Some days it feels like the country is splitting in two, with the extremes on the left and right pulling further from each other, paralyzing our political institutions, creating mass disenfranchisement and distrust that threatens the survival of the democracy. The political polarization mirrors a growing gap between rich and poor, which has led to two very different political ideologies with very different solutions to the challenges that the country faces.
What does this have to do with taxes? Just about everything. As political polarization has increased, the tax code has grown more complex. Now at 70,000 pages in length, even well versed lawyers do not fully understand the tax code anymore. This complexity is, partly, by design, as it creates numerous loopholes through which the wealthy can avoid taxes. Meanwhile, regular Americans spend about $5.1 billion a year in fees just filing taxes…paying money to pay taxes…every year. That’s absurd and is evidence that the US is becoming an extractive society (discussed here). Furthermore, the current taxes of choice incur huge dead-weight losses on the economy, slowing growth, and tax the wealthy at lower rates than the poor. The tax code is both a symptom of, and a cause of, growing wealth disparity in the country.
The “right” pushes the notion that less government is the solution, that lower taxes and a simpler tax code will enable wealth to ‘trick down’ to the masses. The “left,” for its part, advocates that taxes be raised on the wealthy, using the revenue to fund welfare systems that target poverty. Both of these approaches are flawed. The right naively assumes that everything gets better by lowering taxes, while the left’s demonization of the wealthy and capitalism doesn’t address the core problems behind inequality.
A Middle Way
We can, however, address most Americans’ concerns if we rethink the tax code entirely. Let me show you how. Taxes serve two overarching purposes: 1) To raise revenue 2) To encourage or discourage certain types of behavior. Adam Smith, the father of “capitalism” was very astute when he outlined the four canons of good taxation. These canons hold true today:
Canon of Equity: Taxes should be progressive (proportional to income)
Canon of Certainty: Taxes should be clear, not arbitrary or hidden
Canon of Convenience: It should be easy to pay taxes; i.e. no filing fees
Canon of Economy: It should be cheap to administer tax collection
Today we also recognize a fifth canon: that taxes should minimize economic “dead-weight loss.” Dead-weight loss is the loss of economic activity beyond the tax itself, a hidden tax on the tax. Some taxes are worse than others in this regard.
Economists have already singled out the best taxes that fit these requirements: The first and best is a Land Value Tax (LVT). An LVT is a tax on the unimproved value of land. It differs from a property tax, which taxes the value of buildings upon the land (essentially punishing land development). An LVT is progressive (it essentially serves as a wealth tax), creating a built-in mechanism for keeping inequality in check. It is easy to administer and pay, and incurs no dead-weight loss on the economy. An LVT could replace general property taxes in America. This move would unlock tens of billions of wealth, creating huge new growth opportunities while maintaining government revenue.
The second type of tax that we should implement is a broad based Severance Tax. A Severance Tax is a tax on the usage of Earth’s nonrenewable resources. The same principle as LVT applies here. Commodities like coal, iron, copper, helium, oil…etc are all "unearned” wealth (like land) that is part of nature’s bounty. Taxing them provides government revenue but also encourages conservation of Earth’s natural resources while incurring very little economic dead weight loss. The left wins because the taxes help protect the environment, the right wins because these taxes result in little economic damage.
The third, and my personal favorite, would be a smattering of Pigovian Taxes. Pigovian Taxes are taxes on the negative externalities of economic production. The most common example would be a Carbon Tax, Sugar Tax, or Pollution Tax. A variety of these taxes could be imposed to help correct negative externalities in the market, improving human quality of life, promoting sustainable development, while generating some revenue for government operations, with relatively little impact on the economy.
Finally, we should adopt a strict Estate Tax. An Estate Tax is a tax on inheritance. The American right wing is so vehemently against this tax that they have nicknamed it the “death tax.” Believers in capitalism say that they believe in providing everyone an equal opportunity (though not necessarily equal outcome) for success in life. That is precisely the aim of the Estate tax. The Estate tax helps redistribute wealth after someone dies, preventing the formation of family dynasties where each generation is able to build upon the wealth, power, and connections of the one before it. Estate taxes help level the playing field so that everyone can achieve their true potential and no one has too great an advantage.
Some taxes should be eliminated: Trade tariffs are terrible in that they are hidden, incur substantial dead-weight loss, and affect the poor disproportionally. Consumption taxes, such as sales taxes and Value Added Taxes should also be eliminated. Payroll taxes that, ironically, help fund Medicare, should also be eliminated as they are extremely regressive. There are better ways to fund welfare.
Some taxes, like corporate income taxes and personal income taxes, aren’t great but are acceptable depending on government revenue needs. So long as these taxes come with a high deduction (income that is untaxed) and are revised such that they could be simpler to understand and eliminate loopholes that benefit the wealthy. A high deduction, of say $50k, would leave most people in America un-taxed. A flat tax above that level could make filing taxes a breeze, with no filing fees and other nonsense. You really could file your taxes on a postcard in minutes, for free. That is how it should be!
Redesigning the tax code could maintain government revenue at the current levels, while helping to ensure eco-friendly sustainable growth that is not fraught with negative externalities. This tax platform, supported also by The Lianeon Project, would unlock huge hidden economic potential by reducing dead-weight loss, while helping create built-in protections against a yawning wealth gap. If implemented, personal incomes should rise, especially among the poor and middle class as the burden of dead-weight loss is lessened, reducing political animosity, distrust, and the desire for inefficient welfare redistribution systems.
We need to adopt a tax code for everyone.