There is a lot of discussion these days about tax reform, and there are plenty of folks ready to parade out their solution to the problem of funding government and tax "fairness".
Wait, did we say funding a sovereign currency-issuing government? What do taxes have to do with that? Well, as we've gone over already, absolutely nothing! Which is probably why we tax almost everything wrong! How many of our economic and societal troubles stem from bad tax policy? I hazard a guess that it's not an insignificant quantity.
When you start with an outdated and obsolete understanding of how our national currencies work, then you end up with counterproductive (at best) or outright destructive policies that hurt the economy and society as a whole. It seems to me that there is no cohesive economic framework (but there's no shortage of ideology) behind the ideas currently being debated by our politicians and political interest groups.
All parties approach the subject from the faulty perspective of raising money for the government to spend, and much less thought is given to:
1. what objectives we are trying to achieve with each and every tax;
2. what effects our tax policies have on the decisions of individuals and businesses;
3. how do these effects fit into the picture and health of the entire economy, considering the net flows between the private sector and the government, our trade balance, and the levels of private debt; and
4. what are the impacts to society and the maintenance of our liberty and democratic ideals.
The previous post attempted to reorient our thinking about why we tax and what principles should guide us as we think about tax reform. These principles are based on a careful understanding of how our monetary system functions in the real world, so that we can understand the implications on the economy of our current and proposed approaches to tax policy and tax rates.
Applying taxes to the real world
Remember that our approach to what to tax and how much to tax is guided by our real-world objectives: the will and desires of the people; the health of the economy; the stewardship of the land we inhabit; the availability of real resources; the development of national capital. Simply maximizing the number of its own IOUs the government collects back from the people (e.g. the concept behind the so-called Laffer Curve) is irrelevant and counterproductive to achieving our priority objectives.
What are our national objectives?
-A sovereign currency that provides maximum policy space for our nation?
-An economy that provides meaningful work at a living wage for all who desire it?
-An economy that doesn't disproportionately favor the rich and powerful to the detriment of the poor and weak?
-An economy that provides incentives for innovation and entrepreneurs?
-An economy that grows and rewards productivity and progress that benefits all?
-An economy that is in balance with our environment and that sustains & rejuvenates life in all its diverse forms?
-An economy that encourages giving?
-An economy that encourages saving?
-An economy that protects the democratic process and the voice of the people?
-An economy that respects other nations and seeks trade arrangements that are mutually beneficial?
We could go on... the point is that defining collective objectives should be part of our public discourse and political process.
Once we have our objectives, we can determine whether the way we tax is helping or hurting our ability to successfully realize our goals. I am (thankfully!) no expert in the intricacies of the tax code. But let’s try to apply our principles and see how we would rethink our tax system to achieve certain goals*.
Social Security taxes and Trust Funds
Here we have a classic "pay for" error. We have implemented a tax on incomes under the guise that we can collect government money and hold it for the future so that those who worked hard today can get some income after they retire. There were political reasons why Roosevelt did this at the time, but I suggest it's time we remove the veil of deception. The greatest assurance of its protection isn't pretending that the people put in the money to pay themselves back later, but rather that the government never has any excuse that it can't afford to pay.
-Our objective is to provide adequate incomes for retirees so that our elderly are not living destitute or in poverty. Fine - we can always credit bank accounts with whatever amount of newly issued money we deem adequate for the purpose. We don't need taxes for that. Not today and not 40 years from today.
-What is the effect of our payroll tax? It reduces the income today of all our workers, which means they have less money to spend or save or give away, and this also means businesses have less customers and sell less product.
-What could we do differently? Eliminate the Social Security taxes and the so-called Trust Funds, and replace it with a constitutional promise: the government will guarantee all future social security payments forever. Period. And we can make sure the amount paid adjusts as needed to ensure it is adequate for the needs of our elderly.
-What is the effect of this change? People have more income to spend, which means businesses will expand and more jobs will be added to the private sector. The Government's positive fiscal flows will increase and the net financial savings of the private sector will also increase.
