Saturday, April 14, 2007

All dollars are created equal

But they don't stay that way

When I see a penny on the ground, I usually pick it up. Force of habit? I'm not sure. As money, a penny is essentially worthless these days. A penny in your pocket probably creates more wear and tear on your clothes than it could possibly pay for. My young nephew, however, pounces on pennies with utter delight. Pennies in his pocket are a source of great pleasure, at least as playthings if not as legal tender. In that sense, at least, value is quite relative.

What about dollars? Hard-nosed realists would probably explain to us (quite patiently, no doubt, although perhaps with a touch of exasperation), that a dollar is a dollar. Subjective valuations are just a myth. Am I not a mathematician who should appreciate the tautology that a dollar is a dollar?

Actually, no. I agree that every dollar generated by the U.S. Mint is equal to a dollar, but a dollar released into the big, wide world is subject to dramatic variations in valuation—all based on context. A dollar bill in my pocket is worth quite a bit more than a dollar bill in the pocket of Bill Gates (although I doubt that Bill makes a practice of carrying dollar bills around).

To many, I'm sure, this will sound like blatantly relativistic nonsense. To them I would respond by humbly pointing to a book that most of them seem to take quite seriously as a source (or even the source) of wisdom:
As he looked up, Jesus saw the rich putting their gifts into the temple treasury. He also saw a poor widow put in two very small copper coins. “I tell you the truth,” he said, “this poor widow has put in more than all the others. All these people gave their gifts out of their wealth; but she out of her poverty put in all she had to live on.” (Luke 21:1-4)
Go argue with Jesus, why don't you?

Or perhaps you would rather dispute with Lazarus.

I mean David Lazarus, of course, the San Francisco Chronicle business section columnist who recently turned his attention to the notion of a flat tax. In his April 11, 2007, installment, titled The flat tax: It's simple, alluring, Lazarus skeptically examines the notion that the flat tax is the epitome of fairness. If one taxes every dollar at exactly the same rate, how can that be anything but fair?

Well, tell that to the widow in the temple. As a little thought experiment, suppose that the poor widow's income is exactly at subsistence level. (We can quibble about how one makes this “exact,” but you get the idea.) If you tax her income, if you take anything away from her, she is now grimly doomed to be below subsistence level. Unless Elijah comes strolling along and blesses the widow's cruet of oil and barrel of meal (1 Kings 17), she's now condemned to starve.

Unfair! Not even the most adamant supporter of a flat tax would insist on taxing every dollar. Yes, I admit that this is true. Remember Steve Forbes, who was going to be swept into the White House on his flat-tax platform? His flat-tax proposal would have exempted the first $36,000 of income from his 17% income tax. Ah, yes, even Forbes was willing to treat dollars differently, depending on the taxpayer's level of income. Already a tiny element of progressivism is creeping in. Perhaps things aren't as simple as they seemed.

Lazarus reports that the Hoover Institution's Alvin Rabushka (a senior fellow at that Stanford redoubt of irreconcilable Republicanism) has published an updated edition of The Flat Tax (with co-author Robert Hall) that proposes a 19% tax rate coupled with a $25,500 exemption per family of four. Deep in his heart, however, Rabushka admits to Lazarus that he wants more:
But the figures are flexible, depending on how much money we want the government to raise. When I pressed Rabushka on his ideal formulation, he said he favors a 17 percent tax rate and a $40,000 exemption for a family of four.

“In my view, government is too big,” he said. “I want to cut it down.”
Yes, that's the customary motive of the right-wing exponents of the flat tax: Set the rate below the revenue-neutral level so that you starve the greedy federal monster. Sounds cool, like something out of a Grover Norquist wet dream (“I don't want to abolish government. I simply want to reduce it to the size where I can drag it into the bathroom and drown it in the bathtub.”). Let's put a single knob on the income tax system so that we can dial it down, percentage point by percentage point, till Washington is sufficiently emaciated to qualify for a mercy killing. As C. Montgomery Burns might say, “Excellent!”

