When Broad Bases Are Actually Narrow Bases

May 19, 2014

Tax policy experts like to talk about broadening bases and lowering rates. In general, this conventional wisdom is great. If some economic activity is going untaxed, better to add that to the tax base so you can lower rates on everyone else.

However, properly broadening the base is harder than it looks! You can think of it almost like wrapping a present. You want to cover the entire surface area once, but you don’t want to double-cover spots. For example, you don’t want to assess sales tax on gift cards because that would cover the same area twice. If you did, it’s almost as if you have a narrow tax base again. There’s the broad base of the sales tax on all items, but then the smaller, narrow tax on things purchased with gift cards.

The tax treatment of rented housing (and, in fact, most types of investment) is another example of double coverage. If I rent out my property to you, I pay taxes income used to buy the property, and I pay taxes on the rental income derived from it. In contrast, if I lived in the property myself, I would not have to pay the additional layer of taxes.

It’s the same house either way, but because people are eager to “broaden” the base, they end up taxing it twice in some circumstances, and only once in others.

A true “broad” base is a tax on personal expenditures – one that ultimately falls on the people who actually consume. The system described here would be one example of a completely broadened tax base that would allow us to maximize the wisdom of “broad base, low rates.”

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