Summary of my views on the ideal tax system

Government programs (expenditures, mandates, regulations) should be evaluated for their benefits and these compared with their costs. The resulting level of government expenditures politically prioritized and determined (hopefully on this basis) should be financed in the most economically neutral, equitable, and efficient (costs of compliance, collection and enforcement) ways possible. The following proposals are based on these assumptions and objectives. Stress is placed on the high compliance costs and enforcement difficulties of existing taxes in an increasingly globalized world.

Very simply stated, the ideal taxes in terms of neutrality (minimal distortion of relative prices) are either a comprehensive income or consumption tax. A comprehensive consumption tax is more neutral than an income tax, which distorts the choice between saving and consumption by taxing saving. For some, however, an income (the return for what you give society) tax is more equitable and for others a consumption (what you take from society) tax is more equitable. Use taxes (such as tolls or gasoline taxes for the use of highways), which are generally considered both neutral and equitable and thus desirable when feasible, are not otherwise considered here.

However, the ease of avoidance and costs of compliance are very different for income taxes (whether based on the residence of the tax payer or the territories in which the income is produced) than for a consumption tax, which necessarily applies to the territory in which consumption occurs.[1] U.S. efforts to prevent income tax evasion (both business and personal) by hiding income abroad have become increasingly costly, intrusive, and obnoxious to foreign governments. For these reasons, and the reasons of neutrality and equity, I favor a comprehensive consumption tax (VAT) combined with a rebate (negative income tax) to every man, woman, and child legally resident in the U.S. and the abolition of all income, wealth, and wage taxes.

Taxes on business income violate almost every standard of good taxation and contribute most to political controversy and to business costs aimed at reducing evasion. With increased globalization, efforts to define business income within the tax jurisdiction and to detect taxation evasion by moving income (as apposed to actual economic activity) abroad are becoming more difficult and invasive into the policies of other countries. The taxation of business income should be totally abolished.

Payroll (wage) taxes used to finance pensions might be thought of as a use tax. However, in the case of the payroll tax, which is nominally linked to the Social Security pension in the U.S, the pay-as-you-go financing of the Social Security pension makes the link weak. Furthermore, payroll taxes are very regressive.

The primary appeal of an income tax over a consumption tax rests on the public’s perception of fairness. Why should income from clipping bond coupons be taxed less than hard labor? A preference for an income tax may also reflect the desirability of limiting the accumulation of wealth and income inequality even potentially at the expense of less investment and thus lower incomes for everyone. An often overlooked drawback of income taxation is the relative ease with which the wealthiest can evade taxation via various off shore (or even on shore) vehicles for hiding it. IRS efforts to find all income earned or sheltered abroad raise similar problems for international cooperation and relations as do such efforts with regard to the corporate income tax. Defining and measuring properly net income subject to taxation can also be problematic as is the fairness of taxing U.S. citizens living and earning their income abroad. None the less, under the existing tax code those with incomes in the top 1 percent paid 40 percent of all income tax revenue in 2006 and earned only 22 percent of all income, the top 10 percent paid 71 percent and the bottom 50 percent less than 3 percent.[2]

I support a comprehensive consumption tax (Value Added Tax) for all residence in the U.S. When combined with cash rebates to all legal residents equivalent in value to the consumption tax paid on purchases of essential goods and services by every man, woman and child, the tax becomes modestly progressive and satisfies a sensible notion of fairness. As I also think a minimum level of retirement saving[3] and medical insurance should be mandatory as part of making our social safety net more efficient and equitable, the per person cash rebate should be large enough cover these mandatory minimums. To insure compliance with these mandatory payments, these amounts could be deducted from the cash payments and invested in a standard retirement fund or health insurance policy for anyone unable to document that they have satisfied these requirements.

Residents would support government services in proportion to what they take (consume) from the economy rather than on the basis of what they give (produce). By every calculation of actual tax collections, the wealthy would pay more than they do now with existing taxes. Its collection and enforcement would yield enormous simplifications and compliance cost savings. The IRS could stop chasing money around the world. A tax rate of 23 percent on after tax consumption (which makes the rate comparable to an income tax (i.e., 30 percent of pre tax consumption) is estimated to raise the same revenue as existing federal income taxes, including, personal, estate, gift, capital gains, alternative minimum, Social Security, Medicare, self-employment and corporate taxes.

