Untaxing the Virtues

In recent days, many Americans with one eye on the news and another on the calendar might feel that they have been overhearing a squabble between co-owners of a shop they frequent.  In a pause between hurling insults and merchandise at each other, the proprietors have agreed on one thing: sending out a timely bill to their regular customers next week.

Tax season is again upon us, which as usual prompts thought about how to reform a dysfunctional system for raising revenue, and to what larger ends.  In common with much of the world, the biggest pressure for reform involves the imperative to close crushing budget deficits.  The folly of multiple open-ended wars and a giveaway to the banks have added, in America particularly, to the fiscal indiscipline that has built up over decades.  Something will have to give sooner or later.

The form austerity takes is hardly likely to be heartening.  With the debate shaped by the usual interests of right and left, Porchers might reasonably expect the worst of both worlds.  Regressive spending cuts will cause real suffering among the least well-off, while tax rises will concentrate power further in the hands of the state.

Beyond misgivings over what solutions the polity is likely to produce, I suspect that Porchers have a range of opinions on what tax system would best reflect the sensibilities most of us hold.  As far as I know, none of us have directly tackled the issue over the couple of years FPR has existed.  The April malaise is as good a time as any to offer some thoughts about how the debate might be framed.

I want to suggest that one promising option would be what is usually called a progressive consumption tax.  But it would need combining with other incentives to strengthen civil society and encourage the decent independence of widespread ownership.  For what the political mainstream ignores, unsurprisingly, is that any change in how we raise revenue cannot be only about balancing the numbers.  It also involves judgements about the texture of society and the virtues that habits of livelihood can inculcate or destroy.  These are considerations to which Porchers are properly attentive.

The idea of a progressive consumption tax is well developed among some economists but has never been implemented.  It has much in common with proposals for abolishing the income tax and moving to a general sales tax.  Instead of taxing income–what one is paid for producing–a sales tax would tax what one consumes.  The so-called Fairtax proposal would raise all federal revenue from a 30% flat sales tax collected at the point of purchase.  Proponents argue that such a tax system would be simpler, more evenhanded, and less intrusive than the labyrinthine income tax.  By favouring savings over consumption, it would also encourage investment and long term economic growth.

Critics of a straight sales tax worry about the distributional effects.  As the poor consume almost all their income, a flat sales tax would shift the fiscal burden downward while rewarding the wealthy even more for investing.  Most proponents of a flat sales tax  build in some protection for the poor, with a “prebate” that would refund, over the course of each year, the amount of sales tax spent by someone consuming at poverty level.  The result would be modestly progressive, though the reality is that while protecting the poor somewhat, such a tax would hit the middle classes hard while making it even easier than now for the rich to accumulate more.

A progressive consumption tax would go further to address this problem.  Rather than a flat rate, it would accelerate as the individual taxpayer’s total consumption increased.  One simple way to implement this would be to have a flat retail sales tax of, say, 10%–low enough to limit the incentives for off-the-books evasion, but high enough to capture a significant chunk of the economy.  A prebate could then compensate every taxpayer for the amount of sales tax that would be paid on, say, the first $10,000 of consumption per year.  This is like the flat sales tax idea with its protections below the poverty line.  But above that level, the progressivity would kick in quickly.  The rates on income would increase steadily, minus whatever unlimited deductions one could claim for any form of savings or investment.  Someone who brings in $500,000 a year and spends all of it on riotous living would pay stiffly for doing so.

By shifting the tax burden to consumption, this would have the claimed advantages of favouring long term economic growth.  But it would also have other, deeper effects on society.  It would bring some healthy pressure to bear against modern consumer culture.  As Cornell economist Robert H. Frank has suggested, a progressive consumption tax would dampen upscale profligacy and work against what he calls an “expenditure cascade.”  This pernicious effect of growing inequality means that as the wealthy bid up the image of a desired prosperity, the middle classes distort their own spending habits to keep up with them, contributing to the unsustainable burdens of consumer debt.  McMansions and SUVs become the addiction of choice.  However modest the effect, a pushback against consumption for its own sake and some incentive to frugality would send cultural signals congenial to many of us on the Porch.

