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.
Here in Minnesota the income tax goes up to 9.5 percent but it is 5 percent at a very modest level. It's an article of faith that heavy reliance on the income tax is virtuous. As a consequence state tax revenue is highly volatile. But sales and property taxes also creep up because there's never enough money to fund putative necessities. Total state taxes are around fourth highest in the country.
The idea that the tax system is a good way to accomplish social and other policy objectives has led to needless complexity and poor results. It's best that taxes be designed to raise the money efficiently and effectively and that social objectives be accomplished through other policies and programs. I emphatically second the point that a proportional or regressive tax can finance highly progressive policies and programs. Nations with a bigger public sector rely on consumption taxes for this reason.
Stephen Gordon, a Canadian economist, explains why consumption taxes are efficient. His advice is to use high consumption taxes, low corporate taxes, and income taxes somewhere in between, with targeted transfers to low-income households (like Canada's refundable GST tax credit) to make the overall system more progressive. This is pretty much what the Nordic countries do. https://worthwhile.typepad.com/worthwhile_canadian_initi/2009/08/economic-policy-advice-for-the-ndp-part-iii-the-gst.html
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If an economy has a large number of high-return investment projects, then it will have higher levels of investment and - as investment accumulates - higher levels of productive capacity. That increased capacity in turn generates higher output, employment and wages. These are assumed to be Good Things in what follows.
So consider an investment project - the sort of project that involves purchasing machinery and equipment, employing labor and producing something that people are willing to buy - that offers a rate of return of 20%. And let's also suppose that a 20% rate of return is enough for investors to fork over their savings and let the project go through.
Suppose now that there's a corporate income tax of (say) 30%. The gross return on an investment of $100 may be $20, but after applying 30% tax on those profits, the return sent to the investor is $20 - $20*0.3 = $14. Although the investment project is still paying out 20%, the return that the investor sees is now 14%.
The same story goes for the case in which investors pay a 40% tax in their income. A $100 investment (out of income after taxes) is a sacrifice of $100 of consumption goods. That investment may generate a return of $20, but only $20 - $20*0.4 = $12 will be available to spend. Again, the return that the investor sees is reduced from 20% to 12%.
And now suppose that both sorts of taxes are in force. After the corporate tax is applied, the $20 profit becomes $14 sent to the investor. After income taxes are applied, that $14 becomes $8.40 available for expenditure on consumption goods.
This example illustrates the problem with income taxes: they introduce a wedge between the rate of return that is generated by the investment project and the rate of return that the investor actually sees. If there are many investment projects, each with a different rate of return, income taxes can reduce net rates of return to the point where marginal projects are not carried out. Output, employment and wages will be lower than what they would otherwise have been.
Now suppose that instead of corporate or income taxes, the investor is faced with a consumption tax of - say - 100%. This means that the $100 the investor has burning in her pocket can purchase $50 worth of consumer goods. Since there are no taxes on profits or on income, the entire $20 return is remitted. That $20 can then be used to buy $10 worth of consumer goods. Since the sacrifice of $50 in consumer goods has generated a return of $10 of consumer goods, the effective rate of return is still 20%. Contrary to income taxes, consumption taxes do not introduce wedges between the rates of return generated by an investment project and the rates of return that the investor sees.
I can assure you neither you nor your economist has ever worked in the real world where investment decisions are made on the basis of returns to EBITDA (earnings before interest, taxes, depreciation and amortization), which every pitch-book to sources of capital, whether debt or equity, emphasizes. Valuations in the stock market (a secondary market) are mostly driven by interest rates, and earnings expectations, before taxes. Tax decisions are mostly about seeking to book profits in the most tax-friendly jurisdictions, which are quite separate from which investments get made, where investments in productive facilities are made and where investments in human capital are made. If your Canadian's analysis were predictive, stocks and employment in high VAT tax/low corporate income tax countries should way out-perform stocks and employment in the US. Anyone with any knowledge of the performance of European markets and unemployment rates compared to the US would know your Canadian and you have no idea what you're talking about.
I mean I wouldn't assume a lack of real world knowledge in the thread, given the readership. And for the record, when I have seen new business areas or investments pitched internally at multinationals, the focus has always been on the freecashflows thrown off, or failing that the gross margin before any sorts of allocations.
To the point of US vs say Canada, the US having a larger more successful economy does not mean that their tax code is better, unless you think tax codes are the main driver of economic success. The question is would a change in the US code make the US better or worse off, all else being equal. Because to continue the example, the Canadian tax code is so much better then the US one, both in terms of it being weighted more towards consumption taxes, being far shorter and easier to file under, having actual tax integration between companies, partnerships, individuals, trusts, etc., having far fewer arbitrary incentives and add backs. But in spite of this the US is far richer per capita, because having an internal market that is 9-10 times larger and a legal system/culture that is biased towards economic growth, matters more then your federal tax code being a mess. But the US would still be better off with a better tax structure.
As for the mechanisms, having consumption taxes instead of income taxes, means that on the margin you have more funds to be invested period, since the individuals who are investing get higher net returns, and have more capital in the first place, since less is being deducted on the front end from income taxes. So the point is that having more VAT's mean that the people in Canada have more invested then they would in the world where it was all income taxes, regardless of which individual opportunities they are investing in.
As for the cooperate taxes/how this impacts the decisions firms make, its sort of tangential to the point of the article, but the three things I would flag are that 1) corporate taxes impose large amounts of compliance costs, and other deadweightlosses on society, and that the incentives to spend more on jerkoffs like me to avoid taxes gets larger, the higher the rates are, 2) in so far at corporate taxes lower bottom line net income, this lowers the future cash available for distributions to shareholders, which lowers the share price, making it more costly to raise capital for future projects, 3) companies are fake people who can't actually use money (Walmart cant take a vacation), so you are strictly better off taxing actual people who can use the money more, and the company (IE the same people indirectly) less.
I agree with you, the US tax code is sub-ideal for lots of reasons, but not for the reasons the post I was responding to posited. I used EBITDA for your more accurate term of free cash flow, but so long as interest and depreciation and amortization are deductible, the differences are negligible. Ideally, I would get rid of the corporate tax altogether and tax all corporate income to the shareholders. This though is probably an impossibility due to the trading volume of shares and identifying who's a 'shareholder'. It will be interesting to see if the recent global initiatives to impose a minimum corporate tax rate based on reported earnings has an impact on stock prices and the cost of capital. The compliance cost for the S&P 500 is a rounding error. It's a headache to you and me.
All true about VAT we should surely use it to replace the wage tax, as the wage tax in on income some of which might be saved. It is not a true consumption tax.
But a progressive personal consumption (income minus documentable saving and reinvestment) tax (after eliminating business taxes and imputing business income as personal income of owners) would be as easy or easier to collect as the progressive income tax.
