Some Tax Day Thoughts on the Tax Code

As Americans, for the third year running, hold Tax Day Tea Parties, it’s worth setting down a few thoughts on the tax code itself.

1) It’s too progressive

The US has the most progressive tax structure in the developed world. More progressive than the Japan, more progressive than the UK, more progressive than Sweden, for crying out loud. You make it big with Ikea, you’re better off going back to HQ than staying here.

This is a result of generations of structuring the code based on “who can afford” rather than “who has a stake.” Well, of course if you make more you can afford more. But it also means you can afford more shoes, maybe a nicer car, possibly a boat. It also means you can afford – if you choose – to indulge in hobbies or possibly lead charitable efforts.

The question “who can afford” answers itself, but it notably fails to ask, “afford what?” Pretty much every activity except stuffing cash under the mattress helps create more wealth, and in a society with a rule of law and secure property rights, even – perhaps especially – the poor get to participate in that wealth, too. So when the government says that it “needs” more of your money, it really “needs” to be sure that the least important thing it’s going to do with that dollar is more important than the most important thing its owner can do with it. That’s a high bar to get over. As it should be.

2) It picks favorites

Any tax system is going to do this sort of thing. Sales taxes will exempt food or clothing. But the possibilities for rent-seeking seem almost endless with out current tax system. Regulations may raise barriers to entry, but the Aristocrats of Pull are really made through the tax code, rewarding political allies and misdirecting massive amounts of resources in the process.

The income tax, since it’s stated as a percentage of some known amount – what you made last year – also encourages the government’s delusion that it’s really all their money, except for what they let you keep. It’s only with a tax code susceptible to endless manipulation that a President could talk about “reducing spending in the tax code.” When it gets to that point, there’s really nowhere left to go.

3) It encourages debt

This used to be worse. It used to be that all interest was deductible, but that was phased out a couple of decades ago, so now for individuals, we’re down to the mortgage interest deduction. But for businesses, most interest is still deductible, and while this encourages capital formation, it also leads to a debt-heavy capital structure. We’ve all seen what excess leverage can do, but other decisions get distorted as well. Successful mergers tend not to be financed with debt, but with cash, and it’s likely that a whole lot of bad M&A activity – doomed deals – wouldn’t happen if that interest weren’t deductible.

4) It can’t be complied with

Not, “it’s hard to comply with.” It can’t be complied with. We all know about the NTU studies asking IRS employees to work a difficult tax question, and having each of them come up with a different answer. The fact that an average citizen has to spend hundreds of dollars to file taxes every year, and still could end up getting hauled into tax court because he got the wrong one of twenty different right answers is an offense against everything we expect from the rule of law.

5) Business taxes are too high

Right now, the US not only has the most progressive tax system in the western world, we also have the highest business taxes in the industrialized world. Inidividually, either of these would be enough to start chasing wealth production out of the country. Together, they virtually guarantee it, particularly because we also tax dividend income. Dividends, of course, are just a distribution of profits to the owners. Profits which have already been taxed. Not all countries do this. Some allow a tax credit against dividends, and some just don’t tax them at all.

So as we go to our Tax Day Tea Parties, remember, it’s not just how much they’re taking. It’s the way they’re taking it.

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