You are missing a lot of the other factors that go into the relative merits of different taxing methods. The main three being how hard is the tax to collect, how easy is it to avoid, and how neutral is the tax (i.e. how much does it change peoples behavior. For all of these income taxes are worse.
With Salestaxes/VAT's the vast majority of people do not file a return, and the businesses which due file a far more simplified return then a corporate tax one, since it is based on real receipted events rather then GAAP accruals. This means that far less time is forced to be spent by people on it, and far less money is turned into deadweight loss paying jerk-offs like me to prepare taxes.
With Salestaxes/VAT's it is far harder to falsify your return. While I can claim that I made my money in Camen, it is far harder to claim that's where I ate my lunch if I am in LA. And since it s based on real purchases, with subjective deductions it is far harder to slip out of what your owe. And in a VAT system specifically it is far harder for companies to falsify their returns, since your taxes owing is your counterparties tax credit, so the government can find underreporting easily. The overall impact being that is costs the gov far less money to collect per dollar, and the burden is more evenly spread within a class.
Finally Salestaxes/VAT's are more neutral/cause less harmful changes in incentives. With a VAT there is a very limited impact on someone's marginal desire to work, and in so far as they are evenly applied they are not biasing what sorts of consumption those people choose to engage in. So beyond a moderate disincentive towards consumption, and incentive towards investment (which seems good in an inflationary environment?) they don't cause much deadweight loss from suboptimal choices. Where income taxes do have a disincentive impact on people choice to work at the margin. Like for every point you increase the income tax rates there is some amount of people working less or retiring. Which again is suboptimal for society (particularly when we have a labour shortage), since that is now less stuff overall being produced that people find valuable.
Also on being progressive, I want to point out that how progressive a single element is in isolation, isn't really relevant. What matters is how progressive the system is as a whole. Like Salestaxes/VAT's can easily be very progressive if ether you are 1) giving low income people a rebate on them, like they do in Canada, or 2) spend the money you raise on services or programs that disproportionately help lower income groups. Even if people lower down pay more in sales taxes, if they get even more back in transfers they are further ahead. So you are better off finding the methods of taxation that are better at raising funds at minimal costs and making people whole, rather then trying to contort collection, so you only send a bill to Bezos.
Milan, I recommend you stop saying the word “fair” or “unfair” as justification. E.g., “you’d make the bill for existing ones a bit fairer“, “That struck me as kind of unfair”. There just isn’t a universally accepted definition for “fair”.
One could say that the rich can more easily afford a higher tax rate, or that reducing sales tax would have a stimulative effect since lower income quartiles spend a high proportion of their income.
But it isn’t “fair” or “unfair” for higher incomes to pay a higher percentage. In some sense, it is more “unfair” to charge an individual more for the same (or less!) services that they use. When I get a haircut, they don’t charge me based on a percent of my income, nor do they increase the percent as my income goes up.
By the way, I overall agree with raising the progressivity of income taxes (even though this would impact me negatively). It just grates me every time I see the reasoning being given that somehow the current state of affairs is “unfair”. Progressives do this all the time and it drives me nuts.
As someone who works in SALT (I enforce Philadelphia business and income taxes), there’s a huge problem with trying to increase the progressivity of the tax burden in some states—the state constitution forbids it. In Pennsylvania, at least, we have a "uniformity" requirement for state and local taxes that, as interpreted by the state judiciary, requires all taxes be flat taxes. That is, for any given tax, you can’t have different base rates for similarly situated taxpayers just because of differences in their basis of tax (it’s a bit complicated because of course it is). The most direct form is the state income tax, which is what the constitutional provision appears to have had in mind, but it applies to everything. I’m not sure how many other states have this kind of provision in their constitutions, but I suspect it’s more than zero. While of course this isn’t a reason to try and change things, it does make this a much harder lift.
There are plenty of other tax preparers in the Free File program. TurboTax might seem more easy to use, but I’ve used Tax Slayer for years so I’d recommend them. DO NOT PAY MONEY TO FILE YOUR TAXES (if you're under the Free File limit). There are always other options!