Good post. As a CPA/economist myself, this is one of the reasons I've long been in favor of the Fair Tax.
That would save about 200 billion a year annually in tax compliance costs. Get rid of the imbedded taxes in the cost of goods (thus putting domestic goods and imports on an even footing, and giving our exports a boost).
How does a jurisdiction with a VAT handle parts of the production process that occur in other jurisdictions? For example, where assembly of the finished product occurs across multiple jurisdictions?
Ya as Flooey flagged, in most jurisdictions, VAT is charged at the border, and exports are not taxed. So if you're in Canada and buy an input from Mexico, the VAT is applied to the price you pay for that item, and when the finished good is exported to the US no taxes are charged. And any intermediary steps in the country are being charged the difference between the tax credits on purchases, and the taxes owing on the sales.
At least here in Europe, you pay VAT on anything you import from outside the tax regime and exports aren’t subject to VAT. The end result is that if something gets ultimately sold in a VAT area, the full VAT has been paid on it, regardless of how many times it crossed the border in its production.
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.
The textbook formulation is that taxes are fair if they are proportional to the ability to pay and/or are proportional to benefits received. Liberals tend to forget the second of these principles.
Conservatives tend to forget that the rich actually use more of these services, just different ones. FAA, Medicare and medical research (poor die younger), general security(more essential the richer you are), highways.....
First, Im not "forgetting" the proportional-to-benefits idea. But rich people both consume more government services and more importantly they get more value from many of the same services. The security of property created by law enforcement is much more valuable if you have a lot of property.
Second, I just don't find that to be an accurate description of the textbook theory. At least not good textbooks. A better way to describe it would be taxes are most fair when they reduce the minimum utility for the target revenue. Since money has declining marginal utility, higher taxes on the rich are thus "fair" because they aren't giving up much utility even if the dollar values are large. That's not really about "ability to pay" so much as "hardship induced by paying" which may seem like a thin hair to split, but I find important.
I agree with both of these points. This is why I think flat taxes are a bad idea. They almost always have some kind of low income rebate or exemption, showing their supporters are OK with a rate difference between the poor and middle class. But the middle class pays the same rate as the wealthy and the super-wealthy.
I also think in a more progressive system, it is easier for people to work their way up to higher income levels.
I agree, the abandonment of the the idea of fairness seems to be a growing kudzu among the libertarian young. Most humans have an instinctual sense of fairness, which our laws reflect. It's unfair to kill your neighbor or loot his house. When it comes to taxes and government benefits, it gets more complicated and one person's 'fairness' is another person's 'unfairness' (I worked hard for my wealth and income while you did not, so why should I pay a higher rate of taxes on my income or wealth than you?). In a democracy, this gets worked out in elections and the policies our elected representatives enact. I think conservatives, as much as, if not more than, liberals, are more sensitive to the benefits someone else is receiving 'undeservedly' and therefore 'unfairly' than they are to the benefits they're receiving and how much they're paying relative to others in supporting benefits like the rule of law, an impartial and well-armed military to repel foreign invasions, fair elections, the right to petition the government for policies (long-lived intellectual property rights an example), highways, airports and an air traffic control system, without which a company like Amazon wouldn't exist. To the libertarians among Matt's readership I'd say how would you like it if 50 strangers moved into your house or apartment and declined to move out when you said the party was over and the government and courts did nothing about it. Seems 'unfair'; seems 'fair' to me.
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.
Yeah, in Illinois I was very involved during the 2020 election cycle in an effort to amend the flat tax provision in the state constitution. (Ours is a little more explicit than PA: "A tax on or measured by income shall be at a non-graduated rate.") As an amendment to the state constitution, it needed 60% to pass, and it didn't even get a simple majority: https://www.chicagotribune.com/election-results/2020/.
What's more, the legislature had already passed a bill that, if the referendum passed, would have automatically implemented a progressive tax structure wherein *97%* of people would pay less in taxes (but more revenue would be raised). And most of those 3% lived in Cook County (Chicago) or the near-in collar counties. In theory, this should have been a great talking point in Republican downstate counties where >99% would have had lower tax bills, but that was...not the case.
There are some inside-baseball reasons particular to Illinois politics that may have affected the vote at the margins, but I think the opposition messaging worked largely because i) sales and property taxes in Illinois are very high, and ii) it was very easy to portray this as a "tax hike" to already tax-weary voters. The fact that the greater revenues from a progressive income tax could (for example) relieve pressure on local property taxes is a really subtle point that most voters are not going to internalize. And I suspect it will be the same in places like Massachusetts, Pennsylvania, etc.
So I wholeheartedly endorse this post in theory, but I (sincerely) want to see the follow-up post for how to popularize the progressive tax movement.
And that was with our billionaire governor having campaigned on the progressive income tax as one of his key initiatives! I feel like the implications of that failure, despite a deck stacked as much in favor as you could hope, haven't reverberated through the wonkosphere as much as they should.
Agreed. Interesting to hear about IL—I hadn’t known that (which is funny since I know so many people from Chicago, including my own fiancée lol). I’d be interested to see it.
Of course, we all know that the best solution is to drop all of these taxes and just tax land value.
It's interesting that a proposal to reduce taxes on 97% of the population can be "easy" to portray as a tax hike. I'd like to hear more about why the argument that "this will cut your taxes" was heard as "this will increase your taxes." Surely, it can't be *that* difficult to put that message out.
I honestly don't have a great answer but I think it boiled down to three factors.
1) The inside-baseball part is that the Democratic Speaker of the House (Mike Madigan), who is a very well-known political figure and is a caricature of an old-school Irish Democratic machine politician, was closely connected to the indictment of four people in a corruption scandal involving the state's largest utility. (And by "closely connected," I mean it's pretty clear from the indictment papers that he directed his underlings to make legislative promises in exchange for cash bribes, without ever actually saying that in so many words.) So the main opposition message was to insinuate that by voting for the amendment, you were voting to give a blank check to the "untrustworthy" Democrats in Springfield, with Exhibit A of untrustworthiness being Mike Madigan himself.
Polarization being what it is, this meant that basically no Republican would vote for the measure, and it turned off both the Trump-y, socially conservative Democrats (of which there are many in Illinois) and the wealthier, suburban Romney-Clinton types (of which there are also many). Support for the measure collapsed once you left Chicago and a few hippy-dippy suburbs, even though Biden crushed Trump in many of these same places. This theory is also bolstered by the fact that Democrats did not do well in the few competitive state legislative seats (mostly in the Chicago exurbs), even though Biden did relatively well; so voters were definitely voting against Madigan/the machine at the state level even if they were voting Democratic nationally.
