Radical Tax Reform

I know that this is probably-impractical utopian thinking, but whenever I discuss related ideas in conversation, people ask me to write it up, so here goes:

The core idea is to get rid of all current taxes, and some existing government power and regulation, and replace them with externality taxes and progressive consumption taxes.

Externality Taxes: The Basics

All significant, measurable externalities should be taxed. Whenever possible, replace existing command-and-control regulations with a measure-and-tax system. Instead of people paying real economic costs for regulatory compliance, the money goes straight into the treasury as a transfer. This increases economic efficiency and will end up with less overall compliance costs for many businesses.

I've estimated that just the basic and obvious externality taxes will raise one to two trillion dollars a year in the USA. This gives us between a quarter and a half of the government's budget. In addition, there are some other externalities to tax:

Corporate Power is Taxed with a Progressive Corporate Income Tax

When considering only economic efficiency, i.e. avoiding the distortionary unfairness of double taxation, the ideal corporate income tax is zero. However, corporate size and market concentration are plausibly negative externalities that should be taxed.

All small businesses in competitive markets will pay no tax. Large companies pay exponentially increasing tax rates based on size and market concentration. If this is calibrated so that this is roughly revenue-neutral with the existing corporate income tax system, it would raise a quarter trillion dollars annually. 

I have no idea if a quarter trillion is an appropriate estimate of the annual harm done to our politics and society by concentrations of corporate power. I doubt anyone has estimated this in any sensible way. Probably the easiest way to do it would be a QALY survey. Fairly or not, many people hate big business, and would prefer to live in a world where it did not exist. Suppose that, on average, living in a nation with our amount of corporate power costs everyone one-thousandth of a QALY i.e. 1/20th as much discomfort as mild lower back pain. A third of a billion people, times a half a million dollars per QALY, times 1/1000, equals a sixth of a trillion dollars, which is pretty close to the current tax.

Other Externalities

Basically any problem you have with our society can be thought of as an externality to be taxed. The tax system, rather than the criminal justice system or any other power of government, should be the first tool to reach for to try to fix things. 

Advertising to children can be taxed. Advertising to anyone can be taxed. Political lobbying and large donations can be taxed. Actions that break up or damage families can be taxed. Conspicuous displays of wealth can be taxed. Harming the cultural foundations of our civilization can be taxed. Companies failing to hire in an equitable way can be taxed. Social media hate mobs can be taxed. 

I don't know if it would be best to have each separate tax require an act of Congress, or to give the executive branch broad enabling powers to identify externalities. Probably it would be safest for each one to require separate, narrow, enabling legislation. Congresspeople would propose tax-enabling legislation in response to constituent pressure. The legislation should include a rough estimate of the damage caused by the externality, and exactly what actions will be taxed and at what rate. Then we can have a productive discussion revolving mostly around checking the math and thinking about practicalities and side effects rather than shouting at each other. Once the tax is in place, people can either pay it or change their behavior.

Progressive Consumption Tax

Even if we identified all harms that could be profitably taxed without violating rights or causing too many bad side effects, it probably wouldn't be enough money to fund the government. We need another source of money that is as non-distortionary and politically sustainable as possible.

Whenever you tax something, you destroy it. Income taxes discourage productive work and investment. Wealth taxes, if only placed on wealth that the state can see, generate an economy-destroying incentive to hide money rather than invest it. Consumption taxes, on the other hand, have far fewer problems, and possibly some benefits, like discouraging extravagant lifestyles that fuel envy and social division.

In order to allow progressivity, and to avoid double-taxation of retired people and people who have saved, and to more easily transition from the current system, we implement it as an alteration of the income tax system. You would get taxed based on the money you withdraw from the bank rather than the money that goes from your employer into your bank account. Bank accounts that existed at the time of the tax changeover are exempt, under the assumption that you already paid income tax on them, and all of your income from that date forward is deposited in a new account.

Instead of your employer withholding money from your salary and submitting tax information to the government, your bank does, at the time you withdraw or spend it. (Assuming direct deposit. If you have an actual check you cash, it gets reported by the employer as normal and you are assumed to consume all of it, but you get a tax refund for depositing money in an investment account) All brokerage accounts etc. are considered 'in the bank' and untaxed. Charitable contributions are untaxed. Aside from that, the current tax brackets would be roughly the same, except we add lots of increased tax brackets for people who spend more money. Anyone who lives a lavish millionaire lifestyle pays 70%+ marginal tax rates on that spending, and seven-figure and higher lifestyles can be taxed at 80%+ At the top end, you'd lose almost 90% from each withdrawal, so you pay the government almost ten times as much for your consumption as it costs.