Proponents of the flat tax may market it to anti-government groups as a way of reining in the federal colossus, but to the citizenry at large they prefer to emphasize its simplicity. As Forbes was wont to say, “The flat tax would be simple. You could fill it out on a postcard.”

But this conflation of flat and simple is false. Sure, a flat tax is a simple tax, but a simple tax need not be flat. The implication does not go both ways. Lazarus notes that there's a lot of room to reform the federal income tax system:
“Simplification is a different issue from flat or progressive,” said Ed McCaffery, dean of the University of Southern California law school and author of “Fair Not Flat: How to Make the Tax System Better and Simpler.”

“We need a progressive but much simpler alternative,” he said.

In 2005, Oregon Sen. Ron Wyden and Illinois Rep. Rahm Emanuel, both Democrats, teamed up to sponsor what they called the “Fair, Flat Tax Act.” Among other things, it would condense the 1040 form to a single page and offer just three tax brackets—15 percent, 25 percent and 35 percent.

Something along these lines may be the most politically feasible solution to our tax woes.
The Wyden-Emanuel proposal is flat the way the current system is flat: the rate does not change within each bracket. Yet it is certainly drastically simpler than what we're doing now, even as it retains progressivism.

Why do conservatives hate progressivism so much? Although it's easy to attack progressive tax systems as “unfair” because they treat dollars differently depending on context (which I've already argued is a bogus issue), the real animus against graduated rates lies in their impact on the plutocrats who run the Republican Party. The flat tax would shift the bulk of the tax burden toward lower income taxpayers (despite the fig leaf of the family of four exemption, whatever its level might be). From the Lazarus column:
Under current law, tax brackets range from 10 percent for lower-income households to 35 percent for those bringing in some serious coin.

“A 17 percent or 19 percent flat tax certainly would be a massive tax cut for high-income people,” said Eric Toder, a senior fellow at the nonpartisan Tax Policy Center in Washington.

“Simpler? Yes,” he said. “But a flat tax would be inconsistent with the preferences of the American people. By and large, people—not all people, but many people—prefer a progressive system. We have increasing inequality in society. There's no reason to make it worse.”
As Toder observes, “not all people” prefer a progressive system—the millionaires and billionaires certainly don't care for it—but the sense of fairness that goes right back to scripture makes it clear that there are circumstances where the dollar in one person's pocket is quite different from the dollar in someone else's.

As a former government bureaucrat, I am less inclined than most people to parrot the line that smaller government is automatically better government. (We've seen during the Bush administration that neglect of government responsibilities results in suffering and tragedy in the nation.) But I have no objection to judicious trimming and pruning. Would Alvin Rabushka like to chop away at the federal government? Oh, yes! Well, Alvin, think about the Wyden-Emanuel proposal. If real tax simplification were enacted, and the 1040 form reduced to a single page, think of how much smaller the Internal Revenue Service could be!

I do, however, worry a little about how the unemployment rolls would swell with former H&R Block tax preparers and civil service CPAs.


RBH said...

'Strangle the government' flat taxers like Norquist studiously ignore the fact (not conjecture!) that when the federal government (in the form of Congress and the President) thinks it needs more money for this or that, it is simply not constrained by current or foreseeable revenues. It merely borrows the money, mostly from China, Japan, Taiwan, and South Korea these days, along with a healthy dollop from Middle East oil producers.

Borrowing to fund capital improvements ("investment") is sometimes (often?) defensible and even prudent. Chronic borrowing to fund current operations is a recipe for long-term disaster. The latter is the mode we've been in for some years now.

Zeno said...

An excellent point, rbh. David Horsey, the political cartoonist for the Seattle Post-Intelligencer, hit the nail on the head with his cartoon for December 19, 2004: link.

We are owned, aren't we?

King Aardvark said...

As a Canadian, let me say that 35% doesn't sound too bad.

