The tax code is complex. That’s not news. The US federal tax code is also very progressive. Apart from that, the tax code pushes social or other policy goals. The Earned Income Tax Credit, for example, acts as a negative income tax and increases after-tax wages for those who can claim it. The idea is to incentivize earnings.
Economists tend to really like lump-sum taxes (in theory). But, despite the profession’s influence, almost nobody supports them. First, what is a lump-sum tax? It’s a tax that ignores any activities of the target. A per capita lump-sum tax would target the young, the old, the indigent, the working, the rich, the disabled… everyone. The idea is that no behaviors, aside from breathing, incur or disqualify a person from owing the tax.
Economists like them because they don’t change the relative price of labor and leisure. Whereas a marginal tax rate reduces a worker’s effective wage, a lump sum tax leaves it unaffected. People aren’t disincentivized from working/earning. Using jargon, we say that a lump-sum tax is non-distortionary.
In the simple two-good model of consumption and leisure, marginal tax rates reduce the amount of consumption that one can afford with each hour of work, making leisure relatively more attractive. Lump-sum taxes reduce the affordable amount of both leisure and consumption. Affording less leisure is the same as saying that people work more hours. It happens for two reasons. 1) Poorer people must work enough to pay the inevitable tax bill and also reach an income level of sustenance. However much work sustenance entails, it’s surely more when there is a tax. 2) Since working and earning itself is not taxed, people at all levels of income decide to work more because their after-tax wage is higher relative to the case of a marginal income tax.
At this point someone gets what I call the “French” idea. The French idea is that if we provide a lump-sum subsidy, then we can all leisure more and consume less – the opposite of a lump sum tax. What a life! We can avoid the prisoner dilemma problem where we can’t credibly commit to shirking together or actually taking a lunch. By forcing a lump-sum subsidy on everyone, we’d work a little less and do it voluntarily. We can sit outside a cafe, enjoying our coffee, baguette, and cigarette without having to worry about our neighbor with their “go get’em” attitude making us look bad.
But then my eyes widen somewhat maniacally. And I say “No, we should impose a lump-sum *tax* and then leisure less and be richer”. We’d all be richer. That’s more surviving children, babies, baby’s moms, and everybody else. It’s more people who can afford medications, prenatal care, school, private tutors, legal advice, and hypoallergenic such-and-such. Won’t that be hard on poorer people? Probably. Won’t that reduce the effective tax rate paid by the richer people? Yes again. And society would be richer for it. But what’s to guarantee that the rising tide raises all ships?
Another reason for the economist admiration of lump-sum taxes is less intuitive. A lump-sum tax costs less utility/happiness/satisfaction per dollar of tax revenue than does raising the same dollar of revenue by a marginal tax rate. Taxing earnings makes working less attractive to workers. So, a marginal income tax reduces the total number of hours worked, increasing the tax rate necessary to collect any given level of tax revenue. Clearly, people who would prefer to leisure more in the first place will be less harmed. But it’s exactly their eager willingness to leisure that increases the tax burden on others. And if everyone is like that, then we all face a cripplingly high marginal tax rate.
If we stay focus on those in need, then more efficient taxation means that 1) we have more tax revenue to fund programs for low-income households, or 2) we can achieve the same level of funding at a lower social cost. That’s the static analysis. Dynamically, more incentive to work, interact with capital, and pay attention to profit opportunities means that innovation would also be greater. In that case, a rising tide really does raise all ships.
A final consideration includes dissent among economists. Many of us recommend a consumption tax if the alternative is an income tax. But what about a consumption tax Vs a lump-sum tax? Keeping it brief, a consumption tax is like a sales tax. People would not be dissuaded from working as much as a marginal income tax, but they would be dissuaded from consuming. As a result, people would save and invest more of their income. That greater investment subsequently funds entrepreneurs, increases the capital stock, and increases future total output per capita. A lump-sum tax doesn’t include the same ‘future generation’ bias. But then again, many people don’t share the future generation bias either. Parents and relatives often know the appropriate amount to worry about their kids. It’s not clear that we need tax policy to do that too. The future generation will almost always be richer, so it’s not obvious that we should worry too much about their consumption opportunities. They’ll probably be just fine whether we think about them or not.
By this point in the post you’ve surely flinched or squinted incredulously. That’s because these things are socially unpopular. There’s a little bit of Bastiat’s seen and unseen going on here. We know how we feel about the immediate effects that I outline above. But we don’t see what it’s like to navigate such a world in which it’s the modus operandi. It’s a hard sell. Economists aren’t loud about lump-sum taxes because they don’t want to ostracize themselves politically and forego the opportunity to make policy impacts on other margins. But everything that I’ve said above is true. And it’s a political nonstarter.
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