The Many Things Governments Can Tax

What this means

Every tax has two parts. The tax baseThe thing being taxed: an amount of income, the value of a transaction, the assessed value of property, a quantity of emissions. is what gets measured, and the rate is what fraction of it the government takes. Arguments about taxes sound like arguments about rates and are usually arguments about bases, because the base determines who is measured at all.

Think of the possibilities as a menu. Governments can tax income, and even that splits into wages, business income, interest, dividends, and capital gains, each of which can be taxed at its own rate. They can tax spending, through retail sales taxes charged at the register or excise taxes built into the price of specific goods.

They can tax value added at each stage of production. A value-added taxA tax collected at every stage of production on the value each business adds, ultimately borne by the final consumer., or VAT, taxes the difference between what a firm pays for inputs and what it sells the output for, collected all the way up the chain. The economic result resembles a sales tax on the final consumer, but because every business in the chain reports, it is harder to evade. The United States has no federal VAT; most of the rest of the developed world does.

They can tax property, meaning the assessed value of land and buildings, which is how most American local governments fund schools. They can tax production directly, including severance taxes on extracted oil, gas, or minerals, which is a major revenue source for a few states.

They can tax pollution. A pollution taxA tax on emissions, designed to make polluters bear a cost they would otherwise impose on others. such as a carbon tax charges emitters per unit released. The logic is different from other taxes: the goal is to make a producer face a cost that would otherwise fall on third parties, so behavior change is the point rather than a side effect.

They can tax imports through tariffs, financial instruments through transaction taxes on trades of stocks and bonds, and wealth itself. A wealth taxA recurring tax on the total value of assets a person holds, rather than on income earned during the year. is levied on the stock of assets someone holds, not the flow of income they earned. That distinction between stock and flow is the single hardest idea in this benchmark and the one most worth getting right.

Almost no government picks one. Real systems layer many taxes, partly to spread the burden and partly because a broad base at a low rate usually distorts behavior less than a narrow base at a high rate.

Why it matters

Once you can see the menu, you can see that the tax system you grew up under is a set of choices, not a natural fact. Other rich democracies raise similar shares of their economies through very different combinations. That is genuinely useful for evaluating any proposal, because you can ask what happened where it was tried instead of speculating.

It also matters for your own life planning. Tax bases determine which decisions carry tax consequences: where to live, whether to rent or buy, how to hold savings, whether a business is worth starting in one state or another. People make these decisions well or badly depending on whether they know which base they are stepping into.

Try it

1. Build the taxonomy. Make a table with one row per tax type from the benchmark: income, spending, consumption, property, production, value added, pollution, imports, financial instruments, wealth. Columns: what exactly is measured, who legally pays it, who probably bears it economically, and one place it is used.
2. Distinguish stock from flow. Write a paragraph explaining the difference between taxing someone's income for the year and taxing their accumulated assets. Use a concrete case: a retiree with a paid-off house and little income, versus a young lawyer with a high salary and student debt. Determine which tax hits which person harder and why.
3. Research a VAT country. Pick one and find the standard rate, whether reduced rates apply to food or medicine, and how much of that government's total revenue it produces. Explain the administrative reason a VAT is harder to evade than a retail sales tax.
4. Research a pollution tax. Choose a national or subnational carbon tax and find its rate, what it applies to, what happens to the revenue, and at least one published finding about its effect on emissions and on the local economy.
5. Research a wealth tax. Pick a country that levies one now or levied one recently. Find the threshold, the rate, and any documented administrative problems, especially valuing assets that are not publicly traded. Find out why some countries repealed theirs.
6. Do property tax locally. Find your own county's property tax rate and how assessments are set. Determine what share of your school district's funding it provides.
7. Compare two states. Pick two U.S. states with clearly different tax mixes, ideally one with no income tax and one with no general sales tax. Build a profile of a hypothetical family and reason through which taxes each family would face. Do not try to compute a total; the point is to see which bases apply.
8. For each of your researched taxes, name the winners and the losers explicitly. Who bears the cost, who receives the benefit funded by it, and who can rearrange their affairs to avoid it? Write it as a plain list of people, not categories.
9. Write a closing paragraph on this question: why do most governments use many taxes at moderate rates rather than one tax at a high rate?

Check yourself