Dr. Baird is a member, and a past Vice President and member of the Board of Directors, of the Mont Pelerin Society -- the international free-market organization founded by F.A. Hayek and Milton Friedman (and others) in 1947. He was Director of the Smith Center for Private Enterprise Studies at CSUEB from its founding in 1991 to his retirement in 2007. The principal mission of the Smith Center is to foster a better understanding of free market principles and their application to public policy.
The Tax Cuts and Jobs Act (TCJA), announced by the House Ways and Means Committee on November 2nd, has generated a lot of commentary on both sides of the political divide. Much of that commentary is based on which income groups will gain at the expense of which other income groups.
The main reason that it is possible for some to gain at the expense of others is that both the current code and the TCJA are based on different tax rates applied to different people. This is called “progressive” taxation. The current code has seven different rates, and the TCJA has four. One might ask why not three, two, or even one. What principles should guide the choice?
I think the principle of equality should have guided that choice since the inception of the federal income tax and should continue to inform all changes thereto. The Declaration of Independence and the Fourteenth Amendment to the Constitution proclaim that government should treat all people under its jurisdiction equally. Neither mentions an exception for taxes.
“Equality,” in taxes (and in anything else), doesn’t define itself. What constitutes equal treatment of all people when it comes to income taxation?
One possible answer is that everyone should pay the same dollar amount of taxes. This would mean that if a high-income person has to pay $10,000 in income taxes, a low-income would have to do the same. So a person whose income was $10,000 would have zero disposable income. This outcome offends our moral intuition. No serious thinker would accept this definition of taxation equality (unless the tax rate was zero).
A second, and very popular, answer is that taxation equality requires that an income tax impose an equal amount of sacrifice on each taxpayer. Indeed, this is the principal foundation on which progressive income taxation is allegedly based. The loss of $1000 is likely to be a bigger sacrifice to a low-income person than it is to a high-income person. Therefore, the progressives argue, a high-income person should pay a higher tax rate than a low-income person. But that is a logical error.
Most people would agree that the principle of equal sacrifice implies that a high-income person should pay a larger dollar amount of taxes than a low-income person. But that result does not require a high-income person to pay a higher income tax rate than a low-income person.
Sacrifice cannot be directly measured. If I pay $1000 in income taxes, the sacrifice I experience is the significance my mind attaches to the loss. Two people who each pay $1000 in taxes do not necessarily experience the same sacrifice. $1000 may be more (or less) significant to me than to some other person. Therefore, it is impossible for any politician or tax collector to know whether a low-income person and a high-income person suffer the same sacrifice from any tax scheme.
As I put it in an earlier commentary,
If the tax collector were Mr. Spock of Star Trek fame, he could do a mind meld with each taxpayer and feel the pain of taxes. He could feel the pain a low-income taxpayer feels from paying $100 in taxes. He could then take more and more dollars away from a high-income person until that taxpayer feels the same pain.
But in reality no mere earthling, not even the late Leonard Nimoy, can do a mild meld. It follows that any set of different tax rates is wholly arbitrary. There is no science behind a progressive tax, it is purely a matter of a battle of each against all waged by our alleged Congressional representatives.
So, what to do? Equal sacrifice for all appeals to our moral intuition, but we can never know whether any tax scheme imposes an equal sacrifice on all tax payers or not. The idea that a high-income person should pay more dollars than a low-income person also appeals to our moral intuition, but we can never know how much more is needed to achieve taxation equality.
A proportional income tax (everyone pays the same tax rate) meets the requirement that a high-income person pays more tax dollars than a low-income person (10 percent of $10,000 is $1,000, and 10% of $100,000 is $10,000). There are no grounds to assert that a proportional tax imposes equal sacrifice for all, but it could.
Moreover, in every other context I can think of proportionality is widely accepted as fairness. Again quoting my 2013 commentary,
For example, suppose there is not enough water this year to allow everyone to consume as much water as they did last year. Water prices must rise (the best solution) or water must be rationed. In the latter case, what is fair? The (unscientific) answer that jumps to mind, as if from moral intuition, is that everyone should cut back by the same percent of last year’s consumption. Equal rates suggest equal treatment.
As Hayek demonstrated in The Constitution of Liberty (1960), proportional income taxes have long been accepted as both fair and practical. For example, J. R. McCulloch, a 19th Century Scottish economist, wrote:
The moment you abandon the cardinal principle of exacting from all individuals the same proportion of their income … you are at sea without a rudder or compass, and there is no amount of injustice and folly you may not commit.
A. Thiers, a 19th Century French economist, put it this way: “proportionality is a principle, but progression is simply hateful arbitrariness.” According to John Stuart Mill progressive tax rates are “a mild form of robbery.”
A proportional income tax (often called a flat tax) has additional advantages over the status quo. It is simple. Your tax return could really be on a simple postcard. Tax lawyers and tax accountants tell us that complexity is the price of fairness, but that is just self-serving nonsense. Let them find honest work.
More importantly, a proportional tax would be a constraint on the size of government. If politicians could no longer raise anyone’s taxes without raising everyone’s taxes they would be less willing to raise taxes. This would mean they would have to be more willing to cut government expenditures. This would be a huge sacrifice for them, but they deserve it.
The battle over which expenditures to cut would be fierce and entertaining. I would recommend they start by recognizing that the only Cabinet departments called for in the Constitution are State, Treasury, Defense, and Justice.