In most countries, including Japan and, I think, most of Europe, payroll taxes are specifically earmarked to pay for welfare-type benefits. This is true in the US as well, with payroll taxes specifically earmarked for Social Security, disability, and Medicare. The basic idea is that of an insurance program, or, in the case of public pensions (Social Security in the US), a retirement annuity.
I think most Generation X-ers do not generally think of payroll taxes in this manner. They are just a tax like any other, with their supposed “earmark” characteristics nothing but archaic fiction. From the 1980s to the present, when asked by researchers, Gen-Xers have always said that they did not expect Social Security to exist when they retire. It would blow up before then, due to the greed and irresponsibility of the Boomers. Boomers would say that “I deserve my Social Security benefits because I paid into them all my life,” as if it was a private-sector annuity. Gen-Xer’s attitude was more like “you took money from me all my life and then blew everything up, leaving nothing for later generations.” This seems obvious today, but I can attest that this was also the common assumption back in the 1980s, just as the historical polls indicated back then.
So, it might take a little effort for a Gen-Xer to get more in the mindset of Boomers and other prior generations, actually imagining payroll taxes to be part a sort of separate welfare system from the rest of the Federal Government — its original conception, even if it was always a little fictional.
The idea is that all of the welfare-type programs, including public pensions but also healthcare, unemployment benefits, and other need-based support programs, are bunched into a separate “welfare” program, with this directly financed by payroll taxes, serving as something like an insurance scheme. This is not true today in the US, where, aside from Social Security, all the rest of the 100+ needs-based Federal welfare programs, including almost all of healthcare (Medicare payroll taxes do not come anywhere near funding the program), are on the regular budget, and financed with regular taxes (mostly the personal and corporate Income Taxes), not some “Social Security Trust Fund” separate from the budget with some accounting make-believe, with a separate revenue source, a payroll tax. But, this is actually the case today in Japan and, I think, most of the developed countries of Europe.
The payroll tax is, actually, a pretty good tax. It generates a lot of revenue with relatively low rates. At least, it does in the US — as we’ve seen, very high payroll tax rates do not produce proportional increases in revenue. Just as with income tax rates, anything beyond about 20% seems to be counterproductive.
Also, the payroll tax is very simple. In almost 90 years, it has not had much complication. There is no 70,000 page Payroll Tax law, as there is for the Income Tax. There are no deductions and exemptions, which would then require higher rates to pay for. It is, in essence, an Indirect Tax, paid by the employer (both the employer and employee sides), and no personal information is involved except the wage payments themselves. There is no tax return. I’ve called it a “sales tax on employment labor,” having many of the Indirect characteristics of other sales and excise taxes. Self-Employed have to pay a payroll-tax-equivalent, which is administered through the regular Income Tax system, but for regular employees, there is no remaining tax liability once you are paid your wages. No individual has ever been audited by the IRS for payroll taxes.
There are a couple of advantages of this Payroll Tax/Welfare Program system. First, it imposes a Uniform tax (the payroll tax), which goes to fund the Welfare programs. Thus, lower-income people who naturally will want more benefits, would have to face the prospect of funding those with more taxes. We would not have the “tax the rich” tendencies of all Democratic governments, which is why, just as Aristotle said, all Democratic governments destroy themselves. As Alexander de Tocqueville said much later, “the American Republic will endure until the day Congress discovers it can bribe the people with the public’s money.” Or, as Benjamin Franklin said: “When the people find that they can vote themselves money, that will herald the end of the republic.” Aristotle noted that Democratic governments in Greece would inevitably end up confiscating the property of the wealthy, resulting in economic turmoil and disaster, and the quick chaotic end of Democratic governments. This is why Aristotle classified Democracy as a degenerate form of government, a failed Republic. Of course the Founders read Aristotle, probably when they were teens.
The payroll tax typically has an upper limit to which it applies, which conforms the system to more like an insurance program, with a fixed cost, rather than an open-ended scheme of confiscation.
The point of all this is:
I’ve concluded, over time, that the best tax system for the Federal Government today, or indeed State governments as well although it could be combined with a Retail Sales Tax, is the Value Added Tax. We don’t like VATs today, in the US, because we are afraid of ending up with both an Income Tax and a VAT, as is the case in most other developed countries. This is correct. A Federal VAT today would have to be combined with a repeal of the 16th Amendment and the Income Tax (personal and corporate), and probably a new amendment requiring the Federal Government to stick to Indirect Taxes Only, at a Uniform Rate, which was actually the effective form of the Constitution before the 16th Amendment. This is a pretty tall order, I admit, which is why, in the 1980s and 1990s, the Flat Tax appeared as a VAT alternative, which could be imposed as a replacement of the existing Income Tax system.
Nevertheless, I think we are coming to a time where we will make big changes to the Constitution and existing form of the Federal government. We should have some idea of what we would want to do.
