Taxes and human nature

By Edward Hadas
January 30, 2013

The tax system could well be the most idiotic, hypocritical and unnecessarily complicated part of modern industrial economies. The system needs to be rebuilt.

In developed economies, as governments have expanded, taxes have increasingly been used as a tool of economic and social policy. The rich are taxed more than the poor for the sake of a vision of social justice: from each according his ability. Depending on the jurisdiction, some good cause or another is favoured: house ownership, marriage, children, charitable contributions, savings. For companies, an almost endless series of exemptions, deductions and definitions are supposed to encourage investment, employment or some other desirable end.

Each tax wrinkle produces its own complex set of rules. Taxpayers’ continuous efforts to minimise payments lead to yet more rules. Each tax jurisdiction has its own system, a diversity which both increases the intricacies of international business and creates opportunities for individuals and companies to place income where it is less highly taxed.

The complexity has created a lucrative business in tax advice, but it is hard to see how the overall system promotes either economic efficiency or social justice. The complexity does have one clear effect; it alienates people from their governments. The tax law evokes frustration and a righteous indignation which is often undercut by the fervent desire to hold onto particular tax advantages.

The recent moves against tax havens and some corporate tax shifting are a welcome exception – a few parts of the tax system are actually becoming less unjust. Foreign governments used mostly to ignore the practices of banks in Switzerland and other havens, but an international campaign against some of their practices has been effective. A more recent campaign against egregious corporate income-shifting seems to be gathering momentum.

Even if cross-border tax-shifting were to dwindle away entirely, the domestic mountains of inefficiency and injustice will remain almost as high as ever. I believe it is time to admit that the modern experiment in complex tax codes has failed.

The fundamental problem is that the experiment was based on an unduly optimistic understanding of human nature. Yes, if both governments and the governed were wise and good, then the tax code could be complicated, helpful, fair and willingly obeyed. In reality, neither a people nor its government can live up that utopian standard. Motives are always impure and the powerful will take advantage of the complexity of tax codes. Legislators will disagree about both social and economic goals, which may themselves be in conflict.

Of course, such conflicts and confusions are inevitable, but the tax code is the wrong place to work out compromises. The effects of tax policy are too hard to predict and the purposes of tax policy too easily countered by taxpayers’ ingenuity.

The old complex has failed. I have a simple suggestion for what should replace it: simplicity. Taxes should be simple to calculate and to collect. I would suggest the simplest of all possible arrangement: a flat income tax – some constant percentage of all incomes – and a flat consumption tax – some constant percentage of all purchases of goods and services by consumers. Dividends would be taxed as income and there would be no deductions. I would not bother taxing corporate profits, simply because they are too hard to define.

My simple approach would abandon the idealism of the tax system – the notion that it should promote justice and efficiency. The government, however, can and indeed should strive for these noble goals, but its will is much better expressed directly – through law, regulation and expenditures – than indirectly through taxes. Exemptions, deductions and progressive rates can be replaced by grants – to the poor, to parents, to research projects, and whatever else legislators consider worthy.

Of course, no tax code can be quite as simple as my one-paragraph sketch. I have ignored such tricky areas as capital gains and non-cash transactions. Still, my ultra-simple rules are enough to cover the overwhelming majority of economic activity. Practical solutions for the remnants could be found fairly easily – with the help of a tiny fraction of the people who currently work on tax matters.

Unfortunately, my plan is likely to suffer the same fate as the many proposals for tax simplification which have preceded it: perhaps praised, definitely filed and forgotten. Radical change is desired in theory, but stymied in practice by the many interests vested in the current arrangements. It can seem that no new tax construction is possible without a violent demolition of the status quo.

Let’s hope that neither revolution nor Armageddon is required. Tax stultification, with its perceived injustice and undoubted inefficiency, alienates citizens from their governments. A transition to a clearer and ultimately fairer system might not be easy, but the result would be better for everyone.

