income tax – The Menace of Privilege

Fictitious people and their imaginary taxes

Matt Levine has an illuminating post about why the recent reduction in corporate tax rates results in a reduction in some corporations’ reported profits. It seems that past losses can be saved as a “deferred tax asset,” permitting a reduction in taxes to be paid in future years. But the ratio of losses to tax reduction declines when the tax rate declines, so the deferred tax asset is reduced. Levine notes that such tax rate reduction can cause a corporation to appear less well capitalized, since it reduces assets, even tho it increases expected after-tax income.

Just another illustration of the absurdity of a corporate income tax (or perhaps of corporations in general). Of course corporations should pay taxes – based on the land (including spectrum and other natural resources) that they claim. And they should pay additional taxes reflecting the limited liability granted by the state. But the accounting concept of corporate income has little to do with this.

The only honest way to do income tax

“ All of Nature Flows Through Us” by Marc Quinn — photo credit: Randi Hausken CC BY-SA 2.0

In Norway, it turns out, income tax returns are public, sort of. Apparently you need to be Norwegian, or know somebody who’ll let you use their government registration number. And the taxpayer will know who has looked at her information. Authorities say “We like people to do searches which could help us in investigating tax evasion…” Logically, if taxes on income are a major source of public revenue, it makes sense that the public should be able to see the details of how these amounts are determined.

And in Norway, like most places, big landowners are able to minimize their tax:

The tax lists only tell you people’s net income, net assets and tax paid. Someone with a vast property portfolio, for instance, would probably be worth far more than the figure found in the lists, because the taxable property value is often far less than the current market value.

Just to be perfectly clear, I am not suggesting that U S and Illinois income tax returns should be open to public inspection. That would be a second-best solution. The best solution is to abolish the income tax, as well as most other taxes, and obtain revenue for legitimate government costs thru public collection of land rent.

h/t Slashdot which was my original link to the BBC article.

Vague ideas about the income tax

Many of us have a vague idea that the income tax is more or less “progressive,” meaning that those with higher incomes pay a larger share of income than those with smaller incomes. Of course there are some unfair loopholes, but on the whole these people would like to see the income tax cover a greater share of government revenues. Of course, those of us who actually look at how taxes work know that the income tax makes no sense at all, and is only very vaguely related to income.

In fact, a new-to-me report shows that among the richest (top quintile of income), effective average tax rates range from less than 3.8% (for the cleverest 10% of these affluent taxpayers) to 18.6% (for the most tax-burdened tenth of this group). For the “middle class” (third quintile), the range is from -4.5% (meaning that refundable tax credits exceed otherwise-taxable income) to 9%. (Exactly what definition of income applies here is not clear; it’s based on the “Urban-Brookings Tax Policy Center Microsimulation Model (version 0509-4),” which I haven’t examined.)

Of course this weirdness is the result of many “loopholes” and special provisions. In theory it would be possible to eliminate them and come up with a simpler tax, but in front of each loophole stands a lobbyist (and/or a legislator favored by a lobbyist). U S Senators Ron Wyden (D-Oregon) and Judd Gregg (R-New Hampshire) have introduced S-3018, which will do away with many(pdf) (but not all(pdf)) of these provisions.

The mortgage interest deduction stays, which maintains a subsidy for real estate speculation. The deduction for corporate-paid interest would be limited to the amount in excess of inflation, which appears to mean that a corporation, upon issuing fixed-rate bonds, would have no way to know in advance how much interest they’ll be able to deduct. Perhaps this will encourage inflation-indexed bonds? Also, it is not clear what the effect would be if we enter an (unlikely) deflationary period.

I see this as simply one more illustration that the tax on earned income (including revenue from investments in real capital) is a hopeless mess. A tax on privilege (or, what is effectively similar, on the income from privilege) would be much more straightforward and encourage balanced economic growth. Unfortunately, those who hold privilege have great resources to fund lobbyists and other professionals to block to adoption of such a tax.

ht Forbes via Yglesias (indirectly from Felix Salmon)

"Progressive" income tax discourages paid work

That’s no news, but this seems to be a paper that confirms it. Abstract says that the proportion of “potential” income realized as actual taxable income by high income households declined when tax rates increased, while that of low income households grew when their tax rates dropped. That is, folks work more or less hard, depending on what proportion of their income they’ll get to keep.

This seems to be what the paper says, but it’s behind an ssrn screen so I can’t actually get a copy. Abstract from taxprofblog.