A Novel Idea: Rewarding Success and the Incentive Tax

If your employer offered a bonus for increasing your sales over the month, would you work harder? Incentives have a powerful effect on effort and productivity. People tend to try and do what is in their best interest, and nowhere is this phenomenon more pronounced than the realm of economics. The very concept of work relies on a value for effort system. The harder you work, the more difficult your skill, the greater your product, the more you are compensated. Whether it manifest in the form of hourly wages (the longer you work the more you make) or the form of high paid professions (the harder your skill is to master, the more you make) this value system is paramount to all economic systems. As this truth is applied to a system of taxation and governance, unexpected consequences often arise.

  1. Our current system is broken. The revenue being taken in through taxes is being far outpaced by spending. Our deficit in fiscal year 2011 was $1.3 trillion.
    1. We have too many entitlements.
    2. We do not have enough revenue.
    3. The tax base is too narrow. The top 25% of earners paid 87.3% of all federal income taxes in 2009, and the bottom 50% only paid 2.25% of all federal income taxes.
    4. Our tax scheme runs counter to growth.
  2. Our economy is not a zero-sum game. We can grow (or shrink) GDP, or the big pie to use an analogy.
  3. Growing our economy will solve the problems in 1.
    1. It will reduce dependence and the need for entitlements
    2. It will increase tax revenue
    3. It will widen the tax base
    4. It will increase the standard of living for all, the ultimate goal.
  4. Therefore, we need to learn how to grow our economy, in order to solve 1.

Basic Premise: Incentives influence behavior. As B.F. Skinner showed in his experiments on operative conditioning, people will respond positively to incentives and negatively to punishments. People will seek actions that are associated with giving them pleasure. For example, if a person receives a cupcake every time they open a door for a person, they will try to open more doors. Conversely, if a person is smacked every time they slam a door on a person, they will avoid slamming doors.

  1. Our Current Progressive Tax: Determines payment based on a person’s ability to withstand the pain of taxation. The more income a person has, the higher their tax burden. The less income a person has, the more benefits they receive, through tax breaks and benefit programs.
  2. Taxing (Punishing) higher incomes at higher tax rates creates a disincentive for earning more income.
  3. Disincentives to increase income result in fewer increases in income.
  4. Fewer increases in income result in fewer increases in spending power.
  5. Fewer increases in spending power create lower quality of life (or less improvement in quality of life) through decreased consumption (See 4-C).
  6. Decreased consumption creates decreased tax revenues (See 4-D).

 

  1. The Fair Tax: Make a national sales tax from which government revenues can be derived.
  2. Taxing spending creates a disincentive to spend (or conversely, an incentive to save).
  3. Decreased spending equates to decreased consumption and lower quality of life (See 4-C).
  4. Decreased consumption creates decreased tax revenues (See 4-D).
  5. Additionally, consumption can be unstable based on economic conditions. In times of natural decreases in consumption, the government has no other source of revenue to rely on and is thus forced to cut services.

 

  1. The Flat Tax: Based on the current average federal tax rate, a flat income tax would be around 17.4% (if excise and payroll taxes were eliminated). The problem with this is that it still leaves a deficit, and does nothing in and of itself that would close the deficit.
  2. Taxing incomes at a flat rate across the board provides no incentive to earn more or
  3. Income will reflect what it would be in the absence of any tax.
  4. This does not foster growth.
  5. Without fostering growth, government revenues will not increase.

 

  1. The Incentive Tax: Half income you earn in a year that is greater than the income you earned in the last year will be tax exempt for the year. For example, if a person earned $30,000 in 2011, and then earns $35,000 in 2012, $2,500 of those earnings will be tax exempt.
  2. Incentives to increase income will increase income. This is twofold. First, the increased incentive to raise your income in a given year results in a higher probability that your income will indeed increase. You will seek behaviors which will result in raised income (See Basic Premise). Second, the tax break you get on half of your increased income will directly raise your amount of take-home pay, relative to other tax systems.
  3. Increased income creates increased spending power. The more income you have, the more power you have to purchase goods and the larger the pool of goods you can choose from.
  4. Increased spending power creates increased standard of living through consumption. When you have the available funds to buy better health care, better food, better housing, you can purchase these items. You are given the choice to save, invest or spend as you see fit. In doing so, you increase your standard of living, solving problem d. As you increase your standard of living, you have less need for entitlements and services, solving problem a.
  5. Increased consumption creates increased tax revenue. Eventually, all money gets taxed. Increased purchases will increase sales tax revenues. The people creating the product will receive larger revenue through sales. The more revenue, the larger production can be, and the more wages will be required to sustain the larger production. It is immaterial whether this wage increase comes in the form of more jobs or higher paying jobs, taxable income will increase. As taxable income increases, you solve problems b and c. Through this process, you grow the economy.

Currently, the tax and benefit system in the U.S. is designed to punish success and reward failure. If you make more money, you have to pay a disproportionately high share of taxes. You are denied tax breaks and even basic deductions are phased out and eliminated. If you make a low amount of money, then you may be eligible for various benefits. This system should be reversed; instead of rewarding low income it should reward success. It can be phased in over time and act to counter the current disincentives. Each time you pull yourself up; you get a pat on the back and a bonus from Uncle Sam. Not only does this incentivize success, raise the GDP, and increase productivity, it aligns the value system of the government with the innate value system of economics. Productivity is virtuous, and should be viewed as such.

There are various ways to increase your income, whether it is through education, overtime, invention, etc. The government will often try to incentivize and promote the behavior instead of rewarding the result. The way a person achieves success should be less important to the success itself. The positive ends, a higher income and a higher standard of living, are the true goal. Instead of incentivizing the means, which may only work for some, we need to incentivize the ends, which will work for all.

The key goal is to raise the GDP, to raise the water level across the board. When incentives apply to everyone, instead of specific subsections, everyone can benefit. The truth is that economics, especially national economics in a global marketplace, are not a zero-sum-game. The goal is not to steal someone else’s piece of the pie, but to make a bigger pie that everyone can enjoy.

An incentivized tax system also encourages tax compliance. Instead of trying to hide extra earnings, you will actively work to document them in order to get the tax break associated with increased income.

The end result of an incentivized system is three fold:

  1. It creates a higher standard of living.
  2. There is less demand on the system. With less people requiring entitlements and benefits due to improved circumstances, less tax money needs to be allocated to these areas.
  3. It broadens the tax break. As people increase their incomes, they move into higher tax brackets and pay more into the system.
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