Wednesday, September 10, 2003

A Good Article on Tax

There's an interesting new law review article mentioned by Lawrence Solum. The article is titled, "The Fair Timing of Tax," and is by USC law professor Edward McCaffery. (You can find the abstract and a link to the PDF file here.)

McCaffery makes a powerful argument for shifting from our progressive income tax system to a progressive, post-paid, consumption tax. The term "post-paid" is key. Apparently, many proposals for a consumption tax are accomplished by taxing all income up front but allowing deductions for all savings. (Any income not saved is, by definition, consumed in some fashion.)

McCaffrey urges that the most important distinction here is not between the income tax and the consumption tax, but between taxes on inflows (which include both the traditional income tax and the pre-paid consumption tax), and taxes on outflows (i.e., his proposed post-paid consumption tax).

The timing issue is critical: If we tax all inflows, we punish people whose earnings are not stable. Someone who earns 2X in year one and nothing in year two ought to be taxed the same as someone who earned X in both years. But given progressivity, a tax on inflows will relatively punish the person who earned 2X in year one, even if he saves half of it for year two. A tax on outflows, by contrast, would tax both of them equally, because the tax would be triggered by spending on personal consumption.

Along the way, McCaffrey makes a lot of other interesting points. For example, he notes that someone who believes in progressivity, such as himself, should oppose taxation of entities (i.e., corporations). From page 45:
"Genuinely progessive taxation is necessarily personal taxation," as Vickrey began his 1947 Agendy for Progressive Taxation. It is simply not compelling, normatively, as a matter of first best theory, to impose progressive taxes on entities, where the ultimate incidence of the tax burden is apt to be uncertain at best, and quite possibly regressive relative to individuals, at worst.
He also discusses the problems of taxing corporations on page 122.

And then, on page 115, he produces a chart that shows the effective rate of taxation on various income classes -- including the regressive payroll tax of 15.3 percent on all income under $87,000. The results are disturbing: People who earn $15,000 to $36,400 are effectively taxed at 30.3 percent; people who earn $36,400 to $76,800 are taxed at 40.3 percent; people who earn $76,800 to 87,000 are taxed at the highest rate of all: 43.3 percent. All higher brackets are actually lower, because of the phase-out of the Social Security tax at $87,000. Thus, someone who earns $151,500 to $319,500 pays an average of 35.9 percent, a lower percentage than the person earning $36,500.

I'm somewhat familiar with the arguments for and against progressive taxation. But no one of whom I am aware really thinks that regressive taxation -- i.e., taxing poorer people at a higher rate -- is the best system. It seems clear that the payroll tax system should be reformed so as to get rid of its regressive nature.


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