Sorry, I'm going to have to disagree with much of your post. In particular, you gloss over the fact that most states' sales taxes tax only "tangible personal property", i.e. goods and leave services untaxed. This is not good policy, especially since higher income households consume proportionally more in services than goods.
You like to use Massachusetts as an example. MA's problem is that our sales tax only taxes ~25% of consumption. If MA expanded our sales tax to include services, while still leaving groceries, prescription medicine, housing, education, and government services untaxed, that would increase the sales tax base to ~50%. With that money you could fund a fully-refundable tax credit for both adults and dependents AND cut income taxes for the median households by significantly increasing the personal exemption and child tax credits.
Additionally, I think this also ignores the lessons of the Nordic model that many progressives and progressive states claim they aspire too - one of broad universal public goods funded by broad-based income and consumption taxes.
Remind your co-generationalists that their utopian, socialist states in Europe have the most regressive tax systems of all. Up to 50% Income taxes and 15-20% Sales taxes, with no tax exemptions or loopholes.
This is the opposite of what they should be doing, because income taxes are volatile and easier to avoid.
The broad base of sales (and property taxes) is a good thing.
A lot of California's problems come from relying on volatile income and capital gains taxes while having very low property taxes (with unequal rates) and sales taxes with many exemptions which reduces the broad base
I don't know if there's any great alternative sources, but I've always cast a weary eye on how ITEP determines tax burden for different income thresholds. For example, ITEP claims the bottom 20 percent pay 17.8 percent of their income in state and local taxes in Washington state.
Part of that justification if you look at their methodology is they claim certain property taxes and taxes on businesses are "passed" on to individuals. Also, since the sales tax isn't applicable to rent, groceries, and utilities, which constitute a large share of the income of the working poor, I am skeptical of their work.
Likewise, their tax burden on the top percentiles makes large assumptions about income that is not reported.
Mississippi is very likely going to eliminate the state income tax in the next few years and some of the politicians are making claims that they won’t raise sales taxes to offset it (or they will only raise some and not others). I think it’s going to be a real hold-my-beer moment for the poorest state in the nation. The lack of business there isn’t because of oppressive taxes, it’s a million other things, but the Republicans there haven’t been able to fix anything in the last 30 years so they are back to the tax issue as the REAL problem.
It is easier than ever for a high earner in Massachusetts to keep their job and move to New Hampshire (or Florida). Work remotely most of the time and avoid most of the progressive income tax. Still difficult to move from the U.S. to Estonia.
I see many argue for more progressive taxes. But I’ve never seen a serious attempt at finding the optimal level of progressivity. Is the optimal level always just more than whatever it currently is?
Milan—you’re doing a great job here. I hope eventually you’ll be paying just as much in taxes as that partner at Bain. But I promise you right now she pays WAY more than you do.
Massachusetts has, by far, the highest short term capital gains tax (12%), and I think it’s the only state that taxes capital gains higher than income (compare that to the federal progressive narrative that seeks to increase capital gains tax just to match income - Buffet’s secretary and all that.) I think this must be really progressive. I paid nearly 50% effective federal and state rates in a very aberrant, windfall year (one off employee equity sale.)
Milan, good effort. Some constructive criticism below.
Most tax analysis suffers because authors focus on only one side of a two-sided coin: revenue collection and government spending. European countries have a very 'regressive' tax regime; a regime Milan would probably pan in this article. But the conclusion that the European tax system is regressive would miss the mark because, holistically speaking, European systems take money from everyone and give to the poor. The US has one of the most progressive tax collection systems in the world--look it up. But our system is net-less progressive because we spend a larger percentage of that income on the middle class and rich.
A tax analysis that looks at a tax system by just looking at the tax rates is incomplete. Would be interested in a follow-on analysis on how states with similar tax rates/percentages of income spend their money.
