Fairness at the Sales Tax Hearing

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At yesterday’s hearing of the Rhode Island House Finance Committee (which started with four members in attendance and reached a maximum of eight of the fifteen during the three hour meeting), the RI Center for Freedom & Prosperity presented its findings with respect to legislation that would eliminate the state sales tax, submitted by Representative Jan Malik (D, Warren, Barrington). Video of the hearing is available here.

Rep. Larry Valencia (D, Exeter, Hopkinton, Richmond) initiated an interesting exchange around the 86:15 mark on the video:

Valencia: Philosophically, what I’m coming across when I take a look at all these documents is that you feel that the income tax is a fairer way to redistribute income, and that the sales tax is immoral and should be eliminated entirely.

Without transcribing all of the responses (mainly with the message of “not at all”), the panel found the question somewhat difficult to answer mainly because none of us really view taxation from that perspective.  Fairness isn’t an economic variable, and even if it were an appropriate way to frame tax policy, the complications would make it impossible to achieve.

In the progressive view, people with more money can afford to pay more for the services that we all use, so it’s only “fair” that they do so.  Often embedded within that view is the further assumption that they are wealthier because they’ve benefited more from the system, not because they’ve put in any more effort or taken any more risk for the public good than other people have.

Once one starts imagining actual people, though, “fairness” muddies.  Firstly, we don’t all use (or want to use) government services equally.  A healthy, childless person making a fortune working from home (with a septic system and well water) in some far corner of the state hardly uses any government services at all.

Secondly, whatever one’s views on what it takes to have a high income, not having a high income is not proof of purity.  Is it fair that somebody who games the system his or her entire life rarely pays into it?

Thirdly, the earning of income creates divisions of “fairness.”  Is it fair that somebody living off a previous generation’s wealth pays less than somebody whose work, benefiting the economy through his or her expenditure of effort and talent, earns a lot of money each year?  Or is it fair that somebody who lives on peanut butter sandwiches for years while working 100-hour weeks to build a business, perfect an invention, or develop a craft (in or out of college) should be whacked with inordinate taxes the moment he or she begins to profit from those sacrifices?

The larger, more-important point, though, is that the entire premise of taxation as a way to “redistribute income” is dead wrong because it is, itself, immoral and because it creates a system of incentives that practically ensures unfair abuse of government power.

The government requires revenue to function.  The difficulty is that every tax creates incentives in all directions, and the principle is that a tax should in some way be traceable to the value that government adds.

An income tax creates incentive for the government to help its constituents increase income. However, it creates disincentive for people to work to get that income, and it isn’t at all clear (to put it mildly) what the government can actively do within its appropriate bounds to accomplish what it has incentive to accomplish.

A sales tax creates incentive for the government to make it easy to spend money on things that are taxable, as well as to find the money for that purpose.  However, it creates a disincentive (particularly at the state and local levels) to spend money where doing so is taxable.  And moreover, in the “what government can do” column, the incentives are for government to redistribute money to people who will spend it in a taxable way, as well as for them to get it on their own, including by increasing their debt.

On these grounds, the property tax appears in the best light. The government’s incentive is to make property more valuable.  Of course, that creates the corresponding disincentive for people to improve their property, although the incentive to live in more attractive surroundings is naturally pretty strong.

Most important, though, is that improving the area in which you own your property is thoroughly within the scope of government, with infrastructure, security, and other things that we consider basic government functions.  As a bonus, property taxes are more obviously the purview of local government, so to the extent that the system is property-tax-driven, government authority will move closer to the local level, where it is more immediately accountable to the people.

I offer this mainly as an example of how tax decisions ought to begin on a philosophical level. A particular state’s circumstances may make the difference, whatever the principle. A small state with wealthy neighbors, for example, should consider how tax structure affects consumer behavior.

To the extent that fairness and morality come into it, perhaps the measure should be how well we resist ideological calls and formulate an intelligent policy.



  • Mario

    I wish I could respond to this with more than a "Yes," but yes. Exactly.

    I agree that the property tax has a lot going for it, but, and I think I've said this before, switching to a land-value tax would be quite a bit better; the overall effect is similar, but you don't get the distortions in regards to property improvements.

    The sales tax is something I personally don't mind — after the land value tax, taxing consumption is the least distortionary way to generate revenue, and the distortions themselves are generally positive (inducements to save, and all that). Nevertheless, taxing consumption at the retail level, and simultaneously exempting services of all types, is highly distortionary is a ton of ways. Better would be to restructure the income tax as a progressive consumption tax and fix both at the same time — eliminate the tax on interest & capital gains, provide income exemptions for various savings vehicles (like we already do for retirement accounts, but broader), and tax the rest. Since, by definition, anything not saved is spent, all sales taxes can be collected via a payroll tax, and you can virtually eliminate the distortions created by the sales tax as is, plus some of the income tax distortions to boot.