There would still be distributional concerns, however.  The leeway to save, and the incentive to do so, would still be much greater the higher up the income scale one goes.  Long term concentration of wealth would intensify, therefore, unless other countervailing pressures were built in.  Given the distributist leanings of most of us, such pressures would be desirable.  Further surtaxes on very large incomes or patrimonies could always be left intact, of course.  The likes of G.K. Chesterton and Hilaire Belloc did not hesitate to say that accumulating property should be made easier at the bottom and harder at the top.  Any clear vision of a society more decent than the present one should have some image of widespread ownership.  Such a goal need not mean arbitrary, heavy-handed redistribution.  But it should involve the political will to create the conditions such that widespread ownership is more likely than not to emerge organically.

But having to fall back on conventional surtaxes might be a blunt instrument, and best bracketed if we can find a better solution.  If we are serious about strengthening civil society, there are other supporting features of this reform that could deal with many of the distributional issues at the same time.

Most of us are rightly suspicious of the excesses of both top-heavy states and soulless markets.  Removing many aspects of life from their domains is instinctively appealing.  The vast share of national economies channelled through the state as taxation and expenditure is, at most, a necessary evil.  Its necessity is open to debate, but the nature of that necessity usually hinges on three arguments.  First, the state might need resources to provide goods and services that otherwise would be supplied inadequately or not at all.  Second, the state might be the most reliable provider of a safety net.  Third, transfer payments from rich to poor, mediated by the state, might be the only way to moderate heartless plutocracy.

But allegedly necessary evils are avoidable if they turn out to be, or can be made to be, unnecessary.  If civil society can provide such services and safety nets, and if the framework of economic behaviour deconcentrates wealth somewhat as part of its normal operation, then the state’s footprint can shrink.

Tax reform is one way society can make deliberate choices, and send signals, about channelling resources.  Alongside the deduction for savings and investment, such a reformed tax system could also allow taxpayers to divert some meaningful share of their tax bill as a contribution to existing civil society organisations, or to use as seed money for new ventures.  This would be more than just the tax deduction we now get.  Up to the maximum, it would be a one-for-one reduction in the tax bill itself, or even more if one wanted to strengthen the signal.  Such an incentive would have powerful redistributive effects at the top where the marginal tax on consumption would be high.  It would force choices about where to donate, thus driving home the social function of wealth in the psychology of the most prosperous.  Even at the bottom, requiring some choice about where to allocate a portion of one’s tax bill would have salutary effects on the citizenry.  The point is not merely that if one exempts the poor from all taxes, they will imagine government is free—the all too easily made point by many policymakers on the right.  Rather, forcing some reflexion about civil society and what one finds worth supporting would broaden everyone’s horizons.  This is much as John Stuart Mill suggested about expanding the franchise in the nineteenth century: give the humblest person something bigger to think about, and he or she will start thinking bigger thoughts in general.  The psychological effect would dovetail with a massive increase in the amount of resources flowing into civil society.  As functions were demonstrably taken over, probably with greater success, the state’s burden could shrink.

So far I have focused on some more or less static choices.  At any given moment of policymaking, we must decide how to extract resources from society and where to channel them.  But to influence the texture of society more profoundly, I would add to this framework a longer term political pact.  I have often wondered why no one raises an obvious response, whenever some politicians bandy about, for nefarious purposes, dire claims that society cannot afford one or another good.  Such figures are often incorrigible optimists about economic growth in general–contradictory though it might be for them to hold both views at the same time.  Just as with individuals, a society should find it easier to make commitments out of future income growth rather than as present trade-offs.  In keeping with the scepticism about consumerist excess, it might make sense to think of a policy framework that would allocate only a third or so of future per capita income growth to increasing consumption in the conventional market.  The rest–one third each–could more healthily go to improving certain kinds of safety nets and the share of time devoted to leisure and voluntary activity.  This is an abstract figure, of course, but could translate into real policy priorities that feed back into how we raise and spend revenue.

Take the one third of future growth allocated to the safety net, for example.  I mentioned earlier that to compensate for the flat sales tax component of the progressive consumption tax, everyone could receive the “prebate” at poverty level.  For a variety of reasons, many of us might have misgivings about such cash handouts.  An alternative way of paying the prebate could be as a voucher that would have to be used for buying some sort of insurance–most likely basic medical coverage, given the attention it has got lately, though it could include other sorts of protections against disability or the like.  The amount of the prebate would likely be modest enough that it would not provide enough coverage to satisfy even the poor.  But rules could force one to use it to buy one or another discrete product rather than just to subsidise what is now available on the market.  It would force would-be providers of insurance to innovate and offer something at that modest level, even if consumers would then buy other products on top of it.  Incentives could favour nonprofit, mutualist providers of such coverage, thus strengthening the social market sector rather than merely giving another handout to corporations.

