Here is a puzzler worth pondering as Congress scrambles to find enough tax revenue to feed its insatiable appetite for spending. Can you come up with a tax that both uber-communitarian Ralph Nader and uber-individualist Ayn Rand could support – a tax both progressives and libertarians could get behind?
In order to meet Rand’s criteria for justice, a tax must be voluntary, that is, collected without coercion. In order to meet Nader’s criteria for “fairness” it must be progressive, that is, the rich must pay the most while the poor pay little or nothing.
In order for this voluntary progressive tax to gain market share and achieve a sustainable equilibrium it must be tied to the provision of a government service that can be alternatively supplied by private institutions. It’s not necessary for the private services to be an exact replacement, just close enough that taxpayers could choose the private option if the government tax rate, sure to grow over time, becomes egregious.
Figure it out yet? Here’s a hint.
Aside from national security and public safety, what is the number one service provided by the government without which there would be no capitalism, no banks, no stock market, no credit, no large scale enterprises, and no modern economy at all?
The answer is – judicial enforcement of contracts. Buyer and seller, borrower and lender, investor and broker, shipper and receiver—all counterparties in any trade, except for cash and carry transactions, want assurances that if contracts are violated the aggrieved party can seek justice in court. Obtaining justice might be time consuming, expensive, and uncertain, but confidence in the rule-of-law is what keeps the vast majority of contracts from being broken in the first place.
But suppose the government made these valuable services available only to prospective plaintiffs that paid a small fee when the contract was signed? The fee would be voluntary, like an insurance premium. Contracting parties could go without coverage or specify private adjudication. Sure, adjudicators do not have the police power to cart scofflaws off to jail, but they could banish miscreants from the trading ecosystem whose rules they violated. Since banishment would be a death sentence for many businesses, that could make adjudication a robust enough option for contracting parties to consider opting out of the federal levy if it became overly burdensome.
How much revenue could such a tax raise? The U.S. GDP is estimated at about $15 trillion. While the absolute volume of cash and carry transactions is high the aggregate dollar value of cash purchases is low, estimated at less than 1% of the total. In addition, there are a large number of transactions that are not counted in the GDP, namely stock, bond, and derivative sales. All of these are protected by contracts. For free.
Enter Ralph Nader, stage left. In a recent Washington Post op-ed, Nader added his voice to those clamoring for the imposition of a tax on stock trades. Yes, this would have to be introduced at a very low rate lest it drive trading offshore. The rate, in fact, would have to be commensurate with the value of protecting those contracts, considering competing alternatives. But given the tremendous trading volume, a tax rate of even a few basis points could potentially generate a boatload of revenue.
At a low enough rate a financial transaction tax would not impact buy-and-hold investors at all, while barely ruffling active traders. Hyperactive speculators, particularly high-frequency traders that use digital techniques to simulate the front running that used to go on in the pits, would probably complain loudly. But if their trades are really producing value, it would behoove them to pay. As for those who don’t, I suspect the rest of the financial community would be more than happy to see them take their business elsewhere.
Yet, there are some potential pitfalls. A shift to a pay-for-justice model would require piecemeal enabling legislation, and therein lies great opportunity for political mischief. Entire categories of contracts—for example credit cards, mortgages, or derivatives—would have to be declared non-enforceable after a certain date if the parties declined to pay the tax, or insurance fee, or whatever Chief Justice John Roberts decides we should call it. But each time some future Congress tries to raise the rate for contract protection, payers would have a natural inclination to band together and lobby to expand the base to cover more free-riders as an alternative. And isn’t expanding the base while keeping rates low the holy grail of economically non-distorting taxation?
Whatever you think of this approach, it sure beats higher income taxes, higher capital gains taxes, or the dreaded Value Added Tax, which you know is just waiting in the wings. Of course, the way Congress is going we could end up with all of the above. But if ever we needed some innovative thinking about how to fund our government without blowing up the economy, it’s now.
Bill Frezza is a fellow at the Competitive Enterprise Institute and a Boston-based venture capitalist. You can find all of his columns, TV, and radio interviews here. If you would like to have his columns delivered to you by email, click here or follow him on Twitter @BillFrezza.