What are Taxes?
It’s tax day! And just like my taxes every year, this newsletter is little late (5min read)
It’s tax day! And just like my taxes every year, this newsletter is little late ;) Welcome to a very brief primer on taxes - why taxes matter, how taxes work, and what it means for you.
TL;DR
Taxes are a goverment’s business model
Governments and Amazon have more in common than you think - both charge a fee based on platform transactions. Both want to optimize for the right fee amount for the highest transaction volume.
Pay your taxes, and vote!
What are Taxes:
This might seem simple. Taxes are how governments make money. The government charges us, its users, for access to services like fixing potholes, access to global military, and education (errrr). There’s a lot of debate on how the government should spend taxes (more on that later), but no one really argues about what taxes are (I mean I don’t think they do).
We live in a capitalist, democratic republic. And also one founded on that belief of no taxation without representation (see, the Boston Tea Party, unless you live in Washington DC and Puerto Rico...).
How Taxes Work:
Here’s how I think about taxes. Economists might disagree with me. But let’s be real, I’m not sure any economist are reading this (though if you are, please send me a note!)
Think of the US government like Amazon. Amazon charges a fee for every transaction on its website. Amazon makes more when there are more transactions. Amazon charges the sellers on its website. It also charges the consumers, me and you. Amazon wants to charge it’s participants as much as possible to make as much money as possible. But, Amazon knows if it charges too much, transactions may go down. And Amazon, more than anything, needs transactions to make it’s business run.
This is kind of how to think about the government and taxes. The government charges different users - businesses and individuals - different % based on how much money you make (ie your tax rate). This is what’s known as a “progressive” tax system. Just like Amazon, the government knows that if it charges too much money, the overall value of the economy may go down. When the economy goes down, so to do taxes. In general, the US government makes more money when the US economy goes up. And less when it goes down. Why? Because taxes are based on a % of your income.
Why does the government charge us based on our income? Well, mostly because the government wants to know how much it can charge it’s users, and income is the best source of that information. The government receives half of its tax revenue from individuals (income taxes) and roughly half from businesses (corporate income tax and taxes out of payroll to employees). And, as we know, the government spends it on all sorts of stuff.
Why Taxes matter:
No one really argues about what taxes are. But, there is a lot of argument - from politicians, companies, and people - about how the government should spend taxes. Without going into it, this debate is really about - where can the government spend money to have the most impact of the overall economy. Because, if the economy goes up, that’s good for the US government. In wonky terms, people refer to this as the “velocity of the dollar.”
Said differently, if the government invests $100 in education, what will be the governments return on investment overt time? Or, if the government invests $100 in small business (through a tax credit), what will the overall return on the economy be over time? This is a huge debate among politicians and people tasked with government spending.
For me, taxes and the velocity of the US dollar are two cool use cases for crypto - particularly stablecoins and central bank digital currencies. One, there’s no reason we all should have to input our taxes. The governments should (and does!) already know how much we owe. And, blockchains could make that data publicly available. This public data could help us see how money moves through the economy. We could finally answer the question, “does a trickle down tax policy work” or “does investing in the middle class work.” It’s not clear to me politicians want to answer this question, but here we are.
But how else could governments tax? Well, think about Amazon again. Could we all pay an annual prime membership to the US government? That’s known as a regressive tax. A flat fee for everyone, regardless of how much they can pay. Some places do this, or has the same flat % fee for every person. Generally though, the value of say, a 7% tax rate on a person making $40K or less isn’t worth that much to the government relative to how valuable it’d be for that person to keep money to either spend or save.
It seems taxes as a business model are here to stay, but how we spend that money is up to you.
Additional Reading:
Why The Dollar Dominates, Paul Krugman
IRS.gov (some surprisingly helpful resources here!)