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In this installment, I offer up for our governments a simple economic lesson in the incentive effects of taxation. It is well understood that taxes distort economic activity by driving a wedge between the value consumers would be able to obtain from a good and the cost that producers incur to make a good (maybe we’ll post that lesson some time). The magnitude of this distortion can be quite large – some estimates place it as high as 30% of the value of taxes that are collected. For example, if all governments in the US collect $6 trillion in taxes and fees, it is estimated that the economy would be $1.8 trillion poorer than compared to a world where taxes did not distort activity (the taxes themselves pose no particular efficiency problem, at least in a nice world, since they are merely transfers of resources).

Governments seem to ignore this lesson. I think a good way to teach it is to force upon governments a “tax tax.” What am I talking about? Well, I think that if elected officials wish to impose a tax structure on individuals and corporations, then they ought to be held to the same tax structure themselves as governments.

How would this work? Well, we’d create a supra-federal shell government that is responsible for collecting and administering this tax tax. When the government (at any level) collects taxes (just as when we collect income) they will be required to turn 33% of it over to the supra-federal government. Those funds will not be reimbursed back to the public because the point of my proposal series is to make these politically neutral. The funds can be used to advance long-term public goals that are outside the typical visions of politicians who must focus on the next election or public opinion poll. The construction of such an entity can be the topic of another proposal, so for now let’s just assume that troublesome part of this away.

What would this tax do? At the margin it would raise the cost of the government engaging in various activities, which should mean it would be more selective in the public projects it pursues. It also means that there will be some constituents whom otherwise would have received “free” benefits from the government to no longer receive them. But in this sense, the “deadweight loss” of this tax tax is likely to be overall welfare improving.

An additional upshot of such a tax is that at the state and local level it would serve to limit the corrosive and wasteful arms race in government spending across states that seems to be the focus of so much redistributionist rhetoric regarding individual spending arms races. For example, many states pursue program merely to improve their relative standing among the states – the classic zero sum (actually, negative sum) transaction. Therefore, according to economists like Bob Frank, it would be sensible to impose sharply progressive taxes on such consumption behavior to curb the wasteful spending, and also to dedicate those funds for a higher public purpose.

Nothing in the proposal alters the current tax structure. Nor does it advantage any one interest group vis-a-vis another. It is consistent with the Rule of Law. And governments can plan knowing this law is in place. It seems to satisfy my criteria for a sensible policy reform and it will also serve as a lesson to those in government that taxation ain’t free. Alas, this proposal is doomed for the dustbin too.

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