The three most important new tax proposals

Well-designed government taxes can promote social justice, ecological sustainability and economic productivity. Here I present three most promising tax proposals that I encountered the past few years, during my studies in economic policy. They improve both equality and efficiency (or fairness and productivity).

Carbon tax with dividend and R&D funding

What is it?

A tax on greenhouse gas emissions, with tax revenues partly used for clean energy research and partly distributed as a universal citizen’s dividend (a kind of basic income guarantee).

How does it work?

A carbon fee is put on greenhouse gas emissions, starting at a low tax rate of 20 euro per ton CO2-equivalents, and yearly increasing with 10 euro per ton. Imported goods from countries that do not have a similar carbon tax will get a border carbon adjustment: an import tax based on life cycle assessment studies of the imported products. Exported products will receive a refund.

Part of the tax revenues (roughly two third) can be distributed as a dividend such that the purchasing power of half of households (the poorest half of the population) increases. The remainder can be used to finance research of clean energy technologies.

Where is it already implemented?

A carbon fee and dividend system is already introduced in e.g. Canada and Switzerland. Many other countries and regions have a carbon tax (without the dividend).

Who supports it?

There is a strong consensus among economic scientists that a market price mechanism such as a carbon tax is the most efficient (cheapest) economic policy to reduce greenhouse gas emissions, and that the long-run benefits outweigh the short-run costs.

Citizen’s Climate Lobby campaigns for a Carbon Dividend Act. It has chapters in the US, Canada, Belgium, Germany and many other countries.

Why is it good?

Global carbon emissions are probably the biggest kind of market failure through negative externalities. The costs and risks of climate change could result in a loss of 5%-20% of global GDP each year (Stern Review: The economics of climate change). The climate crisis is an existential threat: a non-zero probability of a runaway global warming can derail civilization.

A carbon tax provides the most efficient allocation of resources and investments to prevent climate change. It incentivizes consumers and producers to buy and sell products with lower carbon footprints. It is necessary to counter rebound effects: when responsible consumers personally use less fossil fuels, fossil fuel prices will drop, which results in higher consumption levels by other consumers. This partially negates the reduction efforts of the responsible consumers. Similarly, when consumers use more energy efficient appliances, their energy costs decrease, so they have more money left to buy more energy or other high carbon footprint products.

Combined with a dividend, the carbon tax can be made progressive to decrease inequality. The carbon footprint per person has an unequal distribution: richer people are responsible for much higher greenhouse gas emissions, so rich consumers will pay most of the carbon tax. The carbon tax system becomes progressive and decreases income inequality if the tax revenues are distributed as a dividend. If all revenues are distributed as a dividend, the purchasing power of a vast majority of the population increases (mostly low and middle income households, because poorer people will receive more dividends than they will pay carbon taxes). If for example the median carbon footprint is two thirds of the average per capita carbon footprint, roughly two thirds of carbon tax revenues are sufficient to increase the purchasing power of the majority (51%) of households through a universal citizen’s dividend. Hence, this policy can get a majority of political support. The remaining one third of the tax revenues can be used to finance research and development in clean energy technologies (which is also highly effective to avoid climate change). Public spending on clean energy R&D, combined with a carbon tax, give push and pull incentives to move towards climate friendly technologies.

Excess capital income tax with labor income tax reduction

What is it?

An excess capital income tax is the tax from capital income (i.e. interests from savings and bonds, dividends and capital gains from stocks and other financial assets) above the normal returns to capital (at risk free interest rates), taxed at the same marginal rates as labor income taxes.

How does it work?

The normal returns to capital or savings are the compensation for a delay in consumption. For example, if I am indifferent between getting 100 euro today and getting 110 euro next year, those 110 euro next year have a present value of 100 euro. Postponing the consumption of a product worth 100 euro to next year is a loss of present value, unless I am compensated with 10 euro next year. Hence, in order to postpone consumption, my savings have to earn money: the savings rate should be at least 10% per year. This savings rate is the risk-free interest rate and counts as the normal rate of returns to capital. The interest rate of risk free medium-term government bonds can be used as the normal rate of returns to capital.