[1] This is a simplification. A good may be purchased in another state or country and carried across borders to be consumed at home. Border tariffs for the difference in the foreign and the local consumption tax rates would be needed.

[2] Wall Street Journal, “Their Fair Share”, July 21, 2008 p A12

[3] Funding private pension plans attached to individuals rather than through companies in place of the existing, pay as you go social security system.

Views from Eurasia

I spent last week in Amman Jordan where I presented a paper on the U.S. Subprime mortgage crisis to the Association of Banks in Jordan. Financial market developments in the U.S. have affected markets world wide. I will be happy to send the paper to any of you who would like it.


I am now finishing up a short visit to Astana, the capital of Kazakhstan, where I participated in the founding of the Eurasian Economic Club of Scientist in the run up to the tenth year anniversary of the establishment of Astana as Kazakhstan’s capital. Kazakhstan boarders Russia to the north and China to the East, but as part of the former Soviet Union has closer ties with Russia.


Last night was the final banquet/party. If you really want to party, party with Russians and Kazakhs. They are warm friendly people to begin with but become even more so with each shot of vodka. Following tradition they each expressed themselves to the whole group through a series of toasts delivered from the most senior person on down.


As we were a large group, toasts were delivered from the dance floor with a microphone. Our table went up as a group and the delegate from Beijing next to me, his adrenaline flowing, literally shouted into the microphone warm platitudes of greatness and success to everyone. I had thought of him as soft spoken until then.


There were many Russians attending and I marveled at the warm relationship the Kazakhs expressed toward their Russian brothers. It was an interesting contrast with the attitude I observed sixteen years earlier when I lead the IMF’s technical assistance teams to the National Bank of Kazakhstan, Kazakhstan’s central bank newly established from the branch of the Soviet central bank that had preceded it. The relationship then with Kazakhstan’s former colonial master was tense and sensitive. Now, as an independent country, the Kazakhs wanted to be close to their Russian brothers again. But it shouldn’t surprise us that volunteer relationships work better than coercive ones.


I am reminded as well of comments by dinner guests at my home some weeks ago about the future of China and Russia. The consensus was that China was a good country to do business with because the rules were clear and adhered to and the Russia was not for the lack of the same. Russian President Medvedev has been saying the right things, “we must repeat again and again: protection of property rights is the first and most important task of the state.” The Economist quotes the results of a survey of 60 Russian chief executives in which most want Russia by “2020 to be ‘free, educated and law-abiding;’ only 22% want it to be ‘strong.’” My dinner guests did not think Russia could change. “Ten or twenty years from now no one will pay any attention to Russia,” my dinner guests concluded. “It will be unimportant. It will be all China.”


On a different note, I asked a number of the young Kazakhs helping with the conference what they thought of the U.S. presidential campaigns. They all liked Obama, not because they know and approve of his policy positions, but because his Indonesian step father was a Muslim (Kazakhstan is a majority Muslim country—vodka drinking Muslim’s I call them). Though they know Obama is a Christian, they think he will understand Islam better. The Indonesian delegate at my table (another Muslim country) expressed exactly the same views.

Gitmo and Us – Comments

Gitmo and Us – comments


Dear friends,


After circulating my note on Gitmo, the Supreme Court struck down the government’s denial of the right of habeas corpus to Guantanamo detainees. The BBC News headline was “Foreign suspects held in Guantanamo Bay have the right to challenge their detention in US civilian courts, the US Supreme Court has ruled.” The 270 detainees at Gitmo (down from the peak of 680 in May 2003) include some of the most dangerous people on earth and some total innocents arrested for bounty and revenge by fellow Afghani enemies. Now they will be allowed to make their case before in impartial judge. In his majority decision Justice Kennedy said: “few exercises of judicial power are as legitimate or as necessary as the responsibility to hear challenges to the authority of the Executive to imprison a person.”


