A representation on taxation

Up-front caveat: I am neither an economist (nor do I play one on TV), nor have I done a tremendous amount of study on this matter. But since it’s an interesting issue that’s once again popped up in the political arena, and hasn’t yet degenerated into a Vicious Battle of Demonization, I might as well toss in my two cents worth.

Everyone hates paying taxes. That’s about the only given in the debate.

Most people will agree that the US tax code is ridiculously over-complicated, that the printed form would stretch to the Moon and back, that people spend billions of dollars on H&R Block and TurboTax each year, and burn 200-300 hours doing their returns even with that.

That’s where the unanimity begins to decline, though, because while everyone will agree that, on the whole, income tax code is too complex, point to any given ox you want to gore and things begin to get unpleasant.

The fact is, the tax code isn’t so complex simply to give IRS agents and press operators full-time employment. It’s complex because there are reasons (not all of them good, of course) behind every exclusion, exception, and sub-paragraph.

Sometimes the tax code is put together in a complex fashion to make sure that a certain type of income, which was sheltered by a previous loophole (which was put in for a perfectly good reason) is now covered underneath the specific circumstances. Sometimes it’s to, instead, shelter something that someone feels should reasonably be sheltered.

See, tax policy is not just about revenue. It’s about public policy: encouraging certain activities, and discouraging others. Yes, sometimes it’s also about greed (“the grommet transfibulation industry in my district needs help, so we need to add a shelter for investments in it”), but that, too, is a manifestation of public policy.

So why not simplify the tax code? Because determining which policy objectives are worthwhile ones is deucedly difficult, even in an apolitical vacuum. We can all point and glower at the grommet transfibulation investment shelter — unless, of course, we work for a grommet transfibulation manufacturer, in which case it seems like a great idea — but what about more basic deductions that most American taxpayers use?

For example, deducting interest payments on primary home mortgages? The howling of protest from homeowners about their deductions being ended would belie the moral high ground of their in turn calling for other “loopholes” to be closed. One can argue (with some accuracy) that mortgage interest deductions promote home ownership (ostensibly a good thing), and home construction (an economically productive, if environmentally questionable thing), and also free up money (with refinancing) that people can spend on other activities, thus booting the economy (a good thing). But, then, you could argue the same thing about grommet transfibulation manufacturing.

There was a great gnashing of teeth when consumer credit (credit card) interest stopped being deductible. Had that change been proposed today instead, it never would have flown, given the even wider use of such credit.

Another biggie in the personal (as opposed to corporate — more on that in a moment) tax arena are charitable deductions. Most people would probably agree that such deductions reward (and thus incent) donations to worthy causes (which then reduces the taxpayer burden in supporting analogous causes). Whether it’s donating clothing to Good Will, or writing a check to a local church to support charitable activities, or donating to some other purposes, most Americans think that’s appropriately deductible. Not that they wouldn’t do it were it not (maybe), but they certainly seem to feel entitled to it, and would feel deeply offended were such a “loophole” to be done away with.

On the other hand, most Americans probably get torqued when some rich person donates a work of art, or “shelters” a bunch of money in some sort of charitable foundation, even though the same principle applies.

So one of the biggest problems in simplifying the income tax code is determining what exceptions can, or should, get simplified out of existence. Simplification — a generally worthy goal — suddenly has to vie with both public policy and political pressure; in such cases, simplification rarely wins.

The other problem in simplifying income tax is also policy-related, in that we believe that taxes should be progressive. The poor should pay less, proportionate to their income (each dollar of which is more precious) than the rich. That’s why a “flat tax” proposal never flies, without enough tweaks to make it unflat again. And that’s not necessarily a bad thing.

But, then, that gets into the (re)insertion of complexity into the code, of measuring what’s income, on judging whether two different types of income should be treated differently, and of what, ultimately, you want to incent people to do. As well, what’s a reasonable tax rate, or set of tax rates, for what income bracket, is subject to endless tinkering. Make taxation too progressive, and not only do you disincent pursuit of wealth (which, when couched as “improving one’s economic circumstances” is probably more clearly a good thing), but you tend to cause wealth to flee elsewhere. People don’t invest (time or money) without a return on investment. Reduce that return, and you reduce the investment. Basic economics, no matter how nice it sounds to soak the rich to uplift the poor.

