04/18/2011 01:03 pm ET Updated Jun 18, 2011

Tax Day Observations: An Immodest Proposal

Tax Day. Unless you are an anarchist, you recognize that taxes are a necessary evil. Most discussions about reforming the tax code however, conflate two entirely separate issues:

  1. The amount of taxes we pay, and
  2. What it is that we tax.

For purposes of this essay, I propose to not deal in any way in the issue of the total amount of taxes we pay, but rather to focus on the illogic of what we tax, with one specific example.
If we tax an activity, we discourage it by making it more expensive. Tax it more and we discourage it even more. It stands to reason therefore, that a rational tax code would tax most heavily those things we would most like to discourage and would tax least heavily (if at all) those activities which we would most like to encourage.

My proposal is further based on two observations:

  • Employment is a good thing. If employers hire more people, this has many positive effects. Employment is in and of itself a positive thing. More widespread employment reduces cost of government by reducing the need for such things as the payment of unemployment insurance, and government paid social services programs such as health care and other programs whose focus is primarily on the unemployed and other lower income persons.
  • High energy consumption, particularly sources of energy such as gasoline which are obtained from unreliable and hostile places is generally undesirable. Every President since Jimmy Carter has proclaimed the need for energy independence, or at least significantly lower reliance on foreign sources of energy. Despite these assertions, our dependence on foreign sources of energy has increased rather than decreased under every president who has held office since Carter. Yet we tax gasoline at some of the lowest rates in the world. Not surprisingly, we consume gasoline at a voracious rate.
  • Employment taxes.

    For every100 an employee is paid by his employer, it costs the employer107.65 including employment taxes. Yet the employee receives only92.35. This is an effective tax rate of 15.3%. This is because these employment taxes are paid by the employee is matched by his employer. These taxes exclude income taxes paid by the employee and other tax. This is a pure tax on employment. The funds collected are earmarked for (though in practice rarely actually allocated to) Social Security and Medicare payments. These payments determine the level of benefits to which employees are ultimately entitled under Social Security.

    Let me link these observations in an immodest proposal. My proposal simply is to eliminate both the employer and employee portion of the employment tax. An employee who currently receives $92.35 of a $100 salary will by law receive an instant raise to $107.65. The elimination of these employment taxes would be coupled with an immediate increase in the gasoline tax and perhaps taxes on other high polluting or unreliable forms of energy. The taxes would be substantial -- and high enough to be revenue neutral.

    Employees would continue to receive credit in their Social Security accounts in an amount equal to what would have been paid by their current employment tax though the actual revenues would be paid by the additional energy taxes.

    What would be the effect of this proposal? Obviously, employees would receive an immediate raise of over 15%, but gasoline would instantly become massively more expensive. Because this proposal is revenue neutral, a taxpayer who currently earns an average income and drives an average number of miles will, on average, net out their spendable income to zero.

    But behaviors would begin to change almost immediately. The consumption of gasoline would be much more expensive. Drivers would almost immediately begin to consider the necessity of all of their trips, strategize on how to combine trips, carpool, take mass transit, and the like. All of these are things that many public agencies have been attempting to get the public to do voluntarily for decades, but largely without success.

    While these economic incentives would likely drive immediate changes in behavior, the medium-term effects would likely be even more dramatic. Individuals would have an incentive to switch to more fuel efficient vehicles and alternative forms of fuel. Public demand would fuel innovation since new generations of fuel efficient and alternative fuel vehicles would have huge and guaranteed markets. There would likely be no need for further economic incentives for electric or other alternative vehicles. The desire to avoid highly taxed forms of energy consumption would ensure unprecedented development of new markets.

    One of the telling criticisms of current federal subsidies of alternative technologies is that the government is a poor entity to pick winners and losers. If we merely made undesirable sources of energy expensive enough, as this proposal would do, the increased demand would let market efficiently pick the best and most promising alternatives free of government intervention. Alternative technologies with economic promise would be funded with venture capital. And the flow of American dollars to sometimes hostile powers would be reduced. With reduced cash flows to the Middle East, Osama Bin Laden might even have his funding cut.