Friday, October 12, 2007

Pilgrim’s Progress on Taxing Issues

I’ve been lurking around on some of the blogs concerning US tax policy. I don’t claim expertise on this subject, but from what I’ve read so far, not claiming expertise is better than claiming to be the smartest one in the room. I get a lot of the principles from an Estonian, Mart Laar.

Stage 1 - Shock Therapy

1. Eliminate budget deficits. The priority placed on elim¬inating budget deficits is not only well grounded in economic thought, but also, more practically, the only way out of a desperate situation. Balancing the budget requires radical cuts in all kinds of subsidies and reducing the size of government. Reforms must be pushed through, not piece by piece, but in the biggest chunks possible. Political resistance to both small and big reforms is the same.
2. As part of this momentum, subsidies for state-owned companies are identified as a poor policy, and they are cut. This is important for the devel¬opment of new private companies because subsi¬dies preserve old and often outdated production structures and hamper structural change in the economy.
3. Any movement toward pros¬perity therefore demands the elimination of old, inefficient, artificially supported economic activities and the establishment of the "invisible hand" of the market economy.

Stage 2 - Life Liberty & Pursuit of Happiness
1. Encourage personal responsibility. Success in the second stage requires involving a much broader group of people in the process, touching their hearts and changing their attitudes. In the sec¬ond stage, it is necessary to give them new hope, new prospects, and new opportunities.
2. Many have to be shaken free of the illusion that somehow somebody else would solve their problems for them. It is necessary to energize people, to get them moving, and to force them to make decisions and take responsibility for themselves. The government declares that it can only help those who are prepared to do something for themselves.
3. Free Trade. Openness provides many advantages for a smooth and rapid transition to a market economy. It provides a rational set of mar¬ket-determined processes for resource allocation, introduces more competition, allows countries to specialize according to their comparative advan¬tages, and lets the market rather than the govern¬ment pick the winners. A policy of openness also establishes an environment of transparency, with clear market-based signals for producers. Reduce trade tariffs and non-tariff barriers and abolish all export restric¬tions, making the nation a free-trade zone. One rea¬son for creating a free-trade zone is that tariff protections primarily favors sectors that are politically organized rather than those that are in the most need.
4. Regulation reform. The rule of law is especially important in fighting corruption. Corruption thrives when public officials and private agents have much to gain and little to lose from taking a bribe. Uncer¬tain or non-transparent rules, heavy regulation, and pervasive controls give officials exceptional power, many opportunities to seek bribes, and a wide scope for appropriating public wealth. Any reform that increases the competitiveness of the economy will reduce incentives for corrupt behavior. Reducing controls on foreign trade, removing entry barriers to private industry, and privatizing state companies in a way that ensures competition supports the fight. If the rules are transparent and clear, and if the state has no author¬ity to license businesses or restrict exports and imports, there will be no opportunities to pay bribes in those areas. Eliminating subsidies, "soft" loans, and all other such privileges removes another inducement for bribes.
5. Flat tax. The entire tax system should favor savings and investments and encourage people to create new wealth. The tax system has to be simple, inexpensive to apply, and transparent and understandable to the taxpayers. The tax base should be as broad as possible with a minimum number of exemptions, minimizing incentives for tax avoidance such as the underground economy. The tax rates have to be low, encouraging the activity of people and cre¬ating more growth. The best solution to all these goals is a flat-rate personal income tax. The tax system is simpler and easier to understand for both taxpayers and tax collectors. Taxpayers can easily fill out their tax forms and avoid overly complex calculations and bureaucracy. Tax collectors can avoid a lot of unnecessary work and concentrate on those who are not paying their taxes at all.

Flat rate tax systems have two rates – zero per cent for low income families and one fixed rate for all others – with exemptions primarily for the number of children. In reality, most exemptions in existing progressive systems are not so much helping low income families but middle income and high income families who actually do not need social support. Progressive systems make taxation so complicated that you need a specialist to fill in your tax declarations – it is quite clearly an economic burden. And at the same time it provides incentives for avoiding taxes.

Some argue that flat rate income taxes lead to more inequality of disposable income. A research paper about testing the flat tax in the US concludes that a flat tax would be a boon for the income poor in the US.

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