A pay-per-use model for the state
April, 15th, of each and every year is probably not the favorite day of most Americans.
Paying taxes often feels like being robbed. Especially, when really rich people have effective tax rates that are well below what the so called middle class pays and you don’t belong to the super rich.
On the other hand, essential governmental services need to be paid for.
Is there a just distribution of taxes?
Didn’t you read my other post? No, there is nothing even remotely like an objective justice, so there is no just distribution! Thanks for reading this ninth installment on my series on justice. See you soon!
OK, WAIT! A little bit more can be said about a just taxation system from the perspective of Rawls, which happens to be a conception of justice, I find very useful. Usefulness is the best thing we can judge our systems on. Why?
Here is a great example for why any discussion on taxes in prone to bitter debate. It’s taken from [Kahneman, p. 369-370].
Scenario 1: You assume that the standard family has no children. You want to ease the burden on parents and allow a tax credit for each child. Should this exemption be dependent on income? In other words: Should rich parents get a larger exemption than poor parents?
Scenario 2: You assume the standard family has two children. Children are future tax payers. You want to make couples “that don’t do their part” to chime in and support parents with paying for a tax break. So you want to levy a surcharge for every “missing” child. Should this depend on income? In other words: Should childless poor pay as much as childless rich?
If your answers were “No” and then “No”, you are making a mistake. I can state that with certainty, because both questions are indeed mathematically equal. And answering “No” to both of them is contradictory.
The only thing that changed is the frame of the question. In the first scenario, a “tax reduction” for each child is seen as positive, so we favor the poor. In the second scenario, you don’t want the poor to “suffer” the same penalty as the rich person.
We are looking at the same facts, but a different framing makes us see different versions of reality. Our moral intuition, even a strongly felt one, is utterly useless for answering the real question: Who should pay how much?
That’s why I think there will always be a debate about the “fairness” of taxes. We just don’t have an objective reference point. That’s why I think it’s more productive to look at the usefulness of tax proposals.
As already explained in an earlier installment, there are two tasks for a taxation system: gathering the resources needed to pay for the state’s expenditures, which I hope are focused on enabling a decent life for the members of society, which includes public goods like safety from invasion. The other task is to add friction to the growth of inequalities, which are seen as a threat to the “equal value of political freedom”, about which we already talked. In a nutshell, money buys influence in the political realm and the interests of ordinary people are trampled.
So how are we doing on the two counts at the moment?
Intergenerational Justice
“Justice” and “fairness” between generations is a difficult topic. But what is clear: if any generation behaved selfishly and exploited resources to depletion, dumped waste without any regard to the future, underinvested and burrowed staggering amounts of money for the promise that their children would surely pay, the latter generations would have a really hard time.
Reflecting on this: Doesn’t this sounds pretty much like the current system? What are the effects of this? They can’t be that big of a problem, right? How do we measure this?
There are two methods to make the shift of risks and obligations to the future visible. The first is called fiscal gap analysis. You take “the present value of all projected future expenditures, including servicing outstanding official federal debt, less the present value of all projected future tax and other receipts, including income accruing from the government’s current ownership of financial assets.” [KOTLIKOFF2]
The difference is the gap, i.e. a measure of how much your system spends more than it is taking in.
The second method is called Generational accounting and “measures the burden on today’s and tomorrow’s children of closing the fiscal gap assuming that current adults are neither asked to pay more in taxes nor receive less in transfer payments than current policy suggests and that successive younger generations’ lifetime tax payments net of transfer payments received rise in proportion to their labor earnings.” [KOTLIKOFF2]
This number measures how much of the gap is kicked down the road.
The first number for the US is in the neighborhood of $210 trillion. With a “T”. In today’s dollars! 60% is attributable to unchecked growth of healthcare costs, a lot of the rest can be attributed to retirement payments. The second one is skewed. A lot!
The current system actually looks eerily similar to a Ponzi scheme, from the generational accounting perspective. There is by no means enough current investment for the promised future returns. The gap, i.e. what doesn’t get paid by current payers, has to be made up by either increased taxes or reduced benefits for future beneficiaries. This doesn’t really register as “fair” deal to me.
