Tax luxury, not wealth or income

I favor very high marginal tax rates on the super rich, say 70% to 80%. But I am also opposed to all income taxes and all wealth taxes. Why?

Let’s start with the conservative argument that taxes on the super rich will deter work, saving, and investment, by reducing the incentive to build more wealth. Is it true? The answer will depend on the type of tax.

If you look at the behavior of superrich people like Bill Gates and Warren Buffett, they tend to spend only a few extra pennies on consumption, for each extra dollar they earn. Thus it does not seem like extra consumption is an important motivation for the superrich, beyond a certain point. So perhaps high taxes are not a disincentive.

Warren’s (relatively) modest house

Ah, but you might argue that they have other motivations. They like to be big time philanthropists, or they like to build their business empire up to greater and greater heights. That’s their real motivation, and a punitive tax rate would therefore discourage them from putting in the extra effort that we want to get from talented people. I agree.

But that proves my point! You don’t want a punitive tax on income or wealth; you want a punitive tax on very high consumption—say beyond $50,000,000/year. Gates and Buffett would still be able to use their income for charity and investment purposes, with no almost deterrent effect from high taxes. They’d only be punished for an excessively lavish lifestyle.

Now admittedly there might be a few billionaires that would be deterred by a high consumption tax, say Larry Ellison. But even there, the deterrent effect would be less than you might think. That’s because a lot of the high-end consumption is positional goods.

Let’s suppose that currently the biggest yacht is a 400-foot monster, and Larry Ellison wants a 500-foot one—to impress his friends. Also suppose that a steep consumption tax prevents Larry from getting this mega-yacht. You might argue that this reduces his utility, and would discourage his effort to make Oracle the best company it can be.

Ellison purchased this 453-foot yacht (then sold it to David Geffen)

But here’s what you are missing. The high tax rates would not just apply to Larry Ellison, but to all the superrich. Thus if Larry had to scale back from a 500-foot yacht to a 400-footer, his closest rival would scale back from a 400-footer to a 320-footer. The relative ranking of consumption would be roughly unchanged. Ditto for real estate, where the exact same people would still live on the ocean in Malibu, but the price of land would fall to reflect the lower consumption of the superrich. Ditto for fine art.

Larry Ellison can enjoy parties on a 400-foot yacht surrounded by young Ukrainian beauties just as much as he can enjoy parties on a 500-foot yacht, as long as his closest rivals only have 320-foot yachts. That’s how human brains work, and that’s why even a 70% or 80% tax on consumption doesn’t really deter work effort from the superrich, or at least not as much as conservatives fear.

I’m not sure the best way to implement a progressive consumption tax. One could imagine two systems, one for employees of companies and one for the self-employed. Company employees would simply pay a progressive payroll (FICA) type tax. Very simple—no forms to fill out, even for LeBron James. A wage tax is identical to a consumption tax, in the long run.

The self-employed would pay an income tax with unlimited 401k privileges (which is effectively a consumption tax). So they’d only be taxed when they consumed their income. Income from any shares you own in your own company would be viewed the same as income earned by the self-employed—i.e. “wage income”.

The heirs of the rich would receive their inheritance in 401k-type accounts, and they’d pay taxes as they pulled the money out of those accounts to consume it.

There’s a difficult issue in determining how to tax existing stocks of wealth, at the point the new system goes into place. Perhaps a compromise where existing stocks of wealth above a certain threshold are put into a 401k-type structure, but taxed at a lower rate—in recognition of the fact that a part of the wealth has already been taxed.

If your country needs to raise large sums of money (and it shouldn’t–see Singapore), you need multiple tax systems; otherwise there will be too much evasion. These might include VATs, property taxes and carbon taxes. The property tax is a sort of tax on housing consumption, to make up for the fact that VATs don’t include housing. Currently, the superrich in places like New York pay a far lower rate of property tax than average homeowners, whereas they should pay a far higher rate. The fact that even liberal cities like New York are this regressive is an indication of the confused nature of our debate over taxes. Commenter “dtoh” has proposed a VAT where the poor are rebated what a poverty line person would spend on consumption, so that the tax is not regressive.

