Kahn on Taxes

Given the hot water Indiana Governor Mitch Daniels has found himself in with conservatives for supporting a value-added tax (see Grover Norquist’s statement that “Absent some explanation, such as large quantities of crystal meth, this is disqualifying”) I thought it was worth looking at the context of the remark. As Daniels’ spokesperson, and Ezra, noted, Daniels was actually praising an obscure tax reform proposal from the nuclear theorist Herman Kahn. Kahn founded the Hudson Institute, where Daniels gave the speech, and the occasion of the speech was Daniels receiving an award in Kahn’s name.

Kahn’s proposal came in a book he wrote in 1982, The Coming Boom: Economic, Political, and Social. The book isn’t preview-able on either Amazon or Google, so I checked out a copy. Here are the relevant paragraphs, on pages 209-210:

REFORMING THE TAX SYSTEM TO ENCOURAGE ENTREPRENEURSHIP, SAVINGS, AND INVESTMENT

In order to counter, to some degree, the tendencies toward “creeping stagnation” described in Chapter 9, it would be most useful to redesign the tax system to discourage consumption and encourage savings, investment, and entrepreneurship (again in both the short and long run, though probably different programs would be required for each). If the initial exposure to Reaganomics turns out to be successful, there should be a significant opportunity to do this and much else.

One obvious possibility is a 8-12 system – a value-added tax of around 8 percent or so accompanied by a flat income tax of 12 percent or so – with the only exception being a low standard deduction. By keeping both taxes low the pressures to evade distortions are minimized and there is little need for special tax exemptions. I would guess that while the numbers suggested are low they are probably high enough if there is restraint on the federal budget. The guess includes even more revenue aid to states and cities than today. The value-added tax has the great virtue that it is probably the least distorting tax of all. It is also one of the most easily enforced. (It requires a lot of accounting, but this is not difficult given the widespread availability of computers.) Because usually only a small part of the value-added tax is absorbed by businessmen and most of it is passed on (hidden in the purchase price), it has very little political impact. Finally and perhaps most important, the value-added tax is a tax on consumption and therefore encourages investment and savings.

With a flat rate of 12 percent the income tax would be low enough so that there would be no great incentive for large-scale tax avoidance and tax evasion – or great pressure for legislated deductions and tax shelters. In fact, just the opposite would occur: many of the billions of dollars lost by the government and society because of the great pressure on almost all income groups to look for tax shelters could be virtually eliminated. Further, much of the underground economy would disappear or pay taxes.

The flat 12 percent income tax might easily end up collecting about as much in taxes as the current income tax, and much more fairly and acceptably. (Despite its high rates, the current system collects less than 12 percent of the national income.) There would also be an enormous improvement in the morals and morale of the taxpayers.

Some will feel the 8-12 system is regressive (i.e., taxing too heavily or unfairly the lower income groups), but given the high level of prosperity, the many opportunities for advancement, and the adequacy of welfare, the regression is probably not critical. If it is, then adjustments can be made to the basic scheme; the deductions for tax-free income can be increased, there could be some degree of negative income tax or a similar measure, or the income tax can be made moderately more progressive. (This last is probably not desirable because it is important to keep the principle of a flat rate intact, to avoid “creeping progressivity.”)

In addition, political support for the 8-12 system would increase if some of the proceeds of the two taxes were used to pay for the welfare portion of Social Security taxes and to eliminate or reduce state sales taxes. Indeed, a revised and simplified tax system that did not discourage incentives and encouraged savings and investments without distorting tax shelters would go a long way toward deepening economic revitalization and extending it well into the twenty-first century – and to some degree indefinitely. While analyses of the complexities and ramifications would require a separate book, we simply note here that a basic tax reform ought to be seriously considered within the next few years.

I’m not an economic conservative, so I’m not going to tell tax cutters voting in the 2012 primaries how Mitch Daniels’ interest in this plan should influence their view of him as a candidate. I’m sure Kahn’s reference to the ease of enforcing a VAT will rub small government types the wrong way. But Kahn’s plan is dramatically more regressive than the current tax code, or anything the Republicans in Congress now are proposing. A high, no-exemptions, no-rebate VAT would amount to a major tax hike for low-earners, and a 12 percent flat tax would be the largest tax break for the rich in history. Whatever this is, it isn’t a moderate proposal, and it isn’t some compromise made by a weak conservative in an attempt to appease liberals. It’s a radically right-wing overhaul of the tax code.

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