Asking the Wrong Question
“Taxation is the price which we pay for civilization, for our social, civil and political institutions….” From an 1852 committee report to the Vermont legislature. (https://quoteinvestigator.com/2012/04/13/taxes-civilize/)
Too often the question that gets asked about a measure to avoid taxes is, is it legal? But that’s really the wrong question. I would suggest rephrasing the opening quote as “taxation is a contribution we make for civilization; it’s the seed money we contribute to establish, shape and maintain our social, civil and political institutions, and to insure the benefits that flow from those.”
In that context, the more appropriate questions to ask about a method of tax avoidance are: Is it just? Is it ethical? Does it have more plusses than minuses when considered against the purposes for which we tax? And only then the question, should it be legal?
Here are some basic principles I would use to design a tax system. (And certainly those principles would lead to more questions that would be need to be addressed.)
For individuals:
- The system should be fair and progressive. Individuals with a greater capacity to pay should pay more. We can argue about how progressive the system should be or about how to measure fairness, but not whether those measures should exist.
- The funds used to pay for one’s living expenses should be taxed uniformly by the system. It shouldn’t matter whether the source of the funds is a paycheck, a loan, a dividend, a capital gain, receipts from a sale, a government disbursement, or a trust fund.
Too much of what becomes tax avoidance comes from non-implementation of the second principle. For example, one version of tax avoidance allows an individual to borrow the money for living expenses using assets as collateral. The borrowed money is not taxed as ‘income’ (even though it is being used for exactly the same purposes that a paycheck worker uses the paycheck money), and the interest on the loan is deductible if any tax is owed for other reasons. This method of tax avoidance can be used in perpetuity as long as there are assets to borrow against, until the tax avoider dies, and the debt (not the avoided taxes!) falls into inheritance world, which is its own complicated system rife with methods of tax avoidance.
This is just one small example of tax avoidance and it illuminates what can happen when a system is built without reference to guiding principles. We don’t tax borrowed money for legitimate reasons. We think people should be able to borrow money to buy homes, build businesses, and go to school, and taxing the borrowed money would dampen any borrowing for those purposes. But if the tax system doesn’t examine what should and shouldn't be taxable using something like my basic principles, we end up with a system that asks “Is it legal?” instead of “Should it be legal?”