Thoughts on economics and liberty

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The case against the flat tax

 

I advocate a slightly graded but clearly progressive tax, based on first principles.

However, to get this argument accepted, it is also perhaps necessary to demolish the imposter that has emerged in the last few decades and threatens to swamp liberalism. Regrettably, Hayek himself has added to the confusion on an inappropriate ground, even as he acknowledged the need for at least two levels of progression (one, because of the social minimum; the second, to offset the regression of consumption taxes). Hayek makes one very good point against progressive tax, though. That must be taken into account, and that is why I argue for a very slightly graded progressive tax.

I argue the case for progressivity  separately. This blog is tries to argue the case against flat tax.

This is work in progress and so the stuff provided here will change. The arguments are listed in no particular order. The only reason why liberals can reach two views on any issue is if their assumptions are different or one persons’ logic wrong. In the case of flat tax, it is clear that assumptions of flat-taxers are questionable.

No link of flat tax with the theory of the social contract
The argument for the flat tax has no relationship to a social contract designed to defend life and liberty. One needs to make the necessary link between the state as monopoly, the social contract and the tax system. I’ve yet to see the linkage drawn by any thinker between the inevitable necessity of a progressive tax once we have a monopoly government (Leviathan). A social contract will need to be strategic and just; balancing out responsibilities of participants in their ability to bear these responsibilities. Anything else will ultimately fail as the society slowly but surely converts into a feudal society

Flat tax violates Economics 101
It violates Economics 101, basically violates the diminishing marginal utility of income. This validity of the diminishing marginal utility curve is demonstrated by the simple fact that the solution to the incentive problem in firms has been to increase salaries disproportionately with seniority. That is why CEOs are paid 100 times more than a business analyst. Without paying disproportionately more, sufficient incentives aren’t created for harder work, as the value of money keeps declining. Even the most basic experimental economics proves the existence of the diminishing marginal utility curve.

Note that the rich will never fight wars for their nation. They always leave the dying and bleeding to middle class soldiers and armed service officers. The progressive tax makes sure that the rich – who never pay with their lives for their country – compensate at least by paying a bit more through progressive taxes for their safety and for the upkeep of their nation. They live the cushiest lives. No dirt, no sweat, no blood. We all work hard for them. There is therefore no reason why an army officer must pay 30% tax on income and Ambani must pay 30% as well. The flat tax is purely a whim of the rich and upper middle classes to trick the poorer and lower middle classes into not only slogging for them and shedding their blood for them in war, but also paying for their upkeep! Very clever sleight of hand! Indeed, as I show elsewhere, not only will flat taxes shift the burden to the poorer sections, they will hit them with a much higher tax bill! Great way to give the future generations of Ambani a great free ride.

The flat tax debate takes us away from the key issue that we should pay as low as necessary to get the best government services we need
I’ll let Murray Rothbard speak on my behalf. ‘The flattax movement is part of a process by which the government and its allies have been able to split and deflect the tax protest movement from trying to lower the taxes of everyone, into trying to force everyone into paying some arbitrarily defined “fair share.”’[1]

‘Thus, let us compare two hypothetical tax systems. In system A, there is a progressive income tax, ranging from one to ten percent. In system B, everyone pays a flat, strictly proportional income tax, of 20%. I have a hunch that, in choosing between these systems, even the upper-income groups would opt for the far more progressive, but much lower tax burden. The central point is the lowness of each tax, rather than the distribution of the burden.’[2]

Now let C. Lowell Harriss speak: ‘Clearly, the present system, with federal plus state rates of over 50 per cent at the margin, must deserve criticism. Significant rate reduction, however, does not require a shift to a single rate’[3]

Murray Rothbard again: ‘One of my favorite economists, the 19th-century Frenchman, J. B. Say, after pointing out that taxation is a coercive transfer from individuals and groups to the government, crippling their ability to produce and consume, concluded: “The best scheme of finance is to spend as little as possible; and the best tax is always the lightest.”’[4]

There is nothing in the progressive model that says one can’t flatten and reduce tax rates overall (that is why tax revenues go up in some cases where flatter taxes are introduced, due to the Laffer curve argument – but also by slugging the poorer for greater share of taxes – not because of the flattax per se). I have nothing against a modest progression, and one that kicks in strongly after a much flatter range, with only the richest required to pay the highest marginal tax. Also, no one is saying the highest rates must be 90%. 40% is more than enough (current highest slab in Australia is ; even less is fine depending on what a government needs. But there must be progression. That principle is crucial to a free society where everyone behaves responsibly as a citizen. Everyone who can afford to must contribute as a citizen and not free ride on the poorer sections of the community who are hit hardest by flat tax which is essentially regressive.