Imagining myself behind the veil of ignorance, not knowing what generation I would be born into, I can’t find a reason why I would favor this structure. Why would it be a good idea to let the accident of a late birth impose disproportional burdens? There might be a reason, I just can’t think of one. So I’d reject this proposal.
So let’s start by looking at the largest chunk. Healthcare. How could we collect the money for it?
Expenditure Tax
Rawls favored an expenditure tax. [RAWLS, p.278-279]
This form of tax does not tax what you put into an economy, but what you extract. You can think of it as the pay-per-use model of taxation.
The implementation of such a form of taxes has often been disregarded for the “complexity” of filing this form of a tax. Personally, I think it would have been practical 25 years ago, but it is certainly easily possible in 2020, given electronic tools.
What would you have to do to calculate a your tax burden?
A household would start by adding up all their inflows of funds, including borrowing and so called imputed rents. What is an imputed rent? It’s a theoretical rent you could earn from your durable assets; like yachts or villas. Then you subtract wages and investments. The difference is the total consumption. It’s what you extracted from the economy. And you pay for the usage of it. The tax rate on consumption could be progressive, like ignoring the first $100k of consumption and tax everything above that at 5%, increasing to 30% for consumption above for example $5M.
Why would you calculate it like that and include borrowing and imputed rent?
Because a whole lot of the very wealthy people use a trick to “dodge” taxes, which is completely legal.
They burrow money and put up their assets as securities. They spend the borrowed money for their expenditures and keep their assets, so they don’t have to pay capital gains taxes. On average, the capital value of assets will increase. And so they can borrow more, because they happen to have more securities.
Additionally, this enables them to convey these appreciated assets to their heirs with only limit taxes, if they use irrevocable trusts and other means to avoid estate and gift taxes. This enables people of a certain level of wealth to sustain a high level of consumption without paying taxes for public services, like the military, from whose implicit protection they profit disproportionately.
I think it’s just “Adams’ Iron Law of Bad Behavior” again. It’s a complex situation, the risk of detection is low or even non-existing and the profit is huge. I don’t blame them and would probably do the same. We have to fix the tax system that allows this to happen. There might be a reason to exempt those of unusually high means from financing basic services, but I would not know of any I find compelling.
If we look at the definition of the expenditure tax, it becomes clear that investing your money reduces your tax burden. Investments could of course also include higher education, including for your children, tuition and charitable contributions.
Increasing the capital of society is not taxed, using society’s capital for personal consumption is.
Value Added Tax
[YANG] is favoring a Value Added Tax for his proposed “Freedom Dividend”. The VAT is added at a fixed rate to all purchases. Let’s say the VAT is 20%. A drink, that used to cost 1$ will be 1.20$. The extra 0.20$ are owed to the Treasury by the seller.
Obviously, a VAT is another form of a pay-per-use scheme, as it is levied on all products. Or maybe just on most. A lot of countries have lower VAT rates or even no VAT on goods that are considered to be essential. It’s a “cruder” form of the pay-per-use model, because it doesn’t differentiate between what and individual bought for consumption and what is bought for investments. Only companies are allowed to do a more detailed investment accounting.
A company has to add up its annual total cash receipts from domestic sales of goods and services and subtracts its total purchases of goods, services and investments. Exports are typically excluded from a VAT and the WTO doesn’t count that as an export subsidy.
The difference is multiplied by 20% and that’s the VAT a company has to pay.
Effectively, the tax rate on profits from new investments is 0%. Additional sales revenue from investments is taxed at 20%, but the investments itself is deductible at 20%. So for companies, a VAT doesn’t negatively impact investments. Which is great!
A VAT at a fixed rate is often seen as regressive. A lot more people would consider a tax on wealth and wages at a fixed rate as progressive. Mathematically, they are the same. And interestingly enough, they are neither progressive, nor regressive, they are proportional. If you can double your wages, it will double the amount of goods and services you can buy (in net present value) and also double your paid taxes. Additionally, a VAT reduces the buying power of existing wealth immediately and can therefore be seen as a tax on that wealth. [KOTLIKOFF]
To ensure the progressiveness of the VAT, a rebate on the consumption taxes for consumption up to a certain threshold has to be paid. In Yang’s proposal the UBI would take that role, but the actual payments to ensure that poor people aren’t hit with additional taxes can be substantially lower.