2) The opposition campaign was financed largely by Ken Griffin, an absurdly rich venture capitalist who individually would pay quite a bit more in taxes under the proposal. He paid for ads that contained straight-up lies, most significantly that under the proposal, Social Security and pension incomes would be taxed (they are exempt from taxation under the Illinois Revenue Code). This was actually false, but I can tell you from personal phone-banking experience that the lie--which was blasted in endless TV ads--was very effective, and it was *very* hard to disabuse people of their false impression once they heard it.
3) This is a less empirically-grounded observation, but people like to think they will be wealthier than they are now, and so there are more than 3% of people who think they will be penalized or harmed by the "tax hike" at some point in the future. I don't think this is fatal in itself, but given the overall high-tax environment in Illinois when combined with factors #1 and #2, many people were probably primed to distrust any measure that would raise taxes on *someone,* even if they would stand to personally benefit. Property taxes and (relatedly) pensions are the third rails of Illinois politics, and I think many progressives really understate the severity of this problem and its salience among average voters.
Honestly, it was a pretty disheartening experience. I was already trending this way, but it definitely made me more of a Yglesian popularist and to discount the value of both the Wonks who think that more graphs and white papers are going to make a damn bit of difference and the leftists who think that increased emphasis on material factors is a solution for larger and more permanent Democratic majorities.
I don't want to excuse false claims made by opponents of the measure, but Illinois' high taxes, poor services, and precarious financial situation don't inspire confidence in the state government's ability to set good fiscal policy or spend tax revenues well.
I hear you ChiLiberal. I wish instead of focusing so much effort on an amendment that was never close to being enacted; Illinois democrats spent the time working out a broadening in the sales tax base while promising a reduction in the headline rate. It has not been updated for goods since the 1960s and never includes services. This should have been paired with reamortizing the pension payments that were simply dropped in the mid 90s with a massive balloon make up payment scheme set forth in the '10s (which was bipartisan between a GOP gov and a Dem legislature). Just making regular pension payments over the next 40 years as opposed to a bunch of emergency payments to meet a fictitious threshold (which is forcing tons of year to year borrowing) would immensely improve the fiscal health of the state.
After actually delivering a tax cut, then they could go after some of the other really nasty elements of illinois tax code.
The problem with the democratic party here is that they are unbelievably tone-deaf to the constant corruption, and lately focused on woke signaling. And what's sad is that Gov Pritzker actually has been able to deliver a decent improvement in the state's fiscal situation.
I think that if they could deliver a tax cut which improved revenue inflow with a small reduction in rates and cut ties with the worst elements of the party, then you could try to push a progressive tax apparatus. But the general movement of tax rates in all cases certainly appears to be monotonically increasing. And it almost always is the case that some % of that tax money is going to some comically corrupt politician or connected individuals.
But I'm concerned that we will get another Rauner and maybe a flip of the senate given Illinois' 3C's: corruption, covid and crime...and nothing will get done.
But you can make a flat-rate income tax progressive by having a large deduction. If the flat rate is 5% and the deduction is $5000 per person, then a family of four making $30K pays $500 (1.7%) and one making $300K pays $14K (4.7%)
Yeah, but unless you pair this with an increase in the tax rate, this will necessarily be revenue-negative. So although you are making the system less regressive, you're really just kicking the fiscal sustainability can down the road and not really getting the revenue-raising benefits of a truly progressive system. I suspect that long-term, this would set off a vicious cycle of politicians trying to raise revenue by raising the base rate and make it politically palatable by increasing the deduction.
fair enough but all you are describing is a two bracket progressive income tax where the first X dollars is taxed at zero and the next X is taxed at 5%.
It isn't actually that complicated to add tax brackets, the complications with income tax are 99% in figuring out what counts as income and what doesn't.
Yes but, beyond announcing to the world that you favor progressive taxation, there’s no virtue involved in the creation of brackets. The issue is whether the tax scheme has a progressive effect, that higher incomes pay a higher percentage. I’m pointing out that the absence of multiple brackets doesn’t mean that the tax can’t be progressive.
That’s true in general terms, but I’m not sure if that trick works with all such provisions. Like, I’m not sure that would be allowed under PA's provision (again, I work specifically in Philly tax so I’m not especially up on the case law on the state taxes). But if you can get a court to buy that this doesn’t violate the provision this can work.
True, but if the court decides the provision is about the ultimate rate paid and not the rate assessed then that doesn’t work. Again, I don’t know if that’s how PA has interpreted its provision, but it’s conceivable that it could be (and more to the point, other states could have similar provisions or provisions that dictate such a result. (There is such a deduction structure in PA—Philly property taxes have s a homestead exemption. However, I don’t know if that’s based on a general principle of the uniformity provision or a special exception for property tax—again, I’m in city business and income tax, not property tax.)
Washington state's constitution requires a 2/3rds super majority in the state legislature to levy additional taxes, including income taxes, essentially precluding one. I believe an initiative could establish a state income tax, but voters have historically opposed such initiatives by significant margins.
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!
Maybe this isn't appropriate for everyone's situation, but not having a pretty simple tax situation personally, I just grab my supporting documentation (w2, 1099, etc.), pull up an editable copy of the 1040 and start filling it out. If I'm doubtful about the results, I follow Turbotax's software and see if I get the same results. Assuming I do, then I simply file my return and forget about turbotax.
Yeah, for simple tax situations it's really no big deal. In my 20s I used to fill out 1040 by hand with an ink pen. I'm sure they loved that...but it wasn't hard to do.
That said, it doesn't take *that* much complexity in one's financial situation for the filing complexity to get way out of hand. I just have rental property income, a bit of capital gains, and regular W-2 income and my 2020 federal filing was 23 pages. At that point the question is paying for an accountant vs. paying for one of the high tiers of tax software. Doing it myself might be theoretically possible but certainly wouldn't be worth it.
I pride myself on being able to read and understand the various instructions produced by the IRS and most years, I've done my taxes myself. But when I had rental income, I decided to play it safe and approach an accountant. And what I learned is that a good fraction of how to do one's taxes is not enshrined in the tax code in black and white but rather is found in tax law. My accountant had books of tax law interpretation from previous cases that revealed, for example, how to depreciate assets when shared between the owner and the renters. He saved me more money than he ever charged.
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.
The Nordic Model lessons are ones that Matt has discussed regularly, too. He's made the point several times that focusing on raising taxes on the rich can't be enough to fund the progressive wish list, especially as the amount needed to be "rich" climbs ever upward. While the data is interesting, the piece seems to miss a lot beyond the most zoomed in view
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
yeah and rich people also have particularly volatile income (even though it is always higher than working class people's) because it is a lot of times wound up in stock grants that fluctuate in value for no real reason or based on the zigs and zags of the economy. so if you rely on a few thousand rich people to contribute hugely to funding the safety net you will need to look elsewhere if the stock market goes down. This is even true in California which has a pretty diverse economy. But think of how volatile a tax on rich people would be in like Nevada which is very dependent on tourism...
