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Tuesday, July 08, 2014


Part II - Comparing Various Forms of Taxation

A. Consumption-based Taxes

Value-added Tax

A value added tax (VAT) applies to the market value added to a product or material at each stage of its manufacture or distribution. If a retailer buys a shirt for $20 and sells it for $30, this tax would apply to the $10 difference between the two amounts. A simple VAT would be “proportional” on consumption but also be “regressive” on income at higher income levels (as consumption falls as a percentage of income). Savings and investment are tax-deferred until they become consumption. A VAT may exclude certain goods, intent being creating “progressive” effects. The tax is used in countries within the European Union.

In Australia, Canada, New Zealand, and Singapore this form of national tax is called a Goods and Services Tax (GST). In Canada it is also called the Harmonized Sales Tax (HST) when combined with a provincial sales tax.

A major disadvantage of a VAT is its complicated book-keeping requirements.

Ad Valorem (Sales) Tax

This tax typically applies to the sale of NEW goods, less often to the sales of services or used goods. The tax is applied at the point of sale. The more goods consumed, the more taxes paid. The sales tax may be waived when goods are exported and applied on imports to both promote exportation of goods while providing a level playing field regarding imports.

A major advantage of a sales tax on goods is its simplicity, its lack of duplicity, and its relative fairness.

The omission of “used” goods and services prevents double taxation of the same item, such as used automobiles and the used clothing and other used items to be found in “thrift stores” and “garage sales”.

A slight disadvantage of a sales tax is that the amount paid as a percent of income is highest for those who consume the least.

This disadvantage could be offset by “pre-bate” checks (at the sales tax rate applied to poverty level income) mailed annually to all North Dakota residents. For example, if the poverty level income for an individual in North Dakota is $12,000, the median individual income is $30,000, and the median total sales tax is 6%, a $288 check (12,000/30,000 x 12,000 x 6%) would be mailed annually to each of 700,000 individuals living in the state at a total cost of about $200 million (approximately 0.16% of estimated annual sales tax income of $1.25 billion). Everyone would get the same $288 check to offset the sales tax that potentially would be spent during the year on the first $12,000 of income.

The disadvantage to the poor may also be offset by exempting food, shelter (living quarters) and clothing. Fuel excise taxes (see below) are already applied toward building roads so a sales tax on fuel would represent double taxation. Few, if any sales taxes are applied to healthcare and insurance/pensions.

Five states, Alaska, Delaware, Montana, New Hampshire, and Oregon have no state sales tax. Nearby or adjoining states may decide to exempt residents of these states from their sales tax; otherwise, the lack of a sales tax can be a competitive economic advantage to the state that does not assess one.

Excise Tax

An excise tax is a sales tax that applies to a specific class of goods or services such as alcohol, gasoline (petrol), tobacco, or tourism (motel/restaurant taxes). The tax rate varies according to the type of goods or services purchased and is typically unaffected by the person who purchases it. It often focuses on perceived “vices”, such as liquor and tobacco products.

The major advantage of an excise tax is its ability to fund a specific purpose from specific users. For example road building may be funded by fuel taxes.

Major disadvantages of an excise tax are unintended consequences such as its tendency to foster “black markets” and result in other illegal “under the table” transactions, making lawbreakers out of otherwise honest citizens

A major disadvantage of a tax on a publicly perceived “vice” is that all taxpayers may not agree to the extent of the damage, if any, to others represented by the “vice”. Further, deceitful elements of society may profit by their manipulation of public opinion for or against the “vice”.

A variation of the excise tax is the “Carbon Tax” intended to set up a system of trading “carbon credits” that punishes entities that release carbon dioxide emissions into the atmosphere. Those who invented the concept often stand to profit by purchasing “carbon credits” for pennies upon introduction of such laws in hopes of “cashing in” when laws are fully implemented and such credits increase in value.

Expenditure Tax

A direct, personal consumption tax may take the form of an expenditure tax or an income tax that deducts savings and investments, such as the Hall–Rabushka flat tax (Hoover Institution). A direct consumption tax may be called an expenditure tax, a cash-flow tax, or a consumed-income tax and can be flat or progressive. Expenditure taxes have been briefly implemented in the past in India and Sri Lanka.

This form of tax applies to the difference between an individual's income and increase/decrease savings. Like the other consumption taxes, simple personal consumption taxes are regressive with respect to income. However, because this tax applies on an individual basis, it can be made as progressive as a progressive personal income tax. Just as income tax rates increase with personal income, consumption tax rates increase with personal consumption.

A major disadvantage of an “expenditure tax” is its complicated book-keeping requirements.

B. Income-based Taxes

Individual Income Tax

The individual income tax is assessed on personal earnings (wages, interest, dividends, capital gains, and personal business income) at varying rates.

Major disadvantages of an “individual income tax” are that it penalizes work and discourages saving and investment.

The long term deferral of the personal income tax (until retirement savings begin to be withdrawn) is sometimes called a “retirement tax”.

Seven states, Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming have no individual income tax.

Corporate Income Tax

Corporate tax or “profit tax” refers to a tax imposed on the net profits of various business entities. It hinders the competitiveness of business and economic growth because income taxes are not border adjustable. When a state has a higher income tax than other states, the playing field is tilted against it.

Three states, Nevada, South Dakota, and Wyoming, have no corporate income tax.

A major disadvantage of the corporate income tax is that the tax is “passed on”, adding to the delivered cost of goods and services, reducing the intrastate competitiveness of businesses within the state that levies the corporate income tax.