Would also be interested in the impacts of fiscal capacity. If you look Mississippi (a red, presumed low-tax state) and Massachusetts have similar marginal tax rates and sales tax rates. But Massachusetts is able to raise significantly more money than Mississippi is per capita because it is a richer state. The first order impacts are obvious, but crucially many of the federal programs we set up have state matching requirements to receive money. We essentially are asking rich (blue) states to incrementally increase their tax rates to raise revenue but are asking poorer red states to hike their rates much higher. It's another barrier to full adoption--and one a barrier progressive legislatures should be sympathetic towards.
Not that Intuit’s lobbying to preserve its rents isn’t odious but if you’re a teenager working your first job out of college and your family hasn’t bequeathed you something complicated like property or a trust, you should be squarely in the eligibility zone for filing the 1040-EZ return, which is a single page and takes 15 minutes to fill out if you’re dawdling.
(Well, also unless Slow Boring internships pay really well, in which case congratulations to both you and Matt.)
A Flat Rate Tax is not progressive in and of itself but a Flat Rate Tax coupled with a Flat Rate Standard Deduction is (the percentage of income taxed goes up as the income increases). This is a simple way to achieve progressivity.
Sales Taxes are not progressive but Sales Taxes coupled with Standard Exemptions are. For example, the State of Minnesota Sales Tax has exemptions for items such as medicine, food, and clothing < https://www.salestaxhandbook.com/minnesota/sales-tax-exemptions >. If poorer folks spend a higher percentage of their income on food, clothing, shelter, and medical costs than rich folks do, then rich folks spending on non-basic (non-esential/luxury?) items will be taxed to a greater extent of their overall spending than that of poor folks; therefore: progressive.
As Douglas Feltham points out below; the ease, simplicity, and perceived farness of a tax system are critical factors in whether or not such a system will be successful.
You are missing a lot of the other factors that go into the relative merits of different taxing methods. The main three being how hard is the tax to collect, how easy is it to avoid, and how neutral is the tax (i.e. how much does it change peoples behavior. For all of these income taxes are worse.
With Salestaxes/VAT's the vast majority of people do not file a return, and the businesses which due file a far more simplified return then a corporate tax one, since it is based on real receipted events rather then GAAP accruals. This means that far less time is forced to be spent by people on it, and far less money is turned into deadweight loss paying jerk-offs like me to prepare taxes.
With Salestaxes/VAT's it is far harder to falsify your return. While I can claim that I made my money in Camen, it is far harder to claim that's where I ate my lunch if I am in LA. And since it s based on real purchases, with subjective deductions it is far harder to slip out of what your owe. And in a VAT system specifically it is far harder for companies to falsify their returns, since your taxes owing is your counterparties tax credit, so the government can find underreporting easily. The overall impact being that is costs the gov far less money to collect per dollar, and the burden is more evenly spread within a class.
Finally Salestaxes/VAT's are more neutral/cause less harmful changes in incentives. With a VAT there is a very limited impact on someone's marginal desire to work, and in so far as they are evenly applied they are not biasing what sorts of consumption those people choose to engage in. So beyond a moderate disincentive towards consumption, and incentive towards investment (which seems good in an inflationary environment?) they don't cause much deadweight loss from suboptimal choices. Where income taxes do have a disincentive impact on people choice to work at the margin. Like for every point you increase the income tax rates there is some amount of people working less or retiring. Which again is suboptimal for society (particularly when we have a labour shortage), since that is now less stuff overall being produced that people find valuable.
Also on being progressive, I want to point out that how progressive a single element is in isolation, isn't really relevant. What matters is how progressive the system is as a whole. Like Salestaxes/VAT's can easily be very progressive if ether you are 1) giving low income people a rebate on them, like they do in Canada, or 2) spend the money you raise on services or programs that disproportionately help lower income groups. Even if people lower down pay more in sales taxes, if they get even more back in transfers they are further ahead. So you are better off finding the methods of taxation that are better at raising funds at minimal costs and making people whole, rather then trying to contort collection, so you only send a bill to Bezos.