-The same concept applies to Medicare taxes.
Here we usually make the error of considering this as a primary source of revenues for the government. Why do we want to tax incomes? Are they "bad"? Do we need to?
There are some possible valid objectives for income taxes:
-reduce the spending capacity of the private sector to give "space" for what we want the government to do so it isn't competing for scarce resources and driving up prices (the mass of unemployed and underutilized resources today tells us we have the opposite problem - taxes are too high);
-reduce the incomes of certain sectors of the economy more than others (such as high income earners versus the poor) to avoid excessive inequalities that harm the economy, the political process, and the social structure of the nation;
-maybe income taxes are one of the taxes we should use to create universal demand across the economy for the nation's currency;
-it is an easier tax to collect since employers take it directly out of paychecks, whereas other taxes might be harder or costlier to enforce and collect;
perhaps it can be useful as part of our automatic stabilizing function since as incomes fall, tax receipts fall, which is counter-cyclical to the economy.
-The question economists should study is whether this tax is the optimum solution (or part of it) to the universal tax need and counter-cyclical flows, and if so, at what level.
We should also study the effects of income taxes on various income brackets to see how income taxes affect spending and investing decisions, and its impact on the poor.
Progressive taxation is not about taking from the rich to give to the poor. It is about achieving objectives such as reducing inequality or placing a governor on excessive wealth concentration because due to the threat such concentrated power has to the political process, the fair representation of the people, and the health of the economy.
How could we do it differently? We could lower the income taxes to the minimal amount needed, change the tiers by income levels, or replace it entirely with alternatives that achieve the same or better societal and economic results. Today, I believe a lower tax overall and some adjustment to the tiers would be an improvement.
An alternative to relying on taxing income as our base tax, which could also be "progressive" in an environmental or carbon sense, would be to have a property tax based on square feet of space (or even cubic feet of space as suggested by L.R. Wray). The idea being that those that own larger living and business spaces are using more energy and producing more carbon emissions. Combine this concept with credits for energy savings and renewable energy, and ensure the minimal living income for the poor is sufficient to cover any resulting increase to their rents.
Remember, the amount the government collects is irrelevant for its own needs - it is the effect on the economy that matters.
Business profits & Capital Gains
Liberals love to talk about taxing businesses more so that they "pay their fair share". Conservatives love to justify low taxes on capital gains and dividends due to "double taxation" (the business profits get taxed first and then we tax the distributed dividends). But why do we tax business profits at all? Why not just tax the distributed income or capital gains from a sale and treat it all the same?
-In an economy that has capitalism at the core we generally want a profit incentive. Taxing businesses disadvantages then to foreign companies and reduces their ability to grow. Why would we want to discourage profits? Eventually, all business profits have to end up being either reinvested in something or paid out as dividends.
-If our objective is to provide incentives for entrepreneurs and investments in productive businesses and technologies, then taxing profits only takes away from the ability of businesses to reward risk-taking investors and to reinvest profits into R&D or growth.
-Capital Gains and dividends are often the only sources of income for the very wealthy so why does it make sense that their incomes are taxed at such lower rates than the lower-income workers that produce the gains for the capitalists? Do we want to give incentives for the growth of a "rentier class" that makes money from money without being productive or enhancing the nation's capital stock? Low capital gains and dividends tax rates versus higher income tax rates contributes to growing wealth inequality.
What could we do differently?
-Eliminate all taxes on corporate profits, and just tax all income, capital gains and dividends in the same manner.
-A carefully designed progressive tax rate or alternative concepts such as energy-based or property-based taxes could be applied to find the right incentives and disincentives based on what best produces a healthy economy and society (see income taxes above).
-There's plenty of room to find the right balance that doesn't dampen the investment appetite for entrepreneurs, businesses owners, and capitalists.
-Now businesses have more money to invest of expand, which is good for economic growth and jobs, but if they choose to distribute funds to investors, those are taxed as ordinary income.
-There would likely be additional benefits of simplifying the tax code but also bringing to light special interest group treatment: any subsidies for businesses would have to be out in the open not hidden in the tax code in the form of credits, depreciation allowances, etc.
