How do we evaluate taxes?

Ahhh, it’s spring! The weather is warming; the trees are blooming; and our minds turn inevitably toward taxes. In addition to filing our 1040’s in time for April 15th, the average worker (over 25 years old) has already lost an additional $2,000 this year to the federal government’s payroll (FICA) taxes on income.

At the state level, the Governor and the legislature just passed property tax reform. People are mildly irritated at the recent 16.7 percent increase in the sales tax rate on April 1st. But they’re looking forward to lower property tax bills in the future.

All of this begs the question: How should we evaluate taxes?

Economists answer this question with three criteria.
First, “equity” relates to the “fairness” of a tax. The concept speaks to a number of things, including one’s ability to pay. This concern typically results in a “progressive” tax-where those with higher incomes pay a higher percentage of their income. Another consideration is uniformity: are taxpayers treated equally by a given tax and by the tax system in general? For example, how many people evade income taxes through “loopholes” and are income, sales, and property taxes “balanced”?

Of course, fairness is in the eyes of the beholder. For example, some people believe that the government should be quite aggressive in taking money from some people to give to others. Some people find that idea repulsive and offensive.

Second, “efficiency” speaks to both the cost of collecting a tax and the damage caused by taxes. For example, it’s painful enough that the government imposes income and payroll taxes on what we earn. And although payroll taxes impose a larger burden than income taxes for most people, they are taken from us through “withholding”. So, we rarely notice it and we don’t file any tax forms about it. In contrast, the income tax is collected in a manner that requires us to spend billions of hours and dollars in filing forms or hiring others to file forms for us. This is hardly an efficient way to take our money!

Efficiency is also an issue in that taxation changes the incentives for people to engage in productive behavior. Higher and higher tax rates are more and more inefficient-whether the taxes are placed on production or consumption.

Third, “paternalism” relates to the use of government to encourage us to make good decisions and to avoid bad decisions. The strongest tools in the government’s arsenal are prohibitions and mandates-attaching fines or imprisonment to certain behaviors such as smoking pot or wearing a seat belt. The milder tools available to the government are subsidies and taxes-for example, to encourage people to purchase hybrid cars or not to smoke. Again, whether it is appropriate to use the government in this manner is very much a matter of opinion.

One other consideration that affects equity and efficiency: economists distinguish between the imposition of a tax and the “burden” of that tax. For example, a tax on gasoline is imposed on gas stations. But the firm passes the burden to consumers in the form of higher prices-because we have few substitutes for gasoline and cannot avoid the tax. The broader principle: A tax imposed on firms will be passed, to some extent, from investors to consumers and workers. This is the case with corporate taxes, regulations on business, and payroll taxes.

From those who want to reduce taxes, we hear provocative rhetoric. It is said that a property tax implies that you don’t own your property; you only rent it from the government. Those who oppose income taxes draw an analogy to slavery-that the fruits of one’s labor are conscripted by the government. As for sales taxes, estate taxes, and capital gains taxes, they amount to double or even triple taxation on the same income. So, what’s fair? What will least damage individuals and the economy?

At the end of the day, the larger issue is the size of government. All taxes are bothersome. All taxes destroy economic activity. If people want such a large government, then they’ll have to live with a lot of inequity and inefficiency.

Eric Schansberg is professor of economics at Indiana University Southeast and an adjunct scholar for the Indiana Policy Review. He is the author of Turn Neither to the Right nor to the Left: A Thinking Christian’s Guide to Politics and Public Policy and the editor of SchansBlog.com.


  • Trevor

    “All taxes destroy economic activity.”

    Not quite. A tax on land values does not destroy economic activity.

  • Patrick

    If I own land, I must pay a tax on its value with resources that I would otherwise save, invest or use to buy goods. Isn’t that destructive of economic activity? Or what do you mean?

  • Patrick

    “At the end of the day, the larger issue is the size of government.”

    This is an excellent point, as demonstrated by the effects of the “Bush Tax Cuts.” The tax cuts were never balanced with commensurate spending cuts, and so while the rate of taxation fell, the size of government continued to grow. Therefore the tax cuts were never salient, insofar as there was no meaningful reduction in government spending. This creates a distorted picture of the budget and congress and the administration are able to cut taxes and still hand out benefits, all the while passing on to the next generation an enormous national debt. That’s hardly efficient or equitable.

  • Eric Schansberg

    I would echo Patrick’s question; I’m not sure what you mean.

    To Patrick’s point, it must destroy economic activity as it takes money from X and destroys the opportunity cost of whatever that money’s alternative use.

    From what I’ve seen in the research, taxes on land (at least within the ranges we typically see) tend to elicit the smallest changes in behavior. But it does still distort behavior to some extent.

  • Trevor

    Many (most?) economists have long recognized that a land tax is one of the only non-distortionary taxes.

    The Show-Me Institute, a libertarian think-tank in Missouri, recently did a study on replacing an earnings tax with a land tax. The economic reasoning for a land tax is detailed in the first few pages of the pdf linked below. http://showmeinstitute.org/docLib/20070411_smi_study_5.pdf

    I don’t have time to explain it all here but the report speaks for itself and it’s not too lengthy.