Read the debate in the blogosphere and you’ll see that people are horribly confused by taxes; they aren’t even debating the right issues. They talk piously about the need to tax capital income, which is the worst possible way to think about taxes. Meanwhile Larry Ellison will continue to enjoy his 500-foot yacht, with the extra 100 feet made of steel and employing labor that could have been used to provide dozens of cars for average people.

Sad!

PS. Some people like the following analogy. On Christmas Eve, people bring presents and put them under the tree. The next morning, people show up and grab presents from under the tree. Should we tax those who put them under the tree, or those who take them away the next morning? Based on how much you produce or how much you consume?

PPS. This post is on the superrich. I’m not sure how to handle the far more numerous ordinary rich–perhaps a 50% MTR on consumption. That sounds bad, but don’t forget the unlimited 401k privileges for the rich self-employed. That sort of tax would actually be less than 50% of one’s income. If they are rich wage earners, you can view the system as unlimited Roth IRA privileges.

PPPS. This post was a bit unfair to Larry Ellison, as he sold his 453-foot yacht to David Geffen and bought a smaller one, which could access more ports. And he has far more sophisticated taste than Trump. But I still maintain that high-end consumption is largely about positional goods.


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32 Responses to “Tax luxury, not wealth or income”

  1. Gravatar of Rajat Rajat
    16. February 2019 at 13:25

    I think that makes sense at one level. The big issue seems to be your PPS – how to tax the ordinary rich. Many progressives (even of the conventional liberal variety as opposed to the ‘millenial socialists’) would argue that much spending by the ordinary rich (eg on houses, cars, schools, restaurants, clothes, travel, etc) is on positional goods. It seems hard to justify drawing a clear line on that basis at $50m pa per person, rather than $10m pa or $1m pa, neither of which would affect the vast majority of Americans. I fear that once you drop the principle that higher-income people are entitled to earn as much as they can and spend it how they wish, you open the floodgates to a return to post-war tax scales.

  2. Gravatar of Plato’s Revenge Plato’s Revenge
    16. February 2019 at 14:22

    Taxing changes in wealth (per definition: income) just cements wealth disparities. While we still have a class society, it’s grossly unfair to make climbing even harder than it is. It’s also inefficient in more ways than any other distortion

    (High) income is needed to accumulate capital for investment, the only way to real growth. That will mostly start as wage. It must go into one’s own enterprise, returns on public investments are low and sinking

    Treating building one’s own business as a privileged (401 type) investment opens an incredible can of worms, and the predictable outcome will be overregulation, which will block entrepreneurs, while failing to prevent abuse by tax dodgers

    No, once you commit the original sin of taxing income rather than rents (!) and consumption, you’ve already lost

  3. Gravatar of bill bill
    16. February 2019 at 14:33

    Why no unlimited 401k for wage earners too?

  4. Gravatar of Brian Brian
    16. February 2019 at 14:35

    If I understand your suggestion it seems that if I put a dollar in a 401-k it is not consumption and if I do not put it the 401-k then it is consumption and it is taxed.

    Is there a loophole here? Suppose I send money to a stock brokerage and they “invest” in a bag of groceries on my behalf. The “investment” will not incur the consumption tax. Later it will appear that the groceries were a bad investment that went to a value of zero after the groceries were delivered to my address.

  5. Gravatar of dtoh dtoh
    16. February 2019 at 16:54

    Scott,
    I’ve commented on this a few times before, but I agree in principle (mostly) but would implement quite differently.

    1) Forget the wage tax. You don’t need it. It feeds the beast. Given politics, it will tend to creep up, and it wastes huge amounts of money on tax filing and compliance. Also, it’s trivial to convert wage income into capital income and avoid a wage tax.

    2) Eliminate all income taxes, all estate taxes, all capital taxes and all corporate taxes. Keep social security contributions.

    3) Implement a Federal Sales Tax at a rate of 25% which covers ALL purchases for personal consumption (including rent).

    4) Exempt any purchases by businesses for business purposes as evidenced by providing an EIN (business identification number) at purchase.

    5) Issue a “credit card” to every person which exempts $5k annually in purchases, i.e. family of 4 would pay no taxes on their first $20k in purchases. After the balance on the card is used up (or if no card is presented at the point of sale), then purchases are subject to the full 25% sales tax. (If you want more graduated rates or higher top rates, it’s easy to build into the “credit card.”)

    6) At the Federal level these tax rates and exemptions would be roughly revenue neutral.