-Impact on investors decisions and portfolio choices of such an approach should be carefully studied.
Gas taxes and the Highway Trust Fund
By now we all know that we don't need to sock money away in the trust fund drawer in order to have it available for future needs. We can always create money on demand when we need it. And taking it out of the economy today hurts the economy today. It's simply irresponsible management of the people's currency. Put it to use today for our real needs.
Let's separate our objectives into two parts: the trust fund and the gas tax.
-We have no need to save money to pay for future road improvements, so we can eliminate this one. Let's leave that money in the economy where it can do good today instead of putting it on the sidelines.
-However, we may decide that we want the cost of gasoline to be higher than the market price to provide a disincentive: use less gasoline.
-If we take this approach, we should study whether the marginal increase in taxes on gasoline has any real impact on demand for gasoline in the economy, and secondly, how that impact is distributed over our income demographics.
-Are we disproportionately taxing the poor because they spend a higher percentage of their income on gasoline and have less efficient cars? Do they have an alternative if the cost goes up or are we just hurting their disposable income and contributing to their poverty? Are the wealthy ambivalent to what they pay for gasoline at these marginal price ranges?
-What could we do differently? Obviously, eliminate the trust fund and just commit to maintaining gear roads for the nation's commerce and leisure needs. If we tax gas use, consider providing offsets to the poor and investing in alternatives such as public transportation. As an alternative, consider larger incentives for alternative transportation technologies to drive positive change rather than just punishing the use of oil. And invest heavily in public transportation systems that move away from oil dependency and provide options for the lower income and general public to use less gas.
We have structured into our tax code all kinds of incentives for saving money, much of which ends up in the hands of money managers. 401-k retirement plans, IRAs, 529 college savings plans, pension funds, etc.
-What is our objective? Saving is considered virtuous and prudent by society. On an individual level, we all recognize the value of saving money. But was also know that in the aggregate, saving hurts the economy unless more spending power comes from outside to make up for the reduced spending that results from our saving.
-So it's great to provide an incentive for saving more as long as we simultaneously provide for supplementing aggregate spending in some way so that businesses can sell all their goods and we maintain full employment.
-What is the effect or tax-free saving? When the portion of our income that we save is free from payroll taxes, we are deliberately driving down aggregate spending in the economy. Would prudent savers save anyway? These issues need to be studied.
-Are we doing this for savers or for Wall Street? If we are driving large quantities of tax-free savings into existing stocks, we may be doing more to drive up the prices of existing assets and not contributing as much to the stimulation of new productive investments.
-What could we do differently? Firstly, we should ensure that any incentives to save don't harm full employment. The Job Guarantee may be the best approach to this fallacy of composition problem. If Social Security is turned into a constitutionally guaranteed living income for the elderly, and higher education were an investment by the State in its youth, then the incentives to save today become much less critical, and we could study the effects of reducing or removing such tax incentives.
This would have an effect of potentially increasing aggregate spending in the economy and shifting investment portfolios.
-In general, we should be increasing the incentives for new, productive investments and reducing the incentives for the exchange of existing assets (e.g. stocks, real estate) which lead to booms and busts.
Energy & environment
Full disclosure, my business is developing large-scale renewable energy projects. The science of anthropomorphic climate change is quite straightforward, although the politics and corporate influences on the discussion are disappointing. Why? In my view, it comes down to economics. No politician can stay in office if they are perceived by voters as hurting the economy, and no one seems to understand that we can have economic growth while solving environmental and climate challenges.
-We have many tax incentives across the spectrum of energy production and distribution, from nuclear to oil and gas, to coal, to wind and solar, to bio fuels. Most are there because of lobbying efforts, not because we have a well thought through national energy policy, and certainly not because of any environmental or climate policy or objectives.
This needs to change.
-Debates on tax policy for energy focus on issues like job creation and how it "pays for itself". As we've seen, neither of these are valid approaches to tax policy. We can make jobs out of anything, and tax incentives never need to be paid for.
