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Brooks Wilson's Economics Blog: Three Tax Proposals

Tuesday, May 12, 2009

Three Tax Proposals

Next year's budget deficit is projected to top $1.2 trillion, an ocean of red ink.  Putting aside the merits of a fiscal stimulus during a prolonged recession, budget deficits are a perennial problem because of perverse incentives faced by members of Congress and their constituents.  Using the House of Representatives as an example, nearly all the benefits of a project are collected by those living in a district while the costs are distributed more evenly between all 435 districts.  So long as a project has $1 dollar of benefit locally to $435 of cost nationally, a congressman will support it.  The story in the Senate is only slightly better where a senator has incentive to vote for a project if it has $1 of benefit in her state to $50 of cost nationally.  Stevens' bridge to nowhere and Murtha's airport to the same location illustrate the problem as does the resistance to President Obama's announced plans to cut a miniscule $17 billion in expenditures.  As voters, we experience the same perverse incentives.  How many times have you heard someone say, "I don't agree with many of my congressman's positions but he really brings home the bacon”?  We love pork spent in our districts but we hate it spent in other districts.  I am proposing three rule changes that would alter voter and representative incentives.
The first proposal is based on the benefit principle of taxation, the idea that those receiving the benefits of expenditures should pick up the tab. The income tax code should be modified to reflect expenditures in each congressional district. The modification should make the tax structure less progressive.  If a congresswoman brings home twice the average level of expenditures, her constituents’ tax rates should be twice the average. A natural constituency opposing wasteful spending within each district would quickly materialize because the constituents would now pay for the pork.

The second proposal is to broaden the income tax base and increase its progressivity as expenditures decline as a percentage of GDP. While the first proposal would reduce the unequal distribution of pork between districts, it would not be as effective at reducing the size of government. It is important to inhibit the growth of government because economists generally agree that big government is bad for economic growth. By broadening the tax base to include all income earners, the proposal would give all an incentive to only support valuable spending. The proposal makes both parties pay for something they want with something they don’t. Democrats, who traditionally support a larger role for government, would have to pay for it with a less progressive tax code. Republicans, who traditionally support a smaller role for government, would pay for it with a more progressive tax code.

The third proposal has been floating around for years and is aimed at reducing deficit spending by automatically raising tax rates annually after three periods of consecutive economic growth if the federal government is running a budget deficit. The rates could be raised to close 25% of the projected deficit. Tax rates could automatically fall after one quarter of economic decline building in an automatic fiscal stabilizer.

While all proposals for tax reform meet resistance, these proposals will have natural constituencies. First, it would have support in 50% of the House districts that receive less than average expenditures. It would have support of Republicans that truly believe in small government in theory, but work within the current perverse incentive system that rewards representatives who bring revenues into their districts. Finally, it would gain the support of some Democrats who think that a progressive tax code is more important to economic equality than big government.

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