This is the follow-up tax post I mentioned before. Here, I want to look briefly at what tax policy is supposed to be, what’s wrong with it in America, and a bit about how it can be improved.
I’ve heard that taxes are the price we pay for civilization and the only two certainties in life are death and taxes. I agree with those. I’m ok with them. We can’t live in a zero-tax country, otherwise anarchy will ensue.
What I have a major problem with is how taxation is viewed in the USA. The goal of tax policy is supposed to be to efficiently collect money to run the government without acting as a strong headwind on the economy. As usual, the problem is the politicians because they don’t view tax policy that way. They tend to view it as a tool for their own careers first and foremost. Four major errors come to mind, one the left is particularly guilty of and three both left and right are guilty of.
The left often confuses tax rates with tax revenues. They assume that if we raise tax rates, we’ll always raise tax revenues, and if we lower tax rates, we’ll lower tax revenues. This implies inelasticity in society’s behavior, that we behave the same in various tax environments. Conversely, the Laffer Curve postulates that there's an optimum tax level that maximizes revenue and that tax revenue will fall if the tax rates are above or below that sweet spot rate. Basically, too low or too high of a tax rate lowers tax revenue. History has shown time and again that the Laffer Curve is a more realistic view and the inelastic assumption is overly simplistic and factually wrong. In the 1920’s under Coolidge, the 1960’s under Kennedy, the 1980’s under Reagan, and 2000’s under Bush Jr., we saw that as tax rates were lowered, tax revenue increased. One point is a random point in space, a line can be drawn between any two points, three points make a trend, and four points confirm the trend. When tax rates are lowered, capital is taken out of inefficient, low-risk, low-reward tax shelters like municipal bonds and put to work in higher-risk, higher-reward ventures like business expansion and creation.
My second error is one I’ve touched on previously in the context of charitable donations. If the government controls so much of our money, then they have the power to spend it as they please. Their error is thinking they know better than us and thinking that it’s their money to spend. They're wrong on both counts. Lower taxes would restore power to the people. I’m reminded of a quote by Alexis de Tocqueville that reads, “The American Republic will endure until the day Congress discovers that it can bribe the public with the public’s money.”
Third, politicians on both sides use tax policy to reward friends and “good behavior” and punish enemies and “bad behavior”. Another old adage is that if you want less of something, tax it. This is why tobacco taxes are so high, for example. On the flip side, if you want to encourage something, reduce taxes on it or create deductions/credits for it, like home ownership. With more benign examples like home ownership, this may not seem like much of a problem. However, when framed using more sinister examples, this does become a problem, such as with crony capitalism.
My last point is a direct result of the behavioral modification point I just made. Because of all these, the government has created a needlessly complicated tax code. Do we really need this complex of a tax code? Seriously think about that. Sure, it’s kind of fun in a way to hunt for tax deductions and credits. It’s like being a treasure hunter or trying to solve a giant puzzle. I know “Indiana Jones and the Temple of Doom” sounds way cooler than “Indiana Jones and the Tax Code of Doom” but you get the point.
All those special interests carve-outs make the tax code absurdly complicated. I’ve heard we would save 1-2% of our GDP per year if we seriously simplified the tax code. That’s a major growth tailwind. Sure, a lot of tax lawyers, accountants, and tax preparers would be unemployed, but with the money that goes back into the economy through the savings, these people would likely find other work.
I'll lay out some possible simplifications in a future post.
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