be enacted. The
idea is that simplicity will in the long run do more than the sum of our many incentives. If we
want to subsidize education, subsidize businesses that bring jobs to America, or whatever, we’ll
need to do it directly through spending instead of through the tax code.
8. From this simpler baseline, adjust rates as needed. If unemployment is below 6%, adjust
rates upwards (everyone increases by n% of current rate) to ensure a balanced budget. If
unemployment is above 6%, rates can be reduced as part of a stimulus packet, leading to a
temporary imbalance. Probably it would be better as a general rule when unemployment is
above 6% to leave rates unchanged (since with high unemployment revenue will be lower
so unchanged tax rates will already lead to deficits) and instead stimulate via infrastructure
Below is our intercut responses.
His words are in BOLD, and I responded to his next email in RED.
I'll work with this, but it'll make for a messier blog post...
Just a note - I was approaching this from two sides: the economic feasability and the political possibility.
While there might be some sound logic to this, radically restructuring the entire tax process would have severe impacts on agencies, individuals, and businesses.
Another important issue to consider are all the implications of a new system. Every tax system creates a set of incentives. we need to figure out what the unintended consequences are.
Not to mention put the entire market of tax accountants out of business... :-)

Do you mind if I put your plan and my response/analysis up on my blog as   well? I can either attribute it to you or anonymize it, whichever you're   comfortable with...

Just a cursory response:
1) I'm assuming you're referring to overall payroll tax, not Soc. Sec.   and Medicare. This would certainly incentivize greater levels of employment by   lowering the average cost of labor for employers. The question is whether   cheaper labor will necessarily lead to more job creation.
I'm not an expert: I thought that payroll   taxes equals social security plus medicare. You're right, I was referring to personal vs. payroll taxes (eg: employee vs. employer) that distinction was just for clarification. Guess it didn't work... I meant that we should fund   both programs through the general revenue.  The current system was   designed to create political constituencies to fund the programs through the   illusion that the money gained from payroll taxes is sequestered to pay for   them.  But this illusion is purchased at the cost of a very regressive   tax (vs. the more progressive income tax).  I want to eliminate the   illusion. Part of the problem here is that SS/Medi is directly based on future benefit rates, the reason that they cap at a certain income level (around $170k now, I think) is that you've already maxed out your benefits. Switching payroll tax funds into income tax funds isn't going to change any solvency problems, and, actually, the trust funds are a remarkably effective way of shuffling money into the economy without the general problems associated with seniorage. Another issue goes as follows: your W2 forms right now don't go to the IRS first - they come to us. We pass that data onto the IRS. If you lump everything together, disentagling benefit rates out of the conglomerated income tax system would become phenomally complicated. Presently, this "regressive" system pays out over $600 BILLION dollars a year to the American public, which is a revenue stream you'd need to recoup from income taxes. That amounts, on average, to an additional $2k per person, assuming we're dividing it evenly, which we really shouldn't be unless we first agree to remove the cap and change the payment structure a bit, which also has a snowballs chance in hell.

The stimulated job creation would not be   primarily through decreased taxes on business making labor cheaper to   hire.  Much more importantly, poorer people would have more money to   spend.  If I have a bunch more customers and can't supply them, I need to   grow my business and hire more workers.  Those more workers I hire   have  money to spend, increasing the demand at other businesses.  I   believe that this is classic Keynesian theory about how to get out of   liquidity traps.  I'm not an expert: I may have it wrong, and I know some   folks doubt the entire theory.  But honestly, I can't see any holes in   the "more customers means more business and thus more people hired"   theory. Well, the predominant issue is one of chicken-or-egg - you need the customers and increased cash flow FIRST in order to justify more hires, and that's assuming you are providing a service that is CAPABLE of handling greater levels of demand. There's only so much food a supermarket can stock. There are also only so many job a person can work. Still, it's an interesting idea. Just one that would NEVER get traction at all. A productive alternative would be to encourage more business creation. 
To be honest, I was focused on the WORKER   payroll taxes.  I haven't figured out whether or not to cut the business   portion of those taxes.  My guess is it would be necessary politically,   but I tend to doubt whether it would have much stimulative effect.    However, cutting those taxes fits in nicely with the overall tax theme of   "simpler whenever possible".

2) eh. no comment to be made there. they were enacted in a time of   prosperity to reward ourselves, but they're dragging us down under the false   pretenses of "socialism." Time to let them die.  Also, this   "increase" is balanced by the decreased payroll taxes.  By skewing the   tax towards less regressive income taxes, we put more money in the hands of   consumers, increase demand, and grow the overall economy. Just a reminder that the people you vote into office are on the higher end of the tax scale simply by being there. And most of them have shown reluctance to take money out of their own pockets.

