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Without crashing the economy...

I've recently read a book advocating a steep progressive income tax, where any savings or investments are tax deductible. The basic goal of this tax is to curb luxury spending, claiming that it is wasteful and acts to decrease personal happiness. While I won't go through the reasons they use, or where I agree or disagree with it, let's say that, as a society we decide we are going to adopt it. I will also mention that I'm writing this at 4:30 AM because I can't sleep. Feel free to pick holes at your leisure.

First, I just need to make a little comment: high marginal rates of taxation are not a barrier to the wealthy working harder. This is frequently used as justification for avoiding taxing the rich, and it is nonsense. The argument that people at the highest levels will cut back their working rather than pay more tax doesn't hold water. You only need to look at the business executives who earn more in one year from their bonuses for wiping out billions of dollars of shareholder value than they will ever actually need to see that. You only need to look at the soccer players who will change clubs because only earning 130,000 pounds per week is an insult. Buffett and Gates have both given away a vast amount of their money over the last year. Does that mean that they also cut back on the amount of work they do because they've realised they don't need to? Doubt it.

On the other hand, at the other end of the scale, high marginal rates are a huge disincentive to work. If you are telling someone that to go from not working and just scraping by on the dole (we'll make that assumption) to working and just scraping by, that, in exchange for hours of their week they will not actually be any better off because you will take most of their benefits away, and the difference will go towards the extra costs associated with working (e.g. transport or clothing), why would they do it?

So we do need lower marginal taxes for the poor and we can get away with higher taxes for the wealthy. As always, the devil is in the details, but we'll assume the details are worked out with society's interests at heart and are worked out properly and professionally.

Ok, so we're taxing income but then exempting savings and investments, people who feel obliged to minimise tax can do so easily - they just need to save rather than spend. This does actually bring us to a problem - people quickly readjust, start saving more and spending less. The economy is at a risk of stagnation. You have a lot more dollars coming in for investment, but there is only so much you can do with it. As an example, when you buy a house, you borrow the minimum you need to, not the maximum they will let you have. If there are lots of people who want to lend you money, you have more choice and, supply and demand, you get to borrow money at a cheaper rate.

So if we suddenly throw in billions of dollars of investment into the market, we just make that money worth less because returns drop. The Government got us into this mess, they can get us out of it. My basic idea is that they create new markets for investment. War bonds, if you will. Although with two differences. The first is that you run the account like managed funds so that people can invest or withdraw when needed (you can even gouge the investors like managed funds do, if you can get away with it politically). The second is that the purpose is for specific projects which will have long term economic value. For example, it has been shown that relatively small amounts of spending on grassroots sport and exercise has a huge impact on long term health costs. Why don't governments spend more on grassroots sports? Because they are just creating dividends for the opposition to spend when they get in. Bracks has made sue it isn't going to happen again in Australia for quite a while.

While the money to pay for the investments will be available in the long term through a stronger economy and through the direct benefits from the various programs, in the short term, it has to come from somewhere. This is a relatively difficult juggling act, but, as long as you aren't transferring out more in investments than you get in, you are alright. If someone withdraws to spend, then they get taxed on the spending, so you get to give wth one hand and take back with the other. If someone leaves their money in, earning interest, you will fund that through long term societal savings anyway.

And if you do occassionally find yourself with more money than you know what to do with, you can always drop tax rates or start buying out other countries' infrastructure (hint: many Western countries are flogging off key assets - these are generally undersold and represent a good investment) with the benefit being that in times of need you can always strip them back or sell them, rather than privatising your own essential infrastructure.

A stitch in time save nine, as the proverb goes, so if you pay someone for three stitches when they have done one, it is a good investment if you wouldn't have done it before it needed at least six or seven. Even better, though, is that the government, as managers of the scheme, can actually offer specific projects - say for every dollar invested, you might be able to allocate 50 cents to funding a specific project, be it improving schools, roads, public transport, research or whatever else. This actually gives a much more inclusive feel to the way society is run, as people are given a level of control s to where their money is being used, unlike now, where it is all lumped in a single pool which politicians treat as their own.

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