CAPITAL, AN ELUSIVE TAX OBJECT AND IMPEDIMENT TO SUSTAINABLE TAXATION.
INTRODUCTION 626 I. TAX SORTING AND SUSTAINABILITY 630 A. Tax Subsidies 630 B. Non-Revenue/Subsidy Functions 632 II. INCOME TAX INFRASTRUCTURE AND NON-TAX PURPOSES 636 III. BROAD TAX BASES FOR A SUSTAINABLE TAX 638 IV. THE CAPITAL CONUNDRUM 648 A. Periodic Income 648 B. Capital Gain 649 C. Changing the Base and the Conversation 652 V. CONCLUSION: A SINGLE SUSTAINABLE INCOME TAX 655 INTRODUCTION
A well-functioning tax system is critical to a well-functioning society, but a tax system cannot operate efficiently if it is unfair. Any tax system that does not distribute its burdens fairly will have hostility rather than support from its taxpayers. Complexity opportunities for some to capture unintended tax benefits, and perceptions that tax distribution is not even-handed contribute to dissatisfaction with taxes and active tax avoidance and evasion. (1) Avoidance and evasion threaten tax systems. Constant change to control the threat characterizes many existing systems. Much of the threat comes from the affluent. Affluent members of society have the mobility to take their capital and go elsewhere, depriving their home country of capital resources. They demand a decrease in tax on capital, and taxes on less mobile labor must increase to make up the shortfall.
Sustainable taxation requires stability and predictability. Sustainable taxation is a tax or taxes that collect sufficient revenue to support the governmental goods and services a society needs and wants. The taxes must provide for: 1) even-handedness--something akin to horizontal equity; (2) 2) distributional fairness--a concept emerging from notions of vertical equity; (3) 3) transparency in application so that the populace understands and accepts the tax and the need for it; and 4) collection mechanisms that do not favor some societal groups, especially those with resources to secure creative tax advisors, over others who lack the resources. Narrow base taxes--fuel, alcohol, tobacco--cannot meet these criteria and the broad base taxes currently applicable--value added, payroll, and income--also fail to meet one or more of the criteria. While specialized taxes like environmental taxes and sin taxes--alcohol, tobacco--serve useful regulatory functions and may achieve their behavioral objectives in part, they do so primarily by increasing the cost of engaging in the undesirable behavior and pricing some actors out of the activity. Using a pricing rather than a direct regulatory mechanism, the specialized taxes change the conversation from social rejection of the behavior to acceptance as long as the actor is willing and able to pay the high price. Is it all right to pollute if one pays to do so? (4) Direct regulation might prove less regressive and less likely to be viewed as simply a matter of price and more as a matter of societal mainstream and commitment to addressing a problem.
To secure sustainable taxation this Article recommends a non-preferential income tax on a comprehensive income tax base. While by no means a new idea, (5) the growing resource disparity between affluent individuals and individuals with limited resources renders the idea of a non-preferential income tax on all income including realized and unrealized gains all the more compelling. This Article outlines a method for transition to the recommended tax base from the current realization-based tax base and suggests that in limited cases a taxpayer might defer payment of tax on some items of income but not defer inclusion of the items in the tax base. As it describes its tax plan, this Article reflects on the objectives and shortcomings of the targeted taxes and purposive tax base modifications that have proliferated during the 20th century. This Article concludes that a non-comprehensive tax base may accomplish narrow objectives successfully but is unlikely to become functionally sustainable to support essential governmental goods and services. (6) Neither are targeted taxes nor purposive tax base modifications fully justifiable. They are likely to distribute tax burdens unevenly among taxpayers without any compelling reason for preferring some taxpayers to others. The narrowness of the base of such taxes frequently leads to regressive tax incidence.