I recall when New Jersey, a couple of years ago, had to have serious meetings about a potential budget shortfall because *one guy* decided to move to Florida.
Matt has clearly not been doing enough to market Slow Boring to the Very Online Crank community -- I can't believe we've gotten this far into this discussion without someone bringing up a Land Value Tax and telling everyone to read "Land and Liberty".
(Disclaimer: I am a Very Online Crank and think an LVT is probably a very good idea, although I think my fellow cranks tend to over-sell it: it's just a tax, it's not gonna cure cancer or fix racism.)
A high LVT (like above 80%) is both a good idea in a vacuum, and utterly politically unrealistic. It would involve displacing single family homeowners from their homes, via punishingly high taxes, to make way for density. That's where the supposed efficiency gains come from! So it's combine gentrification with actually affecting the middle class, upper middle class, plus some of the actually rich- and all of this by way of taxation. Every evening the news or social media would have a new story about a middle class family or elderly pensioner forced from their SFH via high taxes.
In other words, it would focus the rage of all the people who actually vote in society into the white-hot nuclear fusion of a thousand suns. I think Trump would win the nomination as a Democrat, or I'd make the NBA roster, before forcing everyone who votes in the US out of their homes via taxes would pass muster. Just utterly, utterly unrealistic
I like to think that here at Slow Boring we’re all familiar with the idea of effects taking place at the margins? You’re quite right that a full on 80+% LVT would provoke civil war; luckily that’s not the only level available, and “right now” is not the only timeline on which one can measure efficacy?
(All of my jokes about very online cranks are a strong hint that I don’t think a LVT is capable of magically solving all of our problems in a single stroke even if it’s probably objectively better than a traditional property tax or a VAT)
I guess I'm just less clear what the benefits of a much lower LVT would be? Like, it either raises more money than the current property tax system- so it'll face popular outrage- or it raises less, so it's pointless.
I read some of the SSC guest piece on Georgism, and some of the comments section, and wooooh boy were there some full-on central planning zealots in there. "So what if the entire middle class is forced from their homes by a 100% LVT tax rate- they'll be better off in the end, it's a Glorious 5 Year Plan Comrades"
on the margin it's better to tax land than structures just because nicer structures contribute to human well-being while the landowner can't really impact the value of the land except tangentially.
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.
I think raising *some* taxes might help a little but the real focus should be on doing things like taking the money the federal government is trying to give the state for healthcare. The impact of having even the most basic healthcare can be life changing when you are on the margins. That would be the thing the Republican legislature could do right now, today to make lives better for millions of Mississippians. They won’t do it because of their underwear pants gnome theory of healthcare where you don’t provide basic healthcare for people who can’t afford it -> ? -> everyone is healthier because they avoided communism! They pair that with a moral hazard argument about how poor people are lazy and if they really wanted healthcare they would just pay for it. It’s a real mess.
I can agree that the medicaid expansion seems like an obvious choice. But I would love for someone like Matt (or you!) to provide a more in depth path to how poorer states (especially in the deep south) should look to make economic progress. Its easy to point to California and say they have immense amounts of money to do tons of stuff with, so they should do x, y, and z. I think its harder, but maybe even more important for people to examine what Mississippi, Alabama and Louisiana should do. (Include Puerto Rico in there too).
My thought is that parts of the federal bureaucracy should be moved to their states. The federal government employs about 400k people in the DC metro area. If you took 100k of those jobs and relocated them to Jackson, MS it would have a profound impact on the region and likely on the federal government.
I think Mississippi is in a really bad spot in particular because it can't use a bordering state as a contrast. It's a very poor state surrounded by other very poor states and an only-moderately poor state in Tennessee. My initial thought would be to try and focus efforts in DeSoto Country as a good spot for Memphis suburban growth, but the problem there is that Tennessee doesn't have an income tax, so it's hard to see why someone would choose that over a nicer community in Shelby County or another outlying community in Tennessee. Maybe try to do what Alabama has done with the university as a way to jumpstart growth (which has really paid off since 2000), but that's harder to do with an improved state school close by and it's not in as good of a spot geographically (Arkansas students wanting to go out of state have Texas options that are better for one)
I think doubling the population of Jackson would be a temporary fix at best. In reality, a lot of people in civil service would quit rather than move there. The idea of slowly opening new offices (and maybe not replacing positions as people in DC retire) in different areas is appealing, though.
That's an interesting idea. I'm not an expert in this area, it would be good to see Matt cover some of these areas in the US that have more of an economic trick shot to pull off with politicians who are only willing to look at solutions that sit on one side of the table.
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.
I agree with both points here - the "fair share" that higher earners should pay is rarely specified, it's just "more than now". I grant that in many cases making the code more progressive would be a good move, but there's got to be *some* target or optimal endpoint.
The phrase "same 5% as the Bain partner" irked me as well, it's true that the rate is the same, but the amount of dollars is quite different.
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.
>>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.
Medicaid--by far the biggest joint federal-state matching program--has a sliding scale so that states contribute anywhere between 20-50% of the program cost based on the state's poverty rate. I haven't looked at the rates in a few years, but suffice to say that Mississippi pays close to 20% while Massachusetts (and a few other states) pay a half-share. SNAP and TANF are the two other main state-administered welfare programs I can think of, but there is not state matching of program (rather than administrative) costs to my knowledge. (TANF is block-granted, creating its own state disparities, but that's a separate issue.)
So I'm not sure what programs you're referring to here, unless your point is that the Medicaid sliding scale isn't well-designed (it could be; I don't have a strong empirically-grounded opinion on that). The other big area for federal-state matching I can think of is infrastructure, but in theory those projects should pay for themselves and the projects can be debt-financed on the state end. (And if the problem is that the states are issuing debt that they cannot pay off through increased tax revenues, then they probably shouldn't be building that infrastructure.)
This was more of a general point/critique. From what I understand, the medicaid expansion has a non-sliding scale requirement from states--albeit 'just' 10%. Does the proposed Pre-K program in BBB have a sliding scale for states' fiscal burden based on fiscal capacity? I haven't read anywhere that it does. Fiscal capacity is just something we need to consider moving forward whenever we decide to put funding obligations onto states, and I haven't seen many outside of Joshua McCabe drive the point home.
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.)
Replying to myself because apparently I have been made to look like a smug idiot by the IRS because… the 1040-EZ no longer exists?! What on earth? Apologies to Mr. Singh for doubting his point.
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.
Thanks for a very useful comment.
Here in Minnesota the income tax goes up to 9.5 percent but it is 5 percent at a very modest level. It's an article of faith that heavy reliance on the income tax is virtuous. As a consequence state tax revenue is highly volatile. But sales and property taxes also creep up because there's never enough money to fund putative necessities. Total state taxes are around fourth highest in the country.
