Time for Tax Reform
Today, the President's Economic Recovery Advisory Board (PERAB) was scheduled to release its recommendations on reforming the tax code. Although they have postponed their release until after the holidays, the need for comprehensive tax reform is no less urgent.
The current tax code is in many ways broken – it is inefficient, distorts behavior, stifles economic growth, and raises insufficient revenue to fund current or projected levels of government spending. It cannot be fixed in a piecemeal way. And given our dismal fiscal picture, reform will need to occur sooner rather than later.
The PERAB is expected to offer an almanac of options “relating to tax simplification, enforcement of existing tax laws and reform the corporate tax system without considering policies that would raise taxes on families making less than $250,000.”
There is no question that the tax code needs to be simplified, the tax gap closed, and the corporate tax system fixed. But while necessary, these reforms are not sufficient. As Congress debates tax reform, we believe they should also do the following:
- Make rational and deliberate decisions on the Bush Tax Cuts. At the end of next year, all of the 2001/2003 tax cuts are set to expire. They include lower marginal rates at every level, an expanded child tax credit, a new 10% bracket for lower-income earners, lower rates on capital gains and dividends, a phase-down of the estate tax, fewer “marriage penalties,” and several other provisions. Letting all of these cuts expire would probably be politically impossible, yet renewing them would cost roughly $2.3 trillion over the next decade, greatly worsening our already dreadful debt situation. Policymakers must think carefully and reach rational decisions as to which provisions should be allowed to expire, which should be renewed, and which should be modified – preferably in a more thoughtful manor than simply renewing them for everyone under a certain income threshold. And they should find a way to finance the costs of whatever they do renew.
- Enact a permanent AMT fix. The Alternative Minimum Tax (AMT) is a secondary tax system originally intended to capture higher-earning taxpayers whose tax liabilities were below a preset threshold; but because that threshold was never indexed for inflation, the AMT is now scheduled to hit an increasingly large number of upper-middle- and middle-income earners. In past years, Congress has taken action annually to prevent the AMT from hitting the middle-class by passing temporary “patches,” which do adjust the threshold for inflation. Changes should be made in a permanent manner instead. A popular option is to index the threshold to some measure of inflation, which would cost around $450 billion over the next 10 years. If policy makers decide to do this, they will need to find offsets. The state and local tax deduction may be a logical pay-for for a number of reasons, but myriad other tax and spending options exist as well.
- Broaden the tax base. Almost all economists agree that the tax base should be broadened. The current tax system has upwards of $1 trillion a year in deductions, exclusions, credits, and other tax loopholes; and these tax expenditures likely lead to both higher than necessary tax rates, and larger than necessary deficits. And in addition to being expensive, tax expenditures tend to be distortionary, causing people to make sub-optimal choices and driving up the price of things like health care and housing. They also tend to be quite regressive in ways that most voters never realize, and are far less transparent than equivalent spending programs. Policymakers should take a careful look at all current tax expenditures to decide which ones can be eliminated, which can be capped or reformed, which can be consolidated, and which simply belong on the spending side of the budget.
- Consider the viability of new forms of taxation. Given the limitations of the current tax system, possible new sources of revenue are being increasingly mentioned. Most recently, for example, a financial transactions tax (FTT) has been discussed. Some forms of an energy tax should certainly be considered, as it would raise revenues and promote improved energy and environmental policies. A somewhat more significant change might be to switch, perhaps in part, to some form of a consumption tax -- perhaps a progressive consumption tax or value-added tax (VAT). Consumption taxes tends to be popular with economists since they can generate significant sums of revenue while encouraging savings and investment.
To summarize: at a minimum, tax reform needs to simplify the tax code, close the tax gap, reform corporate taxation, address the expiration of the 2001/2003 tax measures, fix the AMT, and broaden the tax base. We should also consider new types of taxes, and if it becomes evident that this not enough, we should seriously entertain moving toward a consumption-based system.
And even doing that cannot – and should not – replace tough and painful measures to bring spending under control.
While this all might seem like a tall order, its magnitude reflects that of the problems we face.
A politically viable way of getting to a VAT
PERAB has a tough task – suggest ways to improve the fairness of the tax system, increase jobs, enhance the efficiency of our economy, reduce incentives to take on too much destabilizing debt, and enable the government to raise needed tax revenue before foreigners stop lending to us, all without raising taxes on people making less than $250,000 a year. There is a way to do all of that. Will their report include it?
