You think theft is bad in the cities, just take a look at Federal government looting via monetary and tax policy

Reader Loki makes an observation.

Re your similarities post the other day and raising taxes, I don’t hear it often discussed how inflationary policies are effectively a secret tax. Prices rise, wages rise, tax brackets stay the same.

He is referencing Similarities between the loony left and the British Crown in 1770.  I point out that while the British taxation proposals made perfect sense and were seemingly fair from the perspective of the British, they could be, and were, seen as existentially malign in the American colonies.  The British government was seeking to deliberately reduce not only the degree of freedom in the colonies but also their physical and financial well-being.

My first thought to Loki's comment is, we took care of that in the 1980s when we collapsed the number of brackets down to three which took a lot of the bite out of inflating into higher brackets.  

However, the observation is a good prompt to update priors.  Under Reagan, the tax system was radically reformed, lowering tax rates while widening the pool of people being taxed.  It was intended to be revenue neutral though it did shift the burden somewhat towards corporations.  

My recollection, which I cannot confirm on a quick search, was that part of the restructuring was the collapse of some dozen or so tax brackets down into just three brackets.

Which, if my memory is correct, addresses part of Loki's observation.  

Multiple tax brackets does very much encourage, indirectly, a tolerance of high inflation.  Or, rather, it creates the incentive for the Federal government to allow higher inflation so that people rise into higher tax rate brackets.  Peoples' nominal incomes go up, they land in higher brackets and pay a higher rate in  taxes.

By eliminating brackets, you dampen the incentive to run higher inflation.

So where do we stand now?  How many brackets do we currently have?  Every major reform is followed by a decades worth of backroom interests recapturing the advantages they used to have.

And the simplicity of fewer brackets comes at a price.  At the extreme, imagine there is a single tax bracket.  For purposes of discussion, let's say it is a flat tax of 15% on any income greater than $20,000.  This has the huge benefit of being clear and simple.  Take your total income, subtract $20,000, send a check for 15% of the balance to the Treasury.  Don't need much time to make that calculation and don't have to spend inordinate amounts on tax accountants.   

But a single tax bracket is extraordinarily regressive.  If the bare minimum of a decent standard of living is $20,000, then the ordinary person is paying 15% of anything earned above that.  That is a fierce bite out of income.

If you earn $2,000,000, you are far away from the bare minimum of the decent standard of living.  No, you don't want to give away 15% in taxes, but you can certainly afford it (viewed strictly from a bare minimum perspective.)

Which is why we have only flirted with flat taxes in the past.  Well, that and the fact that in the 1800s it was hard to collect the theoretical returns on those flat taxes when we tried it before.

So a single bracket has negative outcomes.  Too many brackets rewards government by collecting more  tax as people inflate into higher brackets with higher inflation.  The implication is that we want more than a single flat tax and less than many brackets.  What is the magic number?

As I say, my recollection is that we got it down to three brackets with a healthy bump in rate as you crossed each bracket.  I see from a quick search that that progress has been subsequently eroded and we are now back up to seven brackets.  So the reward to government from inflating people into higher brackets remains real.

There is an interesting corollary though.

Around the time of the tax reforms in the 1980s, there was a rising awareness that beneficiary programs such as Social Security, Medicare, Medicaid etc. should be indexed to inflation so that people who paid in have some prospect of getting something out.  Otherwise, every program obligation such as Social Security can be, theoretically, inflated away.   

Consequently, we are now in a challenging position.

51% of Federal spending is now transfer payments.  The obligations are locked in and the obligations increase with inflation.

Only 49% of Federal spending is theoretically touched by oversight of spending on hard goods and services such as the military, transportation infrastructure, education, etc.

You can argue about the effectiveness of that spending, but it at least should be under the control of Congress (though it isn't owing to agency autonomy).  But half the spending is locked in and never reviewed and always escalating with inflation.

Again, trade-offs.  The income transfer programs do serve a useful purpose of keeping people out of poverty and reasonably healthy, etc.  They are aren't efficient or effective but their purpose is important.

A further issue is one we are seeing in states such as California, Connecticut, New Jersey, New York, and Illinois.  These are states which are generally enthusiastic about extracting revenue from residents and increasing state spending.  

However, residents don't generally like to be taxed more.  Politicians in those states have generally skirted this challenge by having brackets and in particular by having a low income for the top rate and a high tax rate above that income threshold.  As a made-up example, the top bracket might start as low as $400,000 but might be a 7.5% state income tax rate on everything above that threshold.  

If your tax base prosperity is highly dependent on a small umber of industries with very significant network effects (Tech in northern California, Hollywood in southern California, and Finance in the northeast) then you can get away with this for awhile.  The centi-millionaires and the billionaires cannot easily extract themselves from the lucrative industry networks by physically relocating.

But when push comes to shove, anything is possible.  And this particular taxing strategy leaves states especially vulnerable to two scenarios.

The first is an excess dependency for state revenues on individuals in particular industries.  At the time of the Great Recession under Obama, my recollection is that New Jersey derived some 50% of its state income tax revenue from a dozen or so of the very wealthy.  When the finance and real estate sectors crashed, so did the incomes of those individuals and consequently so did the tax revenues to the affected States.  Since states have to run balanced budgets, such variability in annual income tax revenues can be catastrophic.

The other vulnerability is longer lasting.  The centi-millionaires and billionaires find ways that allow them to extract value from the geographical network effects without having to be geographically colocated.  They up and leave.  This actually introduces a theoretical third vulnerability which I don't think we have seen yet but could happen.  A tax migration cascade.  Once one billionaire lightens their burden simply by relocating, knowledge transfer and the envious eyes of their fellow billionaires could create a sudden cascade of tax relocations.  It is certainly happening in slow motion, but it could theoretically take on a faster rate.

It is a bedrock principle in economics and finance that the easiest way to get out from under a heavy financial obligation is for inflation to inflate it away, whether at Weimar, Venezuela, and Argentina catastrophic rates in short time frames or just at persistently moderately high rates over years as in the late seventies and early eighties in the US.  

You can take on too big a load of federal debt and then erode it away with inflation.  Which also increases your revenues by bumping more people into higher rate bands as Loki points out.

So citizens end up with a transfer of wealth from the private sector to the government; they end up with lower real incomes; they end up paying higher effective taxes.  Loki is right.  Citizens ought to be looking at the political class as American patriots regarded the King and Parliament.  

And as Loki observes, all that is happening now and no-one seems to be interested in talking about it.