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More on “Failure to Tax” as Subsidies

Posted By Don Boudreaux On January 23, 2011 @ 11:00 am In Myths and Fallacies,Subsidies,Taxes | Comments Disabled

My friend and neighbor, egrass, e-mailed me this morning pressing his point that tax deductions are government subsidies – and again accusing me of seeking government subsidies when I raise tax-deductible contributions to George Mason University’s Department of Economics.

I addressed my profound disagreement with egrass’s perspective somewhat in this earlier post [1].

Here I make another, different attempt – inspired by this line in egrass’s latest e-mail to me:

we live in a closed system such that tax and other government policy necessarily transfers money from A to B unless that policy is strictly neutral for everyone.

There’s a huge and ancient literature on tax neutrality.  Such neutrality is, I think it fair to say, nearly impossible to acheive.  That unicorn has been hunted and proves elusive.

The closest we can actually come to a tax that is both economically neutral and satisfies widely accepted conditions of fairness is a head tax – a lump-sum levied regularly on each person regardless of that person’s income, status, or anything else.  For example, I pay $1,000 annually, egrass pays $1,000 annually, and Bill Gates pays $1,000 annually.  The economic distortions would be minimal, and no income-earner avoids paying.

I believe that egrass should support such a tax, as well as support ridding our polity of every other tax.  Or he should at least support a flat tax.

After all, by his logic, taxing lower-income persons at lower rates than are imposed on higher-income persons is, in effect, for government to subsidize lower-income people.  Money not taxed is – the clear-eyed realist sees – money given by government in this alleged “closed system” of ours.

Every person not in the highest income-tax bracket is on the government dole!  Sure, they might not realize that they’re free-riding on others.  They might think that just because they get no food stamps and no other cash handouts from government that they are paying their own way – pulling their own weight.  But they would be wrong.  They are all, every last one of them, simply by virtue of not being in the highest income-tax bracket, recipients of government subsidies no less than they would be were government to raise their income-tax rates and then immediately rebate to them the difference between what they pay in taxes at the highest tax rate and what they would have paid at the lower tax rate.

It is, as egrass says, merely a matter of arithmetic:

$X$X(.15) = $X – [$X(.40) - $X(.25)]  QED

While a head tax comes closest to eliminating such subsidies, a flat tax – proportional taxation – comes much closer to doing so than does the current progressive system of income taxation.

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