Sunday, October 1, 2017

ICYMI: Tax Math

We posted the following on another of our pages while working on a new commentary. We post it here as well for those that missed it. We also have added a chart further down in the body to better illustrate the point.

Working on the next blog post but some simple math as we do.

One of the most important factors in designing a tax measure is the revenue base over which it is to be collected. The broader the base, the lower the tax, the less impact on those taxed and the more moderate the overall effect on the economy.

For example, if you are trying to raise $100, the tax rate is 50% if the revenue base over which you are trying to recover it is only $200 ($100/$200), the tax rate is 10% if the revenue base over which you are trying to recover it is $1,000 ($100/$1000), and the tax rate is 1% if the revenue base over which you are trying to recover it is $10,000 ($100/$10,000).

Applying the tax over a broader revenue base also increases those citizens with a vested interest in and focused on limiting the revenue raised by the tax. If the tax is spread only over some of the population, they are the only ones focused on limiting the revenue raised. Others in the population are free riders and, at best, are indifferent to the level of revenues raised; at worst, they want to raise more revenues to expand the services they receive as free riders.

The free rider problem also arises if some of the population are taxed at so low a rate that they don't really feel it. For example, if a family with a combined annual income of $250,000 (which puts them in the middle of the Top 20% of Alaska families) only pays $2000 (<1%) in state tax (about the cost of a roundtrip flight to Hawaii during peak periods), they are less inclined to take the time required to stay informed about and become active in attempting to limit the level of revenues raised (and the legislators that actually are doing that); instead, as with other free riders, they are more inclined to seek increases in the level of funding for the services in which they are most interested because they largely are indifferent to the costs.

Frankly, that math is a large part of why we favor a flat tax (if we have to raise new revenues). Looking at the various numbers, a flat tax based on adjusted gross income would apply to a tax base of roughly $27 billion. Even adjusted for tourist sales, a sales tax (with exemptions) would apply only to a tax base of roughly $17 billion. Far worse, a PFD tax only applies to a tax base of $1.5 billion.

The effect of each is apparent once the relative tax rates are calculated. As summarized in the following chart, if the goal is to raise $750 million in new revenue, for example, rounded to the nearest quarter percent the required flat tax rate is only 2.75% ($750mil/$27bil). Raising the same level of revenue through a sales tax ($750mil/$17bil= 4.5%) or PFD tax ($750/$1.5bil=50%) requires much higher rates.



Comparison of Flat, Sales & PFD Tax Rates Required to Raise $750 Million in 'New Revenue'
$BFlat TaxSales TaxPFD Cut
Tax Base$27.0$17.0$1.5
Revenue Goal$0.75$0.75$0.75
Tax Rate2.78%4.41%50.00%

Applying a tax rate of 2.75% equally across all income groups also has a much more inclusive effect than an approach (like the PFD tax) that hits those in some income brackets much harder than others. For example, a 50% PFD tax reduces the income of an average family of 4 in the lowest income bracket by over 30%, while reducing their counterparts in the Top 20% by less than 2%.

Under that approach the Top 20%, those likely with the most power to affect spending levels and legislation, are more likely to act like free riders because they pay only a small share of any required increase in revenues.

As we said at the top, we will be rolling this discussion into a larger commentary in the coming days, but thought it would be useful to post some of the simple math involved as we started to work through it.

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