One can, of course, try to ease the burden on the citizenry by increasing corporate taxes (or close corporate loopholes). But the same caveats (what loopholes are good, which are useless; how do you incent increased productivity/employment if the return on same is reduced through higher taxes) apply as well as another: corporations pay no taxes. On paper, they certainly do. But increased taxes on corporations simply, at least to whatever extent it’s possible, get passed on to customers. Prices rise. The increased tax burden gets spread out. Or, where it’s not possible, other cost-cutting measures are instituted: job cuts, wage cuts, benefit cuts, capital investment cuts, R&D cuts, moving to other less-taxing locations.

As nifty as it sounds to stick it to the Fat Cat Big Businesses, we’re just sticking it to ourselves.

Which leaves just one proposal on the table, and the one that’s popped up of late (as it does every 4-8 years): a national sales tax. Get rid of the income tax altogether, and gather up taxes at the cash register. The tax processing burden gets shifted to retailers (who already have to do it anyway, in most states), and all’s right with the world, right?

Well, not really. Because sales taxes are regressive. Richie Rich paying 5% extra for his newest Jag doesn’t feel the pinch as much as Joe Sixpack paying 5% extra for his gallon of milk. Indeed, even if one assumes that the Rich eat better/more than the Poor, it’s certainly not proportional, so Richie Rich paying 5% more for milk is literally a drop in the bucket vs. Joe Sixpack having to do the same.

Which is why most local governments with sales taxes immediately start putting in exceptions. No tax on food, for example (though you sometimes then get amusing hair-splitting as to what’s food, vs what’s a “snack treat,” and donuts from Krispy Kreme end up getting judged differently from donuts from a box at the store). Which then ends up complicating the tax code again — though only for retailers, not for consumers (except the ones screaming wildly at the cash register over whether something should be taxable or not).

I would still predict, though, we’d start seeing a crazy-quilt of sales tax increases/decreases for certain products. (“The grommet transfibulation industry in my district is in trouble — I want the sales tax reduced 0.25% on grommet transfibulators!”) (“It’s national policy that comic books are bad for kids, so we’re going to increase the sales (‘sin’) tax on them by 5% to deter kids from reading them.”) (“Rich people can afford higher taxes, so we’re going to have a graduated sales tax for different types of cars/trucks/SUVs.”)

Notice as well that you’ve also now removed the incentives (negative disincentives) from the income tax code. No more deductions for charitable contribution deductions. No more mortgage deduction; indeed, buying a house has now gotten much more expensive (unless house sales become tax-exempt). On the other hand, returns on investment (interest, dividends) are suddenly not taxable. What effect does that have? The correct answer is, “Who knows?” And doubtless there would be other unintended consequences (which, like mutations, are usually bad) from such a major restructuring of incentives/disincentives.

It seems to me, from what I’ve observed, that sales tax revenue is also more volatile than income tax revenue. During difficult times (just when tax revenues are most needed), purchasing declines (savings increase) more rapidly than income. Communities hit hardest during the recent recession seemed to be ones that depended on sales tax income.

The last danger of a major change to a national sales tax is how seductively easy it would be to increase. Consider gasoline taxes. Do you know what the rate is on gas taxes? Do you know when it changes? No, because gas prices themselves are more volatile, and any gas tax increases get lost in the noise of that. If local (existing) sales taxes increase by 0.25%, we wouldn’t directly notice it (we don’t now).

And a tax that isn’t noticeable is a tax that will be increased, by any political party. That’s reality.

So, what’s the answer? Like with national health care, I have no idea. The idea of a national sales tax remains seductive, though I suspect it’s more of a talking point than a likely new policy. Certainly it has the attraction of no longer dreading 15 April. It “feels” clean and easy (though that’s because it makes taxes more under the radar). And it’s something new, yet not too unfamiliar, which always seems more attractive than either sticking with a tarnished status quo or delving into the great unknown.

It will be interesting to see what, if anything, comes of it. Alas, it feels already like it will be another of those topics that will degenerate quickly into being a club against the Other Candidate, rather than being a tool to help the body politic.