Let's start with why we need them. We need taxes to construct and pay for things that ordinary citizens would not be willing to pay for, or would be unable to pay for, on their own. Things such as streets, traffic lights, an armed and trained defensive force, a trained enforcement force, among other things. We need this infrastructure and support in order to have a country that is able to grow and prosper, allowing people to improve their life through hard-work and determination. Here in the US, spending has ranged between 30% and 40% of GDP for the last few decades. So tax tenet #1, taxes must be significant enough to provide for an appropriate level of government service, say 30% of GDP. I won't get into why this is too high, but it's a start.
So, how should taxes be levied in order to fairly create that type of country? That is, a country where everyone has an equal standing and fair chance to improve upon their lives or, alternatively, not improve upon their lives without draining heavily on others? It's hard to be poor, a lot harder than it is to be rich. Taxes should be distributed so that some of the difficulty in being poor is offset onto the rich to create a society with a fair possibility of socioeconomic change, which leads us to tenet #2, taxes should be levied more heavily on the rich than the poor.
Income taxes cannot differentiate between someone that is poor and not attempting to improve and someone that is poor but is attempting to improve. Consider four people, Adam, Barry, Chuck, and David. Adam is poor, works just enough at the local grocery store to afford his home and some nice things, and is, effectively, surviving comfortably enough for him. Barry is also poor, works as much as he can at the local grocery store to afford his home and school, and is working to improve himself. Chuck is rich from an inheritance, doesn't work, and lives life lavishly. David is also rich, but from his own hard work, lives life conservatively but comfortably. Of these four guys, who should pay the most in taxes? Arguably, you might rank them Chuck, David, Adam, Barry, which would be a quick and reasonable way to do it; however, how is the graduated income tax going to tax these four? Well, David makes the most so he would pay the most. Chuck has no income so would only pay other taxes (capital gains, etc) -- for this, let's assume that all of his money is cash so there are no additional taxes involved. Since Chuck is not paying taxes, Barry is working way more than Adam, so he would pay more in taxes. Adam would be third in taxes. Chuck would be fourth. This seems incredibly unfair! Why is the lavishly living Chuck not paying any income tax? Well, he has no income. And then, why is Barry paying more than Adam despite them both having the same job? The system is punishing Barry for working harder, leading us to tax tenet #3: taxes should not punish hard work nor should it punish living conservatively and reasonably.
So, we have three rules that taxes should follow to be successful:
- Taxes must be able to reach a critical level of usefulness. (Our target, 30% of GDP)
- Taxes should be levied more heavily on the rich than on the poor. (Graduated tax system)
- Taxes should not punish hard work and efficient living.
In an income tax system, numbers 2 and 3 are at odds. In order to make more income, you generally have to work harder. As a result, there is a marginally reduced value to working an extra hour and the system punishes equivalent hourly earners based upon time invested. So, how do you fix this? In the current tax system, we have thousands of different "loop-holes" to attempt to fix this problem. Educational credits, health credits, earned income tax credits, etc, etc, etc. These are patches that only partially help while making the tax process incredibly burdensome and difficult, leading us to the tax codes that we have today. In short, an income-based tax system is a bear to manage, which might explain why our tax code has become a book that is thicker and as difficult to read as a textbook on econometrics. Aside from these issues, you also have cost of living adjustments that are necessary, yet frequently missing, from such a tax system.
So, we've torn up the old tax code and have no taxes in place, yet we need to somehow get to 30% of GDP to balance our budget. Adam, Barry, Chuck, and David all have different lifestyles, yet we're only taxing them based on their income and then applying thousands of filters to try and determine how they're spending their income in order to more fairly tax them. Instead, why don't we directly tax the ways that they spend money? We will call this a "sales tax". With a sales tax, can we reach the target of 30% of GDP,or will it need to be supplemented by additional taxes?
Gross domestic product is a calculation of our production as a country. It is made up of five components. Investment, consumption, government spending, imports, and exports. In equation form it would look like:
GDP = I + C + G + (EP - IP)
Consumption is made up of, as you likely guessed, all of our local consumption. Food, clothing, cars, yachts, etc fall under this.Consumption makes up approximately 70% of America's GDP. To match our target of 30%, we need to tax consumption at an average rate of ~40%. So, in theory, we can reach the targeted threshold of 30% of GDP. We would be talking about high sales taxes, but your style of living would define the rate at which you would be taxed; however, we're talking about the same amount of taxes as the government should be collecting via income tax anyways.
