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.

Continue reading →