Thursday, April 30, 2009

My View on The Tax System

Recently, I had a few arguments with conservative friends, spurred by the tax debate between Chris Christie and Steve Lonegan. I want get into that debate, I just want to express my opinions on the flat tax.

I think we live in a very socialist society, as exemplified by the highly redistributive progressive tax system. The idea of the progressive tax is that the more you earn, the more you pay in tax from every dollar you make. So let's take the federal tax. Let's say I make $200k/year, and a cashier at Walmart makes $20k/year. I will pay 28c for every dollar I make, while the cashier pays 15c. So according to this scheme, the dollars I earn are worth less than the dollar the cashier makes. I'm severely punished because I got a better job.

The flat (proportional) tax tries to replace this situation with a uniform tax rate, let's say 20% that everyone will pay. Of course, liberals will cry that this is unfair, but actually the flat tax is still an unfair redistribution of wealth. Even with the flat tax, I pay $40k/year in taxes, while the cashier pays only $4k. You'd say that this is normal, since I make more money, but again, why should I be punished because I got to a better job?? Just to explain, we the people pay taxes to the Government so it can fulfill its Constitutional duties, and provide services in return. So if we all receive the same kind of Government services, we should all pay the same tax, right? Otherwise, if I pay 10 times more than the cashier, I should get better roads in front of my house, better schools in my neighborhood and much better police protection. Anything less than this makes the tax plan unequitable and redistributive.

Of course, the alternative which is a lump-sum tax, is not feasible. And this is mainly due to the increased social programs that our rooted in our Government. But the most equitable way of taxation is when everybody pays the same amount of money to the Government. Under the 2008 budget, that would amount to about $16k/taxpayer (or $32k/married couple). And this is more than MOST of the population pays. It just shows how much people should be thankful to the rich that are paying for their Government services. After all, the 5% richest Americans pay more than half the tax bill (55.2%). The 20% top earners pay 83% of all the taxes. 60% of the Americans, the a solid majority, contribute only 3.2% to the federal budget.

The flat tax is the best we can do now, although it's still a socialist system that redistributes wealth. The problem with switching to a flat tax is that for some people the taxes will be lower, and for some they will be higher. And the real political problem is that they will slightly increase for a lot more people (voters), so no one will agree to it. No matter what political affiliation they have, no one will give up this Marxist progressive redistribution.

From an economic standpoint, the flat tax should be calculated by dividing current total tax receipts to the number of taxpayers. This is just a starting point, and the calculation is empyrical. The fact is that a flat tax would probably boost tax revenues, as a result of increased GDP. The decrease in taxes for the high earners acts as a supply-side stimulus, which has a pretty high multiplying effect (even according to previous papers by Christina Romer, currently Obama's economic adviser). The increase in taxes for low earners has a more Keynesian effect (in reverse), which has a lower multiplier. So overall, switching to a flat tax would boost tax revenues and the economy, making it possible to further reduce the tax rate.

As I said, this looks politically unfeasible. The only way it would work would be if the taxes would be lowered for more people than will see the tax increase. And this will result in significantly lower tax revenues, which probably can't be covered even by drastic spending reduction. So far, I didn't offer any solutions, I was just critiqueing the current tax systems... But I'm a blogger, not a political adviser. But if I were to suggest a way to cut spending, I'd advocate for zero-based budgeting for one year. This means that instead of adjusting budgets from year-to-year, by deciding which programs to cut (not many) and what to add (a lot), to start from scratch. Start with the so-called mandatory spending, and add only strictly necessary programs.

Regarding mandatory spending, in 2008 that was $1.8 trillions, 62% of the $2.9 trillion federal budget, and is made of Social Security, Medicare, Medicaid, unemployment, welfare and interest on the national debt. As you can see, most of this (amounting to 52% of the total budget) are social programs. The fact that we call them mandatory shows how hard would be to remove any kind of new entitlement (including national healthcare). Once you start an entitlement program, there's no going back. It was never the Constitutional duty of our Government to take from the rich and give to the poor. This is the result of mainly two movement, FDR's New Deal and LBJ's Great Society. They created most of this spending, and we're paying more and more for them. And it's interesting to see how these socialist programs shadowed major worldwide socialist events, by about 20 years: the creation of the Marxist state in USSR, and the spread of communism through the world, post-WW2. 20 years is what the establishment intelligentsia needed to digest the new policies, and feed them to the uninformed public.

But back to zero-based budgeting. We can't get rid of "mandatory spending", maybe just trim it, although it wouldn't be by much. Apart from this, you have to provide for National Defense, since this is a Constitutional duty of the Government to its citizens, and then everything starts from scratch. Social programs and defense amounted for $2.3 trillions in 2008, and everything that's on top of that (600 billions) would be cut, under zero-based budgeting. Every program that needs to be funded by the Federal government will be studied, and decided if it's worth spending the taxpayer dollars. I'm sure you could get away with spending just $100-200 billions more above the mandatory spending. This would've meant for 2008 about $2.5 trillions, with a budget surplus of about $160 billions.

Now back to the tax system. A flat tax punishes people who got a better job. The current progressive taxes punishes them even harder, to the point where, when looking at the tax share of various percentiles, it becomes confiscatory. Switching to a flat tax would be a very hard political move. But it's been done in many Eastern European counties, and it's considered the reason why those ailing economies are finally starting to move and try to catch up with Western Europe. For a politician, it would be dangerous to advocate for a flat tax, but they don't want to sound economically illiterate, they shouldn't strongly advocate against it. They have to admit that the proportional tax is better, they jsut can't do it.

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