3) I wasn't clear if you were talking about additive or multiplicative   increases: x%+n% or x%*(1+n%) the latter skews the burder toward those that   can bare it, but either way can be presented politically as "increasing tax   rates by n%." I think we need to increase the EITC to help push more   people out of welfare and into productive society.  I don't know   how the numbers work, but I'm pretty sure that the total payroll (medicare   plus social security) is a lot more than the total Bush tax cuts.  This   means that eliminating the payroll tax could not be fully paid for by ending   the Bush cuts--thus the increase in raw tax percents.  I would prefer the   more progressive alternative (because it is fairer and more stimulative) where   all increases are as a percent of current tax rate:  thus 30% would go to   33% while 20% would go to 22% and 10% would go to 11%.  But the less   progressive alternative (e.g., 30% goes to 32%, 20% to 22% and 10% to 12%)   would be a reasonable but less-ideal alternative.
Changing the EITC might be a good idea, but is not central to the   overall plan and could be addressed separately. Until we know actually figures, for the first two, it's pretty much worthless talking about the rates. Overal, it certainly is an interesting idea, but it's worth mentioning that the 10% would now have to be closer to 18-20% to compensate for the elimination of all Social Security and Medicare taxes.

4) hermn... home ownership is a VERY entrenched element of the implicit   "American Dream." This would do some interesting things to the market. It   would disincentivize purchasing a house, and certainly multiple homes. But on   the other hand, it helps those of us who don't own our homes, like EVERY   SINGLE COLLEGE GRAD. By putting more money into their pockets, you enable them   to save up faster toward buying a house, but the cost of mortgages/property   taxes when owned becomes a significant hurdle.
To make it clear: my intent is to   eliminate ALL deductions; and eliminate the distinction between capital gains   and earned income.  Each individual deduction has its own constituency   and good reasons behind it, but each has the negative effect of making the tax   code more complex, which I suspect is a hidden drag on the   economy.  Some specific deductions like housing   and employer-provided health care are so central to our economy that   finding a way to eliminate them required its own bullet.  Other   deductions like charity and the incentives Obama talked about in his   state-of-the-union are much loved, and I mention them because I want to make   it clear that we are getting rid of ALL deductions that aren't tied directly   to individuals (i.e. number of dependents you support).  Any exceptions   open up a Pandora's box.  In truth, as I think about it maybe we   ought to eliminate the individual deduction and pay parents a straight   sum per child or elderly person or other dependent they are   supporting. (That way, we wouldn't conceal the expenditure as a "tax   expenditure".)  Another alternative would be to determine the tax bracket   by dividing by the number of individuals supported:  1 person at $50,000   income per year is in the same bracet as 2 people at $100,000 joint income, as   2 people with a child at $150,000 per year joint income, etc.  As things   now stand, isn't the deduction per-child subtracted for your income, which   means that rich people in higher tax brackets get more money per child than do   poor people in lower tax brackets? No. It's a straight income deduction per dependent, which means that if you earn LESS INCOME, the deduction can lower you into a lower tax bracket much more readily than if you earned, say, $200k. True: since the taxes on that level of income are HIGHER per dollar, the amount of tax relief that provides is "greater," but that's simply the effect of a more progressive tax system - the poor pay less or nothing due to their deductions, but the wealthy get more value since they are ALREADY paying more per dollar. The only real way around this is a "tax voucher" per dependent. Also of note - you don't need $50k per PERSON, because there are decreasing marginal expenses to dealing with multiple household members. For instance, the mortgage stays the same, food costs rise (but not linearly), health care costs rise (but not really insurance rates above 2 people), etc. The present per person deduction is based on a calculation of minimal needs for a certain standard of living.

o.k.:  here is a new bullet for   my original tax plan. 
9) Eliminate even the individual   deduction.  Determine tax rates based not on income, but on income   divided by number of people supported.  Replace the current per-child   deduction with a stratight-up payment per child, which would go even to   non-tax-payers.  The amount would be anywhere from 0 to infinity,   depending on the outcome of a political debate we are currently avoiding by   concealing this payment as a "tax expenditure".  Plus, this would value   poor children as equal to rich children, instead of the current system which   has us spending more in "tax expenditures" per rich child than per poor child.

 Okay, so we're working with a child voucher system. Encouraging people to have more children - the mother with no job and 5 kids now may have negative income, but there's a limit to the drain she creates. You turn that into a per-person tax credit then her children become a goldmine.