There has always been something that bothers me about tax brackets as they traditionally are. Say you've got a tax bracket for earnings up to $100000 that taxes at 25% then above that it jumps to 35%. In this case, you'll have people tailoring their incomes to $99999 and get taxed at 25%, meanwhile someone who makes $100001 will be taxed at 35%. The first guy gets $74999 while the second guy only gets $65001. There's going to be a lot of fuss over all the manoevering to get just under the bracket. Zeno, maybe you could propose a simple sliding scale formula for the tax form that any highschool grad could use. Bush would still have to hire a mathematician to do his taxes though.

Zeno said...

Does it work that way in Canada? That's not how tax brackets work in the U.S. If the 25% tax bracket goes up to $100,000, then the higher 35% rate would apply only to those dollars beyond $100,000. That is, you'd have to pay 35 cents of that final dollar in taxes. The previous dollars were (and remain) taxed at the lower 25% rate.

Of course, plenty of Americans don't understand that either. I've heard people whining about how it doesn't pay to earn more because a higher tax bracket would mean a lower net income after taxes. Well, anything is possible with a tax code as complicated as ours (and that minimum tax clause), but it's not a built-in feature of tax brackets. The rates apply only to those dollars lying within each bracket, not to the aggregate as a whole.

eProf2 said...

It's Monday the 16th and I'm about two posts behind you.

One of the main problems with the progressive tax, which I support, is that the federal government, Congress and the Executive, use taxation as public policy; thus, creating an umpteenth thousand page tax code. I don't know the exact number but an awful lot of rich folks can hire lawyers and accountants (tax deductions) to bring their taxes down to much lower levels than those stated. Remember the rush to buy Hummers a few years ago because the tax break was going to be taken away? Or the tax break on luxury yachts? The latest one I've become aware of is that World Bank employees pay no federal income tax. I haven't a clue as to why they are exempt. This no income tax break even counts when the employee of the World Bank is transfered to an official US agency. (See the Wolfowitz scandal.) Our tax code is terrible and needs not only an overhaul but a complete new system. Let's have a real national debate on taxation and devise something that's workable and not tax write-offs for those who can find them in the massive code.

Incidentally, I used the standard grading system for most of my thirty-five years of community college teaching and found it to work relatively well as grading in and of itself is a difficult proposition. Multiple choice versus essay, matching, fill-in, and a whole host of other ways to help students learn, which after all is the reason for testing in the first place. I also used essays mostly, multiple choice from web sources, current event fill-ins, and the "push" grade (one percent) for students to collect ten cartoons from four artists on one theme and turn them in by the final should they want the extra push. Not a perfect testing system but one that worked relatively well.

Kristjan Wager said...

From what I've read about the Canadian tax system, it works the same way Zeno. The only tax system I've ever heard of that worked like the one King Aardward described was the Swedish tax system, until the author Astrid Lindgreen (and others) protested about it, and they changed the system to the universal way of doing it.

There is a pretty good report about the current US taxation system, that explain why the current system is actually pretty much a flat tax system, with a tendency towards becoming more regressive.

"Progressive and Regressive Taxation in the United States: Who’s Really Paying (and Not Paying) their Fair Share?"

Download it here (pdf)

King Aardvark said...

Ah, I was confused about how you were doing it. Thanks for correcting me on that.

I think it is the way you described in Canada, too.

Eamon Knight said...

Nothing like commenting on year-old posts, eh? Have to put you on my RSS so I don't have to do this....

In years of doing our own (Canadian) taxes (first just the two of us, then add the kids as they got older, then add my parents when they became incapable, last add their estate after they passed away), the complicated part was never about working the tax brackets -- that was a pretty simple calculation (and the govt even provided a lookup table for the arithmophobic!). The complicated part is keeping track of all the information slips, filling in the numbers in the right places, keeping track of investment gains and losses, and figuring out what deductions I was entitled to.

*That* was what eventually drove me to dump the whole mess on an accountant. Collating the damn paperwork is about as much taxation stress as I can handle, nowadays.