I do a fair amount of work now in both the Private Sector and the Public Sector. The mantra of private sector work is to fix things that need changing. With the Public Sector, it is sometimes difficult to figure out what needs fixing. Everyone has an opinion – more of this, less of that. Politics is always front and center, but this is at the expense of our economic health. Deep in our gut we all know that tax policy needs fixing.
What we might consider is stepping back and starting over. Ross Douhat in the New York Times said that “The problem is not that we tax high-rollers too lightly, it’s that we subsidize their irresponsibility”. How true this is. We have a system where we use tax policy to encourage behavior but this has side effects. A few examples:
- Deductibility of mortgage interest in the US encourages people to buy more house than they can our should
- Farm subsidies – why are grain crops heavily subsidized and beef isn’t
- Tax preference for debt versus equity based on tax deductibility of loan interest
- Investment tax credits, once started, never go away and encourage continued development of what eventually become sunset industries
I could go on, but my point is that a truly efficient market can help us make these allocations. The best example of this is with income and tax. Currently the most highly taxed income is salaries and wages. Why is that work more highly taxed than that which comes from dividends and interest or capital gains?
Having the same tax regime for all types of income and expense will encourage earners, savings, investors, and manufacturers and so forth to make decisions based on the merits of the case. This can be a progressive system, e.g., the progressive flat tax (say 10%, 25% and 35%), but it will be one that is based on good economics rather than good tax strategy.
It would certainly be interesting if debt didn’t have such an attraction from tax deductibility that it encourages folks to leverage themselves to their maximum and often beyond.
There are probably many flaws in this logic, but we do need to remind ourselves that the current system doesn’t work and if something doesn’t work, we owe it to try something new. Do we really have the courage to let the markets work to the greater benefit of us all?