5) Inevitably, this WILL harm the stock market by discouraging higher   rates of investment. Actually, the whole thing is skewed - my tax rate is   under the capital gains rate, so the only people REALLY encouraged to invest   now are those that have massive disposable income. Tying the two tax rates   together would push individuals at the lower end of the market toward   investing... might actually be a good idea. I absolutely agree with you that   people would rather earn money through investments than through banks.
Maybe create a minimum tier where capital gains earning less than the   market interest/inflation rate would be tax exempt? in other words, create a   system where people are assured to never lose out if the invest rather than   save?
On the other hand (you have five more fingers), excess levels of   investments being engineered for opacity were precisely what triggered the   economic collapse. If there were fewer money for investments going around,   people would have to fight more for investors money by providing better   investments (or cheating).
Either way, I totally agree with you about the moral hazard - we've   become a nation enamored with the idea of "wealthy retirement" - that the Best   Thing Ever is to sit on your backside and let other people pay you for things   you did years or even decades ago.
See copyright and patent law. In my mind, these are causing the biggest   economic drain on the most vibrant sectors of our economy - technology and   creative expression. They actively encourage this butt sitting mentality and   the major players in the entertainment sector are fighting tooth and nail to   preserve their rights to earn money forever by leeching everything they can   and criminalizing their consumers. </rant>
Again, the guiding principle is "no deductions, no   complexities" (beyond a set of progressive rates)--so I don't want to create   any special conditions under which capital gains are taxed at a special   rate. I think the best way to deal with this is to consider capital a form of self-employment or a personally owned business, subject to the same forms of gain/loss reporting and their associated tax effects.

6) this one is complicated. You're suggesting transferring the burden of   employer-portion of insurance to the government? While this WILL reduce the   cost of labor, it becomes a tremendously expensive government problem to   regulate (how do they know if you've purchased for all of your dependents, or   just claimed to?)
If, instead, you're suggesting that the EMPLOYER give a voucher to his   employees, this eliminates the oligopsony advantage that employers have in   purchasing company wide welfare, and will enable insurance companies to charge   the now-disadvantaged employees more money, eliminating the point of the   voucher. Smarter instead to remove the barriers preventing competition across   state lines and then letting the insurance companies duke it out for   customers. The whole point of insurance is shared risk, and the greatest   benefit is by having a larger pool of subjects to control that risk. Time to   allow the market to enforce what insurance ACTUALLY is about.
I want to eliminate the employer deduction for health care   expenses, under my "no deductions, no complexities" rule.  But this one   is so important I thought we might need to replace it with something.  So   I figured we should let the market control health care costs--something   impossible today, where people have not incentive to reduce their   consumption since I don't pay for anything directly.  The vouchers create   a mock-market, where people shop for the cheapest health care plan that meets   their needs, and health-care plans minimize expenditures in order to maximize   their own profits.  There may be some other way to get rid of the   employer health care deductions, and I'd be open to them--but this seemed the   best to me.
I disagree about the regulation being difficult:  for   example, the plans themselves could easily supply the IRS automated   lists of who was/wasn't on the plan.  The issue isn't just that, it's CORRELATING all that to individuals. Never mind that I know from experience that data exchange is a pain among outside agencies. And that every single insurance company (of which there are technically hundreds, but really five broken ones) would need to be finessed and cajoled into participating. This system would literally take nearly a decade just to get underway.

7) Again, this is tricky. tax deductions are a way of incentivizing on a   personal level precisely the behaviors we wish to see among the population   (again, see housing credits). Not sure that centralizing the decision making   process on which charities receive federal monies is a good idea. And   encouraging people to give to charities takes a certain amount of social   burden off the government. Also, this would essentially be impossible to pass,   as EVERY 501(c)3 would come out in opposition to it.
Re: subsidizing education and businesses, both of those are ALREADY being   done implicitly - the former through government funded public schools and   grants, and the latter through efforts like the payroll tax cuts you proposed.  
I am simply saying that the government should give up   incentivizing through the tax code.  One person's important incentive is   another person's loophole. The federal government would not give any federal   monies to any charities:  rather, all deductions would be   eliminated. And then what happens to every single nonprofit in the US? they all simultaneously go under. And they employ LOTS of people collectively.This honestly has the potential to be disastrous.