The taxation of excess capital income can be done by taxing all capital income, deducted with a rate of return allowance. For example, suppose I save 100 euro (e.g. by buying stocks and bonds or putting the money in a savings account). After a period (e.g. a few years), I decide to cash in those savings (e.g. by selling the stock or withdrawing the money on my savings account). At that time, the savings increased in value and are worth 120 euro. This means a total capital income of 20 euro. If I saved the 100 euro at very low risk, for example with medium-term government bonds, I would have earned a capital income of 10 euro. This 10 euro is the normal return to savings and is deducted from my actual returns to savings. The remainder is my excess capital income that will be taxed. In general, the excess capital income is the actual capital income (the increase in nominal value of the total stock of savings, including financial assets and shareholder equity) minus the normal rate of return or ‘rate-of-return allowance’ (the risk-free nominal interest rate multiplied by the stock of savings). Safe assets that bear no risk have negligible excess returns and hence can be exempt from income taxation.

With a rate-of-return allowance, the excess capital income can be taxed at a progressive tax rate, i.e. at the same increasing marginal tax rates as labor income taxes. The income tax base for a period is the sum of labor income and excess capital income in that period. This tax base measures both labor and capital income. If the tax rate increases when the tax base (the total income) gets larger, the income tax is progressive.

If the actual capital income is lower than the normal rate of return, the excess capital income is negative and the total income tax base will be smaller than labor income. If labor income is small in that period, the tax base can even become negative, which results in a negative income tax (a subsidy). In other words, capital income losses (returns below the rate-of-return allowance) are relieved against tax on labor income (or they can be carried forward with interest mark-up).

The increased capital taxes allow for reductions in labor income taxes.

Where is it already implemented?

An excess capital income tax with rate-of-return allowance has been introduced in Norway.

Who supports it?

The excess capital income tax is one of the major recommendations of the Mirrlees Review for tax reform (Tax by Design).

Why is it good?

Due to increasing labor market power (a rise of employer monopsony), the share of capital income in total income increases (labor’s share of national income is estimated to be 22% lower than in a competitive market). Also, due to product market power, the stock market is overvalued relative to a competitive economy. However, in most countries, capital income is taxed less heavily than labor income. This creates a net-income inequality between workers and owners of capital. Including an excess capital income tax in the total income tax base, i.e. taxing labor and capital at the same marginal rates, decreases this income inequality. It also avoids distortions, i.e. it improves choices of workers, investors and consumers that increase their welfare. A capital income tax rate lower than the labor income tax rate disincentivizes work. If next to excess capital income also normal capital income were taxed, saving and future consumption (and also selling stocks) will be discouraged. Hence normal capital income should not be included in the income tax base. The excess component of capital returns is often a kind of economic rent that can be taxed without distorting the market.

The increased capital income tax allows for reductions in labor income taxes. As the deadweight loss (loss of efficiency or productivity) of an income tax increases quadratically in the tax rate, a medium tax rate on both capital and labor income is better (less loss of efficiency) than a low tax rate on capital and a high rate on labor.

Self-assessed property tax with quadratic funding of public goods

What is it?

A self-assessed property tax, HarbergerWeyl-Zhang tax or Common Ownership Self-Assessed Tax (COST) is a tax on property with an owner’s self-assessed value of the property as the tax base.

How does it work?

An open, public cadaster registers all self-assessed valuations of properties of all property owners. A self-assessed value is equal to or higher than the reservation price of that property: the lowest price at which the owner is willing to sell the property. If a buyer is willing to pay the owner’s self-assessed reservation price for a property, the owner is obliged to sell the property to that buyer at that self-assessed price. If no buyer is willing to buy the property in a time period, the owner has to pay a property tax to the government, as if it was renting that property from the government for that time period. The property tax is calculated as the owner’s self-assessed price times an optimal tax rate.

