Building a Better Tax System
Time for a non-macro post. This Saturday in the New York Times Greg Maniw had an editorial about reforming the tax system. He discusses a lot of issues that I frequently find myself trying to address in conversation and he does so in a very concise and lucid manner. The editorial isn’t very long so I recommend just reading the whole thing, but I’m going to crib my favorite parts.
On the mortgage deduction:
“Consider the deduction for mortgage interest. The policy is politically popular, but economists have long thought it has little justification. Because of this provision, among others, our tax system gives a better treatment to residential capital than it does to corporate capital. As a result, too much of the nation’s saving ends up in the form of housing rather than in business investment, where it could have increased productivity and wages.
This efficiency cost might be worth bearing if the deduction had a benefit from the standpoint of equality, but it fails there as well. Subsidies to homeowners are, in effect, penalties on renters — after all, someone has to pick up the tab. But there is nothing wrong with renting. And once one acknowledges that renters are poorer, on average, than homeowners, the mortgage interest deduction becomes even harder to justify.”
On consumption taxes:
“Almost four centuries ago, the philosopher Thomas Hobbes suggested that taxes should be based on consumption, not income. Income measures a person’s contribution of labor and capital to society’s production of goods and services. Consumption measures the quantity of those goods and services he gets to enjoy. Hobbes reasoned that because consumption better reflects the benefits a person receives as a member of society, it is the proper basis of taxation.
Much modern economic theory confirms that conclusion. In standard models, a consumption tax allows the economy to achieve the best allocation of resources over time, whereas an income tax needlessly discourages saving, investment and economic growth.”
Taxing “bads” rather than “goods” (this is an argument I find myself trying to explain a lot):
“A good rule of thumb is that when you tax something, you get less of it. That means that taxes on hard work, saving and entrepreneurial risk-taking impede these fundamental drivers of economic growth. The alternative is to tax those things we would like to get less of.
Consider the tax on gasoline. Driving your car is associated with various adverse side effects, which economists call externalities. These include traffic congestion, accidents, local pollution and global climate change. If the tax on gasoline were higher, people would alter their behavior to drive less. They would be more likely to take public transportation, use car pools or live closer to work. The incentives they face when deciding how much to drive would more closely match the true social costs and benefits.
Economists who have added up all the externalities associated with driving conclude that a tax exceeding $2 a gallon makes sense. That would provide substantial revenue that could be used to reduce other taxes. By taxing bad things more, we could tax good things less.”
From a political economy perspective, I think if the President wanted to seriously address the issue of climate change, he would introduce a carbon tax as part of a broader plan to lower taxes. I bet if sold as part of a broader tax reduction policy a lot of conservatives would come on board.
Also I was recently discussing with someone how annoying it is when people advocate a carbon tax, but don’t specify the size of the tax. I really like that Mankiw actually specifies a baseline figure of $2 per gallon making it a much more serious policy proposal.