Column: The search for the golden tax system
Wouldn't it be great to have a simple tax system? Everyone who thinks about taxes would like to find one or figure one out. I have considered numerous systems too and had hoped to find a good one.
The problem is none of them pan out, and putting all the tax eggs in any one basket doesn't work.
First, let me distinguish between a simple system versus simplifying what we have. We could do a lot of cleanup and simplifying and closing loopholes and ending deductions that aren't helpful. That is something we should do, and have done in the past.
What I'm talking about are the simple tax proposals - such as having only a sales tax and getting rid of the rest - or a flat tax - whichever of the many versions of that you like - or a consumption tax, or a VAT tax, or etcetera. You can pore over the details of each hoping to find the golden fleece. Each fails to be what you thought it would be, and each brings problems, like the Sirens luring us to the rocks. Or, to steer the metaphor closer to home, it's like looking for the Lost Dutchman mine.
There are three categories of problems: regressiveness, location, and avoidance.
Regressivenss: Most of the simple systems result in low-wage people or middle-income people either paying more than they do under the current system, or just plain paying more. That is, they would pay a bigger portion of their income in taxes than people of higher incomes. That's mostly because sales taxes hit the low-end harder because they have to spend almost all of their income to get by, whereas much higher income earners spend some of it but a lot is not spent. For instance our state taxes, in total, have the result that the lower your income the bigger a portion of your income you pay. Much bigger in fact. See my column of April 18, 2012 for details.
Some sales tax proposals, like the Fair Tax, would give a big chunk of money back to every citizen as a way to fix that, so that for a low-income person it roughly offsets their tax. The problem is it doesn't do enough to help middle-income people, so they end up being the ones who pay more in such a system, while the top ends up paying less.
That can be fixed by making it means-tested. That is, give more of a break to low incomes, a middling break to middle incomes, tapering off to no break at the top. But to do that you have to measure income, so you're back to all the same issues of calculating and verifying that go with an income tax.
Location: One tax is never likely to fit all needs anyway, because different levels and locations of government need different things. Cities need to collect sales tax because it's impractical on that level to collect income tax. Even if cities did collect income tax there would be a problem. Towns with a lot of tourism have all those tourists coming in and using the city streets and water and sewers, a burden that is offset by collecting sales tax from them.
Avoidance: It turns out it works well to have numerous kinds of taxes even at the national level. Having only sales tax would create a huge incentive for a black market that avoids sales tax. On the other hand, having no sales tax would miss what tax we do collect on criminal income, like when drug dealers and those with unreported income spend their money. Also, income tax tends to discourage saving, whereas sales or consumption taxes encourage saving, so a balance is good. Getting rid of corporate taxes and trying to capture it all in income tax likewise causes distortions and avoidance. On excise taxes, on gasoline for instance, charging an extra tax which then goes to pay for cleaning up the pollution from our cars may be the best policy. And excise taxes on utilities have to adapt to local conditions, for parts of the country where providing electricity or water or sewers may be more challenging.
It seems calculating income is going to be an unavoidable part of the system but it doesn't have to be as big of a problem as it has grown to be. The dream of a postcard-size tax return already exists for a wage earner with no mortgage: the 1040EZ. It gets complicated when you want to claim your mortgage-interest deduction. Those deductions come with a price, that you have to track the necessary details. No way around that. Where the calculations get more complex is, for instance, for a small business owner, but then businesses have to keep track of income and outflow, what is an expense, what is profit, etcetera, anyway. With a cleaned up income tax system this wouldn't be much worse than what has to be done for bookkeeping purposes anyway.
A simple tax is an alluring idea, but not practical policy.