The flat tax is essentially progressive, but the flat-taxers don’t explain why!
No one has ever proposed a genuinely flat tax. They are all degressive taxes, with at least two taxthresholds, zero up to a particular amount, and then flat thereafter. (J.S. Mill first proposed this model which calls for zero or negative taxation till a particular point, followed by flat tax).
What justifies this? The flat tax must be purely flat (assuming it has any logical sense at all!). Why is it progressive? And if it is to be ‘slightly’ progressive, why is it progressive at all? What is the justification for that? How do flat-taxers justify this abrupt progression?

Now, I’ll let Murray Rothbard speak:

“The flat tax, quite simply, proposes that every individual and every organization be subjected to the same, uniform proportional income tax. To achieve that uniformity, the flattaxers propose the ruthless suppression of all credits, deductions, exemptions, and shelters, all of which are sneered at as “loopholes” in the tax system. In the flat-taxers’ pure theory, the proportional income tax would apply to everyone regardless of income. But early in the development of the flattax movement they decided that, politically, the poor would have to be exempt from the tax. As a result, all flat taxschemes are now “degressive”: proportional above an arbitrary minimum income floor, below which line income receivers pay no taxes, The “degressivity” leaves an important element of progressivity in what has been touted as a strictly proportional plan.”[5]

To remain revenue neutral, the government would heavily slug the working classes

“Under any conceivable shift to a flat-rate system, the total tax of the highest income groups would be reduced.”[6] The only way to fix this would be by significantly raising the taxes on those who currently pay a lower rate.

Flat tax would allow a larger number to live off the labour of workers

Flat tax would definitely lead to a ‘number of families living very well indeed on inherited wealth as distinguished from income from their own industry and thrift. Desirable?’[7]

The pathetic argument of ‘fairness’
Our personal perceptions of fairness are totally irrelevant to policy discourse. We need to root our policies in a consistent theory of the free society. So if the state we create through our social contract is a monopoly, and it is best that a monopoly price discriminates, and also that marginal utility of money falls dramatically, then there must be a proof that the flat tax model is the necessary outcome of this model.

I’ll let Murray Rothbard speak on my behalf. ‘The major argument for the flat tax is not economic but moral, namely that this is the only fair way to distribute taxation. The assumption is that, given an arbitrarily determined total revenue to the government, that revenue should be distributed in a uniform, flattax manner. But the flat-taxers do not really argue their point; they simply assume it as self-evident to all people of good will. Well, sorry, but I don’t see it.’[8]

‘More specifically, I don’t see why proportional taxation is any “fairer” than many other possible patterns of distribution. Take, for example, Mr. A and Mr. B, each of whom earns a net income of, say, $50,000 a year But Mr. A is a young man, just starting in life, with virtually zero assets. He depends on personal savings to finance a future business. Mr. B, on the other hand, is an older man who has already built up or inherited millions of dollars in assets. Why is it manifestly fair for him to pay the same tax as Mr. A? Neither is it obvious to me that a sick person with heavy medical bills should pay the same tax as a healthy man with the same income. Note that I am not saying the opposite: I am not advocating a tax on health or on wealth. I’m simply saying that there seems to be no convincing argument for the fairness of one pattern of taxation over another.’ [9]

‘In fact, I will go even further, and say that fairness has little or nothing to do with the matter, that, in fact, TANSTAAFT (“there ain’t no such thing as a fair tax”). Conservative flat-taxers like to analogize to the free market, and maintain that they are trying to achieve neutrality to the market. But consider: what in the world is a “fair” price on the market?’[10]

The nonsensical ruse of simplicity
Tax system complexity NEVER arises from the 2-3 marginal rates that form part of the progressive system, but from the identification of income. The arithmetic of calculating tax is the least important part of the tax return calculation. Anyone who has passed primary school can do it. And if one can calculate a flat tax based on a standard deduction, so can one calculate a progressive tax.