The idea that the tax system is a good way to accomplish social and other policy objectives has led to needless complexity and poor results. It's best that taxes be designed to raise the money efficiently and effectively and that social objectives be accomplished through other policies and programs. I emphatically second the point that a proportional or regressive tax can finance highly progressive policies and programs. Nations with a bigger public sector rely on consumption taxes for this reason.
Stephen Gordon, a Canadian economist, explains why consumption taxes are efficient. His advice is to use high consumption taxes, low corporate taxes, and income taxes somewhere in between, with targeted transfers to low-income households (like Canada's refundable GST tax credit) to make the overall system more progressive. This is pretty much what the Nordic countries do. https://worthwhile.typepad.com/worthwhile_canadian_initi/2009/08/economic-policy-advice-for-the-ndp-part-iii-the-gst.html
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If an economy has a large number of high-return investment projects, then it will have higher levels of investment and - as investment accumulates - higher levels of productive capacity. That increased capacity in turn generates higher output, employment and wages. These are assumed to be Good Things in what follows.
So consider an investment project - the sort of project that involves purchasing machinery and equipment, employing labor and producing something that people are willing to buy - that offers a rate of return of 20%. And let's also suppose that a 20% rate of return is enough for investors to fork over their savings and let the project go through.
Suppose now that there's a corporate income tax of (say) 30%. The gross return on an investment of $100 may be $20, but after applying 30% tax on those profits, the return sent to the investor is $20 - $20*0.3 = $14. Although the investment project is still paying out 20%, the return that the investor sees is now 14%.
The same story goes for the case in which investors pay a 40% tax in their income. A $100 investment (out of income after taxes) is a sacrifice of $100 of consumption goods. That investment may generate a return of $20, but only $20 - $20*0.4 = $12 will be available to spend. Again, the return that the investor sees is reduced from 20% to 12%.
And now suppose that both sorts of taxes are in force. After the corporate tax is applied, the $20 profit becomes $14 sent to the investor. After income taxes are applied, that $14 becomes $8.40 available for expenditure on consumption goods.
This example illustrates the problem with income taxes: they introduce a wedge between the rate of return that is generated by the investment project and the rate of return that the investor actually sees. If there are many investment projects, each with a different rate of return, income taxes can reduce net rates of return to the point where marginal projects are not carried out. Output, employment and wages will be lower than what they would otherwise have been.
Now suppose that instead of corporate or income taxes, the investor is faced with a consumption tax of - say - 100%. This means that the $100 the investor has burning in her pocket can purchase $50 worth of consumer goods. Since there are no taxes on profits or on income, the entire $20 return is remitted. That $20 can then be used to buy $10 worth of consumer goods. Since the sacrifice of $50 in consumer goods has generated a return of $10 of consumer goods, the effective rate of return is still 20%. Contrary to income taxes, consumption taxes do not introduce wedges between the rates of return generated by an investment project and the rates of return that the investor sees.
I can assure you neither you nor your economist has ever worked in the real world where investment decisions are made on the basis of returns to EBITDA (earnings before interest, taxes, depreciation and amortization), which every pitch-book to sources of capital, whether debt or equity, emphasizes. Valuations in the stock market (a secondary market) are mostly driven by interest rates, and earnings expectations, before taxes. Tax decisions are mostly about seeking to book profits in the most tax-friendly jurisdictions, which are quite separate from which investments get made, where investments in productive facilities are made and where investments in human capital are made. If your Canadian's analysis were predictive, stocks and employment in high VAT tax/low corporate income tax countries should way out-perform stocks and employment in the US. Anyone with any knowledge of the performance of European markets and unemployment rates compared to the US would know your Canadian and you have no idea what you're talking about.
I mean I wouldn't assume a lack of real world knowledge in the thread, given the readership. And for the record, when I have seen new business areas or investments pitched internally at multinationals, the focus has always been on the freecashflows thrown off, or failing that the gross margin before any sorts of allocations.
To the point of US vs say Canada, the US having a larger more successful economy does not mean that their tax code is better, unless you think tax codes are the main driver of economic success. The question is would a change in the US code make the US better or worse off, all else being equal. Because to continue the example, the Canadian tax code is so much better then the US one, both in terms of it being weighted more towards consumption taxes, being far shorter and easier to file under, having actual tax integration between companies, partnerships, individuals, trusts, etc., having far fewer arbitrary incentives and add backs. But in spite of this the US is far richer per capita, because having an internal market that is 9-10 times larger and a legal system/culture that is biased towards economic growth, matters more then your federal tax code being a mess. But the US would still be better off with a better tax structure.
As for the mechanisms, having consumption taxes instead of income taxes, means that on the margin you have more funds to be invested period, since the individuals who are investing get higher net returns, and have more capital in the first place, since less is being deducted on the front end from income taxes. So the point is that having more VAT's mean that the people in Canada have more invested then they would in the world where it was all income taxes, regardless of which individual opportunities they are investing in.
As for the cooperate taxes/how this impacts the decisions firms make, its sort of tangential to the point of the article, but the three things I would flag are that 1) corporate taxes impose large amounts of compliance costs, and other deadweightlosses on society, and that the incentives to spend more on jerkoffs like me to avoid taxes gets larger, the higher the rates are, 2) in so far at corporate taxes lower bottom line net income, this lowers the future cash available for distributions to shareholders, which lowers the share price, making it more costly to raise capital for future projects, 3) companies are fake people who can't actually use money (Walmart cant take a vacation), so you are strictly better off taxing actual people who can use the money more, and the company (IE the same people indirectly) less.
I agree with you, the US tax code is sub-ideal for lots of reasons, but not for the reasons the post I was responding to posited. I used EBITDA for your more accurate term of free cash flow, but so long as interest and depreciation and amortization are deductible, the differences are negligible. Ideally, I would get rid of the corporate tax altogether and tax all corporate income to the shareholders. This though is probably an impossibility due to the trading volume of shares and identifying who's a 'shareholder'. It will be interesting to see if the recent global initiatives to impose a minimum corporate tax rate based on reported earnings has an impact on stock prices and the cost of capital. The compliance cost for the S&P 500 is a rounding error. It's a headache to you and me.
All true about VAT we should surely use it to replace the wage tax, as the wage tax in on income some of which might be saved. It is not a true consumption tax.
But a progressive personal consumption (income minus documentable saving and reinvestment) tax (after eliminating business taxes and imputing business income as personal income of owners) would be as easy or easier to collect as the progressive income tax.
Good post. As a CPA/economist myself, this is one of the reasons I've long been in favor of the Fair Tax.
That would save about 200 billion a year annually in tax compliance costs. Get rid of the imbedded taxes in the cost of goods (thus putting domestic goods and imports on an even footing, and giving our exports a boost).
