The iron shirt of tax code

Referring to Joe Stiglitz's proposal of a reward system for new medicine discoveries, which I mentioned in my previous post, one spontaneous idea is that someone like the Bill and Melinda Gates Foundation would be ideal to manage such rewards. I agree - if the tax system made it possible!

It is my understanding that the U.S. tax code requires non-profit foundations to give away at least 5% of their endowment every year to maintain their tax exemptions. The Gates Foundation already has trouble meeting this criterion, because they cannot find enough good projects fast enough. They probably could do rewards on the side, and I agree it would be a great idea, but the U.S. tax code makes it impossible for a foundation to exist that does this primarily. Given the government requirements, what happens if in one year there is no breakthrough and you don't spend the necessary 5%? You lose your tax exemption and pay a lot of money to the government in tax, that's what.

You probably already know how I think that income-based taxation is ridiculous. It and its associated fattening of bureaucracy are one of the greatest scourges that afflict modern society - it's right up there with prudery, self-serving interests in politics and the ineffectiveness of governments at doing anything against extinctions and global warming.

We should all be doing things to fix this.

Comments

boris kolar said…
I have come to the conclusion that no enforceable tax system exists. If you pay your neighbor to help you build your house, should the payment be taxed? Of course not, the money you paid was already taxed, so taxing it would mean double taxation. But how is that different from black market?

A fair tax system must have the following properties:
- there is absolutely no tax for any round trip of money
- money transfers are meaningless, they don't need to be interpreted or justified (like "did that student really work on the project or did you just pay him to avoid taxes")

There is one tax system that fits the bill: voluntary tax based on asymmetric currency exchange. Let me explain.

What can the government offer me to justify taxation? In my opinion, the only thing service a government can offer is security (physical, medical, social, legal security). One way to security is to minimize risks, but this is not always possible. The other way is to absorb risk, which is exactly what insurance companies do.

Absorbing risk is exactly what governments should do (and to do that in a more cost effective way, they will promote measures to minimize risk). If I buy a car from you, I carry all the risk and have no consumer rights. If I buy a car from a company registered by the government, I retain all consumer rights (enforceable warranty, right for a refund,...) and the company (and ultimately the government) absorbs many of the risks. And it would be absurd to suggest that governments should absorb all risk for free.

Now we covered the "voluntary" part of my proposal: "taxes" are collected because people are not prepared to absorb all business risk (they could legally buy and sell stuff on a black market without any protection at all).

The second "asymmetric currency" part is just a practical suggestion: the banks should absorb all complexity of a tax system. Here's how. A company has a bank account with a different "currency" (let's call it beuro (business-euro)). There may be a single business currency for all companies (equivalent to flat tax), or different currencies for different kind of business. The exchange rate between beuro and euro is asymmetric: for example, you can buy 10 beuros for 10 euros, but sell 10 beuros for only 7 euros. Round trip between (compatible) companies is untaxed (because exchange ratio between beuro and beuro is 1:1). So why wouldn't everyone use only beuros? Well, there is one difference: euros are completely anonymous, while beuros are exactly opposite, completely publicly traceable.
denis bider said…
Note that a sensible economy allows individuals to do all types of business that companies inherently can, so it needs to be possible for an individual to have a beuro account with which to do business with companies. Therefore everyone who accepts complete transparency of their economic actions can live tax-free.

I think FairTax is very enforceable, very workable, very low bureaucracy, and very clean. It is designed by expert economists as the optimal way to simplify tax code and collect revenue. I don't think it's impossible to improve on it, but I think most proposals that most of us lay people can come up with, will be in one important way or another unworkable or inferior to FairTax.
boris kolar said…
Saw the fairtax.org web page, but I'm not sure I understand the system fully. It seems to me like an income tax in disguise (except that corporate income is taxed, at least for selling products for personal consumption).

The way I see it, you can only tax 3 things: income (corporate ant/or personal in some form or another), land (rent based on land value), externalities (like pollution, tobacco, alcohol, drugs). I believe all 3 taxes are necessary. Income tax (I advocate voluntary version of income tax) is necessary, because the burden on government is proportional to commerce activity (enforcing consumer rights, funding legal system,...) and independent of land usage or externalities.