    7) Any balances on the “credit card” can be freely transferred to other people or back to the government.

    8) Exempt purchases of fixed assets (vehicles and structures) which have a value in excess of $50k

    9) Let the states tax fixed assets (primary residences, vacation homes, yachts, ferraris, jets, etc.) that are not being used for business purposes. The tax would be based on value or purchase price of the asset. This would effectively be a consumption tax charged by the States. (States already have the processes and organization in place to assess and collect these taxes.)

  6. Gravatar of dtoh dtoh
    16. February 2019 at 19:59

    Scott
    And three questions…

    1. Are you trying to maximize the present value of all future aggregate utility?

    2. Do you care about the distribution of utility?

    3. Do you care about distribution of utility between people in different countries. (I’m thinking about Elizabeth Warren’s totally immodest house._

  7. Gravatar of Tim Worstall Tim Worstall
    17. February 2019 at 02:46

    A certain amusement here. As this progressive consumption tax is exactly what Bill Gates has been arguing for for perhaps half a decade now.

    Both he and you are right to do so of course….

  8. Gravatar of BC BC
    17. February 2019 at 03:52

    “They talk piously about the need to tax capital income, which is the worst possible way to think about taxes.”

    Right. That’s probably the most widely held economic misconception that I see. Even Warren Buffett spreads this misconception.
    Economists generally try to educate the public about issues where the general public’s intuitions might be misleading: minimum wage, rent control, trade, etc. However, there seems to be much less effort by economists to correct public misconceptions around capital income taxation. Many economists actually seem to encourage these misconceptions or maybe even hold these misconceptions themselves. Why do you think the misconceptions around capital income taxation are so much harder to educate the public about?

  9. Gravatar of Matthias Goergens Matthias Goergens
    17. February 2019 at 05:01

    Following Scott’s logic, the rich should pay a tax not on capital returns earned, but on returns foregone.

    The opportunity costs incurred in earning less than some standard benchmark, say risk-adjusted S&P500 or some risk-adjusted bond index, some kind of consumption. Eg you might invest locally in your small town to wield your wealth as a status symbol. That’s consumption.

    Similarly, giving to ‘charities’ like the MoMA is also consumption: you are buying status. It’s probably best to cease treating charitable giving different from any other consumption.

    (And that’s not too bad, if you live in a country where government is about competitive in getting utility bang for the buck with typical charities.)

    > The property tax is a sort of tax on housing consumption, to make up for the fact that VATs don’t include housing.

    (Ignoring the portion of the property tax that falls on the house, not on the real estate.)

    The property tax is a tax on owning housing, not on consuming housing. You can see that because in a rental scenario the tax incidence falls on the owner, not the renter who is actually doing the consuming.

    The renter pays the same amount of rent, no matter whether there’s a property tax on real estate or not.

  10. Gravatar of Matthias Goergens Matthias Goergens
    17. February 2019 at 05:02

    Btw, there’s no capital gains tax in Singapore.

  11. Gravatar of Brent Buckner Brent Buckner
    17. February 2019 at 07:26

    c.f. _Luxury Fever_ by Robert H. Frank
    https://www.amazon.com/Luxury-Fever-Money-Satisfy-Excess-ebook/dp/B000FC0RFG/

  12. Gravatar of Kevin Erdmann Kevin Erdmann
    17. February 2019 at 07:28

    Matthias,
    I was going to offer a correction to your comment on property tax, where you say it is a tax on the owner. But, you are correct that where high rents just lead to queuing for development and high land prices, it does fall on the owner.
    It seems like you, I, and Scott would agree on the policy though.
    I think this is a useful tax to think about. The reason it is a good tax is that in some locations it is a nearly pure transfer from rent seekers to the public purse, and so it is a tax that avoids the costs of most taxes. That’s what is so corrosive about the demagoguery of Elizabeth Warren. She treats all capital income as if it were unearned rents. Her rhetoric is inimical to understanding and adds heat where light would help. So she drums up hatred by sowing ignorance.

  13. Gravatar of ssumner ssumner
    17. February 2019 at 13:06

    Rajat, You said:

    “I fear that once you drop the principle that higher-income people are entitled to earn as much as they can and spend it how they wish, you open the floodgates to a return to post-war tax scales.”