8) This presupposes that the natural rate of unemployment is around 6%,   that's approximate, but some others might complain. not really sure how to   work with this one effectively.
Also important to note that unemployment levels can be low and there can   STILL be an overall reduction in GDP if people start fudging the numbers   through artificial methods. It might be smarter to tie tax changes to GDP   growth as well as unemployment, so that if GDP rises even if unemployment   grows (like more money being concentrated among the wealthy), you might still   raise rates. If unemployment falls and GDP rises, you're good. if both are   doing poorly, that's the time for stimulus.
I pulled 6% out of discussions from a   couple decades ago which said 6% was as low as unemployment could go.    That was before Clinton got unemployment below that mark.  But it still   seemed a good low level below which to require a balanced budget.  I   could be open to some other trigger as a "time for stimulus".   

The entire business about raising tax   rates is meant to give us a way to get the whole thing in balance, since   some revenue will be going up and some going down and I don't know   where it will all come out.  The basic principal is that once we get the   whole thing simplified we will need adjust rates up or down so that we get the   right amount of total income.

I am hoping that the market-imitating health care system I described will reduce overall health care costs in the   long run, thus cutting the spending side in our long term attempts to get the   deficit under control.  If that doesn't work, we'd probably need to find   some other way to rein in health care costs. As I said, the fastest way toward creating market competition and reducing costs is to REMOVE BARRIERS. Always. Enabling competition across state lines (or forcing large insurers to consolidate nationally) would be the most effective way of lowering health care costs, and it doesn't effect tax revenue at ALL to do it. Pitting David against Goliath is a terrible idea for health care consumers.

re: stimulus via spending - the thing people fail to realize on BOTH   sides is that temporary government paid jobs DO NOT stimulate the economy.   What stimulates the economy and overall wealth is increasing the overall value   of the community. If highways aren't needed or are in decent enough condition,   building more doesn't magically make things better. If, on the other hand,   there are areas that are underserved, and you target them by building out   better utilities, infrastructure, making them more desireable places to live   and run a business, THEN the communited gets stimulated as everyone benefits   from the additional public goods. That's one of the primary rolls of   government - to protect the public from Bad Things they can't muster force   against and to help build Good Things they don't individually have the funding   for.

Stimulus comes in two ways:  long   term, by building infrastructure that we will really use (as you said) and   short term when there is a "liquidity trap" by getting more customers to   businesses.  That's why I'm ok with deficit spending when unemployment is   above 6% (or when the economy is hurting according to the   measure-of-your-choice)--so long as that spending goes to folks who will   really put it in the economy and give businesses a reason to   grow. Regarding the liquidity trap concept, in most cases the first bit of money goes toward paying off debts. In such a case, it flows right back into lending institutions who don't really have the same affect on the economy as individuals making actual purchases.

If we're really shooting for the moon, how about a government discount card that mediates between buyers and sellers at point-of-sale? Like "scrip" or a discount card, but universal. When you make a purchase with your card, it deducts a certain percent for items or categories of goods (like food, which tends to be local, restaurants, which always are, and unlike TV's, which tend not to be) So it operates as a "kickback" to the consumer and encourages him to purchase more frequently, while the seller still gets full price for his item. I guess it's kind of like an inverse sales tax or a universal form of "duty free." That encourages precisely the behavior we want to see - people putting money into the local economy and making sure it provides local benefits.

Overall, an interesting package. We would need significantly more data to   divine how exactly this would effect present tax rates. Certain ideas   politically would never fly (no charitable deductions) and others would   require some public wrangling to get them in on (tax hikes).
These aren't tax hikes, but rather adjustments to keep the package revenue neutral while making the tax code more transparent.  Who knows:  when we crunch the numbers revenue-neutral could even mean a tax rate reduction. With all the dismantling we're doing here, unlikely.

 Another issue that requires alot of effort is working with   governments internationally to prevent the creation of "tax havens" - the   largest corporations in America shuffle all of their revenue between "foreign"   offices, and since it isn't earned in the US, it isn't taxable here. And since   it is shuffled off of Irelands shores, it isn't taxable there. And the Caymans   are lovely any time of year.
Seriously, I get audited for mistyping a W2, and Walmart dodges millions   in taxes a year? Bogus. Instead of being able to "declare" revenue as   belonging to another entity for tax purposes, change the law so all revenue is taxed where it is DIRECTLY TRANSFERED - at point of sale. And how about "all   corporate revenue not taxed at the comparable rate in another nation is   subject to US taxes over and above taxed amounts until the elegible rate." So   if the Caymans charge you 1% and Ireland takes another 2%, the remaining   revenue is still subject to US tax law up to, say, 15% (or whatever they are   liable for as a business).

Anyhow, just my $0.02.


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