Flat Tax
The crudest form of “pay-per-use” is an income tax. It simply assumes that you will use a proportional amount of your income for consumption. A flat tax is pretty much what the name indicates it to be. A fixed rate that is deducted from earned income. Most proposals for a flat tax, that I have seen, try to include all forms of income, which also includes stocks or stock options.
This form of tax is hotly debated, because of the fact that all people pay the same marginal rate. This is seen a “just” by a lot of people, and as an “injustice” by others, because those of higher means don’t pay more. In relative terms, not in absolute terms.
In America, removing the ceiling on the FICA tax would transform it into a flat tax. Every penny a person makes is taxed by the same amount.
If you add uniform deductions or even a uniform payout, the resulting net taxation will actually be progressive. A deduction of, for example, $40k, which would make a lot of households in America pay no FICA tax at all, as can be seen in this table:
An all of the above scheme
All these different forms of taxes have relative benefits and could be gamed differently. [KOTLIKOFF] combined them in a tax proposal. He adds an inheritance tax, which is supposed to introduce friction on the accumulation of large inequalities in the political power of citizens. His proposal in detail:
15% FICA tax on all incomes above $40k.
a 20% VAT
a progressively increasing expenditure tax for consumption in excess of $100k/a.
an inheritance tax of 20% for all cumulative inheritances above $5M
a lumped sum of approximately $2k/a per citizen, which would replace the Earned Income Tax Credit and Child Tax Credit
I’d like to add that this could also be combined with payments of carbon dividends.
This tax structure would be plenty enough to pay for the basic healthcare vouchers, I presented in a previous post. It would also be enough to replace food stamps with directly distributed, healthy food for low-income families. This would eliminate another component of the poverty trap.
All Americans would face the same marginal tax rate for every dollar they make, be encouraged to grow society’s capital and have healthcare. Furthermore, it would close the intergenerational gap by 60% and free 80% of American households from filing taxes! April, 15th, becomes just another day.
Let’s now look at pensions.
Time to retire
There is a well known counter-measure to the exploding fiscal gap: make people save more for their retirement. Well, duh!
Appeals to this effect haven’t proven to be popular. And a lot of people don’t save as much as they themselves state they would like to.
This is an interesting phenomenon, because even small changes in default options for employer pensions schemes often boost participation significantly. People fail to live up to their own rationally devised plans, a topic, I will talk about in a future post.
[KOTLIKOFF] has a suggestion for this as well. It’s not really subtle.
He proposes to make wage earners pay 10% of their income into Personal Savings Accounts (PSA). This is compulsory. For married people, 50% of the amount is paid into the PSA of the respective spouse. A reduction in income, maybe from a baby break, affects the retirement prospects of both spouses equally.
All balances on a PSA would be invested in market-weight index funds of stocks, bonds, real estate etc. A global distribution might be optimal economically, but I think a distribution that skews national would be more feasible politically.
There might also be a lot to Nassim Taleb‘s idea of the “Barebell Investment Strategy“. Instead of being mildly aggressive with all of your investments, you split your fund into a large portion that’s hyper-conservative and into a portion that’s hyper-aggressive. So maybe it would be better to split the portfolio in to maybe 20% that’s put into lot of startups and spin-offs of national labs etc.
Think gene therapy for diabetes, vaccines against obesity, nanobots that kill cancer, fusion, GenIV nuclear, laser-induced transmutations, 3D printed houses and nuclear reactors, self-driving trucks, hyper-loops, ocean-floor mining, hyper-sonic transport, asteroid mining, space tourism, brain machine interfaces: totally out there stuff.
Most of it will fail miserably. But thanks to limited liability, you can only lose what you put into the companies! You probably created a lot of new knew knowledge even in case of failure, which might be mandated to be disclosed afterwards.
But if they succeed, these companies can become big. Like thousands of times your initial investment. They might also solve a huge problem along the way.