12 comments

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“I would not bother taxing corporate profits, simply because they are too hard to define.”
sounds like another attempt to push all tax burden onto individuals. and you started out so well. how difficult is it to determnine what a company’s sales are? if you are taxing individuals on total gross income with no deductions, then it is reasonable to also tax every company on there gross income at the same rate – allowing only deductions for labor costs, dividends, loan interest that already gets taxed at the individual level. this would be the fairest of plans, no longer penalizing companies for being efficient while allowing their less efficient competition to skip paying taxes (>60% of corps). the overall rate would plummet from the proposed 15% or so individual tax to less than 5% overall when all earners gross income is taxed. after all, corporations are people too. the only corporations that would oppose this are the majority who pay less than this proposed 5% on gross sales or nothing at all. the entire tax code goes back to a handful of pages and tax fraud is virtually eliminated.

Posted by jcfl | Report as abusive

Very astute observations Mr. Hadas. “Let’s hope… revolution… isn’t required. Tax stultification… alienates citizens from their governments.” I used to think I lived in a reasonably fair well run country, now alienation hardly describes my emotion. Just below the surface a very large number of people like me are boiling. This won’t turn into revolution by itself, but it sets the stage for one should the an unforeseen event (e.g. economic collapse) happen. We’d all be wise to put the tax code in the toilet and start over with something simple that actually has a semblance of fairness, because as you point out our current tax abomination doesn’t.

Posted by Truth_Teller | Report as abusive

Just to be clear about corporate taxes: while companies are legal persons, they are economic intermediaries. The taxes on profits are ultimately paid by the people who buy the corporation’s good and services. The abolition of a corporate profit tax might increase profits and corporate power, but the lost corporate expense might also turn into higher wages or lower prices. Again, my fundamental complaint is that taxes are a bad tool for public policy. If there is a democratic decision that profits are too high, that problem should be addressed by regulating the behavior or situation which allows shareholders to claim an unjustly large share of revenue.

Posted by EHadas | Report as abusive

“Exemptions, deductions and progressive rates can be replaced by grants – to the poor, to parents, to research projects, and whatever else legislators consider worthy.”

Mr. Hadas: This is exactly where the issue lies. The Beltway aristocracy, including the President, have no motivation to rethink how they can achieve the same results with a more efficient and effective system. That requires way to much work. Instead they spend their time on “feel good” initiatives that are well outside their purview.

Can you imagine this or any President spending two years on tax policy, while other “critical” initiatives (equal pay, abortion, women’s role in the military, student loans, environmental regulation) all take a back seat? I cannot.

Notwithstanding the fact that 50,000 pages of tax policy is both onerous and ineffective, it also means that a simple policy effectively minimizes the opportunity to grant preferences to personal and political causes and the associated corruption(Pelosi’s tax benefits to fish processing in Samoa, Planned Parenthood, anything “green”, ethanol subsidies, ad infinitum.

That might mean the Washington would not any longer be involved in the everyday personal business of the citizens. And, that is the inflection point where politicians will dig in and refuse to change the system. The current system is designed to concentrate power inside the Beltway. As stated above, it is this power that serves to truly alienate the citizens.

Posted by COindependent | Report as abusive

This was the reason why I wished Herman Caine hadn’t been brought down by personal issues in the Republican primary… we need this. And the author makes a very excellent point that left wing people who oppose simple taxes should take note of: You can express progressive policy through directly doing, as opposed to indirectly (and frustratingly) taxing.

Posted by ShiroiKarasu | Report as abusive

I was astounded to find that I was agreeing with you on taxes, until you made this incredibly stupid remark.

“(The old complex has failed.) I have a simple suggestion for what should replace it: simplicity. Taxes should be simple to calculate and to collect. I would suggest the simplest of all possible arrangement: a flat income tax – some constant percentage of all incomes – and a flat consumption tax – some constant percentage of all purchases of goods and services by consumers. Dividends would be taxed as income and there would be no deductions. I would not bother taxing corporate profits, simply because they are too hard to define.”

(1) A so-called “flat tax” is anything but flat. Basically, it inverts the present system of progressive taxation by holding the tax rate steady, while allowing incomes to escalate without any commensurate increase in taxes.