How does a jurisdiction with a VAT handle parts of the production process that occur in other jurisdictions? For example, where assembly of the finished product occurs across multiple jurisdictions?
Ya as Flooey flagged, in most jurisdictions, VAT is charged at the border, and exports are not taxed. So if you're in Canada and buy an input from Mexico, the VAT is applied to the price you pay for that item, and when the finished good is exported to the US no taxes are charged. And any intermediary steps in the country are being charged the difference between the tax credits on purchases, and the taxes owing on the sales.
At least here in Europe, you pay VAT on anything you import from outside the tax regime and exports aren’t subject to VAT. The end result is that if something gets ultimately sold in a VAT area, the full VAT has been paid on it, regardless of how many times it crossed the border in its production.
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.
The textbook formulation is that taxes are fair if they are proportional to the ability to pay and/or are proportional to benefits received. Liberals tend to forget the second of these principles.
Conservatives tend to forget that the rich actually use more of these services, just different ones. FAA, Medicare and medical research (poor die younger), general security(more essential the richer you are), highways.....
I take issue with a few different parts of that.
First, Im not "forgetting" the proportional-to-benefits idea. But rich people both consume more government services and more importantly they get more value from many of the same services. The security of property created by law enforcement is much more valuable if you have a lot of property.
Second, I just don't find that to be an accurate description of the textbook theory. At least not good textbooks. A better way to describe it would be taxes are most fair when they reduce the minimum utility for the target revenue. Since money has declining marginal utility, higher taxes on the rich are thus "fair" because they aren't giving up much utility even if the dollar values are large. That's not really about "ability to pay" so much as "hardship induced by paying" which may seem like a thin hair to split, but I find important.
I agree with both of these points. This is why I think flat taxes are a bad idea. They almost always have some kind of low income rebate or exemption, showing their supporters are OK with a rate difference between the poor and middle class. But the middle class pays the same rate as the wealthy and the super-wealthy.
I also think in a more progressive system, it is easier for people to work their way up to higher income levels.
I agree, the abandonment of the the idea of fairness seems to be a growing kudzu among the libertarian young. Most humans have an instinctual sense of fairness, which our laws reflect. It's unfair to kill your neighbor or loot his house. When it comes to taxes and government benefits, it gets more complicated and one person's 'fairness' is another person's 'unfairness' (I worked hard for my wealth and income while you did not, so why should I pay a higher rate of taxes on my income or wealth than you?). In a democracy, this gets worked out in elections and the policies our elected representatives enact. I think conservatives, as much as, if not more than, liberals, are more sensitive to the benefits someone else is receiving 'undeservedly' and therefore 'unfairly' than they are to the benefits they're receiving and how much they're paying relative to others in supporting benefits like the rule of law, an impartial and well-armed military to repel foreign invasions, fair elections, the right to petition the government for policies (long-lived intellectual property rights an example), highways, airports and an air traffic control system, without which a company like Amazon wouldn't exist. To the libertarians among Matt's readership I'd say how would you like it if 50 strangers moved into your house or apartment and declined to move out when you said the party was over and the government and courts did nothing about it. Seems 'unfair'; seems 'fair' to me.
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.
Yeah, in Illinois I was very involved during the 2020 election cycle in an effort to amend the flat tax provision in the state constitution. (Ours is a little more explicit than PA: "A tax on or measured by income shall be at a non-graduated rate.") As an amendment to the state constitution, it needed 60% to pass, and it didn't even get a simple majority: https://www.chicagotribune.com/election-results/2020/.
What's more, the legislature had already passed a bill that, if the referendum passed, would have automatically implemented a progressive tax structure wherein *97%* of people would pay less in taxes (but more revenue would be raised). And most of those 3% lived in Cook County (Chicago) or the near-in collar counties. In theory, this should have been a great talking point in Republican downstate counties where >99% would have had lower tax bills, but that was...not the case.
There are some inside-baseball reasons particular to Illinois politics that may have affected the vote at the margins, but I think the opposition messaging worked largely because i) sales and property taxes in Illinois are very high, and ii) it was very easy to portray this as a "tax hike" to already tax-weary voters. The fact that the greater revenues from a progressive income tax could (for example) relieve pressure on local property taxes is a really subtle point that most voters are not going to internalize. And I suspect it will be the same in places like Massachusetts, Pennsylvania, etc.
So I wholeheartedly endorse this post in theory, but I (sincerely) want to see the follow-up post for how to popularize the progressive tax movement.
And that was with our billionaire governor having campaigned on the progressive income tax as one of his key initiatives! I feel like the implications of that failure, despite a deck stacked as much in favor as you could hope, haven't reverberated through the wonkosphere as much as they should.
Agreed. Interesting to hear about IL—I hadn’t known that (which is funny since I know so many people from Chicago, including my own fiancée lol). I’d be interested to see it.
Of course, we all know that the best solution is to drop all of these taxes and just tax land value.
https://youtu.be/1fzk_Sc4bBY
/tongue-in-cheek Georgism
It's interesting that a proposal to reduce taxes on 97% of the population can be "easy" to portray as a tax hike. I'd like to hear more about why the argument that "this will cut your taxes" was heard as "this will increase your taxes." Surely, it can't be *that* difficult to put that message out.
One would think!
I honestly don't have a great answer but I think it boiled down to three factors.
1) The inside-baseball part is that the Democratic Speaker of the House (Mike Madigan), who is a very well-known political figure and is a caricature of an old-school Irish Democratic machine politician, was closely connected to the indictment of four people in a corruption scandal involving the state's largest utility. (And by "closely connected," I mean it's pretty clear from the indictment papers that he directed his underlings to make legislative promises in exchange for cash bribes, without ever actually saying that in so many words.) So the main opposition message was to insinuate that by voting for the amendment, you were voting to give a blank check to the "untrustworthy" Democrats in Springfield, with Exhibit A of untrustworthiness being Mike Madigan himself.
Polarization being what it is, this meant that basically no Republican would vote for the measure, and it turned off both the Trump-y, socially conservative Democrats (of which there are many in Illinois) and the wealthier, suburban Romney-Clinton types (of which there are also many). Support for the measure collapsed once you left Chicago and a few hippy-dippy suburbs, even though Biden crushed Trump in many of these same places. This theory is also bolstered by the fact that Democrats did not do well in the few competitive state legislative seats (mostly in the Chicago exurbs), even though Biden did relatively well; so voters were definitely voting against Madigan/the machine at the state level even if they were voting Democratic nationally.
2) The opposition campaign was financed largely by Ken Griffin, an absurdly rich venture capitalist who individually would pay quite a bit more in taxes under the proposal. He paid for ads that contained straight-up lies, most significantly that under the proposal, Social Security and pension incomes would be taxed (they are exempt from taxation under the Illinois Revenue Code). This was actually false, but I can tell you from personal phone-banking experience that the lie--which was blasted in endless TV ads--was very effective, and it was *very* hard to disabuse people of their false impression once they heard it.
