Tax Policy @ OptimalPortfolio.net

The usual argument in favor of taxing income rather than consumption is that consumption is more elastic than earnings. Although this is the predominant view (supported by studies like: Brookings Paper on Macroeconomics), there is evidence to the contrary.

In the Wikipedia article Wealth elasticity of demand, the author notes that consumption didn’t change substantially after the April 2000 stock market crash (where US$2.1T in investor wealth was wiped out).

On a smaller scale (and admittedly less statistically significant), the Tax Foundation article Delaware Hits the Tax Jackpot shows huge year to year variability in Delaware’s corporate income tax revenue from 1988 to 2007.

If incomes are variable from year to year and consumption is relatively inelastic even in the face of significant declines in wealth, can governments still reasonably justify income based tax policy by rationalizing that incomes are less elastic than consumption? I suspect the explanation is rooted in inertia – if you can find any evidence to support the status quo, why tinker with it?

Perhaps a more disturbing effect is that inflation pushes apparent wages higher while real wages remain static or actually decline. In The Labor Shortage Hoax, Alan Tonelson discusses outsourcing and the labor shortage myth. No less interesting, he drops the little known fact that real wages peaked in 1978 and have declined since then. His prediction is that wages, even high tech wages will continue their inexorable decline.

So incomes are far from inelastic, they’ve been declining for three decades and are expected to continue doing so for the foreseeable future as the Phillippines, Russia, and Vietnam get a taste of future U.S. outsourcing.

Further (slightly off-topic) reading…

Debunking the Myth of a Desperate Software Labor Shortage a 1998 position paper by Normal Matloff at U.C. Davis.

I encourage you to lobby legislators representing your district to consider, if not write/support a bill to replace all wealth taxes (income, capital gains, and inheritance) with a flat consumption tax on new goods and services. Consumption taxes reach the widest possible tax base (including tourists, illegal aliens, and gray/black market elements), thus lowering the average rate. They are also the most ‘voluntary’ form of taxation, allowing the taxpayer to scale their ability to pay according to their projected income and cost of living.

In contrast, income taxes inhibit new capital formation and disregard taxpayers’ vision of future economic conditions. Loopholes intended to offer relief to special interest groups distort the economy and have contributed substantially to the increase in housing costs in urban districts like New York, Chicago, Boston, Washington, Los Angeles, the Bay Area, … Reducing loopholes within an income centric tax system isn’t the answer because it still requires filing (which requires substantial taxpayer effort) and still inhibits individuals from adjusting their spending (and therefore taxation) according to their projected economic circumstances.

This following link provides instant access to phone numbers an email addresses for the U.S. Senators and the congressman (or woman) in your federal district: Contact your U.S. Congressman and Senators. Ask them to restore your financial privacy and give back the time you spend every year complying with myriad income tax regulations. Tell them you need the ability to apply your own vision of economic circumstances to your personal economic circumstances and that means your entire income, not just the portion that the government isn’t presently condemning for tax purposes.

Mention how consumption taxes spread the burden across the entire economy (tourists, illegal aliens, drug dealers, and other gray/black market elements), not just the working class folks pulling a regular (or not so regular) paycheck. Ask legislators to scrap all forms of wealth and income taxes because individuals are best qualified to efficiently exchange capital for goods and services. Tell them that consumption taxes foster increased savings, improved economic robustness (ability to weather economic depressions), and collection/compliance is more efficient.

You might even mention the success story represented by Anguilla’s pure consumption tax structure. The average wealth of citizens has greatly improved over the last thirty years as a result of their pure consumption tax policy (Anguilla has no income, capital gains, or inheritance taxes). [I owe you some hard numbers here. Maybe someone will be kind enough to post a reference.]

We often hear arguments in favor of reduced income tax rates on capital gains. The universally popular argument being that government recognizes the importance of capital as the lifeblood of the economy, if they were to tax capital too heavily (i.e. as heavily as they’re hammering labor), the economy would suffer.

There are several fallacies all bundled within the same argument. First, there is absolutely nothing to differentiate value associated with cash derived by selling labor from capital gains derived from selling goods at a profit. Fifty dollars in your hand from a few hours labor is worth exactly the same in the store as fifty dollars obtained by selling tools out of the trunk of your car, unless you can avoid taxes on one transaction and not the other.

Earned income is capital. Or it would be if the government hadn’t invented an arbitrary distinction to put the working classes at a disadvantage to those that derive their income from ‘passive’ sources like rent, royalties, interest, and dividends.

Visualize a tank of water with a pipe coming out of the bottom (where you draw water for drinking, cooking, etc.) and another pipe filling the tank at the top when the level gets low and you happen to have some water to refill it. Think of the pipe at the bottom as spending and the pipe at the top as income. While the water is in the tank, it’s capital. When you draw water from the tank to spend it, you convert capital into goods and services.

Most (I need to get some hard figures) OECD countries provide preferential treatment for capital, at the expense of current income. The net effect should be obvious – earned income (predominantly derived from working/middle class people) carries the tax burden while established capital stocks (wealthy people) are sheltered.  In reality, the individual’s ability to convert cash into goods and services depends not upon what is going into the tank, but what’s actually in the tank.

In fact, reduced tax rates for capital gains skews the situation further by providing a year to year multiplier (in the form of reduced capital gains taxes) favoring growth of existing capital over the creation of new capital, e.g. by allowing less (as a percentage) current income into the tank.  That’s not just favorable treatment of existing capital, it’s a mechanism deliberately designed to minimize the creation of new pools of capital.  It creates a situation where upward class transitions are more a lottery of extreme circumstances than the policy goal it would be if government served constituents without class prejudice.  Why should government have any preference whatsoever for old vs. new money?