The flat tax does NOT mimic the market
I’ll let Murray Rothbard start the ball rolling on this: ‘The flat-taxers have strongly implied that, in contrast to the progressive tax, the uniform proportionate tax is neutral to the market—for the market would pay in this way for the services of government. But would it really?’[11]

However, Murray Rothbard’s rhetorical answer (see his actual paper) to this question only covers a small part of the reality. Yes, the cost of a bread is the same (not proportional as flat-taxers want it to be), but the reality is that markets set a range of prices for the same good which is cosmetically different – that is called price discrimination. It is a fundamental feature of all markets. I have a Toyota Avalon with the same chasis and engine as a Lexus, but with cloth fittings instead of leather. Put in $2000 leather seat covers, a few other minor tweaks and the same car is sold for $40,000 more!

Conclusion
An FTI member wrote: “This model [flat tax] would hold taxes steady at current levels or lower them as appropriate, while making the govt expenditure more efficient and market-driven. Such a model would seek to maximise efficiency, at the least cost.”

As shown above, all claims made in this regard are wrong. But since when is efficiency the objective of freedom? And efficient for whom? Are we talking Pareto efficiency? Then the price discriminating monopoly model is most efficient. Are we talking ease of collection of taxes? Then socialism is most efficient. It can be (really!) efficient [ie. cheap; quick] to sell all of Bill Gates’s assets now that he is no longer Chairman of Microsoft and get the taxpayer $50 US billion. Thus it can be really efficient to confiscate all the wealthy. The liberal wants to maximise equal freedoms subject to accountability, not to achieve efficiency. Efficiency is one of the many minor issues to be considered, but can’t drive our fundamental theories.

[1] The Case Against the Flat Tax by Murray Rothbard [http://mises.org/rothbard/flattax.pdf]

[2] The Case Against the Flat Tax by Murray Rothbard [http://mises.org/rothbard/flattax.pdf]

[3] C. Lowell Harriss, ‘Important Issues and Serious Problems in Flat-Rate Income Taxation’, American Journal of Economics and Sociology, Vol. 43, No. 2 (Apr., 1984), p. 161.

[4] The Case Against the Flat Tax by Murray Rothbard [http://mises.org/rothbard/flattax.pdf]

[5] The Case Against the Flat Tax by Murray Rothbard [http://mises.org/rothbard/flattax.pdf]

[6] C. Lowell Harriss, ‘Important Issues and Serious Problems in Flat-Rate Income Taxation’, American Journal of Economics and Sociology, Vol. 43, No. 2 (Apr., 1984), p. 160.

[7] C. Lowell Harriss, ‘Important Issues and Serious Problems in Flat-Rate Income Taxation’, American Journal of Economics and Sociology, Vol. 43, No. 2 (Apr., 1984), p. p. 161.

[8] The Case Against the Flat Tax by Murray Rothbard [http://mises.org/rothbard/flattax.pdf]

[9] The Case Against the Flat Tax by Murray Rothbard [http://mises.org/rothbard/flattax.pdf]

[10] The Case Against the Flat Tax by Murray Rothbard [http://mises.org/rothbard/flattax.pdf]

[11] The Case Against the Flat Tax by Murray Rothbard [http://mises.org/rothbard/flattax.pdf]

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India needs political reforms, not a presidential system

Sanjeev Sabhlok

(Sent to Times of India in early 2008. Not Published. Hence published on internet – now published on my blog for completeness)

A question is raised periodically in India about whether a presidential system will work better for us than our current Westminster model. This is a legitimate question given that we have some of the most corrupt politicians in the world.

I propose to make a few comments regarding this debate recently revived by Mr. Shashi Tharoor. My comments are based on the experience of working with ministers within two Westminster democracies, the Indian and the Australian. I propose to show that the performance of India’s current system can be significantly improved, and therefore a presidential system should be ruled out, at least for now.

Our quality of governance is determined by the kind of representatives we elect. The mere form of democratic representation, whether Westminster or presidential, whether proportional or first-past-the-post, doesn’t seem to matter so long as good people are able to get elected. By ‘good’ I mean people who are honest, ie. do not use corrupt money in their election campaigns or lodge false accounts of election expenses, are and competent, ie. knowledgeable on policy matters.

