Saturday, April 16, 2005

Flat taxes don't simplify

I'd better get this post out quick, before everyone forgets what it was like to do their taxes. Now is the best time to point out that a flat tax (one without a progressive rate structure in which lower income levels are taxed at lower rates) won't actually make your taxes any simpler.

What did you spend most of your time on as you did your taxes? If you're an investor, maybe you spent it on totalling up all your stock gains and losses. If you get lots of income from different sources, maybe you spent it getting your motley assembly of W-2s and 1099-whatevers together. If you apply for a bunch of deductions, maybe it was getting deduction-related paperwork together and figuring out whether to take your standard deduction or to itemize.

Chances are, it wasn't figuring out how to work the progressive rate structure. If you used some software program to do your taxes, this took you no time at all -- the computer did it all by itself. If you did your taxes by hand, it was pretty easy to use the tax table in the book the IRS gives you, wasn't it? Just look up your taxable income, and it tells you how much you owe. (I've done it both ways, and I've never had any trouble with the progressive bracket system.)

So if you want to make things easier for tax filers, there's no need to mess with the progressive rate structure.

9 comments:

dadahead said...

The flat tax is of course a terrible idea, but isn't the idea that deductions would be eliminated, which would simplify things in at least that respect.

Neil Sinhababu said...

That's right, dadahead.

Dennis said...

Yeah, but even so that'll never happen -- tax deductions are far too good a political suggestion to kill, so even this benefit is way overstated.

david said...

I don't know much about this topic, but I think it's quite clear that taxing income does require much more energy/time/money than other forms of taxation. There is a whole income tax industry; an army of lawyers and accountants specialize in the income tax. Presumably, these people would be doing something more productive with their time if the income tax did not exist. Compare this situation with other taxes. Collecting a sales tax, for instance, does not seem to require anything close to the same amount of energy/manpower in order to be collected. So, I don't know what the best way to gather taxes would be, but I do not think you can reasonably claim that the income tax does not require much more of our energy than other forms of taxation.

I have heard it argued that a heavier sales tax would be preferable to the income tax. A sales tax would (to some extent) track income (since people with higher income spend more), but it would be much easier and less energy-intensive to collect. (As an aside, a sales tax would also have a more beneficial incentive structure. Sales taxes discourage consumption, and incentivize saving; income taxes simply discourage people from working harder in order to make more money.)

I should say again that I know very little about this topic; all of the above is uninformed speculation and half-remembered rehashing.

Neil Sinhababu said...

I'm really not sure about the relative expensiveness of tax collection for various forms of taxation. Very high sales taxes, however, can encourage people to pay for goods in "under the table" ways and evade taxation. Then you've got to beef up the regulatory apparatus, and things become expensive again. Taking lots of deductions out of the tax code would, in an ideal world, be a good way to do things.

I don't think there's good reason to generally encourage savings over consumption. Certainly, when inflation looms large there is, but when the economy is in the doldrums, you want consumption over savings.

Sales taxes are, of course, hugely regressive, and that's the big reason I don't like them.

david said...

Well, it goes without saying that we couldn't do away with deductions altogether; otherwise people who have their own businesses will be taxed on sums vastly larger than their real incomes. So there have to be some deductions. The government has to decide; but the people in government will make those decisions in ways that will help them get re-elected, not in ways that will be maximally fair or simple. So it seems highly unlikely that we will ever have an income tax without also having a complicated, politically-motivated system of deductions.

Some quantities just happen to be more difficult to calculate than others. "Income," I gather, turns out to be one of the hard ones, especially (but not exclusively) if you have your own business, or have investments, or have any other source of income other than a typical salary. The system needs to be able to accommodate people with these weird sources of income, but they cannot be accommodated without making the system more complicated for everyone.

In light of all this, it seems worth looking for something simpler than income to tax. We'd be looking for something which tracks income (by which I mean: something which goes up when income goes up), but which can be easily calculated. Sales tax might not be a good choice, but I suspect that imaginative people can find one.

What does "regressive" mean, by the way? I thought I understood the meaning of that word, but I don't see how sales taxes are regressive in the sense I had in mind, so perhaps you mean something else by that word.

david said...

Change
"The government has to decide..."
to
"The government has to decide which deductions to allow..." or something along those lines.

Neil Sinhababu said...

Regressive taxes hit the poor more than the rich. Since the rich invest lots of their money or buy housing with it (which can cost as much as you want and is usually untaxed) they don't face as much sales tax. The poor spend a greater percentage of their money on food and consumer staples, which are hit by the sales tax.

On the other hand, the income tax is progressive -- it hits higher incomes harder.

Rousseau said...

I think computer scientists, psychologists, and social-economists might understand the inherent problem with the tax system the best: the more surgical you make your system, the computational costs increase. And computational problems really are nothing to laugh at (in this case, the combined salaries of all tax lawyers).

So for any loophole or such, a proper social welfare equation would take into account “money saved by guy” + “unique stimulus to economy because this guy has it” is greater than “money lost by government” + “computational power to use this”, for one.

In fact, I am tempted to believe that when it comes to what any loophole was intended for, this equation is generally true. The next step, of perverse incentives, where now lots of companies that it COULD work for chase after the credit, is when things really break down. Suppose the social welfare is indifferent between the government having the money or the new-chasers having it (when it’s likely to be slightly pro-government anyway)… it becomes decidedly negative sum, since the chaser also has to pay accountants to exercise these loopholes, and constantly search for new ones.

And our tax code and financial policies are almost always the result of looking at one desired result, and not thinking of all the other perverse incentives created.