The Moral Basis for a National Transaction Tax

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Have you been tracking Congress's frantic search for the hundreds of billions of dollars in new tax revenues it needs to fund its spending orgy? The latest Willie-Sutton trial balloon is a tax on Wall Street transactions. This is being met by howls of protest, as is customary whenever Congress fingers a new source of wealth it would like to spread around. As tax proposals fly, enticing targeted groups to hike their campaign giving in hopes of shifting the burden elsewhere, might it make sense to examine the moral basis of these proposals?

Oddly enough, there is a form of National Transaction Tax that ought to pass the most inclusive standards for the levying of a just tax. If broadly applied, such a tax could potentially eliminate the need for both corporate and personal income taxes. It is inherently progressive in that the heaviest burden would be carried by the rich - who would incidentally receive valuable benefits in direct proportion to their payments - with an almost negligible burden falling on the poor. And best of all, it would be voluntary.

A voluntary tax that could fund the entire federal government? Surely you jest.

The idea, first proposed by a certain novelist-philosopher forty years ago, is based on the simple concept that citizens who expect the government to guarantee the sanctity of their contracts should be asked to pay for this valuable service. The more you utilize the service, and the larger the value of the contracts you want protected, the more you pay. Asking a fry cook at McDonald's to underwrite the enforcement of a Goldman Sachs derivative contract is both morally offensive and economically inefficient. Suppose, instead, that everyone just paid their own way?

Contract disputes could always be handled by private arbitration, and nothing in this proposal limits that. But a fundamental tenet of civil society is that only the government has a right to dispatch men with guns to enforce a judgment. Want the right to use the court system and police to enforce your contract? Then be prepared to foot the bill with the equivalent of a contract insurance premium, paid in advance. Don't pay the fee and you don't get the service.

A true National Transaction Tax would be levied on any and all private transactions in which either party wanted the right to avail themselves of the public rule of law. Caveat emptor deals and cash-and-carry transactions would be spared the tax, again at the choice of the parties engaged. It wouldn't even require mutual agreement; the party that wants the protection pays the tax. But any other transactions with an expressed or implied contract, from buying and selling securities to taking out a mortgage to placing a purchase order for parts to writing a check to using a credit card would be subject to the tax. Proof of payment would be a precondition to achieving the standing required to sue in public courts.

The precise tax rate required to fund all the legitimate functions of government is left as an exercise for the reader. This would certainly vary based on what assumptions you made on the spending side of the ledger - after all, there is still no free lunch. But it would be hard to find a more economically efficient tax, or one with fewer propensities to cause market distortions. Sure, some Wall Street sharpies would invent some complex securities designed to avoid the tax. But if they did, they would have to peddle them knowing that if their Rube Goldberg machine blew up, aggrieved counterparties couldn't come running to Uncle Sam to sort things out. Meanwhile, I bet the rest of us would happily fork over 5%, or whatever the number turned out to be, without even thinking about it. And if Congress set the rate too high, maybe those private market alternatives might start looking attractive.

Because a National Transaction Tax could be applied at every stage in a supply chain, it would bear some resemblance to the dreaded Value Added Tax. Again, I haven't run any numbers but I'd be surprised if it took more than a single digit tax rate to cover the cost of eliminating the corporate income tax. Outsource a piece of your supply chain rather than handle a task in house and you pay the tax if you want the right to seek government redress should problems arise. After all, imposing the cost of private contract enforcement on the public is a classic economic externality. Mom and pop businesses that buy from trusted local suppliers can chose to go bare and forgo the tax, passing the savings on to their customers. Ditto any handshake deal like buying a used car from a friend. But as the expression goes, "don't come crying to me" if the thing breaks down as soon as you drive it down the driveway.

Tearing up the income tax code and enacting a National Transaction Tax, which could probably be codified in ten pages or less, might be politically impractical as it would limit the ability of Congressmen to reward their friends and punish their enemies the way they do with our present tax code. But wouldn't a broad based, voluntary levy thinly applied across the entire economy tied directly to valuable services be morally satisfying? Or would you rather keep playing the tired old game of "Don't tax you, don't tax me. Tax that man behind the tree?"

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 weekly columns delivered to you by e-mail, click here or follow him on Twitter @BillFrezza.

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