    I don’t see where that principle exists today. Are there countries that let the rich keep all of their money?

    Plato, You said:

    “No, once you commit the original sin of taxing income rather than rents (!) and consumption, you’ve already lost”

    I agree.

    Bill, Because you have unlimited Roth IRA for wage earners, which is far simpler to administer. Either way it’s a consumption tax.

    Brian, You said:

    “Is there a loophole here? Suppose I send money to a stock brokerage and they “invest” in a bag of groceries on my behalf. The “investment” will not incur the consumption tax. Later it will appear that the groceries were a bad investment that went to a value of zero after the groceries were delivered to my address.”

    Then you’d have to pay tax as soon as the groceries are delivered to your address. (As a practical matter, 401k’s would probably be limited to bona fide investments.) In any case, this issue could arise with the current system, but how often do people put their 401k into groceries?

    dtoh, I’m trying to maximize global aggregate utility, and I don’t care about the distribution of utility.

    Tim, That’s funny.

    BC, It’s hard to explain because the double taxation of capital income is counterintuitive—hard to see.

    Matthias, You said:

    “You can see that because in a rental scenario the tax incidence falls on the owner, not the renter who is actually doing the consuming.

    The renter pays the same amount of rent, no matter whether there’s a property tax on real estate or not.”

    I don’t believe that’s accurate. Taxes on most consumer goods (including housing) are mostly paid by the demander, even if the government actually collects the money from the supplier. By your logic, gasoline buyers don’t pay the tax, because the gas station actually sends the check to the government.

    I do agree that the land portion of property taxes is paid by the owner. But the building cost is mostly passed on to renters.

  14. Gravatar of BC BC
    17. February 2019 at 15:13

    “BC, It’s hard to explain because the double taxation of capital income is counterintuitive—hard to see.”

    Well, both you and Steve Landsburg have written about it. The explanations don’t seem more complicated than the comparative advantage arguments about free trade advanced by most economists. (Admittedly, many people that support free trade may not really understand the difference between comparative advantage and absolute advantage.) Has Krugman ever written NYT columns about why capital income shouldn’t be taxed? I’m pretty sure he’s written columns explaining why Trump’s tariffs are bad.

  15. Gravatar of dtoh dtoh
    17. February 2019 at 15:43

    Scott, you said,

    >> I’m trying to maximize global aggregate utility, and I don’t care about the distribution of utility.

    Then why do you want a progressive consumption tax? A switch to a consumption tax presumes you favor reducing aggregate consumption and increasing aggregate investment. Even though their marginal utility of consumption is low, individuals with high consumption have a very low marginal propensity to consume.

    I’m not sure (and it probably depends on the discount rate for future utility,) but if you’re trying to simply increase aggregate utility, I don’t think it’s logically consistent for you to argue for a progressive consumption tax.

  16. Gravatar of Matthias Goergens Matthias Goergens
    17. February 2019 at 16:33

    Scott, agreed. Hence my parenthetical remark about the portion that falls on the value of the building. I know about tax incidence.

    Eg in Britain there’s a council tax which works somewhat like a property tax, but is officially paid by the renter. Of course, that doesn’t change the incidence of the tax much. (What does change it, is that land lords get a discount when the property is not rented out. Ie the government subsidises empty places.. but because things are never simple, lots of places do have a penalty rate for long term unoccupied flats. But there’s also a discount for single occupier.) In any case, most renters don’t see that the council tax is pretty much free to them or at least much cheaper than it looks like—because of the difference between tax payer and tax incidence.

    I am just taking about land value taxes of course. A property tax is an imperfect approximation to them. In the closed access cities that Kevin writes so much about, the approximation is better because land is so much more expensive. (Though the queuing costs he mentions raise the price for new construction.)

  17. Gravatar of Rajat Rajat
    17. February 2019 at 16:45

    Scott, I was being a bit flippant, but what I meant was that most current progressive tax scales are fairly gradual and don’t seek to single out a very small group of consumers for dramatically different treatment. If you, say, raise the marginal tax rate from 50% to 75% at $10 million pa consumption, I think it would engender a pejorative view towards people spending above that level that could easily be ratcheted down to lower levels and become almost unstoppable. Assuming that 50% applies at something like $400k pa, why not something like 60% at $1m pa and no increase beyond that on the basis that once someone is consuming more than that level, society is not going to make ever-finer value judgements about what kind of positional spending is frivolous? It would also likely raise more revenue. I would even prefer having a number of gradually increasing tax brackets to a sudden jump.