You observed correctly, that just using beuros will enable everyone to live tax free - it's a problem I'm aware of. Perhaps another measure is in order (possibly replacing complete transparency requirement): all beuro payments are revokable until exchanged for euros. Haven't really thought this through. I imagined that many small businesses will choose to operate on completely untaxed normal euro accounts (like grocery stores, restaurants,... where government protection is not important - after all, normal consumers don't expect money back guarantee if they don't like their pizza).

I imagine paying voluntary taxes as a form of competitive advantage. In essence, to be able to answer "why should I trust you" question with "because I pay taxes". I would even go as far as to legalize most forms of fraud and all cybercrime in the non-beuro sector.
denis bider said…
Saw the fairtax.org web page, but I'm not sure I understand the system fully.

It's very simple.
- All existing taxes are replaced with a single sales tax for all new things and services.
- In-depth economic calculations show that a flat tax rate of 23% would be sufficient to generate the same amount of revenue as the current U.S. system, with way less complexity.
- Social transfers are replaced with a concept of fixed-amount refunds sent by the government to everyone from the tax collected. This is simple, fair and requires drastically less bureaucracy.
- The 23% figure is an inclusive rate, i.e. tax/(tax + value), which equals about 30% exclusive, i.e. tax/value.

It seems to me like an income tax in disguise (except that corporate income is taxed, at least for selling products for personal consumption).

A sales tax is hardly like an income tax. These are only the same if you are someone who spends all of his income immediately!

The difference between income tax and sales tax is that a sales tax allows you to save money and invest, accumulating capital, without incurring taxes. This encourages investment and economic development. The income tax, on the other hand, penalizes saving and investment by taking the money away from you even if you do not intend to spend it. That money is then subsequently spent outright instead of being invested into capital development.

In other words, an income tax slows down the pace of economic improvement in a country, which in the long run hurts everyone. The only reason income taxes exist is because politicians and the population are generally clueless about how the economy works, and have misled Marxist ideas about redistribution of income.

The progressive income tax is a destructive idea originally coming from Karl Marx. The establishment of a progressive income tax is one of the necessary steps he listed as part of transforming an economy into a communist one. Such ideas are based on a misunderstanding of how the economy works and what differences exist between people and what needs to be done about them.
boris kolar said…
I still fail to see how sales tax is that different from income tax. Ultimately, sales generate income. It doesn't matter if you spend your income immediately or not.

Let's say, you know someone prepared to buy Pizza for $12.

Scenario 1:
No income tax, sales tax (is that equivalent to VAT?) is 20%. You charge $10 + $2 tax = $12, you pocket $10 and $2 goes to government.

Scenario 2:
Income tax 1/6 (flat), no sales tax. You charge $12 for pizza, and pay $2 to government, and pocket $10.

The difference?

The way I see it: sales tax makes everything 20% more expensive, while income tax takes 1/6 of everything you get. Assuming both tax systems avoid double taxation, how isn't that equivalent? Or is it double taxation that is the difference? If so, I share your opinion that income taxes are detestable (if I pay you $1000 to do a job for me and later you pay me $1000 to do a job for you, the net gain for government should be $0).
denis bider said…
In the straightforward case you quote, the two systems are equivalent. (Although only in the ideal, almost-non-existent situation where the income tax system really avoids double taxation.)

There are other cases though where the two systems aren't equivalent. Suppose I give you $10,000 as a gift. In the sales tax system, you pay nothing. In the income tax system, the gift loses value to the tax man, although it is just a money transfer and no work was done.

Likewise, suppose you don't earn money by selling a product or service. Suppose you earn your income by leveraging capital. Unless there is a specific exemption, the income tax system will tax your capital gains, even though this is just interest on income you already paid tax for in the past, and which you didn't spend and which you are saving for the future. A sales tax doesn't tax you on this interest. Instead, it taxes you when you eventually decide to spend the capital gains. If you've been investing the capital for 10 years, the income tax will not just double-tax this income for you, it will tax the interest 10 times over every year. In addition the income tax will introduce an unfairness where if you have a positive capital result in a certain year, you will be taxed, but if you have a negative one, you won't get a refund.

So no, sales and income tax aren't quite the same thing. A sales tax is just; an income tax isn't.