C. Wealth-based Taxes

Inheritance Tax

An inheritance tax is a tax on inherited property. Thomas Paine, late in his life, proposed a 10% inheritance tax to compensate for mankind’s conversion of land from its “natural” form to “agricultural” and other higher value land uses. While Paine’s “agrarian reform” argument laments the loss of natural land to nomadic peoples, his proposal did not transfer the revenues to those native peoples. Instead, he suggested revenues be split between those “coming of age” in the form of a “nest egg” and the elderly (those over the life expectancy at the time).

A major disadvantage of an inheritance tax is its affect on the economic situation of heirs. Too often, families have no choice but to sell the estate in order to pay the tax. Family businesses that have been passed down to successive generations can be lost.

Another disadvantage is its tendency to penalize those with unexpected early death of parents while rewarding those with adequate resources to act early to legally sidestep the law.

Property Tax

Property taxes are levied on homes and businesses based on the assessed valuation of real property. Banks may condition loans on homeowners and businesses with mortgages to pay monthly into escrow accounts to insure that the taxes are paid annually.

A major disadvantage of a property tax is that it penalizes property ownership, a major tenant of economic freedom.

Another disadvantage comes into play when property values rise more than the overall “cost of living”. Rather than lowering mill levies to keep property taxes in line with inflation, local elected leaders invariably choose to keep mill levies in place (or only slightly lower, so they can lie, saying they “lowered taxes” when they only slightly lowered the mill levy) to take full advantage of increases in property valuation.

The five states that score the best on property tax are New Mexico, Idaho, Utah, North Dakota, and Arizona. These states generally have low rates of property tax, whether measured per capita or as a percentage of income. They also avoid distortionary taxes like estate, inheritance, gift and other wealth taxes.

Property Tax Collections Per Capita. Property tax collections per capita are calculated by dividing property taxes collected in each state (obtained from the Census Bureau) by population. The states that collect the least per capita are Alabama ($506), Arkansas ($548), Oklahoma ($598), New Mexico ($611), and Kentucky ($662). By comparison, North Dakota’s property tax collections per capita are $1,027, Montana’s are $1,296, South Dakota’s are $1,142, and Minnesota’s are $1,412.

Effective Property Tax Rate. Property tax collections as a percent of personal income are derived by dividing the Census Bureau’s figure for total property tax collections by personal income in each state. This provides an effective property tax rate. States that score well with low effective tax rates are Alabama (1.52 percent), Oklahoma (1.67 percent), Arkansas (1.70 percent), Delaware (1.80 percent), and New Mexico (1.84 percent).

Luxury Tax

A luxury tax focuses on expensive retail commodities such as jewelry, furs and yachts.

A luxury tax can decimate an entire industry, such as occurred in 1991 and 1992 with the nation’s (and particularly, Florida’s) boat building industry following implementation of a federal 10% luxury tax on yachts costing over $100,000.

D. Commerce-based Taxes


Tariffs, also called duties and customs rates, are imposed by government on imported or exported goods.

The major disadvantage of tariffs is the way they prevent a level playing field in the markets. For markets to be truly free, they must be free of these parochial influences.


Tolls, perhaps the oldest form of taxation, are assessed in return for protection, privilege, or comfort.

Tolls such a those assessed on privately funded roads can be important in limiting the growth of government and associated burdens on taxpayers. Instead, road users pay for the improved method of conveyance.

Transfer Tax

Transfer fees cover the cost of transferring goods from one carrier to another, such as goods transfers between trucks, ships, barges, and rail. These fees would not be included in this discussion except for the fact that government too often meddles as an unnecessary “middleman” in such transfers by assessing a “transfer tax”.

E. Hidden Taxes

When criminals print money they are prosecuted and placed in prison for counterfeiting. If criminals were not prosecuted and the amount of money printed grew exponentially, instant inflation (devaluation of the currency) would occur. When a government prints money, inflation of the currency is not necessarily immediate but certainly is inevitable, and in proportion to the amount of money printed.

The Federal Reserve currently holds about $2 Trillion of U.S. Treasury securities (Treasury Notes) and about $1.3 Trillion in Mortgage-backed securities, and continues to purchase $85 Billion per month under its third round of quantitative easing, “QE3”.

Increasing the money supply tends to depreciate a country's exchange rates versus other currencies. This feature of QE directly benefits exporters living in the country performing QE, as well as debtors whose debts are denominated in that currency, since as the currency devalues, so does the debt. However, it directly harms creditors and holders of the currency, as the real value of their holdings decrease. Devaluation of a currency also directly harms importers, as the cost of imported goods is inflated by the devaluation of the currency.

Case History: the United States of America and the Federal Reserve

The average U.S. wage earner in the year 1800 made $16/week (and as low as $2/week). Fourteen to sixteen hour work days were not uncommon. A quart of milk cost 56 cents. A pound of butter cost 40 cents. Average rent was $4/week or about one fourth of gross income.

In 1850, just prior to the civil war, the same dollar was worth twice as much as in 1800, but returned to near its 1800 value ($1.11) by 1865 due to the printing of money to pay for the Civil War.

By year 1900, the dollar appreciated to again double its value in 50 years to $2.04. The Spanish American War resulted in another money printing spree that reduced the value to $1.70 by 1915. In 1913, the “Federal Reserve” was created, becoming the third “central bank” in U.S. history, but with far more power than its predecessors, printing money to finance WWI and leaving the 1800 dollar worth just 83 cents by 1920

The period of peace between 1920 and 1935 increased the value of the year 1800 dollar to $1.22. With the beginning of WWII in 1939 came the constant devaluation that left the 1800 dollar valued at 7 1/2 cents in year 2012.

On a positive note, today a quart of milk costs about $1.12, which would have bought two quarts in year 1800. So the purchasing power of the dollar as relates to basic food commodities appears to have been only cut in half. Thank you to farmers & ranchers!


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