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Wednesday, 01 October 2014

Taxes and human nature

Ethical economy: Taxes and human nature

The tax system could well be the most idiotic, hypocritical and unnecessarily complicated part of modern industrial economies. The system needs to be rebuilt.

In developed economies, as governments have expanded, taxes have increasingly been used as a tool of economic and social policy. The rich are taxed more than the poor for the sake of a vision of social justice: from each according his ability. Depending on the jurisdiction, some good cause or another is favoured: house ownership, marriage, children, charitable contributions, savings. For companies, an almost endless series of exemptions, deductions and definitions are supposed to encourage investment, employment or some other desirable end.

Each tax wrinkle produces its own complex set of rules. Taxpayers’ continuous efforts to minimise payments lead to yet more rules. Each tax jurisdiction has its own system, a diversity which both increases the intricacies of international business and creates opportunities for individuals and companies to place income where it is less highly taxed.

The complexity has created a lucrative business in tax advice, but it is hard to see how the overall system promotes either economic efficiency or social justice. The complexity does have one clear effect; it alienates people from their governments. The tax law evokes frustration and a righteous indignation which is often undercut by the fervent desire to hold onto particular tax advantages.

The recent moves against tax havens and some corporate tax shifting are a welcome exception - a few parts of the tax system are actually becoming less unjust. Foreign governments used mostly to ignore the practices of banks in Switzerland and other havens, but an international campaign against some of their practices has been effective. A more recent campaign against egregious corporate income-shifting seems to be gathering momentum.

Even if cross-border tax-shifting were to dwindle away entirely, the domestic mountains of inefficiency and injustice will remain almost as high as ever. I believe it is time to admit that the modern experiment in complex tax codes has failed.

The fundamental problem is that the experiment was based on an unduly optimistic understanding of human nature. Yes, if both governments and the governed were wise and good, then the tax code could be complicated, helpful, fair and willingly obeyed. In reality, neither a people nor its government can live up that utopian standard. Motives are always impure and the powerful will take advantage of the complexity of tax codes. Legislators will disagree about both social and economic goals, which may themselves be in conflict.

Of course, such conflicts and confusions are inevitable, but the tax code is the wrong place to work out compromises. The effects of tax policy are too hard to predict and the purposes of tax policy too easily countered by taxpayers’ ingenuity.

The old complex has failed. I have a simple suggestion for what should replace it: simplicity. Taxes should be simple to calculate and to collect. I would suggest the simplest of all possible arrangement: a flat income tax - some constant percentage of all incomes - and a flat consumption tax - some constant percentage of all purchases of goods and services by consumers. Dividends would be taxed as income and there would be no deductions. I would not bother taxing corporate profits, simply because they are too hard to define.

My simple approach would abandon the idealism of the tax system - the notion that it should promote justice and efficiency. The government, however, can and indeed should strive for these noble goals, but its will is much better expressed directly - through law, regulation and expenditures - than indirectly through taxes. Exemptions, deductions and progressive rates can be replaced by grants - to the poor, to parents, to research projects, and whatever else legislators consider worthy.

Of course, no tax code can be quite as simple as my one-paragraph sketch. I have ignored such tricky areas as capital gains and non-cash transactions. Still, my ultra-simple rules are enough to cover the overwhelming majority of economic activity. Practical solutions for the remnants could be found fairly easily - with the help of a tiny fraction of the people who currently work on tax matters.

Unfortunately, my plan is likely to suffer the same fate as the many proposals for tax simplification which have preceded it: perhaps praised, definitely filed and forgotten. Radical change is desired in theory, but stymied in practice by the many interests vested in the current arrangements. It can seem that no new tax construction is possible without a violent demolition of the status quo.

Let’s hope that neither revolution nor Armageddon is required. Tax stultification, with its perceived injustice and undoubted inefficiency, alienates citizens from their governments. A transition to a clearer and ultimately fairer system might not be easy, but the result would be better for everyone.

Readers' comments (1)

  • Edward

    Apple initially, then Microsoft and more recently Google, Facebook et al have been involved in designing low cost international tax strategies, very suitable for those technology companies involved in IP, royalties and license fees. The House of Commons hearings on this matter makes me wonder how au fait the local MPs are with these subtle system when they speka about 'British companies'. Perhaps I do them an injustice.

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