To put it more simply, wealthy incomes would increase exponentially, while the amount subject to tax would remain fixed, thus producing an increasingly massive windfall for the wealhy class.

I would illustrate with a graph but this venue will not allow it. I suggest you graph income and a flat tax together, then look to the right and see how the untaxed income rises ever more exponentially while the amount taxed rises at a much lower rate.

That difference is the amount of extra profits the wealthy would obtain by a “flat tax”, all at your expense.

A flat tax is a scam. One that cannot be “adjusted” in any manner whatsover to produce a fair tax. The “hook” the wealthy use to get people to believe this crap is to establish some sort of tax free base below which no taxes would be collected.

Thus, it seems like a good deal. But in reality total tax revenues would drop significantly. So, why should you care if total tax revenues drop significantly, even to the point where we cannot operate our government without significant reduction in spending (which might not be a bad thing, right)? WRONG?

The problem is that government overspending CANNOT be solved simply be reducing revenue, which would then have a cascade effect of reduce spending automaticlly.

That is what Congress is attempting to do now, and it doesn’t work — at least not without crashing the economy. This requires a political solution first, then a revamp of our revenue/expenditures. Without a political solution this government will not survive much longer.

Thus a flat tax would simply hasten the collapse of the government, which would create a host of other problems I doubt any of you would want to deal with.

To prevent this, if we went with a flat tax, there are only two viable solutions.

Either raise the percentage amount of the flat tax high enough to cove the massive losses when the wealthy pay even less taxes than now — a fact which I doubt any of you would like, since the actual percentage of the flat tax would have to be so high that not even the wealthy are suggesting this solution.

(2) Or force the inclusion of other taxes to make up for the losses, which is ALWAYS mentioned in conjunction with a flat tax, because the wealthy know it will not work.

For example, Mr. Hadas recommends “a flat income tax – some constant percentage of all incomes – and a flat consumption tax – some constant percentage of all purchases of goods and services by consumers.”

And there it is, “a flat consumption tax”, which sounds innocuous enough, but it is a mathematical fact that ANY flat tax hits the middle and lower classes harder than the wealthy class and are inherently unfair.

What Mr. Hadas really means is a federal sales tax — typically a VAT (Value Added Tax) — with acts like compound interest, instead of simple interest, on a loan because it is collected at each level of “value added”.

The proponents of a VAT argue that the net effect is no different than ordinary flat sales tax, but that is a lie. Experience in Europe shows it is the most effective way to collect the maximum amount of money from people with the least amount of government effort, and the consumer doesn’t realize how high the tax being imposed really is, because most of it is buried in the product and totally invisible to the consumer.

(3) “Dividends would be taxed as income and there would be no deductions” sounds great, except the typical flat tax proposal argues that a tax rate percentage of somewhere in the teens would be sufficient, while the wealthy only pay 15% now.

“Congress passed the Jobs and Growth Tax Relief Reconciliation Act of 2003 (“JGTRRA”), which included some of the cuts Bush requested and which he signed into law on May 28, 2003. Under the new law, qualified dividends are taxed at the same rate as long-term capital gains, which is 15 percent for most individual taxpayers.”

This is what is known as a “throw-away item” in bargaining. That is something to supposedly sweeten the deal to make it more attractive to a sucker, but one which means nothing to the person offering the deal.

(4) Lastly, Mr. Hadas states “I would not bother taxing corporate profits, simply because they are too hard to define.”

ARE YOU SERIOUS, MR HADAS?

The suggestion that corporate taxes not be levied at all SIMPLY BECAUSE THEY ARE TOO HARD TO DEFINE is an insult to my intelligence, and thus I choose not to reply to such a completely ludicrous moronic and inane suggestion.

———————————————–

Thus, in summary, what Mr. Hadas would have you do is to reduce the income taxes of the weatlhy by an expoential amount, supposedly to make taxes more simple and fair for everyone.

To offset the loss in revenue from income taxes he would introduce a VAT — Value Added Taxes in Europe run, if I remeber correctly, typically in the low 20% range. However, keep in mind this is not an ordinary federal sales tax, which would be egregious enough, but a compound interest-like tax on steroidsl. So the actual amount collected is far higher than that stated VAT.