The simple principle behind the solution is to avoid taxing things that you want to encourage. We want to encourage jobs. We want to encourage companies to locate operations in America. So, reduce taxes on employment. Start by getting rid of the 7.65% tax that employers incur on every dollar they pay to their employees (up to about $107,000 per employee), while at the same time requiring employers to give each employee a raise in the amount of the tax saved. Make up that revenue loss by imposing a new form of sales tax (the Value Added Tax or VAT that virtually every other country on the planet uses, which does not tax businesses) of about 8% on purchases. Give an equivalent subsidy to retirees who don’t benefit from the employment tax reduction. Regular working people will come out even or a little ahead on this trade, but the VAT on people who spend more than $107,000 a year will help to reduce the government’s debt. So this allows the government to get the money it needs without taxing business or employment or regular working people or retirees.
Next, give corporations a deduction for dividends that they pay to shareholders, including your IRA, 401(k), or other retirement account. What does this do? Well, it increases the value of your retirement savings by up to 54% by getting rid of the hidden tax on your investments. It also gets makes America the best place in the world, taxwise, for our corporations to have their jobs and operations, instead of the worst place in the world like it is today. It also gets rid of the incentive for corporations to borrow too much and become financially unstable. Make up the revenue lost by getting rid of special tax rates for capital gains and by imposing a 7.65% tax on income over $500,000 a year. If corporations are allowed a deduction for dividends that they pay, then we don’t need special capital gain rates any more. They just subsidize rich people and encourage the kind of real estate speculation that helped fuel the current crisis. The 7.65% tax is the same that normal working people pay on every dollar of their wage income. Why shouldn’t people who make over $500,000 a year pay the same tax, especially since they would benefit heavily from allowing corporations a dividends paid deduction?
Visit www.sharedeconomicgrowth.org for more information.
Fair tax
Your suggestion is based on the belief that federal taxes pay for federal spending. If you would like to know why that is not the case, contact me at rmmadvertising@yahoo.com
Rodger Malcolm Mitchell
Tax reform
This post, indeed this entire site, can be summarized by five basic beliefs:
1. Taxes pay for federal spending.
2. When taxes are less than spending, the government is forced to borrow.
3. Federal deficits have an adverse affect on our economy, causing inflations and recessions, and must be paid for by future taxpayers.
4. Taxes do not have an adverse effect on our economy. They are more prudent than deficits.
5. There exists a fair tax system; we merely need to find it.
Contrary to popular faith, none of these beliefs is based on fact.
1. Taxes do not pay for federal spending. The government spends by crediting bank accounts and debiting it own balance sheets. It can do this endlessly. Tax receipts do not go into a vault or fund from which the government spends. Tax receipts merely credit a balance sheet, and do not affect future spending. No amount of spending affects the government's ability to spend in the future. In this, the federal government is unlike you, me and every city, state and corporation, which is the reason for widespread confusion.
2. The government does not need to borrow. It borrows by creating T-securities out of thin air, backed only by full faith and credit, then sells them for money it created earlier. It just as easily and prudently could create money out of thin air, also backed only by full faith and credit. This would eliminate borrowing and debt. Federal borrowing is a relic of the gold standard.
3. Federal deficits have a positive effect on our economy, do not cause inflations or recessions (See point # 8 at http://rodgermmitchell.wordpress.com/2009/09/07/introduction/ and never are paid for by taxpayers (See #1, above)
4. A large economy has more money than does a small economy. Therefore a growing economy requires a growing supply of money. QED Taxes reduce the supply of money in an economy, therefore have a negative effect on economic growth. Every recession since 1971 has been introduced by a reduction in deficit growth. (See the link in #3, above.)
5. No fair tax system exists or can exist. See: www.rodgermitchell.com/FairTaxes.html
The belief that deficits harm us, has prevented the government from providing health care for all, supporting Social Security, improving our educational system, feeding and housing the poor, repairing our infrastructure, supporting research and development and protecting our military men and women.
Rodger Malcolm Mitchell
Start Reporting the True Rate of Inflation -
You don't keep the patient healthy by hiding the pain.
The single most important feedback to a capitalist economy is inflation. When that feedback is false, the free market does not make the necessary adjustments (nor does the Fed) and the long term health of that economy is in jeopardy. The Federal Reserve imposed new inflation reporting standards in the early 1990s. In defense of inflation alteration, President Clinton was able to reduce government spending and establish some level of fiscal control.
Underreported inflation has an isidious effect. It tends to suppress wages and social security benefits while allowing excess liquidity (via inappropriate Fed and free market responses) and upward pricing in those areas that have upward pricing ability. My theory is that health care costs have been heavily influenced by underreported inflation.
The U.S. cannot attain and maintain fiscal responsibility without being honest about inflation.
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