  18. Gravatar of Philo Philo
    17. February 2019 at 20:11

    “I favor very high marginal tax rates on the super rich, say 70% to 80%.” Why? What do you suppose the government is going to do with this tax revenue that justifies such expropriation? Larry Ellison’s yachting is a better use of funds than many government activities, and we can get it without extortion.

  19. Gravatar of Ram Ram
    17. February 2019 at 21:25

    The way to do it is with a DBCFT plus a progressive payroll tax. Businesses pay a flat tax on income from domestic sales less purchases from domestic businesses and domestic labor compensation. Workers pay a progressive tax on labor compensation, with the top rate on workers matching the flat rate on businesses. That’s basically the X tax, though a destination-based version rather than the origin-based version.

  20. Gravatar of Benjamin Cole Benjamin Cole
    18. February 2019 at 05:35

    In the words of the great Russell Long (son of Huey Long by the way), “Don’t tax you, don’t tax me, tax that man behind that tree.”

  21. Gravatar of ssumner ssumner
    18. February 2019 at 13:01

    BC, Good point.

    Dtoh, It’s not a question of trying to reduce consumption, it’s taxing current and future consumption at the same rate, so that we don’t discourage investment.

    Marginal propensities to consume are irrelevant here, it’s about current and future consumption. Maybe I’m not following your argument.

    As for aggregate utility, the assumption is that moving $X in consumption from Larry Ellison to a starving person boosts total global utility.

    Matthias, OK.

    Rajat, You said:

    “I would even prefer having a number of gradually increasing tax brackets to a sudden jump.”

    I’m fine with that. As for how all this would affect public opinion, that’s way above my pay grade. I’m just trying to describe the best policies; it’s up to others to craft political acceptable approaches.

    Philo, You are asking the wrong question. Governments already spend a massive amount. I’m trying to replace horribly inefficient taxes like we have now with less inefficient taxes, like the ones proposed here. What tax system would be better than what I propose, and raise just as much revenue?

    If we can get the government to spend less, I’m all for that.

    Ram, OK, but it’s important that all income from the company you work for (including capital income) be treated as wage income.

  22. Gravatar of dtoh dtoh
    18. February 2019 at 18:44

    Scott,
    If a consumption tax reduced Larry Ellison consumption then what you say is true, but Larry’s marginal propensity to consume is very low so taxing his consumption (i.e. lowering his income) will have very little effect on his consumption. All it will do is reduce his investment.

    I don’t think a progressive consumption tax (or at least one on the very rich) argument works from an aggregate utility perspective.

  23. Gravatar of doug M doug M
    19. February 2019 at 11:25

    I agree with the concept.

    And I agree that very few understand taxes, except when they when their tax bill is shoved in their face.

    And when taxes are debated, it comes down to “do I have to pay more?” and if I do, “Why can’t you tax someone else more.” And theory of philosophy go out the door.

    One question, how do you propose to tax real-estate. Is your house an investment or is it consumption (it is both of course). Do you pay taxes due at the time of purchase (or apply to have this tax bill spread over the next 30 years) or fraction of your mortgage payment, and fraction of your down payment, or does it become a property tax paid for perpetuity?

  24. Gravatar of mpowell mpowell
    19. February 2019 at 13:00

    What you are missing here is that a lot of the very recent anger towards the ultra-rich stems from their influence on politics, which is considerable. Highlighted by Schultz’s vanity campaign which appears at first blush to be trying to punish the Dems for talking about taxes on the wealthy by throwing the election to Trump.

    It’s not 100% clear what the best way to reduce this influence would be. If you capture enough activities under ‘consumption’, maybe it will work. But reducing the stock of wealth controlled by the ultra-rich also seems like a pretty definite improvement as well.

  25. Gravatar of ssumner ssumner
    20. February 2019 at 08:52

    dtoh, You have it exactly backwards. An income tax discourages investment much more than a consumption tax. Under a consumption tax, the money put into investment is not taxed at all.

    doug, You pay a property tax, which is a tax on the consumption value of housing. Thus if the consumption value of a home is 5% of its price, then a 1% property tax (based on home value) is a 20% tax on home consumption.

    mpowell, I don’t think the stock of wealth controlled by the rich has much impact on their political influence. The teachers union is 100 times more powerful that Gates and Buffett combined.