Some taxes serve a predominantly political objective, others a behavioral one. Their proliferation may target narrow, albeit pressing, issues such as environmental degradation; (7) others may support targeted economic development. (8) Yet, even carefully crafted, socially desirable, and focused tax choices distract and occasionally misdirect political and social attention from more durable solutions that may lead to long necessary, broad, and sustainable tax reform. Beneficent tax provisions targeting critical issues often burden those with limited resources disproportionally relative to the burden on those with greater resources. Even when Congress chose to make healthcare insurance a substantially universal requirement in the United States, it used the tax infrastructure to support that requirement. Individuals who fail to buy health insurance must make a shared responsibility payment collected through the income tax but not enforced with penalties for failure to file or pay. (9) In National Federation of Independent Business v. Sebelius, the U.S. Supreme Court held the Affordable Care Act to be constitutional and the payment supporting the healthcare mandate to be a tax despite it applying narrowly only to those individuals without health insurance. (10) The Tax Cuts and Jobs Act of 2017 reduced the amount of the payment to zero leaving the tax infrastructure in place but gutting any impact of the payment. (11)
As a result, targeted taxes undercut their own benefits by violating equality principles as they become regressive relative to resources. Despite their virtues, such targeted taxes tend to be unsustainable as a solution even to the narrow problem they address. Often such taxes are used as a proxy for something else--environmental regulation, for example--without being the most direct and certain way to deal with that something else.
Part I of this Article sorts taxes by their objectives, examining how well or poorly they serve their objective as this Article reviews the incidence of the taxes. Part II addresses the legislative addiction to using the tax infrastructure and complexity. Part III considers broad tax bases and observes the shortcomings of existing broad bases in the context of providing sustainability for taxes. Part IV focuses on favored capital under the income tax and the manner in which the income tax disfavors labor as capital income and labor income have split and continue to separate, creating a dual income tax. (12) Part V concludes by recommending a sustainable and transparent income tax that neither perpetuates societal disparities between affluent and non-affluent individuals nor limits the ability of those without capital to accumulate tax favored capital.
TAX SORTING AND SUSTAINABILITY
While taxes serve primarily to fund public goods and services, legislatures often use taxes to serve other functions as well. Sometimes those other functions are free from revenue production goals. Tax systems in developed economies have substantial administrative infrastructures. Rather than creating a new administrative infrastructure to regulate an activity, legislatures may and often do rely instead on the existing tax infrastructure as they regulate or extend subsidies to activities. To fit the regulation or subsidy into an existing tax system, the tax infrastructure may permit the capture of a tax subsidy or avoidance of tax burden by unintended taxpayers. Many examples of this phenomenon exist. The longstanding example of tax-exempt bonds described in the next paragraph illustrates the point.
The United States subsidizes the borrowing cost of state and local governmental units by excluding the interest that is paid from the recipient's income. (13) This exclusion from taxation permits a governmental unit to borrow at a rate lower than it would pay if the interest it paid were fully taxable to the recipient. While some doubt existed historically as to whether the United States constitutionally could tax the interest, the decision in South Carolina v. Baker dispelled any such lingering doubts. (14) Assuming, for example, that the market interest rate were 10% and the maximum income tax rate were 30%, the state interest rate should be 7% so that the state captures the tax subsidy from the gross income exclusion. States rarely can find sufficient buyers for their debt who are 30% bracket taxpayers, so they must offer a higher interest rate to attract lower bracket taxpayers. If the state may sell all its debt if it targets 20% bracket taxpayers, the interest rate it will pay to make the exempt interest comparable to the 10% market rate is 8%. Nothing prevents a lender who does pay the maximum rate of 30% from buying the 8% debt and receiving the equivalent of an above market rate of 11.43%. That high bracket taxpayer/lender captures part of the federal subsidy directed to the state. The United States cannot shift the excess tax saving to the state as a subsidy. Instead it is a deadweight loss that does nothing to advance the U.S. goal of subsidizing states' borrowing costs. A direct subsidy of an interest rate differential would be more efficient and would not enhance the resources of wealthier taxpayers who otherwise are taxable at the highest marginal rates of tax.
An income tax might have a primarily revenue raising function, but the legislature often deploys deductions and exclusions from the income tax base to stimulate the economy rather than providing direct subsidies that would require their own administrative infrastructure. A simple example is the depreciation deduction. (15) A deduction for gradual consumption of durable property used to produce income makes sense where the goal...
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