For properties that do not require personal investments or maintenance, the optimal tax rate is the equilibrium turnover rate of the property: the probability that in a given time period a buyer is willing to buy the property at the owner’s self-assessed price. At this tax rate, the self-assessed value equals the reservation price. For example, suppose I own a piece of land. I value this land initially at 100.000 euro. This value is written in the cadaster, so everyone can see what my price is. Suppose there is a 5% probability that a buyer is willing to buy this land then next year. If there is a buyer, I have to sell the land at 100.000 euro. If there is no buyer the next year, I pay the government 5% of my self-assessed price, i.e. 5.000 euro per year. If this tax is to high for me, I can lower my price of land. The lowest price I am willing to declare, is my reservation price. The probability that a buyer is willing to buy the cheaper land now increases, so the tax rate also increases. Suppose in the end (the equilibrium state) I value this land at my reservation price of 50.000 euro and there is a 7% probability that a buyer will buy the land the next year, then my tax will be 7% of 50.000 euro or 3.500 euro per year. If this tax is still to high for me, it means that someone else values the land more than I do and I have to sell that person the land.

For properties that require personal investments, properties (like a house) that increase in personal value the longer it is in possession, or properties that have many close substitutes (i.e. buyers can easily buy another equivalent property), the tax rate can be lower than the equilibrium turnover rate, and as a consequence the self-assessed value can be set higher than the reservation price. For example, if I invested in the land by building a house on it, the tax rate can become e.g. 3% instead of 7%. In this case, I can put a much higher self-assessed price on the combined property (land plus house). I can also choose to declare one price for the combined property, or multiple prices for the multiple property components.

All kinds of property (land, natural resources, art, real estate, companies, corporate assets, electromagnetic spectrum, internet domain names, intellectual property rights, rights not to be harmed by pollution,…) can be subjected to the self-assessed property tax.

The self-assessed value of property is the result of personal investments, public investments and natural provisions. A property can increase in value because I invest in improvements (e.g. the value of my land increases when I build a house on it), because the government invests in public goods (e.g. the value of my land increases when the government provides a beautiful public park, accessible roads and a train station nearby) or because nature provides valuable services (e.g. the value of my land increases when I discover valuable minerals in the soil, when trees provide a cooling effect during heat waves or when the soil can absorb water to prevent flooding). Personal investments are exempt from the property tax due to the tax rate being lower than the equilibrium turnover rate. Hence, the revenues of the property tax can serve two purposes related to the two other value-increasing factors: public goods and natural provisions.

A part of the tax can be used to finance public goods. The most efficient way is through quadratic funding: people donate contributions to funds that finance public goods. The total value that will be invested in the public good is equal to the square of the sum of the square roots of contributions received for that public good. The funding gap, i.e. the difference between this total value and the sum of contributions received, will be financed by the government with the property tax revenues.

The remainder of the tax revenues can be distributed as a citizen’s dividend or universal basic income. This dividend captures the value of the natural provisions, as if everyone has an equal right to natural resources.

Where is it already implemented?

Almost all countries have property taxes levied on different kinds of property, but none have yet a self-assessed property tax.

Who supports it?

The RadicalxChange movement promotes the Harberger-Weyl-Zhang tax. This tax is an extension of the work of many prominent economists, such as Henry George and Nobel laureate William Vickrey. The tax is also being discussed in the effective altruism community.

Why is it good?

A self-assessed property tax has many benefits. First, it increases allocative efficiency: property can be allocated to (bought by) those who value it the most or make the most productive use of it. It decreases monopoly power of the property owners (and hence decreases deadweight losses and holdout problems). It is one of the few taxes that actually increase efficiency. This increase in efficiency can result in an economic growth of 5%. The taxes capture the economic rent of owning private property and can also promote the sustainable use of natural resources.

Second, it decreases inequality. Wealthier people who have more property, will pay higher taxes. As the government tax revenues can be distributed as a basic income or used for funding public goods, the system can decrease economic inequality.

A self-assessed property tax is an incentive mechanism that counters a market failure of monopoly power. Similarly, quadratic funding is an incentive mechanism that counters a market failure of underinvestment in public good. Market efficiency can be improved by combining both mechanisms. With quadratic funding, governments can gain information about people’s preferences for public goods. People will voluntarily contribute exactly the amount that signals how strongly they value the public good. Such a mechanism helps to decide how to optimally spend the self-assessed property tax revenues.

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