There are issues of “how to treat them” and of “how to try them”. McCain has disagreed with the President on torture, saying that “Weakening the Geneva protections is not only unnecessary, but would set an example to other countries with less respect for basic human rights that they could issue their own legislative ‘reinterpretations,’” but agrees with him that enemy combatants in Guantanamo should not have access to Federal courts. However, in December 2003 after a visit to Gitmo McCain and  Sens. Lindsey O. Graham (R-S.C.) and John W. Warner (R-Va.), wrote to then-Defense Secretary Donald H. Rumsfeld that "A serious process must be established in the very near term either to formally treat and process the detainees as war criminals or to return them to their countries for appropriate judicial action.."  The fact remains (or at least high probability) that innocent men have been held in Gitmo for over five years with no opportunity to clear themselves. The administration’s level of incompetence in this matter is itself a crime (read Philippe Sands “Torture Team, Rumsfeld’s Memo and the Betrayal of American Values”).


Many of you sent very interesting commented on my note and your reactions covered the spectrum.




Good stuff!


David Keene (Chairman of the American Conservative Union)






As for the poor fellow who tossed the grenade, would you have preferred summary execution at the scene (as was done by our troops during WWII with combatants out of uniform — the only people to whom the Geneva Convention applies)?


You said: “… Al Qaeda and others (remember blond haired, blue eyed Timothy McVeigh and the Oklahoma bombing).”


You might be interested in learning that McVeigh’s partner Terry Nichols made some 50+ phone calls to an al Qaida cell in the Philippines before and after the OK bombing. A friend of mine, a Pentagon consultant, has the phone records


Not to say there is no injustice at Gitmo, because there is … mostly with relatively innocent people turned in for rewards by Afghans and others seeking cash.  Keene has some eloquent examples of this.  But your broadside is more than a little over the top.


Here is an exchange with a friend of mine —


“Jameson: From what I have heard from David Keene, there is a large cohort (maybe a third of the detainees?) of people at Gitmo who were turned in, in some cases falsely, for reward money by tribal opponents in Afghanistan etc., not for anything they did.  The military has not been very smart about this … better to have shipped most of these people home by now, to let them be dealt with by their own governments, for better or worse (the latter, probably).”


Here is my reply:


“I’ve heard the same from others.  I’ve also read every transcript of every Combatant Status Review Tribunal that has been released.  The deck was so stacked against the prisoners, there was little opportunity to introduce exculpatory evidence, even when that might have been appropriate.  That attitude could have offended the sensibilities of the Court.  The military wasn’t very smart about it, as you say.


“They would have been much better off to focus on the big fish and be more accommodating of the much lesser individuals, including recognizing that some might have been wrongly detained, particularly considering the circumstances of how people got swept up, including in the fashion Keene describes, and allowing space for those individuals to make their case/present their evidence.  There were–and are–serious problems in treating figures like KSM, Ramzi Yousef, et. al. as criminal defendants, and now we’re back to that  . . . .”


Jameson Campaigne (Chicago)






It’s true of all of life that we are not on the efficiency frontier. Some of the Bush admin exercises have been successful in foiling plots. But presumably they could have been done without as much sacrifice in personal liberty. Somebody must be thinking about win-win reforms in security policy along those lines.

Jim Roumasset (Prof. of Econ, U. of Hawaii)




Oh warren, I so value and respect your opinions, but oh gosh how I disagree.  In fact I am 180 degrees on the other side of your position on Gitmo.  The only black eye that I see in Gitmo is that we don’t move faster to put these guys on trial and then carry out the sentencing. Hey all need speedy trials.  I have no problem with waterboarding….in fact I was disappointed with McCain in his stance on the issue.  Being a firm believer in the death penalty I see no problem with sentencing anyone that is convicted of crimes where it is justified.


The problem with America is that we coddle our people… is going to be our downfall.  Our youth who now expect instant gratification, are allowed to get away with minor problems …  then when they grow up they expect that they can get away with infractions.  Just like illegal immigration…   I keep asking what is it that people don’t understand about the word illegal.


