Time to junk income taxes?
This is America’s 100th year for individual income tax, a system as out of touch with our era as digital music is with the hand-cranked Victrola music players of 1912. It is also the 26th year of the Reagan-era reform for both personal and corporate tax, a grand design now buried under special-interest favors.
With U.S. elections in November, and the George W. Bush tax cuts due to expire at the end of 2012, it’s time for a debate that goes beyond ginning up anger over taxes and the superficial issue of tax rates.
It’s time to consider whether to get rid of income taxes, personal and corporate. What are the strengths and weaknesses of our current system? Should we tax individual and corporate income — or something else?
We need to think about it. Whatever systems we consider, we should weigh up what it takes to raise the necessary revenue along with such other attributes as minimal compliance cost, leakage and economic distortion.
Times change. Tax systems must change with them or else their lubricating effect turns to sand, wearing down the gears of commerce.
Just as the Industrial Revolution transformed a nation of farmers and mechanics into a land of factory hands and office workers, so too the digital revolution and globalization are fundamentally remaking society.
We need for our tax system to serve our 21st century civilization and its needs, including the costs of aging infrastructure and an aging population, costs that will be borne one way or another.
Five ancient principles that have survived the test of time and are, therefore, profoundly conservative, should guide us.
The first is the moral principle of progressive taxation — that the greater the gain you manage to attain, whether through hard work or luck, the greater your duty to pay back the society that made your riches possible so that it will endure. This concept is 2,500 years old, coming to us along with its civil twin, democracy, from ancient Athens.
The second is horizontal equity. Each person, or business, with the same ability to pay should pay the same tax. We must not tolerate a system in which one family or company pays far more than another with the same income, thanks to all the fine print in the tax code.
Simplicity, transparency and ease of payment should be the last three of the five guiding principles, as Adam Smith taught more than two centuries ago.
So what do we do?
Narrowly defining what constitutes income for tax purposes bloats the tax code. To the vast majority who earn a paycheck, defining income is simple. For the very rich and for corporations, it is a game. Too many of our most elegant and rigorous minds design techniques for tax avoidance and tax deferral instead of producing new wealth, imposing a huge cost on society.
In ancient agrarian societies the ruler took a share of the crop. In the cash economies created by the Industrial Revolution the state taxed incomes. But is income the right tax base for the 21st century, when computer software makes it possible to wrap economic income in a cloak of tax invisibility?
And why, in our digital era, must Americans file 140 million tax returns? Digital technology could eliminate 120 million of those tax forms, saving billions of dollars in both private and government spending.
In a global economy, is taxing corporate profits smart? Or could we devise rules that both promote investment and job creation while preventing the accumulation of unproductive fortunes — the great risk if corporations are tax-exempt.
Look at the same question in reverse — is our tax system encouraging unproductive or even counterproductive activities?
What else should we call a system that lets hedge-fund and other financial speculators defer paying taxes for years or decades on their carried interest, while discouraging investment in long-term projects that may not pay off for a decade or more? How else to explain our gross overinvestment in housing?
And what about corporate tax accounting costs?
Under President Barack Obama, business has been able to immediately write off 50 percent of new investment one year and 100 percent in two other years. We need to examine the long-term benefits and costs of full expensing. The White House says full expensing lowers the average cost of capital for business investment by 75 percent. But what other effects are there?
More broadly, we need to debate why corporations must keep two sets of books, one for shareholders and one for the IRS. How much more efficient would taxation, and commerce, be with one set of books?
With the individual income tax in its 100th year, it’s time to fundamentally rethink how we tax ourselves. Even if we end up keeping the income tax, personal and corporate, surely we can make the system easier and fairer.