Considering that yesterday was the day that most Canadians were supposed to have filed their tax returns, I see the usual complaints about it being complicated. With that in mind, here are two possible ways to simplify the tax system. They offer features that should appeal to people from all across the political spectrum.
The first one is known as a “negative income tax“. About four in every five economists (79%) agree (possibly with provisos) that “the government should restructure the welfare system along the lines of a ‘negative income tax.’” The features of a NIT are as follows (I’ve explained them in comments elsewhere, but this is the first time in a post at this blog):
All income, whatever the source, is taxed at a flat rate. This includes incomes that are currently exempt, taxed differently, or deferred, such as capital gains and inheritances. Second, all deductions, whatever the basis, are eliminated. This includes ones like charitable donations, political party donations, or hazardous jobs. The result of this is that everyone with the same nominal income pays the same tax. Third, all welfare systems, like social assistance or unemployment insurance, are eliminated and instead converted into a refundable tax credit of some amount. Each taxpayer subtracts the refund from the income tax they paid. If the result is negative, they get a refund from the government. If the result is positive, they pay the difference to the government.
Let’s use examples to demonstrate. For the sake of this example, we’ll assume that the flat rate is 20%, and that the refund is $5000. There is nothing special about these numbers; they are examples only.
Alice’s T-slips indicate that she earned $20000 last year. She pays 20% of that ($4000) in taxes. She gets a refund of $5000, which means that she actually gets a net $1000 from the government. The same year, Bret earns $25000. He pays 20% of that ($5000) and gets a $5000 refund. Therefore, he actually pays no net taxes and gets no money from the government. The same year, Chris earns $30000. This taxpayer pays 20% of that ($6000) in taxes. After the refund, $1000 is still owing, so this taxpayer actually pays a net tax of $1000.
As can be seen from the examples, by tinkering with the rate or the refund, a guaranteed minimum income can be maintained, and any arbitrary no tax payable point can be chosen. Update (2013–05–05): And it goes without saying that certain “special circumstances” can be given a slightly different refund, such as dependents or disability.
The negative income tax system has a number of significant advantages over the current regime (after the jump). In no particular order:
- It’s much much simpler. By eliminating all deductions or complexities on forms and schedules, it makes doing your taxes easy. Indeed, if you can do arithmetic and percents, you can do your taxes under a NIT.
- It’s distorts the market less. While all taxes will distort the market, by treating all income identically, it distorts it less. And conservatives, if you truly believed that the market gave the optimal results (without government intervention), you wouldn’t want to distort it, would you?
- It makes escaping from bad situations easier. Since it provides a guaranteed minimum income, if a spouse is abusing you, you are no longer trapped in a dangerous marriage because you will no longer face starvation or homelessness if you leave. Likewise, if your employer is screwing you, it really makes it easier for you to quit and get a new job for the same reasons as above. This is one reason why libertarians should support this if they truly believed that people should “pack up and leave” situations they don’t like, and weren’t people who worshiped management like God.
- It produces a smaller government. Since various forms of government assistance (welfare, unemployment insurance, and the like) are replaced by the refund, those government departments can be eliminated, saving on administrative costs.
- It eliminates the welfare trap. Since, as implied above, people will always have an incentive to earn more money, the situation where someone on welfare loses money when they find employment due to benefit claw–backs no longer exists.
- As implied above, it makes comparisons between taxpayers easier.
- It eliminates the tax planning and loophole industries. Tax software will be thrown out of work. Resources used there are therefore freed up for more productive purposes. Update (2013–05–05): And lumping the income of everyone in a household together eliminates any marriage penalty or benefit (we shouldn’t be having different financial treatment for different relationships). And besides, the marriage penalty/benefit is for the promotion of the patriarchal family structure anyway.
- By providing a guaranteed minimum income, it can help lift everyone out of poverty. Additionally, this allows the elimination of the minimum wage, since this refund is accomplishing more effectively what the minimum wage is intended to do.
There are only two disadvantages that I see:
- As mentioned at Wikipedia, studies have shown that it generally makes people work less. This is however less than I expected, and can also be handled by tinkering with the rates as appropriate.
- The same disadvantage as other forms of income tax: most economists believe that income taxes are in general less effective at promoting economic growth than other systems.
I believe that the significant advantages easily outweigh the drawbacks I just mentioned.
There is alternative “simplification” to the above. That is to keep the same/refund minimum income, and additionally institute a flat sales (or better, a value–added tax), and at the same abolish income taxes, and increase the refund by what someone at the poverty line would pay in the VAT. Note that the sales tax should also remain in addition to other sin or Pigovian taxes, such as those on carbon or alcohol.
Such a system share several advantages over the current taxation regime:
- It shares the simplification, distortion, escaping, government size, welfare trap, loophole elimination, and poverty reductions as the NIT.
- Most people spending varies less than their income, so a consumption tax could “even out” their tax burden on a year to year basis.
- It also taxes wealth, as when that is used to buy goods or other assets, it is taxed. Such entities escape income taxation (only the returns on wealth are taxed), and in this sense it is more progressive.
- As mentioned above, most economists believe VAT’s are better for economic growth.
There are also a few disadvantages:
- Paying in cash results in easy evasion. Incentives are especially high with a sales tax instead of a VAT.
- Some people are piss–poor at personal finance, and so a sudden universal price increase could hit them hard. This is another reason why personal finance should be taught in schools.
- Consumption taxes conscript businesses into the role of tax collectors, increasing paperwork and complicating bookkeeping.
But despite the above, either system would be far better than what we currently have.