Then if that socialist candidate on the demo ticket is elected America is going to be in extreme financial trouble. He has no concept of either domestic policy nor foreign policy. The only experience he has is with the liberal give away programs in the corrupt side of Chicago.


But then McCain is good on foreign and security issues, but hopefully he will pick a veep candidate with a good domestic and fiscal background.. and the only one with that experience is Romney in my opinion.


I fear that with Obama’s style, energy and charisma he has a leg up on McCain. Come the end of January, I feel that the U.S. dollar is going to be further down the toilet…..along with give away programs and the increase of taxes that the south side Chicago kid has in mind, it will not be worth investing or working for a brighter further.  I simply don’t understand why it is we have to reward those who don’t earn their keep…providing them with all sorts of benefits that those who work hard can barely afford for themselves.  I keep asking where the incentive is for those individuals who want to work hard, do better and find a better financial life for themselves. 


We need to make congress a part time body, their salaries so they had to get part time jobs in their districts….thus they would have to go back to their districts to be a part of their districts. Seems to me that the more they are in Washington, the more taxes they raise and money they spend.  And believe me, this goes for both demos and reps.  As you know most spend the majority of their time within the beltway. 


I would move to have all departments cut by 20% within 10 years. Totally reduce social programs … if a person is going to receive financial benefits they must do community service first.  No work – no pay. 


Stan Harper (Bakersfield)





Many thanks. I am not so sure that we are on such different political pages. We both started our adult political lives voting for Goldwater and never did a vote feel so right and so good. I want the guilty to be punished, but the question I raised was how sure do we want to be that we don’t punish a lot of innocent people. If we had arrested suspected terrorists and tried them as the criminals they no doubt are with our established judicial procedures (not perfect I am sure) justice would have been done much more quickly without all the embarrassment we now face. Why did Bush/Cheney think they needed to create a whole new military system of justice that has slowed and jeopardized the whole thing? McCain is right to oppose torture. Our Amy field manual on this subject (which McCain wants us to stick to) argues that information gathered with torture is unreliable. Is the Army wrong? If we loose our respect for the rights of individuals we lose our claim to the moral high ground. That is not a trivial loss. We became a great nation in part because we put those rights about the state.


By the way, the south side of Chicago where Obama hung out is where I earned my Ph.D. in econ under Milton Friedman, so it can’t be all bad. Damn cold though.






I’m sorry, Warren, but I do believe that people who have attempted to kill American soldiers and who are committed to the destruction of the United States as part of an ongoing effort by an opponent that continues to be committed to our destruction should be detained without trial.  I do not consider lobbing a grenade into a vehicle full of our soldiers to be a youthful indiscretion like drunk driving or graffiti that a few years can expunge.  The problem in this entire debate, I believe, has been the attempt to employ concepts of criminal justice to war combatants.  In normal declared wars this is not done, and properly so.  (I am not an international law scholar, but I believe that, in normal declared wars, there are restrictions against criminal trials of POWs.)  The reason why the criminal justice system is incompatible with a war situation (which, despite my disgust with Bush, I do believe we are in) is the motivation of the actions: a criminal can be judged by the rules of the society who tries him whereas an enemy combatant is committed to the destruction of that society and owes no loyalty to that society. Therefore, the enemy combatant’s obligation is to resist, even in captivity. Similarly, the enemy combatant’s confederates and supporters are also often beyond the reach of the sanctions and structures of the society that make criminal proceedings (with evidentiary requirements) possible.  In the World War II context, for example, a captured kamikaze pilot fished out of the ocean from his sunken plane would not have been expected to plea bargain or turn state’s evidence against his fellow pilots.
I’m sorry to rant, but I feel that the nation is being forced into false philosophical dilemmas in the war on terror.  I also feel that this is an example of how, because of understandable disgust with Bush, intelligent and clear-thinking people have been rejected valid concepts of the war on terror.  It’s seen most clearly in the way everybody has taken to criticizing the Patriot Act even though, in more than six years of criticism, I have yet to hear anybody name SPECIFIC provisions of that law that I can agree are unreasonable or objectionable.  And, all I can say is GOD DAMN that SOB Bush for so tarnishing everything connected with him and the conservative project that otherwise valid (and necessary policies) have been rendered suspect.


