Taxing bads 

income-tax_1You get more of what you subsidise and less of what you tax. This is obvious. Taxes are often used to discourage things – smoking, for example, or gasoline consumption – subsidies are used to encourage them, such as the tax deductions for mortgages, pension plans and health insurance.

So, here is the big question. If you get more of what you subsidize and less of what you tax, why do we tax income and wealth and subsidize poverty? 

Income is supposedly proportionate to someone’s ability to pay. That may or may not be the case. Over the long-term – especially if you include any transfer of assets to someone, such as inheritance – the two are likely to be related. But in any one year they may be wholly unconnnected. Someone with volatile income may have zero or even negative income in one year but very high income in another. So a “poor” person with a low income may nonetheless have a great deal of stuff bought in previous years. Studies have suggested that there is only a passing relationship between a person’s income and his or her spending, which might be a better indication of standard of living. But even past spending influences someone’s standard of living. The “poorest” man who ever lived – Robert Maxwell, whose income was minus three billion dollars in the last year of his life – died when he fell off one of his yachts.  

So, if spending is a better proxy for someone’s standard of living, would taxing spending be a fairer way of financing government? 

There are two main proposals for tax reform in the US: the flat tax and the fair tax. The flat tax is a flat income tax with deductions swept away. The fair tax is a consumption tax. The problem with the fair tax is that the spending tax might well end up being levied as well as income tax not instead of it. Supporters say it should be combined with a repeal of the sixteenth amendment which authorizes Congress to levy an income tax. That might be a good idea, but given the consensus required to amend the Constitution, it is impractical. 

But could a flat tax be supplemented, or even replaced, by taxes on bads? Milton Friedman advocated pollution taxes. 

The problem with such an idea is that it would undermine the simplicity of the flat tax. Simplicity is a virtue in and of itself: it undermines evasion and hidden subsidies. All other things being equal, a simpler tax system is likely to be both fairer and more efficient. The economy would grow more strongly. 

But pollution and consumption taxes have other merits, and bring efficiencies of their own. They not only discourage damaging behavior, they often do so more effectively than regulations. They allow the market to innovate more creative solutions, that eliminate pollution without eliminating production. Regulations ‘lock in’ technologies which seem like a good idea at the time, but which are bypassed by better ideas. Regulations require London taxis to carry a bale of hay – as food for the horse.

But pollution taxes are open to some of the same problems. There is a necessary uncertainty as to what comprises pollution and greater uncertainty as to the costs associated with any pollutant. This leaves the same space for lobbyists to lock in technologies and lock out competitors.

qlQuentin Langley is a Senior Lecturer in Marketing at the University of Bedfordshire Business School as well as a freelance columnist published in the UK and all parts of the US. He blogs on social media and crisis communications at brandjacknews.com

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