Finally, we need to figure out how to implement a sales tax so that it fulfills rule #3. We want to ensure that conservative and efficient living is encouraged while lavish and extravagent living is discouraged. So, let's consider splitting consumption into three classes: Necessity, Luxury, and Improvement. So, C = N + L + I
Necessities consist of unprepared foods (think "Meal Tax" in the Northeast), clothing under a certain price point (let's pick items under $40), and the first $500/month of rent or the first $50,000 of a home, and desktop/laptop computers under $300. Of course, all of these numbers should be linked to inflation and region. This can easily be done using the measured inflation for each CPI category by region rather than trying to derive a CPI-basket that defines the average person. These items would not have taxes applied to them to allow poor households to cook food cheaply and purchase clothes everyday clothes cheaply. The premise for this tax is that you want to avoid taxing those goods that are necessary to live at the low end, making life just a little bit easier for the poor.
Improvement items will then consist of items that are generally 'of use' as a means of production. These would be items generally bought for school by individuals or for work by companies. Basic stationary, work trucks (18 wheelers, dump trucks, concrete trucks, etc), textbooks, contractors' tools, IDEs, servers, etc, This will be the hardest category to fill as there can be arguments made for many things, but effectively this category should be limited only to objects where the only use is for production purposes. A fully-loaded Ford F-150, for example, could be used by a company or a farm; however, it could also be used and considered as a luxury, so I would not classify that under "Improvement". These goods should be taxed at a relatively low, flat rate. This tax effectively hits corporations and businesses relative to their spending costs. It creates further incentive to price-shop as a $1 increase now results in a $(1+x) cost change, creating fewer barriers to entry for newer firms in a space.
Luxury items will consist of everything else. Prepared meals, fancy clothes, cars, boats, furniture, movies, games, tickets, etc. These items should be taxed on a graduated scale based on price and category. For example, jewelry priced under $100 should have the lowest tax rate, goods priced between $100 and $1,000 should have another tax rate, $1,000 to $25,000 gets another rate, and $25,000+ gets the highest rate. Moving into automobiles, a different scale should be used starting at $15,000 and moving up from there. These are the items that are unnecessary and pleasant to have and should be taxed to disincentivize lavish spending while encouraging and supporting more conservative lifestyles.
All of the tax rates and brackets would need to be linked to inflation-metrics, and, again, since we've got brackets around specific goods (the tax system could be more complicated to allow for cheap cars to be taxed differently from expensive cars, etc. while still being less complicated than our current income tax system) the inflation adjustments would be easier to apply and far more accurate than the current approach of CPI-basket adjustments. Region adjustments can also be applied in the same manner to accomodate for different costs of living
Additionally, annually the revenue to spending ratio could be reviewed with sales taxes being increased or decreased on a 2-year moving window by the appropriate ratio to increase or decrease the revenue to ensure a balanced budget. Alternatively, in an appropriately educated Congress (Yeah, I know, wishful thinking right?), a sales tax could be increased in good times and reduced in bad times very easily without having to target specific income tax segments of the population to reduce the good times while improving the bad times without directly modifying government spending.
The real benefit to this system is that the government is taxing income based on how it is spent rather than on how it is earned. In this system, Chuck would pay the most in taxes, David the next most, followed by Adam, and finally Barry. The person striving to improve himself through efficiency and hard-work would only be taxed on the luxuries he takes. The person living lavishly would be taxed lavishly, encouraging him to live more conservatively, work more, and invest more. The hard workers who have succeeded will pay their fair share of taxes through the luxury goods they do consume, while the poor workers, pushing themselves through school on rice and beans, would be paying little to no taxes. All of this leaves the government with revenue to continue providing the services they already provide where there is plenty of room for reform to reduce the tax burden while still helping people.
Note that investments are not taxed. Investments are what lead innovation, development, and advancement in an economy. By not taxing investments and heavily taxing consumption, America would create a long-term approach to improving our economic future. A high consumption tax would improve America's savings and investment rates (beyond their meager 3.5% rate) which would improve long-term economic health, encourage domestic innovation, and spur job growth in ways that increasing consumption cannot do.
