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Government must be financed. It is supposed to buy public goods, such as security, with the money which it spends. These are two different things. The legacy of many increments, and the tendency to fiddle with the instruments, has muddled up tax raising and public spending. We feel that taxes should be "progressive" and "equitable", and worry that how we raise tax should promote anything from saving rates to access to the labour market. These secondary goals have greatly complicated tax raising, and so made the process more costly and probably less efficient in raising money than might be the case. It has led to the creation of socially-motivated taxes which cost more to administer than they raise. This complexity has also given rise to a huge network of deductions, hidden subsidies and indirection.
This note suggest two policy initiatives. First, tax raising should be disconnected from any consideration except its primary purpose. Simple flat rate taxes should be established with no thought to equity, subsidy or behaviour modification. (We except certain deterrent taxes, for which the collection overhead is not great and where other instruments seem unacceptably burdensome.) Second, subsidy should be explicit and - as decision-takers deem fit and through the democratic process - related to income, life stage, disability and other objectively-measured factors in a person's life. An additional and technical suggestion is the creation of a new legal entity to take over the extant role of the individual and their relationship with the family, dependents and corporate entities.
Tax gets raised for two reasons. The primary reason is to fund the state. The secondary use, which hugely complicates the first, is the view that taxation is a tool for social engineering. Tax is to deter fuel use or drinking alcohol, and tax is to fall with particular weight on rich people, people who live in a particular part of the country, people with particular religious or ethnic backgrounds and the like. I am going to suggest that these two roles should be completely separated. This would make tax easier to raise, and - because it concentrates resources, would ensure that it was more efficiently raised. The second set of issues - of managing behaviour and of redistributing wealth - would be far better handled in a quite separate manner. That is, subsidy - to child bearing or old age, to farmers or to poor households - would be treated completely separately, by - at the point of delivery - by a distinct agency.
The simplest practical model for tax gathering would be the following. All consumption taxes are set to the same level, for ease of collection. All income of all types is taxed at the same rate, irrespective of the status of the individual. Capital gains are taxed whenever an asset is made liquid. (Transfers between individuals are discussed below.) All tax deductions are dropped. Corporation tax and other expensive, low yield taxes are also dropped. Local taxes are levied at a flat rate on all domiciled adults. Site specific tolls such as airport taxes and highway fees are retained only where the tax is a direct fee for use, hypothecated to the facility in question.
This creates a much simplified system of tax collection. It is not progressive, and the absolute sums which people pay is in direct proportion to their income and consumption. There is no element built into this which is intended to force a society into a particular mode of behaviour, with no social or environmental agenda built into it. It would cost little to continue with the existing policy of raising the price of energy and drugs - alcohol, tobacco - through tax.
Simplification has three major advantages. First, it makes the system much cheaper to manage. It would focus attention on a few well-defined areas and so increase the efficiency of tax raising. Second, it is extremely transparent. People would know the unambiguous consequences of certain course of action. There are no poverty traps or much advantage in spinning webs of deductions and evasion. Third, subject to the issues raised below, it encourages saving and investment at the expense of consumption.
The way in which transfers of assets between individuals is handled needs to be clarified. Plainly, if A gives B a share certificate, this is the same as giving them income. At present, some of the these transfers are taxed and others are not: for example, there are exemptions to gifts and bequests between husband and wife. Corporate share schemes can be set up partly to evade taxation. Parents who feed, house, clothe and pay for the schooling of a child are also making it a gift, however, and we do not think of taxing this.
The standard family group is no longer a standard way of life, and certainly not how almost everyone will live out all phases of their life. Perhaps what is needed is a new kind of legal entity, extending the concept hitherto handled by the 'family'. Let us call it the Group. People and other entities - companies, charities - who declare themselves to be a Group acquire the ability to share and transfer assets. When the group is dissolved - on the death of its members, on divorce, on an employee leaving an organisation - then the market assets of it are valued, and tax is paid on them by whoever is the beneficiary of these exactly as though they were income, which is what they are.
What has been described is a much simplified system of tax collection, one which greatly decreases the burden carried by the wealthy and much increases that levied on the poor. The top 1% of US earners pay about 30% of all US tax at present. The bottom decile receives a net subsidy of about 10% of all tax raised. Maps that plot the net value added onto the US terrain show that no net gains are made in the central, agricultural states, which maintain their income almost entirely through agricultural subsidies. These are political choices, some of them made for sound social reasons, such as investing in child health and education, social stability and mobility. Other have resulted from understandable but less worthy motives. For example, the proportion of agriculture in the US economy has fallen very greatly in the past hundred years. However, the distribution of the voting population - and electoral boundaries - has failed to follow this, so that political success requires politicians to keep rural populations content.
How politicians choose to spend taxes is not something for this note. They can manage that discussion very well by themselves. However, if the use of the pot of money created by tax and the mechanisms of collection are teased apart, the choices made in distribution will be that much more clear. Nothing will be done by implication or indirection: monies will be granted for defined reasons to clear beneficiaries.
Many countries have what must be an irrational dislike of "means testing". That is, welfare is paid to those who can prove that they need it, on the grounds of poverty. It is thought that this proof of poverty is humiliating. However, income assessment performs exactly this function, which is to define an individual's income (or the income of their Group, as discussed above, where joint taxation is appropriate.) This is not held to be humiliating, yet precisely the same data can be used to generate what is in effect a negative income tax. A person under one age or over another can receive a payment - or rights to facilities, for example education - as can someone with a disability, who is pregnant or who attracts whatever form of intervention is deemed appropriate.
This is an extraordinary simplification over present systems. For example, a person who becomes unemployed or ill and so unable to work is affected only insofar as their income falls, attracting appropriate adjustments in their tax due or the negative income tax to which they are entitled. The timing of these interventions is of course important, in that people cannot wait for the current tax structure to operate. However, there are many ways in which pay-as-you-earn and self-declaration schemes cannot be adapted to report interruptions in earnings in this way. Some would abuse the system and be detected doing so, but that is also a feature of the current, far more complex structure.
To summarise: we could make our tax and subsidy systems much more simple and efficient is we separated them apart, and focused tax collection on those areas where the yield was richest. Abandoning social engineering on the income side of government would allow legislators to deliver interventions is a far more transparent, focused and probably efficient manner than hitherto. The legal entity that pays tax is, at present, the individual, the family and the corporate body. We suggest that this continuum is re-formalised. This can by achieved creating a new entity which takes on the 'smaller end' of this continuum - that is, individual, family, individual-large group relationships; and retaining the corporate body at the upper end. These envelopes would greatly simplify tax accounting where assets are passed between individuals.