Notes Towards a Policy Platform: Part III

Let’s talk taxes.

We’re going to have to raise them.

There: I said it. You can’t borrow as much money as we’ve borrowed in the last decade, and are going to borrow in the next decade, and expect to simply grow out of it, not with a mature economy like ours. The Federal Government is going to have to raise more revenue.

Now, if that’s the case, and if we’re not simply going to settle for lower growth and a spiral into stagnation, we’re going to have to pay much more attention to the efficiency of our tax system.

The most economically efficient tax out there, meaning the one that is creates the least distortion and the least dead loss, is a value-added tax. There’s a limit to how high you can raise a VAT without creating a black market. But right now, in the U.S.A., the rate is zero. It could be higher. It should be.

The VAT is usually hated by progressives because it’s regressive. Which it is. But spending is generally progressive, and the overall level of spending is up and is going to stay up. And if we cut military spending, and spend more on health care for children and less on the (relatively wealthier) elderly, then our spending priorities are getting more progressive.

Personally, I’d like to see the payroll tax eliminated and replaced by a VAT. The payroll tax is a tax on employment; currently we have very high unemployment. Seems to me we should be doing everything we can to encourage employment. Moreover, paying payroll taxes is a major incentive for individuals to hire other individuals on the books. The VAT is much harder to evade. We’d effectively be bringing a big chunk of the underground economy onto the books. Finally, the employees most willing to be paid off the books are those who are themselves off the books – i.e., illegal immigrants. Not only would replacing the payroll tax with a VAT directly bring this underground part of the economy under the tax umbrella, it would reduce an incentive for employers to hire illegals, and eliminate an incentive for illegals themselves to remain undocumented (currently, going on the books could well mean an after-tax pay cut).

In the income tax code, we need to see a revival of the Spirit of ’86: close loopholes, broaden the base, and lower rates. I think the conservative enthusiasm for lowering the top rate is misguided today; top rates aren’t at 70%, to say nothing of 90%. Rather, we should lower the whole curve, and simplify the code as much as possible. The mortgage interest deduction is long overdue for trimming. If we could eliminate the corporate income tax entirely, and raise capital gains rates to be equal to regular income tax rates, I’d be thrilled, though that would potentially create some very perverse incentives to turn everything into a corporation and provide sole employees a wide array of in-kind benefits. But the general direction that I would take the tax code should be clear: eliminate taxes that are disincentives to employment or investment; eliminate loopholes; simplify the code; and raise the overall amount of revenue to the Federal Government by instituting a VAT. The overall goal: a tax system that encourages capital formation, that generates more revenue than our current system at a lower cost in terms of tax-avoiding malinvestment, compliance costs, and so forth.