    • Mario

      No, sorry, come to think of it, you either eliminate the interest of interest & capital gains or you broaden the income exemption to cover the investment, not both.

      [If the emphasis tag doesn't work, apologies in advance]

  • Dan

    NPRifuture editor Bob Plain is now taking potshots at RI Center for Freedom & Prosperity funding in relation to its testimony yesterday. So do we know if Plain has converted to full-blown SSDI fraud to perpetuate RIFuture's sorry existence, or is he still drawing "unemployment" while covering the state house beat as a progressive "reporter"?

  • Mario,

    I'm not so sure distortions are quantifiable in that way. A tax on land but not structures creates incentive to maximize land usage. That's not necessarily preferable. And with regard to the rationale for taxes, taxing land doesn't as directly connect with the services that government provides. An undeveloped parcel doesn't really need police, fire, water, roads, etc.

    Although, at least if we're talking property taxes, we're talking decisions that local communities can make depending on their unique character and population.

    On the rest, though, I worry that you're not adequately accounting for the politics of it all. As a starting point from which regulations and implementation will proceed, a tax policy that is clear, direct, simple, and well aligned with appropriate incentives is more important than one minutely structured not to create distortion. I also wonder if a lack of stark distortion risks the grander distortion that comes with government's being unobtrusively able to siphon a growing amount of money from the economy. (Putting the frog in the water before turning on the heat, as it were.)

  • fred floon

    Man-
    when ever you hear a Demo talking “fairness,” it’s time to grab your wallet and run.
    Fairness–just like global warming and “equal opportunity”–means giving your bucks to the democrats, who give them to the unions, who elect democrats, who vote for more taxes to give to their pals in the unions…
    I admit that’s a bit simplistic, you’ve got to have hearings in there somewhere before the taxes are raised to give the appearance of fairness. Just like Venezuela, Iran and Russia, the RI demos like the appearance of elections.
    Democrats + Unions = Taxes + Corruption
    Take that one to the bank.

    Freddy

  • Mario

    I'm willing to cede the point on fire protection, but not necessarily the others. Particularly water, where people already pay based on usage, and if your city builds a new sewer line past your undeveloped parcel, you'll pay through the nose just like your neighbors. I have a hard time coming up with a good sense of how police protection and ambulances stack up (a lot of the change would be among underdeveloped properties, not always undeveloped, and my sense is that a lot of it, in terms of straight usage, would behave more like a step function than something that could be accurately measured by housing values). The point on roads, I think, is just wrong; un- and under-developed parcels in desirable areas push people further away from where they would otherwise want to live (the dreaded "sprawl"), creating a need for more (and higher quality) roads further out, and a greater need for things like bus services. If your actions increase costs for others, I don't have a problem asking you to pay.

    I'm not sure at all about the second part. If we could design a tax system where the people didn't notice they were paying and where their decisions were exactly the same as what they would have been without the tax, I have a hard time seeing that as something other than ideal. I can see the long-term problems of a lack of incentive for the government to economize, but still… it sounds good to me.

    On the other hand, I have also always had an affinity for the type of government revenue system where the government simply accepts that it's going to create distortions, and just starts up an industry of its own, like gambling here and things like liquor stores in other states* — the end result is a system that has even greater distortions, but whose costs are concentrated on a single group of (essentially) government-designated ugly people.**

    * [The problem is that for this to work you need an industry that is currently banned (otherwise it's theft), and I think (or at least I hope) that people would not be willing to start up government-run brothels anytime soon]

    ** [Note that taxation of high-income people would not fit that description, as that has an economic impact on the entire economy, regardless of design]

    • Mario,

      1. Tiverton's "fire and water districts" are only water districts, and they charge both a property tax and a usage fee. But the point was on the principle that a tax should have some relation to the services that the government is providing to the taxpayer. The person with undeveloped land isn't using very many services. You could argue that having those services available increases the value of the land, but then I'd remind you that the discussion is between a land-value tax and a broader property tax that covers structures, too. The person with structures is likely to benefit more from government services.

      2. People wouldn't notice their paying the tax because increases would be indistinguishable from general inflation (to the degree that there's no notable and narrow disruption). My point is that it's ideal from a certain point of view, but I think it's good for people to be able to observe the causes and effects of taxation, for political reasons.

  • Warrington Faust

    Discussions of "fairness" when it comes to taxes always leave me somewhat flummoxed. The only "fair" tax is a "head", or "Poll Tax". Whoever heard of a movie theater that charged you differently based on your income, or a restaturant that charged different prices depending upon how many bedrooms there were in your house? The whole concept of "fairness", as we currently understand it, didn't arise until the invention of the progressive income tax.

  • Ummm…

    "Fairness isn’t an economic variable, and even if it were an appropriate way to frame tax policy, the complications would make it impossible to achieve."

    This type of rhetoric makes me very apprehensive.

    First of all, a blanket statement like that can easily be in the future to paint conservatives as "anti-fairness." However academically dishonest doing so may be, I can definitely see it happening, so that worries me.