Here the long term political commitment about future growth would come to bear.  While modest at first–an injection of funding to the bottom of the market and an incentive for certain types of market actors to innovate–that prebate-voucher could grow over time.  A third of future per capita income growth going into it would impose no new fiscal burdens in an absolute sense, but would add massive amounts of resources over a generation or so.  It would allow a gradual and organic increase in funding that over time would likely displace much of both the state-run safety net and the narrowly for-profit insurance market.

The point of such displacement is not to throw people mercilessly on their own resources, as the libertarian Charles Murray has advocated for the last three decades.  He has suggested, in all apparent sincerity, that America’s weak safety net compared to Europe builds character.  There are grains of truth in anything.  I suppose that under the right conditions–which are unlikely to obtain in the world of the American Enterprise Institute and its fellow travellers–a smaller state footprint might well expand room for civil society.  But in any broad perspective, a late capitalist rat race with a sorry excuse for a safety net does not build character in any desirable sense.  To be sure, it does energise.  What it does not do, from what I observe in America or in an even more perverse form today in urban China, is elevate human aspirations.

What I suggest would be more likely to do so, precisely because it tackles several dimensions at once.  The straightforward libertarian proposal would surrender too much to the conventional market and hope that civil society benefits as a byproduct.  This framework, in contrast, would couple every rollback of the top-heavy state to a corresponding increase in resources flowing through civil society.  It would also design incentives, for individuals and for social entities, around an explicit vision of human flourishing.  The linking of the prebate and a certain kind of safety net, which would become more generous over time, is a case in point.  It would take seriously the perils posed by present-day economic risks to both human dignity and to widespread secure ownership.  The greatest threats to the so-called ownership society in America are not, as many on the right would have it, taxation of dividends and capital gains.  They are medical bankruptcies and nursing home expenses.  At the same time, what I propose would favour decentralised ways of dealing with such risks, and conscious choice among options rather than passive dependence on the welfare state.

Finally, civil society requires time, not merely a flow of material resources.  I suggested above that a third of future income growth could go to reducing work time.  This would increase leisure in general, but with special emphasis on encouraging unpaid voluntary work and a broadening of fulfilling human activities.  On a more modest scale, this is the hunting in the morning, fishing in the afternoon, rearing cattle in the evening, and criticising after dinner that a certain bearded malcontent in the nineteenth century once reasonably expected would come with universal prosperity.  In the 1960s, many similar predictions were made that rising productivity would halve the work week by now.  This did not happen, of course, largely because any practical measures to make it so would have involved abrupt adjustments in the labour market.

Taking this reduction of paid worktime in the market out of future economic growth gradually, at the one-third rate I mentioned, might be politically more realistic.  Concretely, what would this shift look like over thirty years?  A generation hence, the American work week would shrink to around thirty-five hours, or annual vacation could grow to around seven weeks.

The policy pressure points for converting growth into worktime reduction are rather more complicated than with the safety net or civil society, however.  Some of the shift could happen naturally as a byproduct of changing habits and the balance of power in society.  Dampening material consumption by taxing it more would be likely to encourage a healthier work-life balance.  A more generous safety net of the right kind along with more widespread ownership of income-generating assets would also increase the bargaining power of employees, letting them extract concessions on working hours over the long term.  The shorter work week in Scandinavia compared to equally prosperous places like America and South Korea is no accident; it reflects market power as well as policy.  Unlike in the increasingly burdensome European model, however, what I emphasise with civil society and decentralised provision of the new safety net would be a much more sustainable way of getting to such work-life balance.  Rather than relying on the blank cheque of public debt, it would have to be actuarially sustainable to work on a voluntary basis.  It would also be diffuse enough in its operation to be less vulnerable to rollback on a whim by future governments.

These are, of course, only some fairly abstract proposals.  My broader hope is that by framing the problem of fiscal sustainability around choices about virtue and the texture of society, we can open a debate that goes beyond the usual narrow opportunism of the mainstream.  How we appropriate resources and allocate them is of far more weight, over the generations, than the political theatre of who is going to foot the bill for past profligacy.