The Tax Pizza

Happy Thanksgiving. I hope you are not having pizza for Thanksgiving!

Charlie, Pete, Diane, and Pat wanted to order a pizza. Charlie, of course, wanted tuna on it. Pete, a long-time lover of squid, voted for octopus. Diane favored brussels sprouts while Pat hoped for a nice sprinkling of calf liver. Eventually they compromised and decided to add all those ingredients together. Those of you who have not yet tossed your lunch will get my point. Compromise is not always a good thing. And that’s the way I feel about current tax legislation.

What seems to be missing in all the jockeying and the zillions of words vomited by the media these days is that tax change is done for many reasons. While one should expect that these reasons might conflict as much as liver and squid, it is not unreasonable that we should try to find a compromise. But it is also very possible that compromise will lead to a very bad tasting pizza.

Tax changes can be used for at least the following six reasons:

1. Taxes might be raised to generate government budget surpluses to reduce the government's outstanding debt. This might also reduce the government’s footprint in financial markets and give more breathing room for firms to attract investors to their assets.
2. Short-term spending management is part of the Keynesian approach to fine tuning the economy. We give tax breaks to people and firms in a recession so they will spend more. By design these tax changes are temporary and should not have lasting impacts on government debt.
3. Taxes can be rearranged to create incentives. This need not impact the total amount of revenues collected – only their composition. Reducing taxes (by giving subsidies or deductions) can be useful to promote more work, saving, investment, baby-making, JD production, etc.
4. Tax changes might be used to affect poverty or the distribution of income. Progressive taxation wherein wealthier people pay higher rates of taxation is part of that effort. But that is just the tip of the iceberg. It is possible to use the tax code to subsidize housing and feed the poor while limiting, say, how much mortgage interest a richer person might deduct.
5. Taxes can also be used to absorb your time and subsidize the consulting industry. A tax code with many deductions, subsidies, and tax rates means you either spend a ton of time doing your taxes or you hire someone to do them for you.
6. Taxes can be used to stimulate long-term economic growth. The way to do this usually involves creating incentives for more production. Note – this is VERY different from any of the above goals for tax changes. This one is meant to create an environment in a largely market-oriented economy for businesses to make more money. The idea is that when firms try to make more money they often need to hire more workers and raise their wages. Despite the fact that the immediate impacts of this kind of tax reform are aimed at higher income people and firms, we expect most people to benefit, though not equally.

Okay so that’s six toppings for the tax pizza. So what? If it isn’t already obvious, the main idea here is that we might want to prioritize our goals when it comes to the current tax debate. Putting all six toppings on the tax pizza will likely taste bad. At best, trying to serve six masters dilutes all of them and the end result is a lot of people who are unhappy they didn’t get their fair of the total benefit.

An alternative approach is to prioritize the goals. Of those six goals, which one or two are the very most important for the country today? I tend to harp on economic growth. But I have friends and neighbors who would rather see income distribution as the number one goal of tax change. I say let the political process work that out. While I might disagree with the outcome, at least we might get a policy with a clear intent to improve a difficult problem.

The problem is that our talking heads don’t want to create such a clear set of choices. They survive and profit through obfuscation. They think we are stupid or maybe too busy on our mobile phones to participate. Isn’t it sad that they might be right? Another slice of pizza for you?