Anyway, most of the portfolio would be invested in boring stuff, like bonds. With Taleb’s strategy, you would ignore the mild-risk mid-range that most stocks are in.
I’ll let economists discuss about that. But I like the futuristic element of the Taleb-inspired strategy.
The government would make contributions for low-income households’ PSAs.
From ages 61 to 70, all PSA balances are gradually sold to purchase Treasury Inflation Protected Securities (TIPS). This whole process can be done by a small, dedicated governmental computer at close to zero costs. The involvement of private banks would not be necessary.
Sweden is actually offering a service like this to its citizens: they have a program which invests in ETFs for their population and charges only a fraction of what other providers do. Not having to advertise and pay CEOs’ and VPs’ cars and private jet usage apparently translates into lower fees and better customer value. Who would have guessed?
The government would guarantee that the PSA balances, when converted to TIPS, equal the inflation adjusted contributions. In other words: participants are protected against inflation-adjusted losses. People are not left to the whims of the market. There is a governmental backstop.
PSA balances are the property of the individual citizens and can be bequeathed. TIPSs cannot. These are insurance instrument that needs an irrevocably closed pool of contributions to work.
This model of PSA is also great for workers, who are only temporarily in the USA. Let’s say an Austrian engineer in her 20s works in Michigan for 5 years and moves to Canada after that. Her PSA would be reinvested in the economy till she reaches the US retirement age. She would receive payments for her PSA after that. If there were a whole lot of countries with such a retirement system, mobility of highly qualified workforce could actually be increased substantially.
Did I mention that the current beneficiaries of Social Security would still get all the money the system owes them? It’s not the current beneficiaries that will break the system, but the underfunding of future retirees. That’s what’s going to be fixed.
In a nutshell, PSAs are a way to make retirees pay for the services they are promised to enjoy by forcing them to save and invest. What is such an investments? It gives the next generation of entrepreneurs, home builders and companies the resources they need to build the wealth that will be enjoyed collectively.
Piecemeal increments
The distribution branch of the government has to allocate the resources needed for provision of services to the population. It has also to look a the intergenerational aspects of the transfer systems. We have to choose from a range of different tools to do so and I think the plan devised by Laurence Kotlikoff might be a good starting point to reflect on the topic.
It broadens the tax base significantly, simplifies the system and uses different instantiation of taxes on consumption, albeit of different accuracy in measuring the exact consumed amount, by implementing the expenditure tax, the VAT and a flat tax. His proposal also includes an inheritance tax, which is not levied on the estate itself, but on the transfers to the heirs. Spreading out the wealth reduces or even eliminates the tax burden.
I don’t think the scheme would produce enough revenues for a full-fletched UBI, but it puts the instruments into place that could be used to finance it later on, including a regular payment to all citizens, if automation should make that necessary. It generates, however, the revenues necessary for universal healthcare vouchers, closing a huge gap from the perspective of Rawlsian justice. Investing in the future or alternatively making people to save, closes another gap.
The combined effect of these measures is more a long the lines of what Daron Acemoglu suggested with the Guaranteed Basic Income, than of what Andrew Yang proposes with the Universal Basic Income. But might it be a step in the right direction? Might this be prudent from a risk-management perspective?
What are your thoughts on the topic of taxes? I’d love to hear from you.
There is a lot to be tested.
Let’s get going!
SOURCES:
[KAHNEMAN] KAHNEMAN, Daniel. Thinking, Fast and Slow. Farrar, Straus and Giroux. Kindle-Version.
[KOTLIKOFF] KOTLIKOFF, Laurence. You’re Hired. A Trump Playbook for Fixing America’s Economy. Available at: https://kotlikoff.net/wp-content/uploads/2019/03/Youre-Hired-A-Trump-Playbook-For-Fixing-Americas-Economy-1.pdf. Accessed 2020-05-15.
[KOTLIKOFF2] Available at:
https://theinformact.org/
. Accessed: 2020-05-17
[RAWLS] RAWLS, John. A Theory of Justice (Oxford Paperbacks 301 301). Harvard University Press. Kindle-Version.
[YANG] from: https://www.yang2020.com/what-is-freedom-dividend-faq/. Accessed 2020-05-09