-What is the effect of our policies? We continue to provide incentives for questionable investments in fossil fuel energy extraction without careful evaluation of the impacts and regulation of the activities to ensure water and air protection. We implement poorly designed and inefficient tax incentives for new energy solutions, such as tax credits, which provide above-market returns for banks and distort energy markets.
-What could we do differently? You begin to see how these issues tie together. If corporate taxes were eliminated and income taxes reduced, tax credits (which were always inefficient) become less useful. We could eliminate them entirely and just provide direct subsidies for the things we want more of, which adding taxes on the things we want less of.
-Remember, these are not tied together! We don't tax oil companies to pay for renewable energy companies: we tax because we want to raise the cost and lower the demand for something we decide is harming us, and we provide subsidies if we think the market is not adequately stimulating the development of necessary resources or to protect businesses and consumers from the cost of such products if they are currently higher than existing ones.
-When viewed this way, subsidies can keep energy costs low while adequate investments are made to move our nation's energy portfolio to one that reduces carbon emissions and doesn't pollute the land, air or clean water resources.
Real resources need to be stewarded in a way that is sustainable and even regenerative (where we have degraded them below a healthy regenerating state). Tax policy can be a useful tool to find this balance, by redirecting investments and resources.
-As described above, one proposed solution is to bring our primary tax policy in line with environmental stewardship, so that we encourage a sustainable relationship between human needs, economic activity, and the rest of the biosphere that provides us with life and health.
-Moving toward a tax based on carbon-based, non-renewable, and polluting energy use makes a lot of sense, but should also be carefully constructed to avoid being regressive in nature and a burden to the poor.
-In a capitalist system, incentives can often be more effective than disincentives, and we must always caution against thinking of taxation as a means for paying for things - it is just a means to an objective.
-Investing in the "goods" should be emphasized at least as much as taxing of the "bads" - let's focus our nation's political energy on the right investments that build our shared future, not the tearing down and demonizing of past decisions.
States, Counties and Municipalities
Finally, a brief word about those parts of our government that are not currency-issuing but are rather currency-using.
-In the United States, much is made of the importance of State and local governments, and the need to keep the federal powers to a minimum and drive as much as we can to the local level.
-However, the more we push down to the local level, the more the local level has to potentially fund, and since they don't issue their own currencies, they have to tax or borrow in order to pay for what they are required to do for the people.
-Shifting the burden to the States or municipalities or counties adds a tax burden to the people, and creates a strong disincentive for appropriate funds to be spent on important priorities such as roads, regional infrastructure, city services, education, and more.
-For example, if we say states should have responsibility for health care, then they must raise taxes to pay for it. If the federal government had the responsibility, new money could be issued to pay for it without additional taxes.
-Across our nation we have aging city water and sewage systems, inadequate urban mass transportation infrastructure, and many other areas where we could all agree improvements could and should be made for our children's future.
There's an alternative.
There is no reason there has to be a direct link between the federal government paying for something and the federal government doing something. We could very easily direct some portion of funds to the various local governments, perhaps on a per-capita basis, and perhaps by simply making certain major infrastructure projects the fiscal responsibility of the federal government. All planning and decisions could be made locally, but the burden of taxation and funding is lifted from the local governments, freeing their budgets up for the truly local and discretionary government decisions.
We've obviously just scratched the surface. Tax reform is greatly needed, but not for the reasons most are talking about, and certainly not in the manner in which it is being proposed. Start with the right framework of how money functions, and then we can rethink our entire tax policy in a way that balances our national priorities.
Separate taxing from spending. Place the people and the environment at the top of our priorities. We can then solve for a prosperous economy. Reversing the order: making "The Market" our god, removing a proper investing and balancing role for fiscal policy, and leaving people and the environment to suffer the consequences, can only be detrimental to our future prosperity.
Let's build the national awareness and corresponding political process where we can use the people's national currency to fund all the things that we know will make for a better nation and world for the next generations; challenging them to outdo us when we pass the baton.