Happy April 15th to you and yours!

From my most recent op-ed as it appeared in the Jeff/NA News-Tribune...

How do we evaluate taxes?

EDITOR’S NOTE: In the interest of disclosure, Schansberg is a declared candidate for the 9th District Congressional seat in Southern Indiana in the 2008 election.

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.