Shower Thoughts: New Tax Regime

As I was rinsing off that extra glass of wine from last night, I was thinking about, obviously, efficient taxation.  Let’s consider replacing the current income tax system with one on gross income (corporate and personal) with zero deductions— even for cost of goods and services. 

That is, at a 15% rate, if you make $100,000 per year, you pay $15,000 in taxes— even if you have 6 kids and a mortgage.  If your company has $1mm per year in revenue, it pays $150,000 in taxes— even if it only makes a profit of $1 on that $1mm in revenue prior to taxes.  Under this system, some profitable (barely) companies will become unprofitable.

Advantages:

• Economic- A business should create more of its product until the marginal cost of the next unit of production exceeds the marginal increase in revenue.  The problem with this equilibrium is that it does not include externalities.  It occurs to me that the simplest way to price in externalities is to tax revenue.  It is a rough fit, but generally speaking a firm that has more revenue demands more of the government and the environment than one with less revenue— regardless of profitability.  There are too many firms out there that aren’t profitable enough to justify their externalities and if externalities were priced in would either dramatically change ($WMT) or cease to exist ($GM).  Why should $AAPL pay more in taxes than $GM— it is clear who has the greater externalities, isn’t it?  Under this regime, less capital would be wasted.
• Practical- Firms spend billions each year “managing” their income to reduce their tax burden.  For the same reason many fundamental analysts like sales-based ratios instead of income-based ratios, I think taxation would be more equitable if based on revenue instead of profit.  It’s very difficult to hide revenue, so most people won’t even try.  This has the nice side-effect of fewer smart people using their intellectual capital to reduce taxation— maybe they’ll invent a cure for cancer instead.
• Fairness- Those with greater resources have greater ability to avoid taxes by maximizing deductions and generally working the system in our current regime.  I think a system like this would be very progressive without being explicitly progressive.  Also, our current system is a treasure trove of social engineering experiments (child tax credit, mortgage interest deduction) and implicit subsidies of high tax localities (you can write off your local taxes today).  No more under revenue based taxation.

Disadvantages:

• Both- We certainly don’t want this tax and the traditional income tax.  It has to be a replacement.
• Black market- Unlike a property or sales tax, those who earn income in the black market are not affected by this tax, which is a shame. That said, if you legalize drugs, the black market becomes much smaller.  The issue with a consumption tax (which I’m in favor of in principle) is how to migrate to it— it’s not really fair to move to a different tax regime while millions of people are living off their savings that was once heavily taxed as income.

Of course, any tax system is probably ok— even a tax on smiles— if fewer dollars are collected.  This system will not balance the budget until we stop spending like drunken sailors.  

It could make things a bit more efficient and fair, though.