Milan, I recommend you stop saying the word “fair” or “unfair” as justification. E.g., “you’d make the bill for existing ones a bit fairer“, “That struck me as kind of unfair”. There just isn’t a universally accepted definition for “fair”.
One could say that the rich can more easily afford a higher tax rate, or that reducing sales tax would have a stimulative effect since lower income quartiles spend a high proportion of their income.
But it isn’t “fair” or “unfair” for higher incomes to pay a higher percentage. In some sense, it is more “unfair” to charge an individual more for the same (or less!) services that they use. When I get a haircut, they don’t charge me based on a percent of my income, nor do they increase the percent as my income goes up.
By the way, I overall agree with raising the progressivity of income taxes (even though this would impact me negatively). It just grates me every time I see the reasoning being given that somehow the current state of affairs is “unfair”. Progressives do this all the time and it drives me nuts.
As someone who works in SALT (I enforce Philadelphia business and income taxes), there’s a huge problem with trying to increase the progressivity of the tax burden in some states—the state constitution forbids it. In Pennsylvania, at least, we have a "uniformity" requirement for state and local taxes that, as interpreted by the state judiciary, requires all taxes be flat taxes. That is, for any given tax, you can’t have different base rates for similarly situated taxpayers just because of differences in their basis of tax (it’s a bit complicated because of course it is). The most direct form is the state income tax, which is what the constitutional provision appears to have had in mind, but it applies to everything. I’m not sure how many other states have this kind of provision in their constitutions, but I suspect it’s more than zero. While of course this isn’t a reason to try and change things, it does make this a much harder lift.
There are plenty of other tax preparers in the Free File program. TurboTax might seem more easy to use, but I’ve used Tax Slayer for years so I’d recommend them. DO NOT PAY MONEY TO FILE YOUR TAXES (if you're under the Free File limit). There are always other options!
Sorry, I'm going to have to disagree with much of your post. In particular, you gloss over the fact that most states' sales taxes tax only "tangible personal property", i.e. goods and leave services untaxed. This is not good policy, especially since higher income households consume proportionally more in services than goods.
You like to use Massachusetts as an example. MA's problem is that our sales tax only taxes ~25% of consumption. If MA expanded our sales tax to include services, while still leaving groceries, prescription medicine, housing, education, and government services untaxed, that would increase the sales tax base to ~50%. With that money you could fund a fully-refundable tax credit for both adults and dependents AND cut income taxes for the median households by significantly increasing the personal exemption and child tax credits.
Additionally, I think this also ignores the lessons of the Nordic model that many progressives and progressive states claim they aspire too - one of broad universal public goods funded by broad-based income and consumption taxes.
Remind your co-generationalists that their utopian, socialist states in Europe have the most regressive tax systems of all. Up to 50% Income taxes and 15-20% Sales taxes, with no tax exemptions or loopholes.
This is the opposite of what they should be doing, because income taxes are volatile and easier to avoid.
The broad base of sales (and property taxes) is a good thing.
A lot of California's problems come from relying on volatile income and capital gains taxes while having very low property taxes (with unequal rates) and sales taxes with many exemptions which reduces the broad base
I don't know if there's any great alternative sources, but I've always cast a weary eye on how ITEP determines tax burden for different income thresholds. For example, ITEP claims the bottom 20 percent pay 17.8 percent of their income in state and local taxes in Washington state.
Part of that justification if you look at their methodology is they claim certain property taxes and taxes on businesses are "passed" on to individuals. Also, since the sales tax isn't applicable to rent, groceries, and utilities, which constitute a large share of the income of the working poor, I am skeptical of their work.
Likewise, their tax burden on the top percentiles makes large assumptions about income that is not reported.