  26. Gravatar of dtoh dtoh
    21. February 2019 at 04:45

    No Scott. That’s not correct. For someone whose marginal propensity to consume is very low (i.e. extremely rich people like Larry Ellison,) changes in the income or the price of the goods and services they are consuming have almost no effect on the amount of consumption.

    A consumption tax will lower your and my consumption. It will have no effect on Larry’s consumption.

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    21. February 2019 at 06:06

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  29. Gravatar of Kyle Kyle
    2. March 2019 at 16:36

    Would this work in a global world? People could move their wealth around and use it to generate income in the country of their choice.

    Advantage of warrens wealth tax is that it works in global world – cant be evaded – if implemented properly.

  30. Gravatar of tpeach tpeach
    13. March 2019 at 04:37

    I may be a bit late to comment on this post but I am only just catching up on my reading.

    I agree with Scott’s proposal, but just want to add a couple of things.

    The wage tax is equivalent to the cash flow consumption tax in the long run, but only assuming there is a flat tax and tax rates are constant.

    I also think having the payroll tax alone would restrict people’s investment options. If Le Bron James earned $10M and wanted to invest 10%, he could only invest $300,000 under the payroll tax. If he could borrow at the risk free rate that wouldn’t be a problem, as he could just repay the borrowing from his untaxed income streams. But even he probably wouldn’t be able to do that to make a risky investment!

    If given the option to use either the wage or consumption taxes, people can use tax smoothing to overcome the problem of different tax rates at different stages of their life cycle.

    But for public revenue reasons it would probably only be feasible to introduce a compromise where it was otherwise like a normal income tax, but had a Rate of Return Allowance on investment income equal to the risk free rate as suggested by the Mirrlees Review. Or you could have a cash flow consumption tax (unlimited 401ks) but you could not claim the tax rebate on contributions immediately. Instead the rebate would be added to a Tax Offset Account which could be drawn from to offset tax on future investment returns and scaled up by the risk free rate each year. Another benefit of the cash flow tax over the wage tax is that you don’t have to have a distinction between labour and capital income.

  31. Gravatar of ssumner ssumner
    13. March 2019 at 09:07

    tpeach, Thanks for that interesting comment. I’m not sure I follow your argument on LeBron James. Why does it matter if he could only invest $300,000 in that example? Does it create a consumption/saving bias, or is your complaint about tax progressivity? (For the sake of argument, assume he’s always in the top bracket.)

    Or is your argument about the distortions caused by people being in different brackets at different ages?

    I view tax complexity as one of the biggest problems with the tax system, so I lean toward a system that is “good enough” for the lower 99%. Perhaps your Tax Offset Account could be reserved for very high incomes?

  32. Gravatar of tpeach tpeach
    14. March 2019 at 06:38

    Thanks Scott
    It was more about tax progressivity, but I am probably thinking about it wrong.
    I thought that it would be better to tax people when they consume, instead of when they earn. If your incentive for working is to save and invest (due to diminishing marginal utility of consumption), then wouldn’t a wage tax at a very high rate be a disincentive to work? Essentially, I think high MTRs in a consumption tax matter less when you can choose when the tax is paid and smooth it over your lifetime consumption.

    My ideal tax system would be like this:

    1. A Business Cash Flow Tax, essentially a subtraction style VAT.

    2. A progressive Personal Cash Flow Tax, with unlimited 401ks and tax rebates added to a Tax Offset Bank to be claimed against future 401k withdrawals. There would be also be Roth IRAs with annual contributions capped at $50k per year, to reduce complexity for people on modest incomes who invest. Bank account interest would also be tax free as it is roughly equal to the risk free rate.

    There would be no need to distinguish between labour and capital income and the personal tax would capture windfall gains which would go untaxed with a wage tax. There would still be a need for special rules around Trusts.

    3. A Resource Rent Cash Flow Tax to capture economic rents on mining projects.

    4. A Land Value Tax based on unimproved land value, with progressive rates based on value per square meter.

    5. A Carbon Tax and other “sin taxes” on negative externalities.

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