Thursday, August 12, 2010

Discouraging Effort and Success

Why do we tax labor? We know that any tax on an activity discourages people from engaging in that activity by reducing the rewards for doing it. So why do we tax hard work, production, and wise investment? Do we really want less of those things?

We need to fund our government (some claim), so we need to tax something. Why not tax behaviors that we want less of? Wouldn't that be killing two birds with one stone?

What would happen if we ditched all income taxes (including capital gains, and corporate income taxes) in favor of taxation levied exclusively against consumption? How would our society change?

I imagine a system wherein my income is not monitored by the government, but the total amount of my consumptive spending is instead. It's easy enough to do - just give up cash and require banks to report the amount of spending. As long as my consumptive spending total for the tax period stays below a legally established minimum, I pay no tax. But when my total rises above that level, I begin to pay tax out of each additional dollar spent. So if I don't spend much beyond the limit, the taxation I experience will be very low.

There are many advantages to such a system. For one, we'd stop punishing smart and hardworking people for being so productive. Every dollar they earn would be theirs to keep. This would include dollars earned for good investments (capital gains). Similarly, we'd stop punishing businesses for competence in producing and selling products and services to people who need them. When a highly successful business has to pay a large amount of income tax while its less successful competitor pays no tax (due to writing off business losses) the playing field is being unfairly tipped to reward poor performance! Not only that, but why tax production at all when production is what gives us the things we need and desire?

Also very important is the fact that taxing consumption, instead of labor, production, and investment, allows individuals to adjust their tax liability to fit their circumstances and desires. If I don't want to pay so much in taxes this year, I can reduce my consumption and pay less. And, I bear no penalty for working extra hard to earn additional money to fund my future, or my children's future.

Under this kind of system saving would be strongly incentivized. For those who wished to avoid taxation, saving and wise investment would be the safest harbor for their money. Everyone would be faced with compelling reasons to defer spending to a later date. Government subsidized retirement could become unnecessary for average Americans.

It's possible to take this idea to a more extreme level and suggest that leisure (time spent not producing or learning) could be taxed when it exceeded a certain minimum amount. This could spur the indolent and chronically unemployed (whether poor or wealthy) to return to productivity, lending their efforts to the improvement of society.

Undoubtedly there are many weaknesses in such a plan, and opportunities for clever gaming of the system. But that is no different from our current system for taxation.

Are there structural problems with this proposition?

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