3) This is a less empirically-grounded observation, but people like to think they will be wealthier than they are now, and so there are more than 3% of people who think they will be penalized or harmed by the "tax hike" at some point in the future. I don't think this is fatal in itself, but given the overall high-tax environment in Illinois when combined with factors #1 and #2, many people were probably primed to distrust any measure that would raise taxes on *someone,* even if they would stand to personally benefit. Property taxes and (relatedly) pensions are the third rails of Illinois politics, and I think many progressives really understate the severity of this problem and its salience among average voters.
Honestly, it was a pretty disheartening experience. I was already trending this way, but it definitely made me more of a Yglesian popularist and to discount the value of both the Wonks who think that more graphs and white papers are going to make a damn bit of difference and the leftists who think that increased emphasis on material factors is a solution for larger and more permanent Democratic majorities.
I don't want to excuse false claims made by opponents of the measure, but Illinois' high taxes, poor services, and precarious financial situation don't inspire confidence in the state government's ability to set good fiscal policy or spend tax revenues well.
I don't disagree!
I hear you ChiLiberal. I wish instead of focusing so much effort on an amendment that was never close to being enacted; Illinois democrats spent the time working out a broadening in the sales tax base while promising a reduction in the headline rate. It has not been updated for goods since the 1960s and never includes services. This should have been paired with reamortizing the pension payments that were simply dropped in the mid 90s with a massive balloon make up payment scheme set forth in the '10s (which was bipartisan between a GOP gov and a Dem legislature). Just making regular pension payments over the next 40 years as opposed to a bunch of emergency payments to meet a fictitious threshold (which is forcing tons of year to year borrowing) would immensely improve the fiscal health of the state.
After actually delivering a tax cut, then they could go after some of the other really nasty elements of illinois tax code.
The problem with the democratic party here is that they are unbelievably tone-deaf to the constant corruption, and lately focused on woke signaling. And what's sad is that Gov Pritzker actually has been able to deliver a decent improvement in the state's fiscal situation.
I think that if they could deliver a tax cut which improved revenue inflow with a small reduction in rates and cut ties with the worst elements of the party, then you could try to push a progressive tax apparatus. But the general movement of tax rates in all cases certainly appears to be monotonically increasing. And it almost always is the case that some % of that tax money is going to some comically corrupt politician or connected individuals.
But I'm concerned that we will get another Rauner and maybe a flip of the senate given Illinois' 3C's: corruption, covid and crime...and nothing will get done.
But you can make a flat-rate income tax progressive by having a large deduction. If the flat rate is 5% and the deduction is $5000 per person, then a family of four making $30K pays $500 (1.7%) and one making $300K pays $14K (4.7%)
Yeah, but unless you pair this with an increase in the tax rate, this will necessarily be revenue-negative. So although you are making the system less regressive, you're really just kicking the fiscal sustainability can down the road and not really getting the revenue-raising benefits of a truly progressive system. I suspect that long-term, this would set off a vicious cycle of politicians trying to raise revenue by raising the base rate and make it politically palatable by increasing the deduction.
fair enough but all you are describing is a two bracket progressive income tax where the first X dollars is taxed at zero and the next X is taxed at 5%.
It isn't actually that complicated to add tax brackets, the complications with income tax are 99% in figuring out what counts as income and what doesn't.
Yes but, beyond announcing to the world that you favor progressive taxation, there’s no virtue involved in the creation of brackets. The issue is whether the tax scheme has a progressive effect, that higher incomes pay a higher percentage. I’m pointing out that the absence of multiple brackets doesn’t mean that the tax can’t be progressive.
That’s true in general terms, but I’m not sure if that trick works with all such provisions. Like, I’m not sure that would be allowed under PA's provision (again, I work specifically in Philly tax so I’m not especially up on the case law on the state taxes). But if you can get a court to buy that this doesn’t violate the provision this can work.
Well, both the tax rate and deduction are “uniform”
True, but if the court decides the provision is about the ultimate rate paid and not the rate assessed then that doesn’t work. Again, I don’t know if that’s how PA has interpreted its provision, but it’s conceivable that it could be (and more to the point, other states could have similar provisions or provisions that dictate such a result. (There is such a deduction structure in PA—Philly property taxes have s a homestead exemption. However, I don’t know if that’s based on a general principle of the uniformity provision or a special exception for property tax—again, I’m in city business and income tax, not property tax.)
Washington state's constitution requires a 2/3rds super majority in the state legislature to levy additional taxes, including income taxes, essentially precluding one. I believe an initiative could establish a state income tax, but voters have historically opposed such initiatives by significant margins.
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!
Maybe this isn't appropriate for everyone's situation, but not having a pretty simple tax situation personally, I just grab my supporting documentation (w2, 1099, etc.), pull up an editable copy of the 1040 and start filling it out. If I'm doubtful about the results, I follow Turbotax's software and see if I get the same results. Assuming I do, then I simply file my return and forget about turbotax.
Yeah, for simple tax situations it's really no big deal. In my 20s I used to fill out 1040 by hand with an ink pen. I'm sure they loved that...but it wasn't hard to do.
That said, it doesn't take *that* much complexity in one's financial situation for the filing complexity to get way out of hand. I just have rental property income, a bit of capital gains, and regular W-2 income and my 2020 federal filing was 23 pages. At that point the question is paying for an accountant vs. paying for one of the high tiers of tax software. Doing it myself might be theoretically possible but certainly wouldn't be worth it.
I pride myself on being able to read and understand the various instructions produced by the IRS and most years, I've done my taxes myself. But when I had rental income, I decided to play it safe and approach an accountant. And what I learned is that a good fraction of how to do one's taxes is not enshrined in the tax code in black and white but rather is found in tax law. My accountant had books of tax law interpretation from previous cases that revealed, for example, how to depreciate assets when shared between the owner and the renters. He saved me more money than he ever charged.
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.
The Nordic Model lessons are ones that Matt has discussed regularly, too. He's made the point several times that focusing on raising taxes on the rich can't be enough to fund the progressive wish list, especially as the amount needed to be "rich" climbs ever upward. While the data is interesting, the piece seems to miss a lot beyond the most zoomed in view
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
yeah and rich people also have particularly volatile income (even though it is always higher than working class people's) because it is a lot of times wound up in stock grants that fluctuate in value for no real reason or based on the zigs and zags of the economy. so if you rely on a few thousand rich people to contribute hugely to funding the safety net you will need to look elsewhere if the stock market goes down. This is even true in California which has a pretty diverse economy. But think of how volatile a tax on rich people would be in like Nevada which is very dependent on tourism...
