Even if one accepts that radical tax reform is a political nonstarter, it is still important to put forward such projects as forcefully as possible. The reason is that they can serve as a benchmark for evaluating our current dysfunctional tax systems. In addition, these reform proposals can be refined and sharpened in three respects.
First, it helps to be explicit about the purpose of taxation. It is the price an individual must pay for goods and services provided by government, plus the amount of money an individual is forced to contribute to help poor members of the community.
Now, it seems reasonable to assume that the amount of goods and services one buys from the government is proportional to one’s standard of living, and that one’s ability to help the poor is proportional to one’s income. It follows that taxation to finance expenditure on public goods and services should consist of a proportional tax on consumption, while solidarity should be financed with a proportional tax on personal income. All other forms of taxation should be eliminated, including levies on financial income, assets and real estate. Tax progressivity should be banned, since solidarity is expressed through public spending, not taxation.
The cost of personal income tax systems is excessive and a major source of complexity
The second point concerns the administrative cost of managing a personal income tax system. Purely for purposes of financing solidarity, this cost is excessive and a major source of complexity. It would be much more efficient to allocate a share of consumption-tax revenue to finance the solidarity projects promoted by the government. This suggests that a tax regime that combines simplicity and fairness would include only one tax – on consumption.
Third, it is important to understand the difference between VAT and a consumption tax. Both taxes are ultimately paid by the final buyers. However, these buyers are not the same. In the case of VAT, the buyers are producers (including investors) and consumers; while the consumption tax is paid only by consumers. If we wish to stick to the principle that the ability to pay taxes is proportional to one’s living standard, then the only fair tax is a tax on consumption. One should not give in to the temptation to introduce or maintain VAT-based systems.
See Part I
See Part II
This article was originally published here.