29 April 2009

Tax Funneling or No Tax?

"In recent years, Congress has graciously refrained from raising our income tax rates. However, Social Security taxes have risen dramatically. Simultaneously, inflation, prompted largely by the rapid growth of government spending, has shoved more and more Americans into higher and higher income tax brackets. 

Thus there is less and less incentive to earn incomes that are taxable. So unless we like more leisure, we are increasingly inclined to enter the so-called 'underground economy'... 

...The phenomenal growth of such activities has become so substantial that, by some estimates, our “underground” activity may now be the equivalent of 20 or even 30 per cent of Gross National Product. Certainly, this production is, in some sense, less desirable than it would be if everything were out in the open. Besides that, our government is losing tax revenue which might otherwise be used to build schools or shore up our national defense. 

If tax rates fall, American workers will have greater incentives to produce goods and services for American consumers. Some people who are already working will leave the underground for the more efficient open economy. Thus, income subject to taxation will grow. 

In fact, it’s even possible that, though income tax rates fall, the increase in taxable economic activity will be so great that tax revenues will rise. That is the thesis underlying the now-famous Laffer curve, originated by the economist Art Laffer. The implication is that, while tax rate cuts will directly benefit individuals, in the end society as a whole will prosper."

This quote, from an article written by Russell Shannon in 1981, illustrates a couple of key points about taxes:

1) The economic impact of increasing taxes is largely counter-productive to an economy.

2) The "underground economy" will thrive to secure income by avoiding taxes.

These two points are obviously closely related and they have become the gist of a lengthy--very lengthy and very interesting--series of exchanges between The Insider and The Jenius over at his blog Puerto Rico: A Paradise Lost?

Fair warning: the exchange is very long, has a few dozen discussion points and is carried out with elegance (by The Insider) and a mildly snarky attitude by Yours Truly. I even apologized for it, which The Insider graciously waved away. In any case, the discussion is quite extensive and intense. You have been warned.

Oversimplifying as only a Jenius can, The Insider wants to use the local sales tax revenue to establish a points-based system of socioeconomic development. I, on the other hand, think We can do that simply by eliminating the sales tax altogether. I suggest We tax the monies held in banks as capital gains unless they are invested in Puerto Rico (at present they are almost always invested overseas) and adjust property taxes from their ridiculous 1950s values to at least 1995 market values, while exempting homeowners from the excess tax if the property has been developed since 1980 or is their single residence.

(Yes, I explained My side more than The Insider's. He does his side much better than I can. Go ahead and see what I mean.)

The evidence of sans sales tax economic benefit is clear, but does that mean that The Insider's plan is less likely to work? That's where the debate stands, with Me on one side looking to slash the sales tax to force government shrinkage and stimulate the economy and The Insider on another side getting Our society involved in making better decisions at the individual level. (You didn't see that coming? Well, he did that. I told you it was interesting.)

I'm sure We--The Insider and Moi--would both agree that there are other sides to this debate. We're on record as stating We'd like to hear about those other sides, or receive feedback about the sides We espouse. Bottom line, We are at least engaged in a debate; it still bears watching to see if this debate becomes something more.

The Jenius Has Spoken.

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