Jim Colt (Lawyer, Washington DC)




These are dark days.  Those in power in our country who have orchestrated this war demean me as a Veteran, and all my fellow Veterans before me.  There are far more important issues at stake here in this torture business than the military’s petty and vain attempts to wrest a few drops of questionable intelligence from a few hundred miserable, mistreated POW’s.  The Bushies are so narrow-minded, and their view of the world, and of history, and of our important place in it, is so limited that they are blind to the damage they do.


I can hardly believe that the majority of envoys and Administration representatives that Bush has sent abroad during his terms of office are persons who have never been out of the United States before.  Self-righteous asses they are, who, like Bush when he cockily squeezed from behind the shoulders of the German Chancellor, are like Babes in the Woods, Naive pinheads, who rightfully should never have come to power.


BTW, if you ever manage to corner Ralph Nader sometime, call me, and I’ll hold him so you can punch him, and then you can hold him…..


Again, nice letter.


Steve Paliwoda (Army Veteran, Alaska)



Hi, Warren, am always happy to hear from you,


Prisoners being held in Gitmo are experiencing deteriorating mental health because of their isolated confinement. In a new report from an organization which is not always objective about the truth, especially about Russia, Human Rights Watch said 185 of the 270 detainees at Gitmo were being housed in tougher conditions then the highest security "supermax" prisons in the US. Most of those detainees spent 22 hours (!) a day in cells with little , if any, natural light, and are only allowed two hours of exercise each day. None of these detainees has been allowed family visits, and most have so far not been allowed to make phone calls home. The Pentagon recently changed policy to allow detainees to phone home once a year.


"Security measures don’t justify locking people in windowless cells (cages) 22 hours a day, for months and years on end, with almost no opportunity for human interaction, physical exercise or mental stimulation", said Jennifer Daskal, senior counterterrorism counsel at Human Rights Watch.


While the report conceded that the detainees were not being kept in solitary confinement-since many can communicate through the gap bellow cell doors-it said the reality of "extreme social isolation" was causing the mental health of many detainees to deteriorate. The report pointed to the examples of a number of detainees , including 13 Uighurs-from the Chinese province of Xinjiang-who are housed in isolated conditions despite having been cleared for release when a host country can be found.


Human Rights watch also raises concerns about the mental health of two detainees whose military commissions are due to reconvene at Gitmo Bay alter this month.

Citing the concerns of lawyers for detainees , the report says Mohammad Jawad, a 23-year-old Afghan accused of murder, cannot assist his defence because of his unstable mental condition. It also claims that Salim Ahmed Hamdan-the alleged driver for Osama bin Laden and first detainee to appear before a military commission-cannot make competent decisions about his trial because "he is so distraught over his living conditions".




Denis Gryzlov (Russian living in England)


Gitmo and Us


            Is the driver of an important Al-Qaeda leader a sufficient threat to our national security to justify holding him in prison without charges until the “war on terror” is over? Are we being made safer by torturing a 24 year old Afghani charge with lobbing a grenade into a passing U.S. Special Forces vehicle in Kabul five years ago and also being held indefinitely?


The balance between freedom and security is one of the many characteristics that help define people and nations. A country’s system of justice is meant to enforce law and order (the rule of law as we like to say these days). It administers justice by punishing the guilty and in doing so establishes and enforces incentives for playing by the rules, what ever they are (remember, I am an economist for whom incentives play a central role in behavior). Our system of justice also reflects the balance we feel comfortable with between freedom and security and helps define us as a nation.


The rules that govern when and how people can be arrested, tried, convicted, and incarcerated reflect the desired balance between freedom and security. No system is perfect and no system is capable of punishing only and all of the guilty. In every system, some innocent people are falsely found to be guilty and some guilty people are falsely found to be innocent. Some systems are more efficient than others in reducing both types of errors to a minimum (and I leave to experts to debate the features considered efficient). But for efficient systems (those on what economists call the pareto optimal frontier), you can only reduce the error of setting guilty people free at the expense of convicting more innocent ones.


