Tax the Middle-Aged!
A few bold new ideas to make taxes more efficient and more fair.
Most people reading this column will be of the opinion that taxes are a bad thing, especially this week. But why? Popular wisdom is that taxes are bad because it's painful when you pay them. That's pretty much the opposite of the truth: Taxes are bad only when you don't pay them.
When you pay a dollar's worth of tax, the government collects a dollar's worth of tax. The economy has not shrunk. (It might shrink, if the government then spent the money unwisely—but we're talking about taxes here, not government spending.)
The problem comes when you don't pay the tax. If the IRS plans to tax your overtime pay at 35 percent, you may decide to stay at home, instead. You're denied your income, and the IRS is denied its tax revenue.
For this reason, economists like taxes that avoid such discouragement problems—which we call "dead-weight losses"—as much as possible. But the quest to avoid dead-weight losses leads to some arresting conclusions: 1) The rich should pay lower tax rates than the poor; 2) there should be a tax on being middle-aged; and 3) it's possible that a DNA test should earn you a tax exemption. These are not as crazy as they sound.
Take the idea that the rich should pay less than the poor. By this I don't mean that the rich should pay less of their incomes in tax, but that if Bill Gates earns one extra dollar, he should pay less tax on it than I would pay if I earned one extra dollar.
This is because organizing taxes like that reduces dead-weight loss. If you raise taxes on a low-income bracket then you discourage overtime for people in that bracket. But you collect cash from those earning above the bracket without discouraging work and causing dead-weight loss, because their overtime pay will not fall inside the bracket and will not attract extra tax.
Since raising the tax on an income-tax bracket discourages those in the bracket but collects cash from those who are richer, it's not hard to see the argument for raising taxes on the lowest possible income brackets. Taxing Bill Gates on his income, on the other hand, discourages him from working without raising revenue from anyone else.
But shouldn't the rich pay more tax? Surprisingly, you can make Bill Gates pay lots of tax without excessively taxing his decision to work a bit harder. How much tax Gates pays overall and how much he pays on his last dollar are not the same thing. For instance, imagine a tax allowance of $20,000, then a 50 percent rate on the next $20,000, then a 30 percent rate on all income above that. A poor journalist earning $30,000 would pay $5,000 tax, less than 17 percent of his income. Bill Gates would pay very nearly 30 percent, since he'd hardly notice the tax-free allowance. But if Gates took a newspaper route to earn extra cash, he'd pay 30 percent tax on the earnings, while the journalist would pay 50 percent if he did.
What would be even cleverer, of course, would be if Bill Gates had taken some kind of intelligence test or DNA test to establish his earning power. He could then simply have been required to pay a $50 billion lump-sum tax at the age of 18. That would be the ultimate motivating tax: Every billion he earned beyond the first $50 billion would be his to keep in entirety.
In practice, this is patently ludicrous. But since you can decide to be less diligent, but you can't decide to be less gifted, it's not hard to see why some economists espouse the idea in principle.
Tim Harford is a Financial Times columnist. His latest book, The Logic of Life, will be published in paperback on Feb. 10.