Mississippi is very likely going to eliminate the state income tax in the next few years and some of the politicians are making claims that they won’t raise sales taxes to offset it (or they will only raise some and not others). I think it’s going to be a real hold-my-beer moment for the poorest state in the nation. The lack of business there isn’t because of oppressive taxes, it’s a million other things, but the Republicans there haven’t been able to fix anything in the last 30 years so they are back to the tax issue as the REAL problem.
It is easier than ever for a high earner in Massachusetts to keep their job and move to New Hampshire (or Florida). Work remotely most of the time and avoid most of the progressive income tax. Still difficult to move from the U.S. to Estonia.
I see many argue for more progressive taxes. But I’ve never seen a serious attempt at finding the optimal level of progressivity. Is the optimal level always just more than whatever it currently is?
Milan—you’re doing a great job here. I hope eventually you’ll be paying just as much in taxes as that partner at Bain. But I promise you right now she pays WAY more than you do.
Massachusetts has, by far, the highest short term capital gains tax (12%), and I think it’s the only state that taxes capital gains higher than income (compare that to the federal progressive narrative that seeks to increase capital gains tax just to match income - Buffet’s secretary and all that.) I think this must be really progressive. I paid nearly 50% effective federal and state rates in a very aberrant, windfall year (one off employee equity sale.)
Milan, good effort. Some constructive criticism below.
Most tax analysis suffers because authors focus on only one side of a two-sided coin: revenue collection and government spending. European countries have a very 'regressive' tax regime; a regime Milan would probably pan in this article. But the conclusion that the European tax system is regressive would miss the mark because, holistically speaking, European systems take money from everyone and give to the poor. The US has one of the most progressive tax collection systems in the world--look it up. But our system is net-less progressive because we spend a larger percentage of that income on the middle class and rich.
A tax analysis that looks at a tax system by just looking at the tax rates is incomplete. Would be interested in a follow-on analysis on how states with similar tax rates/percentages of income spend their money.
Would also be interested in the impacts of fiscal capacity. If you look Mississippi (a red, presumed low-tax state) and Massachusetts have similar marginal tax rates and sales tax rates. But Massachusetts is able to raise significantly more money than Mississippi is per capita because it is a richer state. The first order impacts are obvious, but crucially many of the federal programs we set up have state matching requirements to receive money. We essentially are asking rich (blue) states to incrementally increase their tax rates to raise revenue but are asking poorer red states to hike their rates much higher. It's another barrier to full adoption--and one a barrier progressive legislatures should be sympathetic towards.
Good idea in theory, but unfortunately high earners can (and do) just pack up and move. There was a story from a few years ago about one really rich guy moving out of New Jersey and blowing a hole in the budget (https://www.nytimes.com/2016/05/01/business/one-top-taxpayer-moved-and-new-jersey-shuddered.html). States have already proven they will race to the bottom on taxes.
Not that Intuit’s lobbying to preserve its rents isn’t odious but if you’re a teenager working your first job out of college and your family hasn’t bequeathed you something complicated like property or a trust, you should be squarely in the eligibility zone for filing the 1040-EZ return, which is a single page and takes 15 minutes to fill out if you’re dawdling.
(Well, also unless Slow Boring internships pay really well, in which case congratulations to both you and Matt.)
A couple of points:
A Flat Rate Tax is not progressive in and of itself but a Flat Rate Tax coupled with a Flat Rate Standard Deduction is (the percentage of income taxed goes up as the income increases). This is a simple way to achieve progressivity.
Sales Taxes are not progressive but Sales Taxes coupled with Standard Exemptions are. For example, the State of Minnesota Sales Tax has exemptions for items such as medicine, food, and clothing < https://www.salestaxhandbook.com/minnesota/sales-tax-exemptions >. If poorer folks spend a higher percentage of their income on food, clothing, shelter, and medical costs than rich folks do, then rich folks spending on non-basic (non-esential/luxury?) items will be taxed to a greater extent of their overall spending than that of poor folks; therefore: progressive.
As Douglas Feltham points out below; the ease, simplicity, and perceived farness of a tax system are critical factors in whether or not such a system will be successful.