A Lost Opportunity for Tax Reform

Right From the Start

Right From the Start

According to the national media, the opportunity for significant tax reform is all but dead for another two years – if not forever.  If you recall, the extreme partisanship between the Democrat Senate and the Republican House and spurred on by President Barack Obama has resulted in a stalemate on virtually all fiscal policy matters.  So poor are the relationships between the parties that they resorted to the “sequestration” option in hopes of making a failure to find a compromise so painful that both parties would find a way to agree.  What we found out in the aftermath is that there is no end to the bickering and posturing in Congress and the ‘pain” from sequestration turned out to be a minor annoyance to the public and really only impacted the public employees unions.

The second round of sequestration cuts are due beginning in 2014 unless a compromise is found.  The dire warnings of imminent catastrophe are muted this time around since the public has twice demonstrated that they simply don’t believe the politicians despite Mr. Obama’s attempts to make any cut in spending unnecessarily burdensome to the American public.  The current budget compromise being discussed in Congress is described as a “small deal” in which some of the required cuts are reduced through a combination of cuts in other programs and “user” fee increases for other programs.

But the concept of a general overhaul of the current income tax system appears to be lost.  Lost for the same reason that it has been stymied ever since Mr. Obama was elected.   The Democrat leadership views “tax reform” as a means to increase taxes.  The Republicans view “tax reform” as a means of reducing taxes and thus forcing a reduction in the growth of spending.  They are both wrong.

The “shape” of tax policy should be reflective of economic and political realities – and in today’s world that means global economic realities and, domestically, reflective of the goal of maintaining a representative democracy in which the rights of the majority and minorities are protected.  The “amount” of taxes should be reflective of the legitimate needs of a complex, highly industrialized society which – like it or not, Mr. Obama – is a world leader and is the only world leader that remains a force for peace and stability.

I’ll leave the discussion of the “amount” of taxes to another day.  Instead, let’s focus on the “shape” of tax policy.  It has been said, truthfully, time and time again that we exist in a global economy.  The United States cannot operate in a vacuum and its tax policies should be included in that recognition.  Currently, the tax burden imposed on individuals and businesses in the United States is among the highest, if not the highest, for all industrialized nations.  Capital tends to flow to where it can achieve the greatest return and that return is effected by tax policy.

One of the things that liberals and other big government advocates fail to understand is that one of the first things wealth enables is mobility.  We have seen a rapid outward migration of wealth in New York to more tax friendly states such as Florida and Texas.  Similarly, Oregon continues to experience its own outward migration because of its burdensome taxes.  For those of you who doubt it, just take a look at the residence of former chairmen of the Portland Business Alliance who, upon retirement,  routinely move to other states to avoid Oregon’s burdensome income taxes – including a number of members who actively supported one tax increase after another proposed by a succession of Democrat governors but now avoid those taxes by leaving.  Now the same is true on a national level.  A FOX News report in August of this year noted:

“Globally, more U.S. citizens have renounced their citizenship in the first and second quarters than all of 2012 combined, and 2013 is already on track to becoming a record year for renunciations. A total of 1,130 names appeared on the latest list of renunciations from the Internal Revenue Service, according to Andrew Mitchel, a tax lawyer who tracks the data. That is far above the previous high of 679, set in the first quarter, and more than were reported in all of 2012.”

Stricter enforcement of Foreign Account Tax Compliance Act has resulted in those wealthy individuals with friends in high places to come face to face with the United States tax structure.  No longer can those with political connections avoid the high tax rates imposed by storing money offshore and wink/winking their friends in Washington (remember President Bill Clinton’s pardon of Marc Rich after his former wife (Denise) contributed significantly to Mr. Clinton’s campaign).  Now, in order to avoid those taxes, the wealthy must renounce their citizenship.  That includes Ms. Rich who recently renounced her citizenship to avoid taxes.  The point is that current tax policy coupled with modern conveniences in a whole variety of places (think Belize) are making mobility easier and easier for those who have accumulated wealth.

