Wednesday, October 22, 2008

The Coming Class War

An article by Professor Adam Lerrick, “Obama and the tax tipping point” appeared on the op ed paged of the Wall Street Journal on October 22, 2008. Prof. Lerrick notes that 40 percent of American workers paid no federal income taxes in 2006. Obama’s tax credit proposals would raise that number to 49 percent. This would result in increasing the tax burden on those who currently pay most of the taxes now. As I wrote in “Class Envy” Obama has declared war on the 5 percent of Americans who earn $250,000 or more and who pay 60 percent of Federal income taxes. Increasing this burden will result in difficulties in raising tax revenues. Those who have to pay will practice tax avoidance and trying to tax those who don’t pay will be political suicide. This will pit one group of Americans against another - a recipe for disaster.

The solution is to move in the opposite direction: instead of taking citizens off the tax roles, the government should require all Americans to pay Federal income taxes. As I pointed out in my Knoxville News- Sentinel article on July 6, the result would be to lower the overall tax rate. Every citizen who earned income from any source would be required to file a tax return. As we say in East Tennessee, all of us would then have a dog in the hunt. The tax code would have no rebates, no refunds and no deductions. Those who have lower incomes would then be supplemented by the myriad of Federal income transfer programs. This would also serve the purpose of eliminating one of the main purposes of the Federal income tax, namely to reward one’s friends and punish one’s adversaries. My News- Sentinel article follows. 

Harold A. Black

July 6, 2008

The Federal budget calls for spending of $2.8 trillion. How best to raise the money? The answer is simple. It is to cut the effective tax rate in half and create a dramatic and profound increase in the economic wellbeing of all. 

The current tax code is a joke. It raises funds in an inefficient convoluted manner that only a Rube Goldberg could love. The only reason that the tax code is so complicated is that it offers politicians a method for rewarding some and punishing others. Therefore, proposals for tax simplification are doomed to fail. Politicians don't want to simplify the tax code because it would severely reduce their power. It doesn't matter that the code induces circumvention and waste. It doesn't matter that over 5 billion hours and $265 billion are spent by Americans just to comply with the tax code and that that cost as a percent of dollar collected rises yearly. What matters is that it benefits politicians, tax accountants, tax attorneys and, of course, the IRS with its 100,000 employees and $10 billion budget. 

Except for the above constituents, the tax code is rightly vilified as wasteful and counterproductive. So if we change it, what should be done? Immediately, two problems present themselves. One, how do you define income? Two, how do you make the tax code fair and equitable? 

First, define income as any form of earnings received during the year that can be spent such as wages, salaries, dividends, tips, and royalties with no exceptions unless specified by the Constitution. Second, fairness and equity have no place in the tax code. The tax code should be used only to collect money. 

One popular tax reform idea is the "fair" tax (consumption tax). The "fair" tax replaces the federal income tax with a national retail sales tax, levied at the point of sale. An argument against the "fair" tax is that it is not “fair” since lower income earners spend a greater percentage of their income on goods and services than do the non-poor. As a consequence, the “fair” tax adds a rebate that "untaxes" the purchases of the poor. Once you start allowing rebates, simplicity is doomed.  Anyway, I don't like this tax because it hides the cost of government. 

This past fiscal year the income tax comprised 48 percent of all federal government receipts. With all of today’s deductions, only 40 percent of gross reported income was taxed with the average tax rate of 19.5 percent. Instead, I propose to tax everyone at the same rate regardless of income or situation with no deductions, no exemptions and no exceptions. That rate is a flat tax of only 10 percent of total personal income. Since total national income last year was $13 trillion a 10 percent flat tax would yield $1.3 trillion, instead of the $1.1 trillion from the current tax structure. This would reduce the projected deficit to “only” $200 billion. 

Can you imagine the impact on productivity, jobs and income? Most would pay lower taxes and all would waste less time preparing for April 15. Those say that a flat tax is not "fair" and it isn’t “equitable” miss the point entirely.  Government programs, not the tax code, should be used to address issues of fairness and equity. Subsidies from these programs would offset the taxes paid by certain groups. Just think of the benefits: no need to interpret the tax code, no need for tax lawyers, tax accountants and no 100,000 employee $10 billion Internal Revenue “Service”.


Anonymous said...

Very interesting post, Harold. You raise issues of efficiency and equity that will surely resonate with many people, especially those who think in the tradition of market-oriented economists and who have to deal with the complex income tax codes at the state and federal level. I've also been sympathetic to notions of a "flat" tax over the years for the reasons you mention.

My current thinking is a bit less clear. My sense today is that the split among people in this country is already well underway and growing after many decades of relatively balanced growth. This split is in terms of income and wealth, but also in terms attitudes about the ideals many of us espoused and the difficulty of visualizing a bright future. For example, my sense is that the cost of raising a family is just daunting to many young people, especially when one attempts to provide higher education, health care, decent housing, and the like. I'm fortunate that my wife and I have been able to do this reasonably well, but I surely sympathize with many young people who wonder whether hard work and a modest education will allow them to do for their children what we've tried to do for ours.

With this in mind and if my premise is "true", the issue is how to address the growing divide. Perhaps a more redistributive income tax might allay some of the angst and sense of injustice that seem to exist and lead to a greater desire by those in the bottom income and wealth groups to see opportunities for personal growth and development. Many who benefit from such a system might be quite willing to do their part in the future to help others.

Alternatively, and as you say, perhaps spending programs are the way to go, e.g. housing and education vouchers. However, recall Milton Friedman's espousal of the negative income tax as an alternative, which is just another form of a progressive income tax.

In any event, thanks for stimulating the discussion.


Steven said...

Dr. Black,

Is there a developed nation that has successfully shielded their tax system and it's control from political pressure? I am thinking an institution similar to the US Fed could exist with success.