How Conservatives Would Design an Ideal Tax System

What would an ideal tax system look like to a conservative?

Taxes should not be levied on any investment, on any use of capital, or on land. Taxes might be levied on work, but any tax on work, conservatives would argue, should be a flat or per-capita tax, since any kind of graduated tax would discourage work.

The Ideal tax has nothing to do with social justice, by the way; it is only designed (theoretically) to increase production and the wealth of society overall. There is nothing in its structure that would prevent huge inequalities, like the ones found in fifth century Rome, but conservatives are rarely much concerned with inequality.

The theory that an ideal tax system would generate greater wealth for a society has not been borne out in real life. There are too many cases where the attempt to legislate something similar has left societies poorer: the case of Rome is a poignant example, but pre-revolutionary France, contemporary Argentina and many other third world countries have similar systems.

If there were to be any taxes on investments, the ideal tax would also be flat, that is, would not rise with the amount of profit at anything above a constant percentage, say ten percent.

To really meet the criteria of an ideal tax system, taxes should only be on consumption and at a constant percentage, conservative economists often argue, since any tax builds in an economic disincentive. It would be better therefore to tax consumption at a constant rate, which would only minimally discourage consumption and would not discourage investment, or work.

The Roman Empire of the fifth century did not have an ideal tax system by these criteria, but it came close. Wealth was not taxed; land was only taxed on those who worked it, not on those who owned it; the rates were flat, except that the wealthy were exempt of all but one small tax that actually validated their status. To see more on the Roman Empire's tax system click here.

What is involved here, in the Economist's toolkit, is the argument of marginal tax rates. Any increase in the marginal rate, i.e. the rate, or percentage of tax levied on an additional dollar of consumption, wages, or investment, economists argue, discourages additional activity (work, investment, consumption). This is why they advocate flat taxes, constant percentage taxes.

First of all, in the real world, most people don't act with much or any reference to marginal tax rates. Investors invest if they expect a profitable return, i.e. if they can predict a demand for a product or service and at a price at which they can produce it. The marginal rate might figure into their calculations, but much more important would be the amount of demand for the product.

Workers work because they have to, in order to support themselves, and if their marginal tax rate goes up when they work and earn more, they will usually still work more, unless they don't need the money. The same is true of consumption. People will buy something if they want it and can afford it, and may buy less if taxes increase the cost, but few would expend extra effort to avoid paying for something at a slightly higher tax rate.

What the ideal tax argument does not address is the effect it would have on society. If there are no income taxes, and if all taxes are flat, and there are also no inheritance taxes, then the poor would end up paying much more and the rich much less in terms of the share of their earnings. This is because the wealthy consume only a small portion of their incomes, while the poor (almost by definition) spend more than their earnings.

While the rich might pay more taxes in absolute terms, because they buy yachts and fancy homes and new luxury cars, while the poor buy used cars, or none at all, and rent their homes, still, as a percentage of income, the wealthy will be paying considerably less than the poor.

The effect of an ideal tax system, sometimes also called a "fair tax" system, will be to increase the wealth of the wealthy and reduce the resources of the poor even more; it will increase inequality.

Inequality is actually a poor social model for increasing society's wealth, since there are so many more poor, or middle class than there are rich people. Who is going to consume the goods created by the investments of the wealthy people? After all, it is investments that are most favored by this kind of tax system.

There may be great opportunities for a few yacht builders, for the few makers of fur coats, for the top of the line car sales, but mass consumption depends on the mass of the people, and if the mass of the people are getting poorer, not richer, then consumption as a whole will not grow; it might even get smaller.

This is what happened in the Great Depression, and it happened after a period of conservative "pro-business" dominance, when levels of inequality were about as high as they are now. Consumption withered, prices fell (deflation) and the great economic machine of the United States (and much of the rest of the world) came nearly to a standstill.

The conservative economist's ideal for a tax system does not have much to recommend it, unless you are rich.