(if I pay you $1000 to do a job for me and later you pay me $1000 to do a job for you, the net gain for government should be $0)

This is incorrect. The objective of tax is to collect a fair proportion of constructive work done in a country. If you pay me $1000 to do some work, the state should get the sales tax from that, and if I then subsequently pay you $1000 to do some other work, the state should get the sales tax from that as well. This is a fundamental property of taxation. If you remove this, then no one needs to pay any tax whatsoever, because all transactions can be rearranged to fit a "I scratch your back, then you scratch mine" scenario.
boris kolar said…
"(if I pay you $1000 to do a job for me and later you pay me $1000 to do a job for you, the net gain for government should be $0)

This is incorrect. The objective of tax is to collect a fair proportion of constructive work done in a country. If you pay me $1000 to do some work, the state should get the sales tax from that, and if I then subsequently pay you $1000 to do some other work, the state should get the sales tax from that as well. This is a fundamental property of taxation. If you remove this, then no one needs to pay any tax whatsoever, because all transactions can be rearranged to fit a "I scratch your back, then you scratch mine" scenario."


This is not necessarily true. Here, I think, my proposal is superior to FairTax. Advantages are twofold.

First advantage. If we trust each other, we pay both transactions in the same currency, which means no tax. If we don't, we must rely on some kind of insurance services for each transaction, and that can only happen when currencies are converted via asymmetric exchange rate. In the second case, we pay for a well defined service - insurance service. And no one is better positioned to offer insurance services than government. So in absence of trust, there are two conversions, as it should be, since both transactions are insured.

Second advantage. Very small business doesn't have to rely on trust, so it can operate untaxed. Very large businesses (banks, insurance companies,...) can't operate without trust, so they must be taxed (and subjected to heavy government control). Middle-sized businesses can choose to be taxed or not (and being taxed may offer some advantages that are now offered for virtually free, like limited liability, which looks and smells like insurance to me). Some refinement may be required to encourage more businesses to choose to be taxed, but I think the idea goes in the right direction.

Additionally, taxes are not the only source of income. I would introduce banks that will hold your currency at zero interest rate, free of any fees, without possibility for your balance to drop bellow zero. Think of it like a secure purse. Such banks would be effectively a source for interest-free loans to the government.

And going back to our example ($1000 exchange). Even our existing systems strive to make such transaction pairs zero cost. VAT, for example, has this property. Income tax (at least corporate income) has it as well, to some extent, because you can register expenses. Of course, that system works only if a good portion of expenses remains unregistered.

One additional idea: each citizen should receive Guaranteed minimum income, paid in euros, which would discourage people to operate exclusively in beuros. Also, businesses operating with beuros may be put under contract to exchange all euros they receive to beuros. Whatever practical problems exist, they all seem solvable.

Summary of advantages:
- there are two (or more) currencies: euros ("spending money") and beuros ("business money"), exchangeable with asymmetrical exchange rate
- paying taxes is optional
- paying taxes is not governmental theft, it's competitive advantage
- governments compete with legal (but anarchic) underground economy, which keeps tax rates reasonable
- banks absorb all complexity of tax system
- because banks absorb tax complexity, it doesn't matter how complex tax code is, it may even be adjusted frequently
- average Joe doesn't need to worry about tax code, because it's virtually impossible to break tax law unintentionally
- it may be in best interest for some small businesses to have government insurance, just to differentiate themselves from fraudsters
- some government services (consumer rights enforcement, contract enforcement, limited liability,...) are no longer free, they are paid for (and therefore, arguably, of better quality)
- I named it income tax, but on afterthought it seems more similar to sales tax than income tax
- tax minimization is difficult (unless you're willing to loose insurance) and requires constant effort, not just once yearly, so most people won't bother
- there is no cost for money circulation between mutually trusting parties
- there is no need to interpret transactions until an actual dispute (no more stupid "purpose" field on transaction records)
- since government is ultimately liable for all businesses it insures, it may promote good business practices in exchange for tax reduction (more favorable exchange rate), like descriptive invoices, reliable record keeping, invoice time stamping, transparency and peer review,...
- it's the only tax system I can think of that is both fair and progressive (more insurance naturally costs more)
- investors are not taxed, it's businesses seeking investment that ought to be insured/taxed

So many advantages :) BTW: I'm licensing my tax system for merely 1 billion €, if you're interested :)

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