As I said, taxing dividends as income no deductions is a throw-away to confuse suckers who don’t know any better.

And, finally, last but not least and buried in the “fine print” at the bottom of the paragraph is the argument that we can’t collect taxes from corporations who are raking in billions/trillions of dollars per year, and barely paying any taxes on those amounts now.

Mr. Hadas clearly knows absolutely NOTHING about economics or finance, which is evident by the load of absolute bullshit in this article.

This article by Mr. Hadas is not the exception, but the rule. Therefore, I seriously question Reuters reasons for allowing such a complete moron to express an opinion on its pages.

Posted by PseudoTurtle | Report as abusive

The elephant in the room is that the same Congress that has allowed the present “system” to emerge over the years will oversee it’s successor. And the same “special interests” will put their money to work buying the influence to tweak whatever “new system” is adopted to favor themselves at the expense of others.

It’s not unlike our Constitution. It was made difficult to change with good reason, because change is not always good and people are not at all times reasonable.

And then there’s the inevitability of a VAT under ANY system of taxation, simply because the power to impose is unquestioned and the political greed for all it can fund is insatiable. There be no question of “whether” but only of “when”.

Such “change” as is “good” for “our” government will NOT end well for taxpayers.

Posted by OneOfTheSheep | Report as abusive

I agree that the current tax system is too complex. However, I disagree with your fix. Income for individuals and corporations should be defined and taxed in exactly the same manner. For simplicity’s sake, I don’t mind a flat tax as long as it exempts all income under a certain level.

Posted by M.C.McBride | Report as abusive

@ M.C.McBride –

I suggest you read my comment regarding a flat tax.

You may want to change your mind.

Posted by PseudoTurtle | Report as abusive

Step 1: Remove ALL exemptions and deductions…
Step 2: have a graduated tax rate (10%, 20%, 30%, 40%) at defined levels (TBD)
Step 3: Tax companies on the profits they report to the markets for quoted ones, and for small companies, tax all profits @ 20%
Step 4; Tax all income the same way, be it wages, capital gains, dividends, carried interest, inheritance… treat it all the same.

Step 5: get rid of 50% of the IRS, and focus the remaining people on investigating tax avoidence schemes. Also get rid of those parasitic tax prep places.

Posted by GA_Chris | Report as abusive

2:57 pm UTCStep 1: Remove ALL exemptions and deductions…
Step 2: have a graduated tax rate (10%, 20%, 30%, 40%) at defined levels (TBD)
Step 3: Tax companies on the profits they report to the markets for quoted ones, and for small companies, tax all profits @ 20%
Step 4; Tax all income the same way, be it wages, capital gains, dividends, carried interest, inheritance… treat it all the same.

Step 5: get rid of 50% of the IRS, and focus the remaining people on investigating tax avoidence schemes. Also get rid of those parasitic tax prep places.

Posted by GA_Chris | Report as abusive

I agree with GA_Chris! This is the best plan and most fair plan.

Posted by Concernedcitz | Report as abusive

Simplifying tax systems, either as suggested in the article, or as suggested in some of the comments (e.g. GA_Chris’) seems like a great idea to me, at first glance. On second thought, however, with advances in technology rendering more and more jobs obsolete, there is really not much left for most people to do, other than to join the ranks of those who prepare tax returns.

Not to dispute GA_Chris’ characterization of “tax prep places” as “parasitic,” but it seems to me that much of what remains of viable employment has been similarly described at one time or another, and it looks to me like those who cannot retrain as some kind of professional parasite will only survive if they wind up being lucky parasites, such as lottery winners, a group which of course includes those who planned ahead and made sure they were born to billionaires.

If anything, then, we must constantly complicate the tax code to keep it at least one step beyond automated processing, at least until such time as we render our own species entirely redundant by evolving into the machines that, till then, will make continued complication of the tax code essential for perpetuating our illusion of purposeful employment.

Posted by MoBioph | Report as abusive