    Secondly, fairness actually comes up quite frequently in economists' discussions of tax policy and I think it is often a very appropriate frame for these issues.

    For example, in my own research, an important question is "Are property taxes horizontally equitable?" A major argument against property taxes is that two identical houses may have two very different assessments (because one was on the market more recently than the other or because assessors have imperfect knowledge and limited resources, etc.) and therefore receive drastically different tax bills.

    This is, quite simply, a question of fairness. I think is a perfectly appropriate to frame it as such and I don't see what "complications" arise from that frame.

  • mangeek

    "A healthy, childless person making a fortune working from home (with a septic system and well water) in some far corner of the state hardly uses any government services at all."

    Yes, but if you multiply him by 100,000 you end up with a vast suburbia that permanently damages the ecology. He also uses several times more water, fuel, and electricity than a comparable person living in the city. Do we just ignore the 'costs' of this? This person needs electric poles and cable lines pulled miles away from their sources to accommodate him, with acres upon acres of trees felled, and his utility costs are the same as mine, where the cable needs only be drawn twenty feet across the asphalt. WHen he does go to the office, he traverses a path that costs $4 million dollars per-mile of public money to build and maintain, and he goes many, many miles.

    "…creates the corresponding disincentive for people to improve their property, although the incentive to live in more attractive surroundings is naturally pretty strong."

    For many of us, yes. But to a distant landlord or a renter, usually not-so-much.

    I like the idea of taxing property based on square footage of land, rather than the value of structures on it. Undeveloped or unoccupied land in the 'urban zones' would be penalized a bit, while the same parcels in 'suburban' or 'rural' zones would get a discount on unused space to discourage more growth.

  • Tommy See

    The only way the sales tax can be eliminated is for Smith Hill to take on the kleptocracy of the cronies and public unions (state AND municipal), the do-nothing government funded non-profits and the welfare/illegal alien industry.
    Anyone care to handicap the odds of that happening in a state where productive people are leaving by the day and Third World leeches along with their rich, white enablers-the "progressives"-are pouring in?
    LOL

  • Warrington Faust

    Ummm, To make sense of this discussion we need a definition of "fairness".

    You give the example of real estate taxes. Of course it is only "fair" that they be taxed at actual market value.

    My questions arise when I ask why is it "fair" that 50% of Americans do not pay income tax. Why is it fair that a childless couple pays more tax than a couple, of equal income. with three kids? Why is it fair that a homeowner pays less income tax than a renter of equal income.? The answer seeems to be social engineering with no concept of "fairness".

    • Ummm…

      You raise excellent questions, however, I would retort that all you've shown is that determining what is "fair" is difficult, not that fairness should be excluded from the policy discussion.

      Yours are exactly the types of questions that policy makers should be asking, not avoiding.

  • To return to your initial objection, you're making my statement mean something it doesn't. I don't dispute that "fairness" is a legitimate policy question — especially if we mean "fairness" in terms of making sure that different people pay the same rate for the same taxable situation.

    But the point remains that "fairness" isn't an economic variable. You can perhaps get there by way of likely responses (a "fairer" tax is more likely to be borne by the public and so on), but it's far from the starting question in discussing tax law. (Indeed, I'd argue that the unfairness of our current overly progressive tax structure is leading to a shrinking tax base.)

    Before you get to fairness, though, you have to ask what sort of taxes are appropriate to government and which are most practical for a given state or locality.

    • Ummm…

      Yet, in your original post, you deny that fairness is an appropriate frame for tax policy. My contention is that it is an appropriate frame. In fact, I'm not entirely sure how one determines "what sort of taxes are appropriate" without considering issues of fairness.

  • "Fairness" isn't a frame. It's a detail. When I was a carpenter, I didn't use doors as the central support of the house; I used framing lumber. Starting one's thinking by asking "what tax is the most fair" is like asking how many panels should be on a door if I'm using it to support the roof.

    Well, in political theory, what justification is there for the government's levying a tax on a particular activity or population? (Will doors fit within the walls?) What economic effect will a particular tax have? (What's the load-bearing capacity of a door?)

    How do you even begin answering whether a tax is fair before you've considered its rationale and its effect on the overall society?

  • helen

    My understanding is that people who do not pay any taxes beyond sales taxes can get tax refunds from the Federal Government. That is unfair.

    People who do not pay any taxes in our state can get and renew driver's licenses and vehicle registrations while those who are in arrears of their taxes for any reason cannot. That is unfair.

    People who cannot keep up with their property taxes lose their homes. That is unfair.

    Maybe these situations seem too simplistic,yet the conversation is about fairness.

    Forced redistribution of wealth is unfair. It hurts working class and middle class people the worst too.

  • Warrington Faust

    Helen, I think the governmental idea of "fairness" is easily synopsized:

    "From each according to his ability, to each according to his need" – Karl Marx

    That sounds like the idea behind any system of progressive taxation I have ever heard of.

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