Sunday, May 03, 2009

Paradox of Tax

Currently, the United States government, states, and cities derive tax revenue from income, property, gambling, sales, and sin taxes. These tax revenues have been used to build public services: roads, police & fire forces, healthcare, and parks. Rarely are the taxes people pay directly attributed to the benefits received. For instance, income taxes build roads, and higher income individuals build more roads than lower income individuals. However, lower income individuals pay less per mile than higher income individuals who drive less. The paradox of our tax system and usage of tax dollars forces people to act unnaturally.

A person acts unnaturally when he cannot assess the full cost of performing an action. Collectively, the problem multiplies. I’ll discuss roads because everyone is familiar with driving. However, it should be replicated across as many services as possible.

Governments should remove the portion of income, property, gambling, sales, and sin taxes spent on building and maintaining roads. Then, instate that tax on gasoline sales. Net effect on the average citizen who makes the average income and uses average gasoline will be zero. Net effect on high-income individuals who use less than average volumes of gasoline will be positive. Net effect on low-income individuals who use above-average volumes of gasoline will be negative. Therefore, people will directly associate actions with costs.

When people directly associate a cost with an action, they minimize that action. Revenues for road maintenance and building will crumble in the short-run. The US observed this with demand destruction at $4.50 / gallon. However, people make decisions that lower the cost of road maintenance and building: driving lighter cars that consume less gas, move closer to required amenities, or walking versus driving. Individuals are given the option to choose their tax rates (but actually a 'service fee').

Taxes and government policies produce unnatural incentives. Income taxes versus actual cost taxes subsidize actions of lower income residents no matter the cost to society. Abnormally low-cost mortgage arrangements encourage people to purchase houses, instead of renting. Disproportional transportation costs people to make decisions contrary to collective best interests.

I’m not against the “American Way of Life:” traveling to work in the city from a big house a away in a suburb. I am for government not creating false incentives for people to act unnaturally. As much as possible, consumers of public services should recognize the costs associated with their actions. The paradox of tax is: no matter the intent, it makes people act unnaturally.


Kelley said...

Flat tax is the way to is fair, 10% of what you make....if it is "good enough" for God, it should be plenty good for the gov't.

Andrew said...

I'm not gonna say Flat Tax is the way to go. I do, however, agree with your underlying hypothesis, that people will more directly react to their actions if penalties are more directly linked to them.

The missing piece in your analysis, of course, is that the government wants to act rationally. The problem is that because of special interest motivations to preserve the "American Way" of life, the government does not, in fact, act rationally.