A taxing subject

On his trip to Houston this week Fred Thompson was asked if he as President would sign the Fair Tax bill, and replied "absolutely". The FAIR Tax is a proposal that would rip out practically every tax we have - payroll, income, death, capital gains - and replace it with a single, broad tax on consumption (usually at a sales tax rate of 23% or so).

It's a "fair" question to ask why we need to have such a profound and radical change. (Unless you have actually been forced to file the tax returns and figure out your AMT; depreciation; the tax basis for an old stock that was spunoff and had dividend reinvestment; the rules on itemized deducations; or hunter through drawers to find that proof of giving to goodwill - in which case you will likely respond "Hallelujiah!" to such a proposal.)

There is much wrong with the current system. Coyote blog tells us the 5 worst things about taxes:
1. Complexity and Preparation Time
2. Disguising the Tax Load - If you add all these up, the average American pays about 30% of his/her salary in taxes.
3. Taxes on Wealth and Savings
4. Picking Favorites for Special Treatment
5. Class Warfare and Punishing Success


The Federal income tax scores terribly on the above items. It is hugely complex and gets worse over time due to Congressional tinkering that picks favorites for bogus social engineering reasons (Prius, anyone?); withholding disguises its impact each year; lastly, it punishes success. Chief Justice John Marshall said "the power to tax involves the power to destroy." The taxing authorities go after wealth, income, production and economic success because, well, that's where the money is. But in doing so, taxes harm the very engine of our prosperity.

You can't blame yankees for the income tax. A history of the income tax notes: "The Sixteenth Amendment owes its existence mainly to the West and South, where individual incomes of $5,000 or over are comparatively few."

Times change. More recently, Taxpayers filed 130.6 million U.S. individual income tax returns for 2003. Adjusted Gross Income (AGI) reported on Tax Year 2003 returns totaled $6.2 trillion for 2003, while taxable income was $4.2 trillion and total income tax was $750 billion. The largest component of AGI was salaries and wages, totaling nearly $4.7 trillion. A total of $261.4 billion in business net income was reported on 14.4 million returns.

Not surprisingly, The rich pay most in income taxes: The top 20% pay 80% of taxes; the top 10% pay 64.8% of income taxes; the top 5% pay 52.1% of income taxes; the top 1% pay 31.0% of taxes. What is surprising, though, is the fact that both Reagan and Bush 'tax cuts for the rich' as the Democrats like to call them actually increased the share of taxes paid by the rich, by lowering the tax burden for the poor (taking millions off the tax rolls) and the middle class.

The Federal tax system fails to tax imports commensurate with taxation on American production, sometimes up to 40% to 50% of marginal tax rates (adding excise, income, business income, social security and meidcare taxes). Our current Federal tax system is biased against production by taxing work, investment, savings, and capital gains, and biased in favor of consumption of imports by not taxing consumption. A consequence of this is that most other industrialized and developing nations now have border-adjusted business transfer taxes that are not as skewed as American tax law, and a result of this tax bias is an 18% disadvantage for American producers as compared with overseas producers, further resulting in large merchandise trade deficits for the U. S. that undermines our long-term economic health.

The FAIR tax is one solution that addresses that problem. It taxes imports consumed in America just as much as it does home-grown production.

David Hartman has a solution as well - the business transfer tax. This may be the most profound and best tax reform of all:

This leaves the Business Transfer Tax as the most viable proposal on the table. What are its advantages? Apart from the fact that it can be made border adjustable, the BTT would establish a tax base that includes all commerce and employers, eventually reaching even employment and purchases in the government sector and employment in the ballooning not-for-profit sector. Although aimed at consumption, the BTT, by collecting from employers rather than from consumers, would offer little justification for allowing exemption, but it would also provide equitable rebates to offset spending on necessities. Such rebates would serve as replacement for exemptions, deductions, and credits, and, if the BTT were adopted as a single flat tax, all taxation of income could be eliminated.

How should a Business Transfer Tax be implemented on a revenue-neutral basis, replacing current taxation in order of priority? First, the corporate income tax would be replaced by a 5.5-percent BTT. Next, the BTT would be raised to 10 percent, enabling the personal income tax to be flattened to a 14-percent single rate. Finally, the entire tax code (apart from personal FICA taxes) would be replaced by a 20-percent BTT. If the socialists insisted on maintaining a “progressive” code, a somewhat lower BTT rate could be adopted, supplemented by a modest upper-income tax. This is not recommended, but this is not a perfect world.

Following this plan would mean an equitable, neutral, transparent, and politically feasible supply-side and border-adjusted reform of the federal tax code. It would dramatically reduce our perennial trade deficits on manufactured goods and provide optimal growth for all sectors of the U.S. economy. It would level the playing field for U.S. corporations in general, and manufacturing in particular, and for U.S. blue-collar workers, whose earnings have been increasingly depressed over the past three decades. It would mean a return to a more equitable sharing in the growth and prosperity of the U.S. economy—not only for those in manufacturing but for all sectors of the U.S. economy.

Because the BTT is a consumption tax, it will burden economic activity widely and hit imports more than current law. Because the BTT has a wide tax base, it can very effectively raise a lot of money on lower rates. Becaue the BTT is attached to businesses (wholesale, retail and services), there are fewer filers. Billions would be saved in tax compliance costs.

On the last point about keeping the income tax and such a sales tax. Conservative fear that the sales tax would be abused and get increased and lead to huge welfare state just like Europe - so all the proposals, like the FAIR tax envision a complete replacement. But what if we did it gradually, i.e., halfway? What if we took up Hartman's proposal to have a BTT of 10% - we could abolish the corporate income tax and cut the top income tax rate to 14%. Consider this option the BTT+FlatTax option. We could also possibily shift social security tax burdens in ways to lessen the regressiveness of the system, while yielding a better system overall, where 'better' means - simpler, flatter, fairer (no biases) and less economically destructive.

Contrawise is this view that sees all the tax reforms as flawed precisely because they are revenue neutral and don't slay the leviathan:

We just believe that a tax plan that perpetuates the welfare state and pays for the warfare state is not the solution. Obviously, the "best" tax reform plan, from the standpoint of liberty and less government, would be to eliminate taxes entirely. None of us are naïve enough to think that will ever happen as long as we have the state to deal with. However, in the mean time, the next best type of tax reform is one that results in a substantial lowering of the amount of taxes collected. If taxes are cut by a large enough amount, then no one will be too concerned about how the government collects its taxes. Real tax reform begins with the drastic reduction of taxes and tax rates.