Monday, August 25, 2008

Principles of Taxation

Someone must have a set of principles of taxation that would clear up much of the nonsense one hears when talking about taxation. Since I am not familiar with any though, I thought I would compose some.

First. Be clear on what you are taxing. Taxing revenues is a sales tax. Taxing revenues less expenses is an income tax. Taxing assets is a property or wealth tax. Defining revenues, expenses, assets and determining values is the hard part. Don't assume tax law gets it right. It rarely does.

Second. If you tax something you will have less of it, unless everything else is taxed more. Tax something less and you will have more of it. Differences in taxation are there to be exploited. Money flows to its least taxed form and taxes are avoided where ever possible. Don't tax business and most income will be become business income. Allow business but not personal deductions and personal deductions will migrate to business. Gaming the system is standard behavior.

Third. One can tax transactions but one can't prevent them from disappearing. People sometimes argue debt should not be deductible, but one can't prevent debt from disappearing through internal lending. Taxing sales can shift to leases and rentals. One must always consider unintended consequences.

Fourth. Taxation should be indifferent to the entity involved, but never are. Changing from an individual to a business often changes many things. This offers another means to game the system. 'Businesses don't pay taxes, people do' doesn't make much sense when people should just be considered businesses with their own revenue and expenses.

Fifth. Simplicity and fairness often conflict. Ease of collection and ease of evasion must always be considered. The narrower the base the higher the tax and more desirable avoidance and evasion.

Sixth. Nothing changes like taxation. Time offers another dimension for avoidance. The benefits of improvements must be weighed against the costs of doing so and how the system will adapt to them.

Consider each individual a business with revenues and expenses. They need food, clothing, shelter. They need utilities, communications, and transportation to work. They need education, and health care. The standard deduction is $5-10k. Does anyone think this comes close to covering basic expenses? I don't know anyone that could even rent for that. The real figure must be several times that. Yet, the income tax considers that income. Is the income tax really progressive, or do we labor under a false assumption?

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