Charles Wheelan, Ph.D. The Naked Economist

Tax Day is approaching. So maybe you're reading this as you prepare to write Uncle Sam a big check. Or maybe you don't pay taxes, and you've convinced the warden at your minimum security federal prison to give you Internet privileges. In either case, if you're looking to me to provide some intellectual rationale for why your tax bill should be lower ... I can't.

It's certainly true that lower taxes can inspire lots of good things. Economics is all about incentives, and lower tax rates generally create positive incentives. Lower payroll taxes make it cheaper for employers to take on new workers. Lower taxes on capital gains make investment more attractive.

Lower marginal rates on income tax encourage greater participation in the labor force -- particularly in families with two potential earners. That second job looks a lot more attractive when you get to keep 70 or 80 percent of the salary, rather than half or less.

So, yes, there are lots of good things about low taxes, as politicians like to remind us. But that doesn't mean that the road to growth and prosperity must be paved with tax cuts.

Incentives That Benefit Society

Alas, there's an inconvenient counterpoint. We use tax revenues to pay for things that also protect and promote growth and prosperity -- handy things like highways, education, stoplights, mosquito abatement, counterterrorism, civil and criminal courts, a stable currency, and all those Americans currently trying to bring order to Iraq.

The notion that lower taxes must always be better for the economy becomes an obvious fallacy when carried to its logical conclusion: The economy would grow fastest with no taxes at all. Of course, that doesn't make any sense. A nation with zero taxes would look something like Haiti, or Baghdad just after the U.S. invasion. It wouldn't necessarily be a great place to do business or raise a family.

So, the economic reality is more nuanced. Some taxes, particularly those that create the worst distortions, should be lowered or scrapped entirely. Others should actually be much higher, for reasons that I'll explain in a moment.

The important thing to recognize is that different taxes create different incentives. An income tax makes working less attractive, a cigarette tax makes smoking less attractive. Which incentive is better for society?

Who Says It's Wasteful Spending That Gets Cut?

The same is true on the spending side. Some government spending is a prodigious waste of money (e.g. enormous farm subsidies), while other programs have paid for themselves many times over (e.g. the Interstate Highway System).

Yes, a smaller government leaves less room for waste, but who says it's the wasteful spending that gets cut? Farm subsidies are shockingly resilient, no matter which party controls the White House and Congress. And "smaller government" could leave out some pretty crucial things. Wouldn't it have been nice to have a few more Arabic speakers in the CIA and FBI before 9/11?

Economics offers few sweeping generalizations about whether you should pay more or less to the government every year. But I'm not done with this column. Economists do spend a lot of time arguing that whatever revenue is collected ought to come from different sources. All taxes are not created equal. We could make ourselves better off by raising some taxes and lowering others.

In that spirit, here's my Tax Day wish list:

1. Flatten and Simplify
   
   The more broadly a tax is imposed, the lower the rates can be in order to collect the same amount of revenue. The converse is also true: Every time a politician comes up with some new tax deduction or credit, it means that everyone else has to pay slightly more in order to raise the same revenue.
   
   Tax credits and deductions have a superficial allure because they give us the sense that the government can accomplish something without actually spending money on it. The President doesn't thump the podium during the State of the Union address and declare that he's going to give cash to private companies that invest in new capital equipment. Instead, he thumps the podium as says he'll ask Congress for a new Capital Equipment Tax Credit.
   
   It's the same thing. If those companies pay less in taxes, then you're going to pay more (or the government will borrow more, and someone will pay more in taxes at some point). Economists actually refer to these kinds of deductions and loopholes as "tax expenditures". And we have thousands of pages of them.
   
   These loopholes have several other subtle drawbacks. First, they create both an opportunity and an incentive for dodging taxes, legally or illegally. If Congress does create a new Capital Equipment Tax Credit, then an army of accountants are going to make darn sure every purchase your firm made last year is categorized as capital equipment, including those new machines in the employee gym.
   
   Which brings us to the second problem: The IRS must then promulgate scores of pages of regulations on what constitutes capital equipment. Your tax return just got more complicated.
   
   So let's start eliminating the loopholes. A simplified tax code makes for lower rates, fewer unfair disparities among taxpayers, less opportunity to game the system, and a lot fewer headaches at this time of year.
   
   Sound good? Well, everybody is keen on simplifying the tax code -- until they learn what they have to give up. Something like the home mortgage-interest deduction -- a real favorite at this time of year -- belongs on the chopping block.
   
   Most analysis has found that it has a minimal impact on the rate of home ownership. (Would you be living in a rental apartment if you didn't get the deduction?) Instead, it merely enables people to afford larger houses, which is a nice thing but not really the role of government.
   
   We don't like other people's loopholes, but we're rather keen on our own.
   
   
2. Tax the bad stuff, not the good stuff
   
   Taxes raise the cost (or lower the benefit) of doing something. Think about the income tax, which reduces the benefit of working. When you're deciding to take a job, or a second job, you don't calculate how much you'll get paid. You calculate how much you'll get to keep. If taxes take too big a bite, you may not take the job, regardless of how good the salary looks before Uncle Sam gets involved.
   
   Taxes change behavior -- which can be a good thing. Wouldn't it be better if the tax code discouraged burning dirty coal or making a long commute in an SUV rather than say...getting a job?
   
   We've done this with smoking. Smokers pay cigarette taxes because it's particularly expensive for the government when they get heart disease, cancer, emphysema, etc. When cigarette taxes go up, some smokers quit or cut back (which is good), others just pay the tax (which is fair enough).
   
   We should do more of that. For example, if global warming is for real (and/or if we're serious about cutting our dependence on Middle East oil), then we ought to tax the use of fossil fuels (a carbon tax) and offset that new revenue by cutting the income tax, or the payroll tax, or the capital-gains tax, or some other tax that discourages productive activity. We'd use less polluting energy (good) and have greater incentive to work, hire, and invest (also good).

Protecting Their Loopholes

So why aren't we doing these things? Well, let's think about the politics. So far, by my rough tally, I've offended the farm lobby (who are rather attached to those huge agriculture subsidies), the entire real estate industry (who recognize that the mortgage-interest deduction helps prop up demand), and the oil, gas, coal, and auto industries (none of whom are excited about a carbon tax).

That should give you some sense of why the tax code looks the way it does. Happy Tax Day.