A general tax overhaul following these principles would stem that outflow of wealth and encourage foreign investment in the United States:

1.    Tax policy should require everyone to pay.  Alexander Tyler, a Scottish history professor warned at the advent of American democracy:

“A democracy is always temporary in nature; it simply cannot exist as a permanent form of government. A democracy will continue to exist up until the time that voters discover they can vote themselves generous gifts from the public treasury. From that moment on, the majority always votes for the candidates who promise the most benefits from the public treasury, with the result that every democracy will finally collapse due to loose fiscal policy, which is always followed by a dictatorship. The average age of the world’s greatest civilizations from the beginning of history, has been about 200 years.”

The Democrats have learned this lesson well as evidenced by Mr. Obama’s constant refrain of raising the taxes on the wealthiest and Govs. Ted Kulongoski and John Kitzhaber support of Measures 66 and 67 raising taxes on only the wealthy in Oregon.  In both instances the majority of voters could vote an increase in taxes without being subject to their vote.  It is the tyranny of majority rule that is most likely to cause the downfall of democracy.

Everyone pays something and by doing so they reap the consequences of their acts.  Tax increases should likewise be equally applicable to all eligible to vote.

2.     The number of tax rates should be minimized.  Democrats and liberals are fond of reminding us of President John F. Kennedy’s admonition:

“To those whom much is given, much is expected.”

Which is simply a bastardization of the concept of:

“From each according to his ability to each according to his need.”

Unfortunately, that is a concept that underlies communism and was enunciated by Karl Marx.  It relates more to the concept of income redistribution than it does tax equity.  Be that as it may a graduated tax structure seems to be ingrained in the American political system and the best that we can expect is to minimize that structure to no more than three levels of taxes.

3.    The tax rates for individuals should apply to all income without deductions.  There is no greater justification for providing a tax deduction for someone who pays $1500 per month in interest on a mortgage than there is for someone who pays $1500 per month for rent.

4.    Tax rates for businesses should be abolished and the taxable income from such enterprises should be taxed directly to the owners/shareholders.  The vast majority of businesses in America are either partnerships (full and limited) or Subchapter S corporations where taxes are paid by the owners directly already.  It is absurd to tax a corporation for its profits and then turn around and tax the distributions (dividends) to its owners.  It amounts to a tax on a tax. Taxing income directly to shareholders may have been impractical prior to the advent of computers and large databases but now it is no more difficult to track the ownership of corporations (including the partial year ownership) than it is to track the purchasing habits of retail customers.  It will also help ameliorate tax driven anomalies such as excessive retention of earnings, etc.  Deductions for determining taxable income should be common (the cost of producing and selling goods) with the only variance being in depreciation rates which should be reflective of the economic life (as opposed to the physical life) of a capital asset.  Research and development costs should be amortized over a period commensurate with the time frame for patent protection (regardless of whether such costs result in a patented product or not).  The cost of preparation and extraction of a non-renewable resource should be amortized over the expected period for extraction of marketable amounts of the resource.

5.     Tax subsidies should be eliminated, including those to the producers and those to the consumers.  The most striking of these recently have been the tens of millions of dollars poured into the wind generation and solar energy industries.  These should include the direct subsidies through grants and tax abatements as well as the indirect such as the requirement that utilities purchase a fixed percentage of power from unreliable and costly wind and solar generation sources.  Government policy should not choose the winners and losers in a competitive environment.

The net effect of these changes will be several.

  • It will reduce overall tax rates by broadening the base and eliminating special interest deductions
  • It will provide tax stability and predictability for business which encourages growth and investment – oh, yes, and jobs which appears to be the redheaded stepchild for Mr. Obama and the Congressional leadership.
  • It will simplify tax preparation for individuals by reducing it to a single page (no deductions, no credits, and no qualifications for special treatment.)
  • It will eliminate the army of bureaucrats and rule writers deployed by the Internal Revenue Service whose primary duty appears to be to abuse and confuse taxpayers.
  • Similarly it will eliminate the army of tax professionals needed by individuals and businesses to comply with ever shifting rules, regulations and legislative changes.

But it is doubtful that any of this can occur because of the heighten partisanship infused by Mr. Obama during his tenure as President and because of the special interests who control the flow of information (and campaign funds) to the members of Congress.

In the words of Alexis de Tocqueville:

“There are many men of principle in both parties in America, but there is no party of principle.”

And quite frankly, the number of men (women) of principle continues to decline at an alarming rate.