Milton Friedman once said he loves all tax cuts, “under any circumstances and for any excuse, for any reason, whenever it’s possible.”
Still, some tax cuts are better than others. Because they create jobs or raise wages in addition to keeping more money in people’s pockets. Meanwhile, of course, some tax cuts are easier to sell, because it’s easier to see the benefit for voters.
So let’s rank tax cuts, from best to worst.
Broadly speaking, the biggest bang for your tax-cut buck are taxes that target investment. Next are taxes on work. Third are taxes on consumption. The logic is simple: a tax will reduce whatever you’re taxing. If you tax beer, fewer people will drink. And if you tax investment or work, fewer people will invest or work.
Investment, in particular, needs defending because not only is it the source of work — you can’t hire staff if you don’t have a business. But investment needs additional help because it’s a harder sell. Voters can see the pain from income taxes in a way they cannot see the pain from corporate taxes that strangled their next great job in the crib.
So investment is the most heroic of tax cuts: it gets the job done for workers, and it can be a tough sell. This includes the corporate tax, and also taxes that specifically target investing, like capital gains taxes.
Next up is the closely related category of savings taxes. Savings don’t create jobs like investment, but they have several features that you don’t want to tax. First, a lot of savings will ultimately be invested; people might want to set aside $10,000 in the bank and then invest everything after that. In this case, the savings becomes a kind of shadow investment, acting like insurance so people can feel confident investing in the stockmarket. And because savings have that insurance function, they make it less likely that people will need to rely on public support if they run into a rough patch in life.
A second reason we should promote savings is interesting: economically, when you save a dollar, you are effectively lending it to everybody else who holds dollars. This is because you temporarily reduce the money supply, meaning remaining dollars buy more. So if Scrooge McDuck hoards half of all the money in his swimming pool, everybody else’s dollars buy twice as much. It’s as if Scrooge had lent us all his money, for free. Saving is sharing.
The next category of taxes are those on work. Obviously, as a society, we want more work. Not only because it makes people richer, but also because it creates more goods, services and innovation for the rest of us. When you choose to work, I get more options as a customer. The ultimate win-win.
Taxes on work break into two parts — about one-third comes from flat-rate payroll taxes, and the other two-thirds come from the income tax, which discriminates against higher earners. Both are harmful, of course, but the discriminatory income tax ends up having a higher “wedge” or disincentive to work, especially as it rises towards 50% or higher. After all, a surgeon might not take on more patients if she’s only keeping 50 cents on the dollar.
So if we really want an economy to grow, we remove taxes on investment, on savings, and on work. Taken together, this rogues gallary makes up about 68% of taxes today — 45% from investment and income tax, and another 23% on payroll tax.
That leaves about a third of taxes — about $1.7 trillion — that is collected less destructively. These are consumption taxes, and there are three main kinds.
First, sales taxes paid at time of purchase. Second, excise taxes that are basically super sales taxes on politically disfavored things like beer or gasoline. And third are property taxes, which are levied like a wealth tax over time. Property taxes are actually paid by business as well, often at a rate 2 or 3 times higher than residential, but most are still paid by homeowners, so I’ll count those primarily as a consumption tax.
Of course nobody likes sales and property tax. But if we want taxes even just for police and an army, we have to tax something. Besides, take that anger and vote on it — better a tax you can see than one that’s hidden.
Moreover, taxing consumption does far less harm to the economy, therefore to your job prospects and salary growth. This is because consumption itself is the act of taking something out of the economy. While investment and work are putting something in — growing the pie. China, for example, has largely been growing because Chinese invest so much instead of spending. If you have to tax something, better to tax destruction than creation.
Unfortunately, if we want today’s level of government spending, consumption taxes would have to be tripled or quadrupled. Fortunately, beyond the obvious solution of cutting spending, or “starving the beast” as Reagan put it, there are two out-of-the-box solutions that we might choose instead.
First is the Federal Reserve. Going by m2, the Fed actually creates about $750 billion per year — 15% of what we pay in taxes. This is enough to replace nearly the entire sales tax. The Fed does this by subsidizing loans, which effectively creates more dollars and dilutes every existing dollar. Economically, the Fed does the exact opposite of what Scrooge was doing above — it takes from you rather then lending for free.
Alas, those $750 billion aren’t handed directly to the Treasury, rather the new money goes to borrowers and banks in the form of artificially cheap loans, along with bank fees on those loans.
So the fastest way to cut taxes would be to simply tell the Fed to stop lending to commercial banks, and instead credit the Treasury with $750 billion every year. Is it unfair to steal everybody’s dollars by inflation? You bet. But inflationists are entrenched at this point, on right and left. So, at least the proceeds should go to regular people, not to well-connected borrowers and their banks. Until Ron Paul abolishes the Fed, let’s at least get some tax relief out of it.
The second neat trick is borrowing. This is more contentious, of course. The big picture is that government has a credit card with a very high credit limit. Japan is up to 200% of GDP in central government debt, with few ill effects — Japan’s economy is doing fine, despite an almost cultlike consensus that it’s dying (see here for why). 200% of GDP would mean another $21 trillion in borrowing for the US.
Just as you don’t leave an 8-year-old alone with a $21 trillion credit card, you don’t leave Congress alone with one either. Ideally, we’d have a balanced budget amendment, but at the moment that $21 trillion is financing Bernie Sander’s dreams. This leaves voters with a choice: spend it on economy-growing tax cuts, or let some socialist use it to buy his way into office. I choose life.
So how much could we borrow? Just to keep the debt to GDP ratio sustainable, about $500 billion. If those tax cuts on investment and work raised growth by, say, another 1.5% per year then we’d be looking at closer to $900 billion per year.
In sum, today’s taxes weigh heavily on the economy, with $2.4 trillion borne by job-killing income and corporate taxes, $1.2 trillion on payroll tax, and $1.7 trillion on relatively benign sales and property tax.
Any tax cut should target the worst taxes first, meaning the income tax and business taxes that pass on to workers. Focus on those before we even think about cutting the deficit. And if you can find your inner Ron Paul, by all means abolish or re-route the Fed inflation tax to the Treasury.