A problem is, replacing the existing Federal tax system today would require a rather high VAT (about 20%, and that doesn’t cover existing deficits) if the Federal Government had all the spending that it has today, including all welfare-related spending.
In the past, which has been a period of policy stagnation and decay, the prospect of making big changes (a Flat Tax) to the revenue system, and also big changes to the spending system at the same time, was considered an impossible task. But, I think that exigencies alone might force that outcome in the next few years, before 2032.
I’ve thought that this transition to a VAT could take place with the Federal Government basically getting out of the welfare business altogether, devolving that to the States, which is also the original form of the Constitution, and also what the Federal Government actually did until an explosion of welfare programs in the 1950s and 1960s (which were and remain basically unconstitutional).
Flat Tax income taxes have been adopted by dozens of countries worldwide, with excellent results. But, while the Flat Tax was, to a significant degree, a means to avoid VATs in the US, these Flat Tax adopters worldwide (especially in Eastern Europe including Russia) actually already have VATs. Thus, even at a 13% Flat Tax rate, combined with a VAT of 20%, it is something like a 33% combined VAT, or 33% combined Flat Tax, if you want to think of it that way. Although the 13% Flat Tax is great, I would aim at gradually eliminating this, perhaps cutting 1% per year, until it disappeared, leaving only the 20% VAT.
This I also recommend for other countries such as Argentina, which has a 21% VAT and a 35% top Income Tax rate. Just get rid of the Income Tax altogether, phasing it out if necessary, leaving the 21% VAT which is enough for any responsible government. The combined Payroll Tax in Argentina is 37.4%, way too high, but as we can see it is a system which is paired with a big welfare program. In Bulgaria, big reductions in payroll taxes did not result in a decline in revenue, even as a percentage of GDP. They were wholly unproductive. I would aim to reduce this to about 20%, expecting that revenue from the 20% Payroll Tax rate would actually be about the same, in %GDP, at 20% as at 37.4%. But, since that would definitely be accompanied by a big improvement in the economy, or larger GDP, actual tax revenues would increase. This is what we indeed saw in Bulgaria. (The story is in the Magic Formula, now available in free .pdf.)
This will make some Statist uncomfortable, but any responsible Statesman should accept that a combined 20% Payroll Tax and (indirect) 21% VAT, or 41% total, is more than enough taxes for lower and middle incomes.
A VAT is of course “uniform,” in that everyone pays the tax, typically indirectly as revenues of businesses which actually pay the tax. At the State level, the Retail Sales Tax would take roughly the same role.
However, Social Security does not lend itself very readily to this “devolve it to the States” model. That might be retained at the Federal level, until it could be replaced by a combination of a Provident Fund system (basically a mandatory 401(k), common in other countries today), and a needs- based Welfare system for elderly for whom the Provident Fund system proved insufficient.
Social Security could thus continue to be funded with an earmarked Payroll Tax, just as it is today, although this would be stripped of later add-ons such as disability and Medicare.
The Social Security system is itself a flawed and failed system, as the ratio of workers to retirees make it unsupportable. At some point, it will probably blow up, more likely from currency depreciation (making SS benefits worthless) than nominal benefits actually going unpaid. So, maybe making all these exceptions and strategies for SS is not that important, since we are really talking about the time after it blows up, when we can do whatever we want.
Singapore, which has a Provident Fund system and no public pensions (Social Security in the US), has the same demographic conditions (large elderly population) as other developed countries, but no Social Security crisis. The existing Provident Fund assets are actually quite ample.
Once we remove all welfare commitments from the Federal budget, expenditures become a lot smaller, and you could fund all of it with about a 10% VAT, which seems about right to me.
I would just end these Federal programs. There is no need for some elaborate transition, or “block grants” or whatever. Just say “it’s over on January 1,” and then let the States do whatever they please, using their own legislative systems, if they feel a need to respond.
This would leave all government Welfare programs to the States. At the States, these programs could be funded with a Payroll Tax, as they partially are today (States add their own State-level payroll taxes to the Federal taxes today, notably for Unemployment Insurance), separate from a VAT or Retail Sales Tax which funds all non-welfare State expenditures.
Thus, we have a role for all three primary Indirect taxes: Payroll, VAT and Retail Sales.
April 18, 2021: Grand Unified Theory of Indirect Taxes
Somewhere in this process, we might have to consider whether even the States should have today’s array of welfare programs, or whether more of these functions should be left for private-sector charities, as they were in the past, mostly via churches. “Everything the government touches turns to shit,” as Ringo Starr once said, and that is true also of charity.
The result would be something like a 10% Federal VAT, for all non-welfare Federal activities (mostly the military), and a Payroll Tax of some amount (let’s say it is 15%, as today) specifically paired with a Welfare Program, although that might be at the State level, with a State payroll tax. This could be paired with a Provident Fund system, for retirement (basically a 401(k)-like system, of individually-owned private assets), and healthcare (basically a Health Savings Account), as in Singapore today.
