The Four E’s of Taxation

It’s obvious:  “Federal, State and Local tax law must be reformed.”[1]

If, by “reformed” we mean, “improved”, then I agree with this statement.  As it’s a command, it’s not literally true or false, so, we should consider it’s efficacy rather than it’s veracity.  In my previous posts to this blog, I’ve made the case for tax reforms.  To recap, the federal, state and local tax laws are too complex, insufficiently progressive where they are progressive, regressive in other areas, challenging and expensive to maintain and enforce, and generally ineffective at fulfilling their role in governing.

In general, a tax code must satisfy four properties (the “four E’s”), it must be:

1. Equitable,
2. Effective,
3. Efficient, and
4. Enforceable.

By “Equitable”, I mean, “must affect each taxpayer equally”, to the extent possible.  This notion is the most difficult of the “four E’s” to define or even characterize.  To many, it simply means, “fair”, viz., applies equally to everyone in a single way.  A single tax rate for all is the usual example of this type of fairness.  I’ve argued, I believe persuasively, that the nature of economic needs and wants renders a single tax rate regressive, therefore, inequitable.  In addition, no matter what tax code we adopt, if we apply it to everyone, it meets this standard.  I’ve argued that some income is more valuable than other income and that as annual income, say, increases, it’s marginal value to the earner decreases.  An Equitable tax rate schedule would tax higher marginal income at a greater rate than lower marginal income; the first dollar you earn is more valuable than the millionth dollar you earn.  The current federal tax code satisfies this principle.

By “Effective,” I mean, “results in enough money to fund the associated government”.  Of course this notion depends on prior notions we hold about the functions of government, viz., their nature, their quality and their cost.  Governance in a republic includes an iterative process of clarifying and changing these prior notions and designing tax structures that reflect these notions.

By “Efficient”, I mean, “optimizes the ratio of benefits to costs”.  In the area of tax codes, this means, to me, the ratio of the total cost to determine and collect taxes to the total amount collected in any given year.

By “Enforceable,” I mean, “taxes due from any taxable entity can be determined with precision and collected without use of force or litigation”.  This standard is quite strict (perhaps, a pipedream); it requires the elimination of estimates.  Such estimates as “economic life” of an asset, “depletion basis” of a natural resource (oil field, landfill, mineral deposits), “full cost” of production, “reasonable economic transfer price” and “goodwill” are estimates, the outcomes of which impact the amount of taxes due and when they must be paid.

Only the federal income tax and some state income taxes address any of the four E’s; none of the current tax regimes satisfies any of them.  This criterion is Equity, which they address inadequately.  When Warren Buffet pays taxes that represent 17% of his income and Mitt Romney pays taxes that represent 13% of his income, yet, most taxpayers pay taxes that represent at least 25% of their incomes, it’s clear that higher marginal income is not taxed at higher rates.

In my next post, I’ll outline a tax code that is Equitable, Effective, Efficient and Enforceable.  I will argue that it improves the international competitive position of US companies, reduces the size of the IRS, minimizes tax management, funds all governments, releases resources for more productive deployment elsewhere, offers one mechanism for minimizing “the tragedy of the common” use of shared resources, and never needs to be changed.

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[1] I don’t use “reform” because reform is ambiguous; “reform” means, “change” and doesn’t imply “improve.”  Unfortunately, when we call for “tax reform” or “gun law reform” or any other “reform”, this term connotes improvement