From Taxing Income to Taxing Inefficiency

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= Open Market Sustainability policy proposals by Patrick Doherty.



Patrick Doherty:

In 1942, in order to pay for the war effort, the U.S. government extended the income tax from a high-earner tax to a universal tax on income from labor. In 1950, national security advisors recommended to President Truman that the wartime income tax be continued, based on the experience gleaned in World War II, in which a productive, highly employed economy was able to generate considerable revenue for national defense. Today, more than 80 percent of the federal government’s revenue comes from individual income and social insurance taxes, while we subsidize resource consumption, yet another legacy of the inherently industrial strategic challenges of the twentieth century. Reversing the relative prices of labor and resources—taxing waste not wages—takes smart growth and regenerative agriculture to the next level, harnessing them to form an innovation juggernaut that can capture the resource productivity prize for the United States.

Though important 60 years ago, the universal income tax has created perverse incentives, most importantly, an incentive for businesses to conserve labor and waste resources. Under our present-day system of taxing work and subsidizing resource use, total per capita consumption of material in the United States rose by 23 percent from 1975 to 2000. Today, American material flows are 50 percent higher than the average of 15 European nations, and unemployment is chronically high. With 675 million people arriving in Asian cities and an additional 3 billion entering the global middle class over the next 20 years, commodity prices will only continue their steep rise, making resource efficiency the key driver of competitive advantage for businesses and nations alike.

When the relationship between tax and subsidies is as dysfunctional as it is today, the opportunity for a tax shift is clear. With minimal pricing of carbon ($30 per metric ton of CO2 equivalent) and unsubsidized water, the McKinsey Global Institute estimates that approximately $3.3 trillion in resource productivity gains are waiting to be harvested by the private sector.4 A sustainable tax shift would generate revenue for government operations from material, energy, and natural resource inefficiency—or waste—and reduce the percentage of revenue that comes from traditional sources, most especially individual income, payroll taxes, and business income from small- to medium-size enterprises. Needless to say, reducing the tax burden on hard-working Americans and job-producing small businesses would likely prove popular politically.

Under open-market sustainability, the approach is to shift the tax base to throughputs and away from income and payrolls. Former World Bank economist Herman Daly wrote, “Shifting the tax base onto throughput induces greater throughput efficiency, and internalizes, in a gross, blunt manner the externalities from depletion and pollution.”23 Different from either a consumption or value-added tax, throughputs are those resources—oil, minerals, fertilizers, or renewable resources like forest products—that are essential material inputs to economic production but not the products themselves.

At a time of domestic recession and low-cost overseas labor competition, reducing the cost of working while supporting small businesses and the entrepreneurs who start them will simultaneously boost employment and innovation. With prices established for keystone resources, prices in the market will reflect our strategic necessity. With a phased and predictable introduction, such a shift will allow the marketplace time to work through which technologies are appropriate, while ensuring that the United States leads the way to a resource productivity revolution. Applied in the context of the simultaneous resets in housing, transportation, and agriculture, under the tax shift, families will be assured of higher-efficiency options to reduce their household footprint, workers will enjoy a strong job market, employees will experience the increase in take-home pay, and industry will be powered by a new engine of innovation and investment around resource productivity. Combined with long-needed tax simplification, the package is positioned to win popular and bipartisan support.

The tax shift described in the “Innovation Tax Shift” sidebar embraces this long-overdue opportunity, creating a predictable schedule of prices that will allow businesses to plan their own strategies to compete and win. Income taxes are ended for 79 percent of Americans, who also receive a break on payroll taxes, while the income cap on social security is lifted. Business income taxation is fixed to encourage the small entrepreneur, with no taxes on firms with less than $5 million net business income and a flat tax on all other businesses thereafter. Taxing waste provides the first opportunity to price environmental costs in the economy, ending one of the greatest market failures in human history. Toxic releases, water withdrawals, carbon, forest services, and municipal waste all get a starting price that increases over time to push innovators while paying down the national debt." (

Policy Proposals

(U.S. Context)

"Reward Hard Work

  • End the universal income tax. Repeal individual income tax for 79 percent of earners making under $100,000.
  • Reform social insurance taxes. Reduce FICA taxes on earners making less than $100,000 by 40 percent; end the cap on income above $106,400.
  • Enact a 25-35-45 wealth tax. End loopholes by taxing adjusted gross income. Then tax incomes of $100,000–499,999 at 25 percent, $500,000–$2,000,000 at 35 percent, $2,000,000+ at 45 percent.

Help Businesses Succeed

  • Reward entrepreneurs. End taxation of businesses with less than $5 million in net business income.
  • Go flat. Repeal the graduated business tax and replace it with a flat tax of 35 percent on net business income over $5 million.

End Perverse Subsidies

  • Be consistent. End subsidies for fossil fuels, nuclear, “alternative energy,” and fossil water (groundwater that has been sealed in an aquifer for a long period of time).

Internalize Ecosystem Costs

  • Fix the market failure. Phase in taxes on toxic releases, municipal waste, and carbon emissions. Set the starting carbon price at $83, the price at which all carbon-abatement technologies become profitable. Federally price resource use for forest ecosystem services and nonresidential water draws.

Leverage America’s Market Power

  • Level the playing field. Phase in a price on the embedded inefficiency in imported goods, equivalent to the increased prices set in the domestic U.S. market.
  • Use trade to promote sustainability. Encourage all nations to exercise the World Trade Organization’s Article XX to advance resource productivity. A cornerstone of the free-trade system overseen by the World Trade Organization, Article XX allows members to establish a price on imports “to protect human, animal or plant life or health,” or to address threats “relating to the conservation of exhaustible natural resources if such measures are made effective in conjunction with restrictions on domestic production or consumption.”