Monte Carlo Methods in Tax Policy
I was thinking about two things recently. One was Monte Carlo simulations and their potential applications. The other was an argument about flat taxes and consumption taxes that I recently had with my friend Leeor. One of the principle benefits of flat taxes and consumption taxes, according to proponents, is a significant simplification of the tax code which reduces loopholes and cause tax-evasion to become more difficult.
Loopholes in laws are often inadvertently created by poor foresight, particularly in the convoluted morass of federal tax law. The public typically discovers loopholes with surprise and shock some time after their creation. These unintended consequences could easily be discovered and solved by simply running some kind of adaptive Monte Carlo simulation of the entire tax code. It would be a straightforward matter to randomly generate several billion tax returns according to some kinds of realistic income and deduction "distributions". Such a simulation could then proceed by simulating rational taxpayers by optimizing every deduction and intricacy of the tax code to minimize taxation. To identify potential loopholes, one could, at the very crudest, apply a sort of loophole "threshold" for the difference between taxation under the rational case, and taxation under a simplified taxation regime with no loopholes--say by just applying the federal income tax brackets and no deductions.
Although implementation of such a simulation would be tedious and daunting given the current complexity of the US tax code, it would not surprise me if something similar already exists. A quick Google search for 'Monte Carlo tax policy' did not reveal anything, however. If nothing else, it would be a very simple matter to implement "partial tax models" that could simulate a particular new piece of tax policy in conjunction with a few other preexisting pieces of tax law to check for loopholes. It would also be useful in evaluating the effectiveness of the numerous radical tax-reform proposals, such as a flat tax or the "Fair Tax", in combating tax evasion.
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People always do their best to avoid having their money taken away, and they're very clever about it. No matter what system you use, when you try to take trillions of dollars by force, you will need a ruthless tax office to enforce it. The details of how to be ruthless aren't very interesting.
On the contrary, what we really need to do is stop trying to collect multiple trillions of dollars every year, and lower the rate to make evasion less profitable. Then, collect in a hard-to-evade way, like a retail sales tax or a flat-rate import tariff. If you're willing to shrink the government, funding it is much less difficult.