By Julia Rubicam
Different Types of tax systems
A progressive tax is a tax by which the tax rate increases as the taxable base amount increases. This is the system we have now. Tax brackets are created via income ranges. You will pay a different tax rate, meaning a different percentage, depending on how much you earn. At the moment the current highest federal tax rate is 35% while the lowest is 0%.
The Fair Tax would replace all federal taxes on personal and corporate income with a single broad national consumption tax on retail sales. The Fair Tax Act (H.R. 25 /S. 13) would apply a tax once at the point of purchase on all new goods and services for personal consumption. The concept is that your tax burden will be proportional to your consumption. This would encourage savings and investment while allowing the government to exempt certain items such as food and healthcare to assist those close to the poverty line with covering their basic needs.
A flat tax is a tax system with a constant tax rate. The term flat tax refers to household income (and sometimes corporate profits) being taxed at one marginal rate, in contrast with progressive or regressive taxes that vary according to parameters such as income or usage levels. Flat taxes offer simplicity in the tax code, which has been reported to increase compliance and decrease administration costs. Everyone pays the same percentage but not the same dollar amount. In order to aid those close and below the poverty line, a minimum income level may be established as a threshold above which everything else is taxed.
A negative tax is a progressive income tax system where people earning below a certain amount receive supplemental pay from the government instead of paying taxes to the government. The implementation of the negative tax also implements a basic income system. A basic income guarantee is a proposed system of social security that regularly provides each citizen with a sum of money. In contrast to income redistribution between nations themselves, the phrase basic income defines payments to individuals rather than households, groups, or nations, in order to provide for individual basic human needs. When a negative tax is used to create a basic income guarantee, a threshold is established for a minimum annual income to cover basic human needs. This system replaces food stamps, Medicaid, social security and all other entitlement programs with one guaranteed basic income. People earning below the threshold are given supplemental pay to ensure that they reach the threshold. People earning above the threshold are taxed at a flat rate ONLY on the earnings above the threshold. So if the threshold is $25,000 and you make $30,000 you will only pay tax on $5,000 but if you earn $130,000 then you will pay tax on $105,000. This way the system is inherently progressive in that the percentage of tax you pay depends on your income but the tax rate itself is flat greatly simplifying the tax code.
It is possible to combine these systems as well. For instance a negative tax could be instituted to pay for the social security of the people with a guaranteed basic income. Then a fair tax, a VAT based on consumption, could be instituted to pay for running the federal government, defence spending etc. This can lead to greater transparency. The negative tax is only used to pay for the supplemental payments to those below the threshold while all other costs are covered by the Fair Tax. In doing so, every citizen can see every time the purchase something how much tax revenue the government is getting which may lead them to being more concerned about where that money is spent. Meanwhile social programs are a non-issue because they are now working on a self perpetuating system.
The Laffer curve is a theoretical representation of the relationship between government revenue raised by taxation and all possible rates of taxation. It is used to illustrate the concept of taxable income elasticity (that taxable income will change in response to changes in the rate of taxation). The curve is constructed by thought experiment. First, the amount of tax revenue raised at the extreme tax rates of 0% and 100% is considered. It is clear that a 0% tax rate raises no revenue, but the Laffer curve hypothesis is that a 100% tax rate will also generate no revenue because at such a rate there is no longer any incentive for a rational taxpayer to earn any income, thus the revenue raised will be 100% of nothing. If both a 0% rate and 100% rate of taxation generate no revenue, it follows that there must exist at least one rate in between where tax revenue would be a maximum.
Laffer curve: t* represents the rate of taxation at which maximal revenue is generated. This is the curve as used by Laffer but in reality the curve need not be symmetrical or singled peaked at 50%.
Please note that the point of the Laffer curve is the idea that there is a tax rate which will maximise revenue while causing the minimum decrease in GDP and that the optimal tax rate is probably not the highest tax rate one could get away with enacting.
It DOES NOT claim that every single tax cut will result in increased revenue. It merely suggests that we find a tax rate that maximises productivity in the economy which will also maximise revenue. Also remember, that temporary tax cuts, like the ones from the previous Bush Administration, will never have this effect. By being temporary, people know that they will be gone soon. The Laffer curve is about how people behave. People will not make permanent changes to their spending / investment habits based on a temporary policy. Only permanent tax cuts can stimulate the economy. Finally, remember that people do not radically change their behaviours over night. Any changes in behaviour take time for their effects to be felt. As such there will be lag between the actual tax cuts and any revenue increase. This must be considered before making any firm policy decisions. No one is saying that tax cuts pay for themselves BUT that over the long term the economy is stronger and more prosperous with lower tax rates which over time and in the long run will lead to higher revenues.
I want to briefly touch on the concept of ‘hidden’ taxes and by that I mean things that are not by definition taxes but mimic the effects of taxes in the marketplace. These would be regulations, quotas and tariffs, anything that increases the cost of doing business will act like a ‘tax’ on the market. PLEASE NOTE! This is not an ideological argument for the free market or an anti regulation soapbox. I am not saying that regulations are bad or unnecessary. They may very well be vital and save lives and make the world a better place. That is not my point. What I am saying is that before enacting regulation, you must look at as though it was a tax hike on a specific industry. It will increase the cost of doing business in that sector and will decrease profitability. It may be that the trade off between having the rules and the loss of productivity is worth it. But it may not be. The point is that it has to be considered. If you have read our section of the Laffer curve, then you understand that sometimes a permanent tax cut may lead higher tax revenue. However, if you decrease taxes but vastly increase regulation then in reality you have probably increased ‘taxes’ on net. Regulation may be necessary but unintended consequences will always exist.