Monday, September 10, 2007

We are all supply-siders

It's fun to read the wingnuts sometimes. Don Luskin (who used to spend most of his time baiting Paul Krugman, before Krugman's NYT articles disappeared behind a paywall) says (endorsing an anonymous reader's comment) that JFK was a "supply-sider". The reason? 'In August 1962 he proposed slashing the top marginal tax rate from 90%, calling it "a creative tax cut, creating more jobs and income, and eventually more revenue."'

Hm. India too used to have such absurd tax rates. And in Britain it went as high as 95% (as George Harrison sang: "There's one for you, nineteen for me, 'cause I'm the taxman.") But today I doubt there's a single person, economist or otherwise, who thinks that a marginal tax rate of 90% will boost either the economy or the government's revenues. Does that mean we're all supply-siders now?

Leading from which, here's a question that's always bothered me. Why not supply-side the tax itself, in the form of taxing products, not incomes? We do tax products (formerly sales tax, now VAT), but what if we taxed them a bit more -- the tax increasing according to luxury value, but not becoming exorbitant -- and removed all income tax?

In India, everyone buys things, but fewer than 4% of the population pays income tax. And that's not because 96% of us are wallowing in poverty. Income tax evasion is astronomical. And the evaders tend to be among the richest people: even if they do pay tax, they do not declare all their income. Only the salaried class is honest, because they're forced to be: it's deducted at source.

If we decided that income tax merely annoys citizens and abolished it, replacing it with an equitable scheme of taxing products (being careful not to tax products that the poor depend on), why wouldn't that work? Could we even have "negative taxes" on essential items?


Anonymous said...

Taxes on commodities changes the "relative price", between two commodities. This can and does cause inefficiencies. The first modern analysis of how to do commodity taxation while minimizing such inefficiencies was done by the great mathematician, Frank Ramsey. In his short life, Ramsey tackled two important economics problem, one on optimal commodity taxation and the other on optimal growth. I think both problems were suggested to him by Keynes.

Evasion is only part of the problem in India. The other part is that agricultural income is totally exempt and there is no political will to bring that into the tax net.

Abi said...

The naive non-economist in me thinks that your proposal might work. I would add some extras:
Commodity taxes at a uniform rate, coupled with a uniform handout of about 2000 rupees per person per year to everyone. Uniform taxes render unnecessary a bureaucracy for labeling things one way or the other. And the lack of progressivity in commodity taxes (which hurt the poor disproportionately) is addressed by the uniform handout.

I don't know what kind of problems arise in the system you propose. There ought to be some, right?

If non-compliance and tax evasion are a problem in the current system, they would continue in the new system as well; our traders are quite notorious when it comes to taxes!

I know you get Krugman's current columns in the Hindu. But if you are interested in online versions of his columns, check out Mark Thoma's blog where they are excerpted -- quite extensively, in fact.

Rahul Siddharthan said...

anonymous -- well, yes, taxes on commodities can cause inefficiencies. The question is will these inefficiencies be worse than what we have in our income tax system?

Abi - indeed a major obstacle for simplifying (let alone getting rid of) income taxes is the bureaucracy. What would you do with all those babus if taxes became easy? But as for traders evading taxes, there are two options: 1. monitor them (you'd need to do that anyway to collect income tax, but now you need to monitor fewer people); 2. tax the manufacturers -- even simpler to monitor.

Anonymous said...

there is a huge literature on optimal taxation. check it out if interested - the work of Mirrlees, Diamond etc. etc. in the indian context, some of the people at NIPFP (like Indira Rajaraman, Arindam Das Gupta [now at NUS, Singapore]) and others (like Dilip Mookherjee, Boston U, Raja Chelliah etc.) have done a lot of work on tax policy. Mookherjee and Das Gupta have a book on this subject (Oxford Univ Press).

as for whether your proposed modification is better or worse, no way of saying, so far as i can see. it is a counterfactual exercise and the answers you get (like in the iraq estimate of the number of additional casualties) will depends on the assumptions you make.

note that any change in tax policy will also changes people's incentives and evaluating how people are going to react to those changed incentives is not straightforward. At a very simple level, there are two type of effects. On the consumer side, some products will become cheaper relative to others and people will change their buying patterns to some extent in response. On the producer side, some products will become cheaper to produce in the new tax regime and others more expensive. even at a theoretical level, evaluating the net effect of such demand and supply changes is hardly easy. Once you add in things like tax administration, evasion etc. things become even more muddied. I certainly have no idea of what the eventual outcome on tax revenue is going to be. presumably you and abi have a much better idea. i'll leave it at that.

km said...

Yes, but does your tax proposal have a backward guitar solo played by Paul McCartney?