Taxes revolt

I'm in the midst of paying my taxes (you know what's more fun than freelance income and business expenses? That's right--moving between states mid-year!) So it's time for our annual Megan McArdle tax rant. Every libertarian fiber in my body has been quivering with indignation for a solid twelve hours. Obviously, like everyone else I do not enjoy contemplating my cash outflow to Uncle Sam--I can think of a lot of uses for that cash. That, however, is the price of living in a free society. What bothers me is that it's so bloody complicated.

I should not have, in the course of paying my debt to society, to spend nine hours answering questions about my educational habits, proclivity to recycle, the location of my potentially qualified small business, whether or not I happen to farm, or any of the 87 trillion other things TurboTax wanted to know. It might have been 87 zillion. Frankly, I lost count.

More than two hundred years ago, we fought a whole revolution and everything to get the government to leave us the hell alone. Now it thinks it's entitled to know whether I am a qualified small business owning woman. Small business? Check. Woman? Check. Qualified? Who the hell do you think you are, Mr. Tax Man?

All this useless activity is so that our politicians can look like They Care by giving tiny tax breaks to all of their favorite people--that is to say, the people who vote for them and give them money. All of these tax breaks, almost without exception, do the most good for the people who least need them. Meanwhile, they waste time for the rest of us, distort the economy, and require us to pay extra people to process tax returns. It's lose-lose-lose all around unless you owned a seal-fur farm between 1987 and 1991.

As others haul out the plastic inflatable Santa every Christmas, I showcase the Jane Galt Tax Plan every April 15th.

1) Get rid of all our poverty programs, except those aimed at the disabled, and temporary unemployment assistance, and institute the negative income tax. That is to say, the system should be continuously progressive, from a steep negative rate of up to 100% on very low earners, gradually declining until it zeroes out around $28,000 a year, and then rising gradually until it maxes out around 35% on the top brackets.

2) Eliminate FICA and pay for Social Security and Medicare out of general revenue. It's time to stop pretending it's a pension system, when there are no assets in the "trust fund"

3) Eliminate the corporate income tax

4) Eliminate the special treatment for capital gains. All income should be taxed at the same level, regardless of its source.

5) Eliminate all deductions. Period, end of statement. No mortgate, student, child, etc. All causes are equally worthy in the eyes of the person who possesses the deduction; it is a waste of our time as a nation to sit around arguing about who deserves what.

6) Just say no to the Value Added Tax. In theory, it's a good tax. In practice, because it is extremely hard to tell what proportion of the price of anything represents the tax, it removes the good and natural pressure upon tax rates.

7) Get rid of the estate tax, and tax the capital gains on whatever is sold.

So why these particular features?

Well, the negative income tax does two things: encourages work by removing the disincentives created by potential loss of benefits; and means that the entire country, poorest to richest, faces a marginal tax increase if they want more spending: the poor have to give back some of their rebate, while the rich have to pay higher rates. For many on the left, that may of course be a bug, not a feature, as it forces the electorate to think much harder about whether or not they want new spending.

The arguments between conservatives and liberals often go like this:

C: The rich pay all the taxes
L: That's not true -- what about FICA?

Both have points. But the central issue that the conservatives are trying to get at is that the majority of the electorate does not face a marginal tax increase when they agitate for new spending. FICA may indeed be regressive, but its rates are unaffected by the level of spending in government. So a majority is prone to agitate for higher taxes, because they will not be paying those taxes.

I don't think it's a healthy situation for the electorate when a large majority is voting for spending that costs them nothing. To the minds of someone who pays no income tax, there's no cost/benefit analysis to be made; they're getting stuff for free. Even something of trivial benefit to them is thus better than not raising taxes. So we end up spending money on a lot of crap, because most of the voters don't care -- it's not their money.

On the other hand, liberals have a point about fairness. It isn't fair to say that some guy who brings home $20K should pay the same quarter of his income as Warren Buffett. The decrease in Joe Schmoe's standard of living represented by that 25% is much greater than the decrease in Warren Buffett's SOL from taking a quarter of his loot.

A negative income tax increases fairness, removes perverse incentives from the current benefit system, and makes sure that everyone has to think about whether they really want that new spending they're voting for -- enough to give up some of their cash.

Killing FICA increases fairness while removing some of the obstacles to reform by eliminating the fiction of an insurance program.

Eliminating the corporate income tax while equalizing treatment between capital gains does a number of things. It mitigates the current bias towards (tax deductible) debt financing. It ends all the ridiculous distortionary crap that corporations do to get around taxes. It ends the bias towards retained earnings that helped produce such interesting results in the stock market. It takes away a large chunk of the ability of the rich to avoid taxes by deferring their income in capital gains. It ends the tax preference for stock options that helped make the start of the new millenium so lively. Under this plan, income is income is income, no matter where it comes from. Thus we can stop the multi-billion dollar industry in shifting income from tax-disadvantaged to tax-advantaged forms.

If you just end the corporate tax without changing capital gains, you keep much of the distortion and shelter for the rich. If you eliminate special capital gains treatment without eliminating the corporate tax, you bias the economy away from investment, because now income is taxed at a high level twice -- once when its made by the company, and a second time when its distributed to the company's owners. This way, we tax it once, when it hits a real person.

We eliminate deductions for two reasons. First of all, they're distortionary. If it makes economic sense for adults to go to school, they will go to school. Giving a tax credit for it just encourages marginal activity that wouldn't pay for itself without a subsidy. Try thinking of it not as a tax credit, but as you giving someone else money to follow their dream of learning Old Church Slavonic, and you see what I mean.

Second of all, deductions are the way that the rich make sure that they pay a lot less taxes than the upper middle class. There is a reason that Barbra Streisand thinks that income taxes should be raised; she isn't going to pay much more tax. Most of her money is in assets, earning more money. It's the guy who owns the gas station down the street who's going to get it in the teeth. If we want to tax the rich, let's tax them, not give umpteen zillion deductions so they have the same marginal rate as your average bike messenger.

That's fine, I hear you say, but why all the deductions? Why not just the bad ones?

Because, as we've found since Reagan's simplification, there's no such thing as just one deduction. If you want the mortgage tax credit, you're going to need to give someone else the land-use abatement, and then there's the guy with his Urban Empowerment Zone Qualified Small Business, and next thing you know, we haven't gotten anywhere. The only way to get a clean code is to get rid of all of them. This won't be fun for many people. Housing prices will drop, for starters. On the other hand, so will tax rates. And come on -- why should an apartment renter be paying more taxes so you can frolic in the greenery?

Why get rid of the estate tax? Because the revenues raised are trivial, and people spend an enormous amount of time and money structuring their estates to get around them. Again, a disproportionate share of the tax is paid not by the super rich, but by the poor schmucks with one or two big assets they can't structure to get around the tax. On the other hand, when it's sold the inheritors should pay all the capital gains -- if you get rid of the estate tax, you should get rid of the stepped-up basis as well.

As I wrote way back when, guaranteed to satisfy no one but it's owner . . . but at least I feel better.

The rest of you should probably get back to your taxes.