Every society makes its own decisions about where it wants the balance in the trade off between freedom and security. I think that when we characterize ourselves as the “land of the free, home of the brave,” we are reflecting a preference for more freedom at the expense of some security. As a nation we have developed a system of justice that gives more weight to protecting the innocent than punishing the guilty. In the tradeoff between freedom and security we give more weight to freedom (to safeguards against falsely punishing the innocent even at the expense of setting some guilty people free). Without question this reduces our security some (or at least the security of those not falsely incarcerated). Our social consensus on where to strike that balance shifts from time to time and is often hotly debated, but we have consistently favored the rights of the accused to defend themselves from false charges more than most other nations.


It is pretty obvious, as noted by our founding fathers, that periods of war and unusual danger, increase our desire for security, which invariably comes at the expense of freedom (if we are on the efficiency frontier). Examples are the incarceration of Americans of Japanese ancestry and many restrictions on speech during World War II, and the anti communism of the Cold War. We experienced this quite dramatically following 9/11.  Public reexamination of whether we have adjusted the balance between freedom and security appropriately or gone too far is now underway—a demonstration of another strength and safeguard of American culture and institutions (free press and speech).


Guantanamo, the U.S. detention center in the Guantanamo Bay Naval Base in Cuba (Gitmo in military slang), is a huge black mark on the United States not only because the Bush administration authorized the use of torture there and elsewhere, which is a violation of the Geneva Convention to which the U.S. is legally and hopefully morally committed, but also because it represents a huge revamping of our system of justice away from freedom in the name of more security. I do not think what is being done in Gitmo will actual increase our security—quite the opposite—but that is another story.


To glimpse how far we have swung in Gitmo, consider an interview of its first commander in 2002, Major General Michael E. Dunlavey. The interview was conducted by Philippe Sands, a Professor of Law at University College London, and reported in his book: Torture Team: Rumsfeld’s Memo and the Betrayal of American Values Palgrave Macmillan, New York, 2008. “When Dunlavey arrived at Guantanamo, the interrogations had already begun… Planeloads of detainees were being delivered up on a daily basis. Many posed no threat, men who had been in the wrong place at the wrong time; some were very elderly…. By May [2002] Dunlavey had concluded that half the detainees had no intelligence value at all. He reported this to Rumsfeld, who told him to take his problems to [Douglas] Feith… In Feith he met solid resistance to the idea of returning any detainees, so it was on with the interrogations, even if the usual techniques wouldn’t work.” (page 43). See the movie “Rendition,” to see how this works.


Or take the example of Mohammed Jawad, who at the age of 19 “was arrested after a Dec. 17, 2002 attack in which he allegedly threw a grenade into a passing U.S. Special Forces vehicle in Kabul that was on a humanitarian mission.” Guantanamo prison records show that Jawad was subject to a form of sleep deprivation after it had been banned. Air Force Maj. David Frakt, who represents Jawad and moved last week to dismiss all charges against Jawad, stated that: "I think it reflects the abandonment of basic American values of human decency that occurred on a widespread basis in detention operations in the first two to three years of the global war on terror," Frakt said in early June of this year that "What started as an effort focused on a few detainees believed to possess critical intelligence filtered down to ordinary detainees and became routine."[1]


Our usual legal checks and balances have been swept aside for these detainees. They were to be tried by new military procedures (ultimately struck down, in part, by the Supreme Court) unencumbered by inconvenient safeguards. We must ask and decide whether this new balancing of freedom and security is effective (is it really increasing our security) and whether it is compatible with the values we wish to commit to and defend. My answer to both is no.


Our “give me liberty or give me death” forefathers did not fight for independence nor establish our constitutional republic in order to maximize our security. There are some bad people out there—Al Qaeda and others (remember blond haired, blue eyed Timothy McVeigh and the Oklahoma bombing). It is very likely that we will suffer far worse attacks than the twin towers. We can survive them and pick up and move on. But to react with a Patriot Act squared or cubed—to shut down into a protective Garrison state—would be to surrender what we were founded for and have become great because of.

[1] Josh White, “Detainee’s Attorney Seeks Dismissal Over Abuse”  Washington Post June 8, 2008; Page A04