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Principles of Taxation: Fair or Foul?

02/27/2013 05:50 pm 17:50:16 | Updated Apr 29, 2013

Underlying every sovereign system of taxation are some ideas used to justify and support, in the context of that society's sense of justice, public acceptance of the tax burdens imposed on them.

For example, in a dictatorship, such as Nazi Germany, Hitler created a public need, as well as hope, by sponsoring a war machine that promised to free all Germans of the economic shackles imposed on them after WWI.

That may have been a Keynesian scheme of extraordinary size and deception, intended to pull Germany out of its inflation-ravaged depression in the 1930s. It did succeed for a while in bringing the German economy back to vitality. But, it was, of course, doomed to fail, as all fraudulent schemes ultimately do. Along the way, however, the German people accepted the burden because the goal at the time seemed worth the cost. Not to mention their fear of the Gestapo if they did not pay.

Thank goodness none of that history applies today!

In democracies such as ours, where the will of the people has vastly more power than that of self-appointed leaders, public support for taxation is far more subtle and rests on a delicate foundation of trust. 'The People' have to see clearly that the uses of the tax burden are consistent with their view of the world, and they must believe that the tax burden is borne in a reasonably equitable way among all sectors of their society.

In our current political environment, both the benefit and equity of the tax burden are increasingly doubted. We are riven not only by a dispute over how taxes are spent, but also by dwindling confidence in the opaque and distorted political system that dictates the allocation of the tax burdens among classes. The issue is less "why so much" than "why so much for me, when my neighbor, who makes twice what I do, pays half as much."

Oversimplified, our political world seems to be divided between people who insist on more defense and less social expense and people who insist that only social expenses are paramount. A similar division exists about who should carry the burden. The first group wants the masses to pay more; and the second group wants the privileged rich to pay more. "The People" simply want fairness and transparency, and, by wide margins, support both defense and social programs.

One might think the politicians could compromise and find some sort of common ground, particularly when that ground is shared by the people who elect them to office. They yet may, but the game plays on with a serious risk that our economy could go over the edge of sensibility in the process.

When one rethinks the methods of the distribution of the burden of taxation in today's world, there are a couple ideas that have had little attention but which might have some real merit and warrant a closer look today.

There is talk about a large scale revamping of our tax system to make it fairer and more acceptable to many people. Most people think that is a worthy goal and favor it. But, until it has been revealed thoroughly, no one can know enough to place any reliance on what the outcome might look like. Some reform proposals (think 'flat tax') greatly simplify the tax code, but exacerbate the disproportionate share of taxes shouldered by middle- and lower-income households. Others simply create new wrongs to address particular grievances.

Our tax system has been built on a few basic principles. The first is progressivity, applied largely to income with the better off paying more than less well-off people. This is the heart of our existing tax code, with higher rates kicking in as incomes move up the scale. The second is transparency and simplicity of collection and enforcement, with clarity about how much different types of people pay. Third is a basic belief in a general sense of fairness.

Unfortunately as a tax system ages, it inevitably gets top heavy and unwieldy. And, as time passes, everything gets a coat of confusion, leading to a broad loss of confidence. Half a century ago, it was already so bad that the best advice at Harvard Law School about studying tax law was "do not try to understand it; just learn it." It has gotten a lot worse in the intervening years.

Perhaps the most important goal in revamping our tax system should be a genuine clarity in purpose and principle. From this foundation and with a commitment to the minimum level of taxation sufficient for the purposes for which it is raised, the specifics of the kinds of taxes we assess and the question of who has to pay how much may become easier. Perhaps instead of starting from a progressive income tax system we might begin on a different basis:

  1. Transparency and simplicity of collection and enforcement can be enhanced by using more of a transaction and sales tax system.
  2. Fairness and equity in distribution of the burdens can be much more visible in such a system.
  3. And, progressivity can be built into such a system by having different rates at different and higher levels of the taxable events, or through other readily available mechanisms (exceptions, exemptions, tax credits, etc.).

The basic argument for moving away from an "income tax" is that the definitions and calculations are so fraught with interpretation and manipulation that they have lost relevance, not to mention the confidence of the tax-paying public.

We are all familiar with sales and transaction taxes and that they give rise to a lot less manipulation and confusion. We do have to remember as well, that whatever tax system we utilize, it exists in a shrinking world and we have to be very careful not to disadvantage our economy by making our products and services uncompetitive in global markets.

A system based primarily on sales and transaction taxes (not the complex value added ideas of the past) can accomplish a great deal in a relatively simple way. The idea, of course, needs to be tested by people with access to big, smart computers which sample and try many iterations of how to patch together a new system of taxes with progressivity on many types of transactions from sales of cars, clothing, entertainment, energy, financial transactions etc.

People should be able to see sharply and clearly how the different configurations would affect their situation and thus be able to reasonably and easily judge how a new system would affect them. If computer tax geniuses can find a formula that distributes the burdens reasonably compared to today's distribution, and it overall raises enough revenue for the national budget, then we will all be better off for a long time with a durable and transparent system.

One is reminded, in considering whether this type of quite radical idea could really be achieved of the question a stranger asked a grizzled, old Mainer about how to get to some faraway place. The Mainer thought a moment and said: "You can't get there from here!"

Yes -- there is a lot of truth in that wisdom. But, do not forget we did get to the Moon and now Mars.

And, perhaps we had better try something a bit radical or we may slip further and sooner into an even bigger mess.