    There is also an argument for a land tax based on principles of justice. If we think of public goods (schools, roads, etc.), the lion’s share of the benefit of these goods shows up in land values. Cross the boarder from Kansas to Missouri in Kansas City and the cost of buying a home shoots up. Why? Better schools, better services, better roads, less crime, etc. Most of the things our taxes pay for end up increasing our land values. So why not use this increase in value to finance the services? Why should taxes on labor or sales go toward services that increase private landowner’s land values? Clearly, a land tax is far more just than a sales tax or an income.

  • http://www.cdobs.com John Powers

    Drat, the Henry Georgians are back, and I can’t resist posting.

    So Trevor, what if an offshore company never has any land in the US, but makes a ton of financial transactions(like a hedge fund), all of which consume common resources, but none of which incurs property tax?

    1) That is a trend, and a sensible one, due to the destructive property taxes in Illinois at least

    2) It negates your Georgian argument entirely.

    The Henry George system is not applicable in the 19th century, let alone the 21st.

    JBP

  • Eric Schansberg

    Typically less distortionary, but not non-distortionary.

    Your point stands, however, about the potential justice/equity of property taxes in some contexts.

  • Trevor

    Henry George and most economics define land as the natural world outside of man and the fruit of his hands (goods and capital).

    Which negates your argument completly. Common resources are still “land” and would thus by taxed.

  • Patrick

    Who defines “land” as “the natural world outside of man and the fruit of his hands (goods and capital).”? Perhaps you mean “property” rather than “land”? Regardless, a land tax is not simply more just than other forms of taxation. As has been discussed above, it might be less subject to the distortionary effects of taxation, but that does not make it “more just.” It makes it an easier target.

  • Trevor

    Who defines “land” as “the natural world outside of man and the fruit of his hands (goods and capital).”? Perhaps you mean “property” rather than “land”? Regardless, a land tax is not simply more just than other forms of taxation. As has been discussed above, it might be less subject to the distortionary effects of taxation, but that does not make it “more just.” It makes it an easier target.

    No, I mean land, not property. John Locke, as one example, defines property as those goods which one has an individual right to use based on the labor used to remove them from nature. “Nature” is everything else outside of man and his “property”. So Nature is the ocean, soil, radio frequencies, air, etc. and in classical economics Nature=Land. Adam Smith defined it as such.

    My argument for land being a just tax was not based on it being non-distortionary (or nearly so). Setting up a strawman doesn’t help your argument one iota.

  • Patrick

    I’m not sure that I have an argument here, other than trying to understand your claim that a land tax is not destructive of economic activity, is the only non-distortionary tax, and is the most just form of taxation. As to the last point, I was not attempting to set up a straw man, but perhaps I was confusing your rationale. You have offered that a land tax is just because land values increase when government services are provided. Is that much correct? My thought is, fine, most states have a property tax which is reflective of this fact. What about government services that increase the value of wages, such as labor laws and licensing requirements – isn’t an income tax just under this analysis? Likewise with goods, since regulation and consumer protection laws add value to those, isn’t a sales tax just? What is it specifically about land that make a land tax particularly just?

  • Trevor

    Yes, I think land value taxes are more just than other taxes because the value government creates via government expenditures primarily causes land values to increase. In essence, by paying for government services out of income and sales tax revenue we’re taking money from the many and giving it to a few. Better that the few pay directly for the services the benefit from.

    Labor laws and licensing requirements are not “services”, they are laws. Yes they give certain groups wage advantages over others but these groups are not direct beneficiaries of government expenditures. Also, in-so-far as certain groups are given wage advantage through government protected privilege, I do think a tax on this income advantage is appropriate. Better yet, I say remove the privilege all together. Likewise with goods.

  • http://www.cdobs.com John Powers

    “the value government creates via government expenditures primarily causes land values to increase”

    Most government spending is Social Security and Defense, neither of which has much to do with property values.

    These arguments were settled in about 1870. Unfortunately, the Henry Georgers won in Illinois (and many other states), and we have a nasty property tax that stifles local business and chokes education.

    JBP

  • Trevor Acorn

    John, what are you talking about? Neither I, not Henry George advocated for property taxes. We want a land tax (property taxes with buildings exempted). The difference makes all the difference in the world.

    Also, Social Security isn’t government spending so much as forced personal savings. Defense is, we should all hope, a temporary expenditure that will go away. Henry George and other Georgists do see a other taxes as necessary evils in times of war when very high revenues need to be raised for short periods of time.

    And John, why the degrading rhetoric? Arguments settled in 1870? What are you talking about? Illinois does not have a high land tax, they have a high property tax which is the exact opposite of the “Single Tax” advocated by George. Get your facts straight man. And please, argue against something I agree with, not a strawman.

  • http://www.apostlesandmarkets.com Stephen J. Haessler

    It is interesting to note that for all the Congressional posturing about ‘excessive oil profits’, the truth of the matter is that Federal and state revenues from taxes on the oil industry far exceed those profits. For more on this, see A&M Blog. http://www.apostlesandmarkets.com/weblog/default.asp?Display=7