Two democratic frameworks which look alike on the surface can lead to dramatically different outcomes based on whether they can attract good people to politics or not. A comparison of the performance of the Indian and Australian systems is a case in point. While the Australian system elects brilliant and honest representatives, the Indian system largely elects incompetent and corrupt representatives. I say this from direct observation of ministers during my working relationships with them in these two countries.

Indeed, I would suggest that the Indian system actively prevents honest candidates from contesting elections. For example, a candidate in India loses the money spent on an election campaign since there is no reimbursement on the basis of votes polled. India also pays its representatives a salary that is too low to attract talented and knowledgeable people to politics. Therefore, the numbers don’t add up, and it is primarily the morally challenged, imprudent, and incompetent Indians who participate in politics.

Our real problem, therefore, is that our Westminster system produces extremely low quality representatives, even though its Australian counterpart is able to produce outstanding results. Why is this so? I attribute this to three design features in the Australian and American systems that are not found in India. First, these countries do not have election expense limits. This allows for complete transparency in fund raising and expenditure; there is no incentive to lodge false statements of electoral expenses. Second, their governments partially reimburse election campaign expenses. The Australian system pays for each valid vote cast. Third, successful representatives are paid salaries comparable to what senior managers in the private sector get.

These design features enable thousands of good people to join politics in Australia and the USA. Citizens of these countries are spoiled for choice. By adopting similar practices, India will also be able to attract thousands of currently disenfranchised good people to politics. That will mark the dawn of a completely new era for India, an era of honesty and competence in public life that we have never experienced in sixty years.

Discussions on the presidential system should therefore be put on hold and the focus shifted to reforms of the current system. The reforms needed include the three reforms suggested above, as well as others I have outlined in a forthcoming book. These reforms should be easy to implement, at least compared with moving to a completely new system of representation.

Of course, one reason why these reforms won’t be implemented is that many current politicians will lose their seats if they allow good people to enter politics. That does not mean the presidential system will do any better. The same resistance to let good people enter politics will mean that when a presidential system is introduced, our most corrupt politician will become President.

The author, a former IAS officer, now works in an Australian state government.

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Monthly articles in Freedom First – completed, and proposed

Subscribe to Freedom First

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My articles published in FF so far

2008

2009

2010

Proposed further articles

At this stage I decided to pause writing for FF and move into the blog on a more active basis. Should I find time to do so, I'll write on the following subjects:

 

  • Leadership in politics
  • Industry policy (that there should not be a policy)
  • Arts and archeology policy [the value of social cohesion, including +ve externalities of bollywood and cricket]
  • Alcohol and drugs policy
  • Sports policy
  • Physical infrastructure policy 
  • Transportation policy (roads, rail, etc.
  • Energy policy
  • Water policy
  • Space and nuclear policy
  • Trade and commerce policy
  • Urban planning – a detailed article
  • Defence policy
  • Justice system reforms

Sanjeev Sabhlok

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Synopsis of "Breaking Free of Nehru"

The book discusses the impact of Nehruvian socialism on freedom in India. It reflects on Indias post-independence experience and finds that India needs to move well beyond socialist paradigms towards freedom and innovation if it wishes to retrieve its status as a great nation.

It then traces the causes of India’s political and bureaucratic corruption, its poverty, and its large, illiterate population. The book then proposes numerous ways to transform India’s governance thorough competitive, freedom-based, solutions.

Solutions recommended range from a re-write of the Indian Constitution in order to make it simpler and clearly focused on freedom, to the radical restructure of the Indian public services based on modern public sector reforms across the world. It advocates state funding of elections, raising the salaries of politicians significantly, freeing the labour market, imposing carbon taxes on pollution, seeking compensatory payments from developed countries for their prior carbon emissions, and complete privatisation of school and university education.

It argues that India can, and should, aspire to be the worlds best in everything it does. I believe that no Indian should settle for anything less than that.

REQUEST

My ‘business’ model for this book is to supply it freely on the internet for wider dissemination of the message, and to hope that someone will find it worthwhile to print and distribute this book cheaply in India. I’d therefore request you to review this book on your blog and to send out the link to the book to your friends.

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