Some people will complain that this is unfair, because rich people can 'evade' almost all of their taxes by living a frugal middle-class lifestyle while their money sits around growing. But this is exactly the kind of behavior we want to encourage; it would increase investment and economic growth. We should think of the consumption tax as a kind of externality tax: Purchasing things takes them away from others, and plausibly harms them by decreasing their perception of relative status, but earning and storing money doesn't hurt anyone (assuming all the harms involved in what you did to earn the money are taxed properly as externalities).

Tax Liquid Wealth that Produces Power? 

We are probably already taxing lobbying and political donations as an externality, and of course they also get taxed as consumption. But potential power is still power, and it may be possible for large concentrations of wealth to exert improper influence, without paying any tax, by merely threatening to spend a lot on lobbying. If this turns out to be a problem, we can have a wealth tax on large pools of liquid assets. Make sure people can escape this by locking their money up in long-term investment projects, or by signing some kind of binding pledge to never spend money on lobbying or influence.

That is basically it. We've switched away from taxes that give bad incentives and toward taxes that give good incentives. In most cases, 'tax evasion' is stopping doing things that harm people. The next two points are details on stopping nonproductive tax evasion under this new system:

Include all Perks and Benefits as Income

In order to prevent powerful executives from evading taxes by disguising consumption as business expenses, we can count absolutely everything they get from their employer as income. The cost of all benefits is taxable income. In addition, something like exclusive use of a company car is income equal to the rental cost of the car. Use of an office counts as income equal to its rental cost.

All business travel is income equal to what it would cost an outsider to participate, e.g. a trip to Davos counts as income equal to the airfare plus the hotel cost plus all expenses plus whatever it would cost an ordinary person to bribe or buy their way in. If the event is so exclusive that there is no observable market for its tickets, this cost is assumed to be in the tens of millions.

In order to enforce this in an incentive-compatible way, the government collects taxes from companies on everything they spend on employees at a rate a little higher than the highest possible marginal tax rate of the recipient. (If a company has any employee who gets over a hundred of million dollars including benefits, it pays a tax on any benefit they get equal to ten times the total cost of the benefit.) Then individuals declare the value of all benefits and perks they received, in order to get a tax refund on them. 

For example, if consuming all your income (after including the benefits) would put you in the 50% tax bracket, and you got $100k worth of perks and benefits, then the company paid a bit more than $100k on your benefits (at a 50% consumption tax, you need to withdraw $200k to purchase $100k of consumption). If your actual consumption only takes you to the 40% bracket, you'd get a tax refund of a bit more than $33k. (with 40% consumption tax, you need to withdraw $166k to end up with $100k, so the proper tax would have been $66k.)

The more benefits you report, the higher your refund is, so you have an incentive to report everything you possibly can, even at the highest bracket, because the company was forced to pay a bit more. If employees collectively report more in benefits than the company reported and paid taxes on, the company pays the difference plus an additional fine.

This would result in total compensation becoming more transparent, and taxed properly, and would probably quickly settle down into everyone being paid in mostly cash, which would end a lot of current economic inefficiencies like health insurance being tied to employment.

Include Imputed Consumption Value of Non-investment Assets  

In order to discourage certain kinds of tax evasion, and to properly measure lifestyles, we also need to count as income the consumption value that you get from owning things like yachts and mansions. Most or all of this would apply only to people in the new lavish-lifestyle tax brackets; it isn't sensible or desirable to try to collect these taxes from people in lower brackets.

The imputed consumption from any non-investment asset you own is added to your income. For most things, this can be the rental market value. If you own a home, the government uses real-estate data to look up how much it would cost to rent a similar home, and increases your income by that amount. Same for cars, yachts, vacation property, etcetera. 

In cases where there are no rental markets, we do our best to estimate its auction value and assume that the consumption value is a fixed percentage of that. For example, someone hanging a Picasso on their wall, or who owns a million dollars' worth of jewelry, would pay a percentage of its value each year.

In order to avoid double-taxation, you subtract from the property value the amount that you paid for it. So if you paid $300k for your house, your imputed income is reduced by the rental value of a $300k house. If your house still has that value, you pay no additional taxes. If you bought it before the changeover, it is assumed that you paid appropriate taxes, and if you bought it after the changeover, you already got taxed on the money that left your bank. But if the house value has gone up since you bought it, you pay based on the difference.

This system taxes speculative profits rather than productive investment. Purchasing something that later rises in value is taxed, in a way that buying stock in a productive enterprise is not. The current system gets things exactly backwards, giving people strong incentives for unproductive real estate and art speculation.