Monday, December 10, 2012

Adjustable Taxes on Investment Income and Sales

When we in the democratic capitalist countries want to encourage or discourage certain behaviors we use either taxes or subsidies to influence peoples' choices. Smoking is one example, another is borrowing money to purchase a home. The former is discouraged by being taxed, the latter is encouraged by means of a tax break or subsidy.

But we Americans are going to have to revise our tax code if we intend to stave off fiscal insolvency in the near future. Below is an idea that may take some revision but seems like it would be a step in the right direction.

The proposal assumes that any revenue generated will be equal to the revenue generated from income taxes as they are collected in 2012. It is revenue-netural, in other words. But the proposal includes two additional taxes (perhaps offset by reducing the existing income taxes) which can be adjusted according to the prevailing economic climate.

First, it is clear that we are going to move to some kind of value added tax (VAT). I say it is clear because a VAT is widespread in Europe and I can't help but notice that most of the movement of European nations toward liberalism are eventually copied (if not modified somewhat) in the U.S.

Currently we tax income--wages, salaries, tips, dividends, interest, capital gains and other forms of making money. And although the income tax doesn't appear to discourage work (perhaps because it is universally applied in the form of payroll taxes) citizens may be more sensitive and respond more quickly to taxes on non-wage income.

Income from investments does not come from the sweat of one's brow; these payments come in the form of dividends, interest payments, capital gains and other disbursements we get from loaning our money to others or in speculating on assets we may not even hold title to or perhaps own only temporarily.

We need a core and predictable base of tax revenue and under my proposal, that would remain the payroll or income tax. But this tax could be reduced somewhat and supplemented by two other forms of taxation: a value-added (or national sales) tax and taxes on investment income. The beauty of the three-part tax (wages, sales and investment income) is that the latter two can be adjusted annually to reflect the economic needs of the nation.

For example, if we as a nation are spending (consuming) too much then the sales tax can be increased on all goods (with some exceptions such as food staples) to help reduce consumer expenditures and spur savings. This was the case in the early 2000s when the U.S. had a negative savings rate.

If on the other hand, there is an epidemic of asset bubbles, or if Americans need to stop saving so much and start spending more to spur economic (and job) growth, then the value added tax rate can be decreased and the investment income tax rate can be increased. This should result in a lower savings rate and higher consumer expenditures at a time when we need more economic activity to put people to work.

We could (like most European countries and what appears to be inevitable for the U.S.) institute a value added or national sales tax. At first, this VAT could be revenue-neutral as we would offset the burden on consumers by lowering their income taxes.

After we are satisfied that we can have two national tax revenue streams, we should adjust the VAT and the tax rate on interest, dividends and capital gains according to the behavior the government economists want to encourage or discourage. That is, if consumer spending is down and our economy needs more people to buy consumer goods, we should lower the VAT and raise taxes on investment income. Vice-versa for a period where we need to stop buying so much and start saving. This could be done annually and the rates published prior to the first of the year.

Some would object to the government or other body making decisions on taxation based on what it feels is best for the country. Those who resist this would argue (as they have since the beginning of the Republic) that only individuals can decide what's best for themselves and that the government should stay out of it. But like it or not, the government has made decisions on economic policy that may seem to others to be intrusive on personal liberties. And this would not set any precedent for government intrusion into our lives that hasn't been the case before.

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