Income Tax is Stupid and Should be Abolished
May 22, 2022, Edited June 11, 2022
Income Tax is stupid and should be abolished. There are two reasons for this.
1) Income Tax does not make economic sense.
2) Income Tax is actually counterproductive.
The first reason: That income tax does not make economic sense is easily understood if you know the Theorem of Proper Taxation. The Theorem of Proper Taxation is:
The Theorem of Proper Taxation consists of four assertions:
1) The purpose of national taxation is to control inflation.
2) The only time money causes inflation is when it is spent.
3) Therefore, the only time nationwide taxes should affect is when money is spent.
4) Ergo — consumption taxes are far preferable to income taxes.
Some people who read the Theorem of Proper Taxation immediately understand. If you do not and need supporting arguments, please see:
The second reason: That income tax is counterproductive, can be easily seen in the state of the real estate market today.
The real estate market today is characterized by boom and bust cycles. Prices rise excessively until they become untenable, and then they crash precipitously.
This boom-and-bust cycle is caused by deficient government policy, expressed through the income tax.
The income tax provides inducements to own real estate that are excessive and therefore rational actors in the economy buy all they can.
They are induced to buy by interest deductions from their income tax. They are induced to buy by capital gains exemptions on some of their real estate gains. They are induced to buy by being able to deduct expenses from their income taxes, if they can claim they use it as a business.
In other words, income tax distorts economic activity in an unhealthy manner.
Without income tax, with money instead siphoned from the economy by transaction taxes, nobody would buy anything to save money. Spending would be a cost and you would only buy something for its intrinsic benefit.
This would not preclude investing or speculating in any asset, including housing, which is fine. These activities are part of the capitalist system.
However, real estate used as housing is a special case.
It is a social negative to have policy cause houses to rise to such an extent that large portions of the populace are priced out of owning a house. It is also a social negative to have excessive price appreciation because reselling houses provides no actual benefit to society. Nothing new has been produced and therefore it is a nonproductive activity that only siphons wealth from the buyer to the seller, excessively benefiting those who speculated and who did nothing genuinely useful while impoverishing the buyers, who are just trying to live their lives, raise families, and so on.
The whole point of the capitalist system is that it induces people to do things that add value. Flipping houses does not add value.
If the government wants people to own their own houses, they could offer zero down payment loans to those who qualify and do not own any other real estate. This makes it easy for those who do not own a house to get one.
At the same time, to prevent excessive speculation in houses, they could impose transaction taxes that tax away most capital gains of short term owners as well as impose significant down payment requirements on those who already own real estate.
The goal is to keep house prices reasonable and stable by diminishing the allure of residential housing as a speculative asset.
An attribute of our current economic environment of income tax and interest rate adjustments to control inflation is that the Federal Reserve is forced to essentially kill the entire economy when inflation mandates interest rate increases. In a no income tax environment with easily adjustable transaction taxes in their stead, they could target excessively hot sectors of the economy with higher transaction taxes to cool them off.
For example, they could impose a 30 percent transaction tax on houses in areas with excessive price appreciation. This would spare the rest of the economy from the effect of the alternative, which is higher interest rates.
Real Estate is just an example of bad policy caused by a Congress that loves to hand out tax breaks but finds it very hard to remove them.
In summary, income tax is both economically not useful and also distorts activity. It should be abolished and replaced with targetable transaction taxes.
Once you decide what needs to be changed, then the details of the mechanism you wish to implement become important. Congress and the President are great at deciding to spend money, and that does not need to change.
However, just as we have a separate politically independent agency, the Federal Reserve, tasked with job and price stability, we should also offload taxation to a separate politically independent entity.
That agency could be the Federal Reserve, which is already watching prices, or else a brand new agency which could monitor price levels and adjust consumption taxes as needed.
This is actually politically attractive, because politicians love to spend money but do not like to raise it. It would free them from accusations of tax raising.
In such an environment, if Congress wished to promote a particular activity, they could offer a subsidy, which is far more transparent than a tax break and also helps everyone, not just those looking for a tax break.
All of the above is just a rough framework of what we need to change for a more robust economy. The actual changes themselves can only be implemented by Congress itself, and given that Congress is characterized by momentum and a lack of introspection, it is unlikely to make significant changes. Another way to achieve significant change would be through a Constitutional Convention, which is an entity whose greatest contribution might be made if it were a regularly scheduled event, as discussed here, perhaps excessively viciously: https://trillionstrillions.medium.com/engineering-evolution-into-nonbiological-systems-c2d371ffe51c
EXAMPLE SCENARIO:
It may help to clarify the stupidity of income tax with an example.
Assume we have two citizens. The first is Sammy Saver. The second is Larry Leverage. They both have the same income from their employment.
Sammy Saver lives frugally, small house, old car, banks all the surplus or buys stocks and bonds. His activities have almost no inflationary effect, since he is not competing for goods and services.
Larry Leverage lives very well, mansion, many nice cars. Additionally, Larry buys a lot of houses, putting only a small amount as a down payment and leveraging as much as he can. He has many deductions on his income. His activities have a great inflationary effect, as he outbids people for houses, drives up the prices of cars and consumes the maximum amount.
Under an income tax regime, both Sammy and Larry would likely pay the same amount of income tax per year. Larry might even pay less since he would have many deductions. So, the income tax would be failing at its very purpose, to constrain inflation. The far higher inflationary actions of Larry Leverage would be unnoticed by the income tax, until he sold an asset and was not able to hide the income somehow.
Under a transaction tax environment, where the taxes affect when money is actually spent, Larry Leverage would be paying transaction taxes on all his outlays. He would pay a transaction tax on every monthly payment on his houses. The tax would be calculated on a percentage of his mortgage principle, interest and insurance paid each month. Thus, a transaction tax would be a far greater inflationary constraint.
Conversely, Sammy Saver, in a transaction tax environment, would pay very little tax since he saves his income, which is fine. When the day comes that he or his heirs consume, they would then pay their fair share. In the meantime, his savings will help propel investment into the economy.
SUMMARY:
I really discussed two things here. The superiority of transaction taxes and ways to limit excessive house appreciation. Both are worth policy goals.