I recall when New Jersey, a couple of years ago, had to have serious meetings about a potential budget shortfall because *one guy* decided to move to Florida.
Matt has clearly not been doing enough to market Slow Boring to the Very Online Crank community -- I can't believe we've gotten this far into this discussion without someone bringing up a Land Value Tax and telling everyone to read "Land and Liberty".
(Disclaimer: I am a Very Online Crank and think an LVT is probably a very good idea, although I think my fellow cranks tend to over-sell it: it's just a tax, it's not gonna cure cancer or fix racism.)
A high LVT (like above 80%) is both a good idea in a vacuum, and utterly politically unrealistic. It would involve displacing single family homeowners from their homes, via punishingly high taxes, to make way for density. That's where the supposed efficiency gains come from! So it's combine gentrification with actually affecting the middle class, upper middle class, plus some of the actually rich- and all of this by way of taxation. Every evening the news or social media would have a new story about a middle class family or elderly pensioner forced from their SFH via high taxes.
In other words, it would focus the rage of all the people who actually vote in society into the white-hot nuclear fusion of a thousand suns. I think Trump would win the nomination as a Democrat, or I'd make the NBA roster, before forcing everyone who votes in the US out of their homes via taxes would pass muster. Just utterly, utterly unrealistic
I like to think that here at Slow Boring we’re all familiar with the idea of effects taking place at the margins? You’re quite right that a full on 80+% LVT would provoke civil war; luckily that’s not the only level available, and “right now” is not the only timeline on which one can measure efficacy?
(All of my jokes about very online cranks are a strong hint that I don’t think a LVT is capable of magically solving all of our problems in a single stroke even if it’s probably objectively better than a traditional property tax or a VAT)
I guess I'm just less clear what the benefits of a much lower LVT would be? Like, it either raises more money than the current property tax system- so it'll face popular outrage- or it raises less, so it's pointless.
I read some of the SSC guest piece on Georgism, and some of the comments section, and wooooh boy were there some full-on central planning zealots in there. "So what if the entire middle class is forced from their homes by a 100% LVT tax rate- they'll be better off in the end, it's a Glorious 5 Year Plan Comrades"
on the margin it's better to tax land than structures just because nicer structures contribute to human well-being while the landowner can't really impact the value of the land except tangentially.
Agreed. Consumption taxes > income taxes. There are better ways to solve for regressivity than switching to income taxes.
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.
Which leads to an interesting question - if you were Mississippi, what would you do?
Cutting taxes doesn't seem like it would be very useful, but would raising taxes help them in some way?
I think raising *some* taxes might help a little but the real focus should be on doing things like taking the money the federal government is trying to give the state for healthcare. The impact of having even the most basic healthcare can be life changing when you are on the margins. That would be the thing the Republican legislature could do right now, today to make lives better for millions of Mississippians. They won’t do it because of their underwear pants gnome theory of healthcare where you don’t provide basic healthcare for people who can’t afford it -> ? -> everyone is healthier because they avoided communism! They pair that with a moral hazard argument about how poor people are lazy and if they really wanted healthcare they would just pay for it. It’s a real mess.
I can agree that the medicaid expansion seems like an obvious choice. But I would love for someone like Matt (or you!) to provide a more in depth path to how poorer states (especially in the deep south) should look to make economic progress. Its easy to point to California and say they have immense amounts of money to do tons of stuff with, so they should do x, y, and z. I think its harder, but maybe even more important for people to examine what Mississippi, Alabama and Louisiana should do. (Include Puerto Rico in there too).
My thought is that parts of the federal bureaucracy should be moved to their states. The federal government employs about 400k people in the DC metro area. If you took 100k of those jobs and relocated them to Jackson, MS it would have a profound impact on the region and likely on the federal government.
I think Mississippi is in a really bad spot in particular because it can't use a bordering state as a contrast. It's a very poor state surrounded by other very poor states and an only-moderately poor state in Tennessee. My initial thought would be to try and focus efforts in DeSoto Country as a good spot for Memphis suburban growth, but the problem there is that Tennessee doesn't have an income tax, so it's hard to see why someone would choose that over a nicer community in Shelby County or another outlying community in Tennessee. Maybe try to do what Alabama has done with the university as a way to jumpstart growth (which has really paid off since 2000), but that's harder to do with an improved state school close by and it's not in as good of a spot geographically (Arkansas students wanting to go out of state have Texas options that are better for one)
I think doubling the population of Jackson would be a temporary fix at best. In reality, a lot of people in civil service would quit rather than move there. The idea of slowly opening new offices (and maybe not replacing positions as people in DC retire) in different areas is appealing, though.
That's an interesting idea. I'm not an expert in this area, it would be good to see Matt cover some of these areas in the US that have more of an economic trick shot to pull off with politicians who are only willing to look at solutions that sit on one side of the table.
Insightful
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.
I agree with both points here - the "fair share" that higher earners should pay is rarely specified, it's just "more than now". I grant that in many cases making the code more progressive would be a good move, but there's got to be *some* target or optimal endpoint.
The phrase "same 5% as the Bain partner" irked me as well, it's true that the rate is the same, but the amount of dollars is quite different.
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.
>>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.
Medicaid--by far the biggest joint federal-state matching program--has a sliding scale so that states contribute anywhere between 20-50% of the program cost based on the state's poverty rate. I haven't looked at the rates in a few years, but suffice to say that Mississippi pays close to 20% while Massachusetts (and a few other states) pay a half-share. SNAP and TANF are the two other main state-administered welfare programs I can think of, but there is not state matching of program (rather than administrative) costs to my knowledge. (TANF is block-granted, creating its own state disparities, but that's a separate issue.)
So I'm not sure what programs you're referring to here, unless your point is that the Medicaid sliding scale isn't well-designed (it could be; I don't have a strong empirically-grounded opinion on that). The other big area for federal-state matching I can think of is infrastructure, but in theory those projects should pay for themselves and the projects can be debt-financed on the state end. (And if the problem is that the states are issuing debt that they cannot pay off through increased tax revenues, then they probably shouldn't be building that infrastructure.)
This was more of a general point/critique. From what I understand, the medicaid expansion has a non-sliding scale requirement from states--albeit 'just' 10%. Does the proposed Pre-K program in BBB have a sliding scale for states' fiscal burden based on fiscal capacity? I haven't read anywhere that it does. Fiscal capacity is just something we need to consider moving forward whenever we decide to put funding obligations onto states, and I haven't seen many outside of Joshua McCabe drive the point home.
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.)
Replying to myself because apparently I have been made to look like a smug idiot by the IRS because… the 1040-EZ no longer exists?! What on earth? Apologies to Mr. Singh for doubting his point.
Somewhere, an Intuit lobbyist is smiling.
Seriously. What the hell?
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.