Tuesday, April 19, 2011

A Simple Consumption Tax

Taxes tend to discourage the thing taxed. An income tax discourages job growth and a capital gains tax discourages capital improvement.

For this reason, there are many people who would like to change America's tax system from an income tax to a consumption tax.

There is a simple way to do this.

This simple plan has the odd name: "The Object Oriented Tax."

I developed this idea while studying object oriented programming. My goal was to apply system engineering techniques to complex systems like tax collection.

This new system taxes an abstract object between income and consumption. As such, the tax allows designers to combine the best of an income tax with the best of a consumption tax.

Because the OOT taxes an abstract object between income and consumption, it is possible to implement the tax with an minimal amount of disruption.

The tax is surprisingly easy to implement.

In its simplest form, a taxpayer would have a savings account and checking account. All income goes into the savings account tax free. The taxpayer must pay a tax to transfer money from the savings to checking (or to cash).

The OOT is essntially a personal consumption tax.

As it a personal tax, one can easily make it progressive. The state could implement a standard deduction by allowing people to transfer a set amount from savings to checking without tax. It is also possible to use a progressive tax rate.

The OOT makes banks the point of taxation.

This makes a lot of sense. The income tax makes employers the point of taxation. Tax compliance is expensive and reduces demand for labor.

The fairtax makes stores and businesses the point of taxation. Stores and small businesses have problems with compliance and collection.

Banks, by their nature, are set up to handle large amounts of money and extremely large numbers of financial transactions.

Because banks are institutions specifically set up to handle financial transactions, collecting taxes at the bank would have significantly lower compliance costs than either the income tax (where taxes are collected at the place of employment) or the fairtax (where taxes are collected at stores).

The OOT also helps protect your privacy. The income tax invites the government into your place of business to scrutinize your employment. The Fairtax invites the government into stores to scrutinize your purchases. The OOT restricts the government to looking at your bank statements.

One intriguing aspect of the OOT is that it encourages people to develop a budget as part of their day to day life. The tax is not collected at the point of consumption, but at the point when a person prepares for consumption.

This process of preparing for consumption is called budgeting. The OOT would encourage large numbers of people in the lower middle class to start budgeting which would move them into the middle class.

Separating the tax collection from employment would encourage people to develop multiple streams of income ... which would improve the lot of many Americans.

The OOT is a little bit more complex than a simple account tax. As mentioned, the system taxes an abstract object between income and consumption. In the example I gave, the abstract object was the transaction between savings and checking.

The OOT assigns to all financial instruments a tax attribute. This attribute has two states: "pre-tax" and "post-tax." While the system is likely to be used in an accounting system, the OOT goes beyond simple accounting allows people to track the taxation on any object of value.

The OOT has many interesting implication for things like capital gains and inheritance taxes.

The OOT would eliminate the current capital gains tax. People could buy and sell stock or other goods without paying tax. However, they would have to pay tax whenever they transferred money from their investment accounts into a spending account for consumption.

BTW: I noted that the OOT is progressive. I would actually design the trigger so that it considers both income and capital assets. A millionaire would have to pay the high tax rate even if the millionaire had a low income.

The OOT also simplifies inheritance tax. When a person dies, the assessor would determine the tax status of all of the items in the estate.

The heirs would inherit things along with their current tax status.

Assets in a pre-tax state would be inherited into pre-tax accounts. Items in a post tax state would be inherited into a post tax account.

For example, lets say a person had a wide screen TV bought with post tax dollars. The heirs would inherit the TV with no taxes. They could sell the TV with no tax penalty.

Let's say the deceased had a farm. The heirs would inherit the farm into a pre-tax state. If the heirs sold the farm, they would pay taxes.

This structure allows for the continuity between generations without a big tax hit.

There would be some complexity with art collections and antiques. Such items were purchased with post tax dollars but had a substantial financial gains in which case the heirs would need to pay a tax on the difference to maintain their post tax status.

I confess that the name "Object Oriented Tax" is awkward. However, this notion of taxing an abstract object between income and consumption allows the government to develop a robust progressive tax that is easy to implement.

Taxing an abstract object between income and consumption allows the government to develop a fair an

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