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The logic of taxes

1 February 2012 By Edward Hadas

President Barack Obama thinks taxes can help the government achieve a precise policy objective. In last week’s State of the Union address he outlined a complex set of tax adjustments to discourage companies from moving American jobs to foreign parts. In the same speech, Obama also suggested that taxes can be made simple and clear: “No side issues. No drama”, he said. He applied that description to the extension of the cut in the U.S. payroll tax rate. It was followed by pushing for “common sense” on a minimum tax rate for the rich. “Washington should stop subsidizing millionaires”, the president said.

The rhetoric may not be entirely contradictory, but it points in quite different directions. If the tax code is written to reflect particular concerns, whether of the government or of influential taxpayers (and non-payers), it will never be simple. And if simplicity is the guiding principle, it is hard to understand why the president wants to add to a U.S. law which already has 9,834 sections.

The current president is not the first person to dream of improving a complex, arbitrary, inefficient and unjust tax system. On the contrary, the history of taxes in every country is replete with efforts at reform, although they come along far less often than desperate measures to squeeze more money out of unwilling subjects. Governments’ consistent need for more revenue and the governed’s equally consistent reluctance to pay helps explain why reformers find progress so difficult.

Obama’s inability to support simple tax principles for even the length of a single speech suggests another reason: irresistible temptation. Politicians love to give favours, to redress particular wrongs, to promote special rights. Obama and other would-be tax-reformers are more likely to succeed if they base their proposals on principles which are both idealistic and pragmatic.

First, the primary goal of tax systems should be justice. In one sense, that’s obvious; injustice has few defenders. But in discussion of taxes, justice is often sacrificed for expediency or the pursuit of efficiency. This results in exemptions for important cases or special measures that promote good causes – say home ownership or American jobs.

How does this fit with the principle of tax justice? In our social market economies, taxes should primarily serve the social side of the system. A just tax system will follow what Pope Benedict XVI called the “logic of public obligation”. He says that the compulsion of the law should be used to support the social fabric by making people do what they would want to do voluntarily – if they were perfectly good. Taxes should help but not pamper the poor and discipline but not break the rich.

This principle of justice will not end all arguments about tax policy. It can be used to argue for flat or rising tax rates; for levying taxes predominantly on wages or on prices; and for countless other arrangements. But if those who write the tax rules keep to this principle, the tax system is more likely to be just.

A second goal of tax systems should be to prefer imperfection to complexity. In this convoluted world, even a basically fair tax system will be unjust to some people. But additional rules designed to help the maltreated almost inevitably have unintended consequences. A common effect is the creation of loopholes through which the privileged quickly move, managing to pay less tax than they would otherwise. If a Save American Jobs tax benefit becomes law, companies will undoubtedly go through contortions to show they qualify. Obama would be more likely to do good if he dropped his own tax contortions to focus on simplicity.

Third, taxes should not be used to guide social policy. Taxes are too crude and indirect to be effective for that. If bosses are paid too much, it is better to pay them less than to tax them more. If ordinary wages are too low to support families, raise the pay rather than cut the taxes. If governments want to subsidise investment, culture or some other public good, they should do so with grants rather than tax breaks.

Fourth, vigilance. From the tax exemptions of monasteries in medieval Europe and 11th century China to the “carried interest” of today’s private equity managers, the powerful have always twisted tax rules to their advantage. They should be held in check. More pertinently, since lawmakers are usually representatives of the elite, they should hold themselves in check.

In that respect, President Obama deserves praise for admitting that it’s “not right” when “I get a tax break I don’t need”. If his Democratic followers and Republican opponents showed some of the same humility, a better U.S. tax system might become more than an idle dream.


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