Fiscal Summit - Tax Policy

The Summit that will convene on Monday, and the first Obama Administration budget that will be released on Thursday are very important steps. First, we must realize the inherent unreliability of budget projections and estimates because almost no one knows that exact trajectory the economy will follow.

That said with governments (especially our's) borrowing so much money, it is important that policy makers send a strong signal that in the medium and long-term we are taking important steps to sure up our fiscal situation. Our AAA credit rating and our ability to borrow unlimited amounts in the short-term will be buoyed by our strong sign about future fiscal responsibility.

The Presidents main proposals seem to be income tax hikes on those who make more than $250,000, estate tax hikes on those who inherit more the $3.5 million, and ending the wars in Iraq and Afghanistan.

Although I think these things are necessary, I think the whole tax code needs to be reformed in a way that tax things we want less of and cuts taxes on things we want more of. I have some suggestions for the Obama folks such as:

- Institute a Carbon Tax: Many think $90 billion can be raised, I think we should raise about $250 billion by taxing carbon.

- Cut and Raise the Payroll Tax: Many conservatives say 40 percent of income earners do not pay taxes, not true they pay payroll taxes on up t0 $106,800 in income. First, broaden the base, every dollar in earned income should be subject to the payroll tax. Second, cut the rate. Right now the tax rate on Social Security is 6.2% for the employee (and the employer). The Carbon tax and the broadened base should give the leeway to cut the rate to about 4 or 4.5%.

- Institute a National Consumption Tax: Some estimates show that a consumption tax would raise about $100 billion for every 1% of taxation. Once we are back at full employment in 2011 or so, we can apply this tax at 1% then have it increase at 1/2% per year until at 2%, meaning by 2013 it will be bringing in about $200 billion per year. At that time the FED will think we need to start applying the breaks (because inflation will be a worry again - wont that be nice), they can take a longer lag while raising interest rates, because the consumption tax will have similar contractionary effects on the money supply. The concerns with a consumption tax is that it is regressive, so policy reform (like increases in the EITC, TRA, etc) will have to take place to compensate those hurt most by the tax.

There are a number of benefits. One, above there is mention of it as a countercyclical measure to help supplement FED action. Two, is the additional revenue. Three, it will be a measure that will spark more savings and an increased national savings rate - something that needs to be closer to the 7% of the early 1990s than the 0% of the preak houseing bubble years. Four, it can be changed to help affect the savings rate. Five, when the country goes through a tough reccession like the one we are going through now, cutting it will be a very simple first line of defense as stimulus.

- Cut Income and Capital Gains Taxes: As of right now, the income tax brackets in this country are as follows. For the bottom two brackets I propose that they be combined and turned into one 8% tax bracket. (this is less appealing and less important than payroll tax cut but it is important none-the-less)

- Raise Capital Gains Taxes: This above cut in the bottom two tax bracket should be combined with a change in the way we treat capital gains. All capital gains should be treated just like regular income. So, just like in Great Britain the two forms of taxation should be the same. This means all income would be taxed at income tax rates, including capital gains (this solves the carried interested problem we have when taxing hedge fund managers). The only exception will be that when people take their money out or retirement accounts at 59 and 1/2 the first $100,000 will be tax free (and have a yearly inflation adjustment), and every dollar after that will be taxed at 15% up to $500,000, and every dollar beyond that will be taxed at 25%. *Don't forget Roth IRAs are tax free.

- Raise the Gasoline Tax: A carbon tax will good, but it will be incomplete. Why not tax gas a little more? Or maybe a congestion tax?

- Raise the Alcohol and Cigarette Tax: We want to tax things we don't want like drunk drivers and lung cancer. Need I say more?

- Raise or Institute a Sin Tax on Certain Foods: I don't know that it is our place to do this, but creating a disincentive for kids to eat ice cream is probably a good idea considering the childhood diabetes rate around 2%.

As far as long term trajectory, I think that we need to continue to tax things we don't want and cut taxes on things we do want. Eventually, I would like to see much lower income, payroll, and capital gains tax rates (and these areas as a lower part of taxes as a percentage of GDP).

My hope is that over the next ten years the Carbon Tax will be massive to contain global warming and act as the tool of the second Great Compression (along with the other ideas), spurring on another era of a large middle class society.