The Perfect Tax System?

The perfect tax system, for most of us, is one where there are no taxes.  Since this is extremely unlikely in our lifetimes (and many more to come), most tax regimes could still use a complete overhaul.  According to this article in The Economist, a group of economists headed by Sir James Mirrlees has proposed radical tax reform, arguing that the "most governments could find a way to raise the amount of money they need from the tax system while imposing much lower costs than they currently do".

Some of the other interesting points in the article include:

  • An ideal tax system would have three main features - it would be progressive, it would tax income earned from different sources at the same rate and it would be simple (the US tax system is renowned for it's complexity).  They describe the British tax system as being "a jumble of tax rates, a lack of a coherent vision of the tax base, and arbitrary discrimination across different types of economic activities”
  • Although many tax regimes are already progressive i.e. higher income earners pay a higher rate of tax, the economists suggest that this should apply to taxation as a whole rather than making every individual tax progressive.  For example rather than having exemptions to the Value Added Tax (VAT) charged in the UK like children's clothes etc., it is better to apply the VAT on everything,.  and compensate those in lower income brackets, to whom the VAT exemption is targeted, directly.  This would simplify the system, make the tax benefits more targeted and increase tax revenues.
  • Taxes could incorporate an individuals expenditures rather than just his or her revenues, over a person's lifetime.
  • The tax system should provide incentives for people to work eg. by altering child tax credits after a certain age to encourage mothers to reenter the workforce or give individuals who are approaching retirement age a greater incentive to work.
  • The report proposes that the source of income eg. employee or self employed should not affect the amount of tax paid..
  • Corporations could receive a tax deduction based on equity.  This would give equity owners a tax reduction that is similar to interest on debt, which is deductible, and incentivizes ownership versus debt.

Overhauling a tax system (or any system) requires massive resources, vision and a political environment where this is possible.  The bulk of costs for most tax systems lie in administering them.  As such simplification of the system alone can lead to massive cost savings, and perhaps even reduce the tax burden on individuals.