Remember when the Democrats talked about “tax reform” but they really meant tax increases? With the election of Donald Trump (R) as President and control of the House of Representatives and Senate still in the hands of the Republicans that narrative can change. But, quite frankly, I am not particularly encouraged that it will, particularly after an article in Saturday’s Wall Street Journal:
“Fault lines inside the corporate world are emerging over a proposed rewrite of the U.S. tax code, pitting importers against exporters.“At the heart of the fight is a Republican plan in Congress that would impose corporate taxes on imports while eliminating them from exports, a move that would upend decades of tax policy.
“The proposed shift in effect would curtail existing incentives for U.S. companies to move profits and operations abroad, but it would also pose new challenges for some global businesses. Retailers selling imported products and refiners using imported oil could be hardest hit, while some exporters could see their tax bills vanish.”
This isn’t tax reform; this is re-arranging the deck chairs – Congress continuing to pick the winners and losers by “tax policy.” If Mr. Trump is serious about “tax reform” he needs to establish some basic principles which drive the final results. Let me offer a sound set of such principles:
1. Taxes should be designed to produce the revenues necessary to fund the legitimate functions of government – that’s it. Nothing more, nothing less. Taxes should not be used to encourage or discourage investment in particular lines of business. Taxes should not be designed to redistribute income or wealth. And taxes should not be designed to encourage or discourage a particular form for doing business.
Acceptance of this principle would eliminate all incentives, tax subsidies and special treatments. There would be no more special treatment for oil, gas, and coal producers. No special treatment for solar power producers or users, or for wind generation, or any other “alternative energy’ producers. There would be no special treatment for Wall Street moneychangers, investment houses or speculators. No special treatment for agricultural producers, nor importers nor exporters. No special treatment for anyone. No interest deductions for mortgages, and no tax credits of any kind. Income produced in the United States would be taxed in the United States and income produced elsewhere would be taxed in that jurisdiction. Profits after taxes would be repatriated to the United States with no further tax or penalty.
2. Everyone should be required to pay taxes. The whole concept of a representative democracy is that the law, having been adopted through the representatives of the people, should apply equally to all. If you start carving out exceptions for the application of the law, we are no longer a nation of laws but rather a people subject to the whims and caprice of the powerful. The same is true of taxes. If the representative of the people exempt groups from the impact of taxes or tax increases, then they become the representatives of a segment of the political body and impose burdens on the minority.
The whole concept of a democracy is fraught with the danger of the tyranny of the majority. It is why our founding fathers created a constitution replete with guarantees of individual rights. In every instance, our laws should be structured such that a majority cannot impose a burden for which they have exempted themselves or their supporters.
The Oregon Democrat Party, at the behest of its financing arm – the public employee unions – has now adopted a pattern of tax increases that will apply to a small minority of citizens but will be passed by the overwhelming majority of taxpayers who will not be subject to the tax. Their latest attempt with the I-97 gross receipts tax lost because the business community was able to show that the tax would, in the end, be paid by the very taxpayers the public employee unions sought to fool.
Unless all pay taxes, all are not equally impacted by the decisions of government – and particularly not impacted by increases in taxes.
3. The calculation and payment of taxes should be simple and efficient. Today, the Internal Revenue Service employs slightly over 82,000 people. There are at least that number in the private sector who attempt to provide guidance, preparation and defense for taxpayers. Not one of them provides any benefit. In fact, they represent a sword (IRS) and a shield (tax consultants) both paid for by the same taxpayers.
The average cost of a federal employee is approximately $110,000 per years, including salary and benefits. Elimination of half of the employees of the IRS would result in savings to the cost of government of nearly $4.5 Billion annually. A comparable benefit – probably a greater benefit – would be realized by the private sector by being freed from employing less people to advise, prepare and defend tax returns. Elimination of special treatment, benefits, and incentives coupled with elimination of taxes as a means to redistribute wealth will, by definition, simplify the calculation and payment of taxes. It would also eliminate literally tens of thousands of the approximately 74,000 pages of the IRS rules and regulations that grow by an additional 750 pages annually.
4. If progressive tax rates are used, they should result in no more than four categories. There are good policy arguments for a single tax rate applicable to all levels of incomes. However, we have become accustomed to graduated rates for increasing levels of income. If that is to continue under a “tax reform” they should be limited in number and correlated to a specific economic measure.
Let me suggest the following four categories: First category – income from zero to the federally mandated minimum wage. Second category – income from the federally mandated minimum wage to the median income (statistical middle of income distribution) determined annually by the Department of Labor Bureau of Labor Statistics (BLS). Third category – income from the median income to triple the medium income (average income) determined annually by the BLS. Fourth category – all income above three times the medium income. The tax rate for the first category should be minimal – probably one percent. The tax rate for the second category should be low. The tax rate for the third category should be double the second category and the tax rate for the fourth category should be double the third category. Any tax increases or decreases thereafter should be applied proportionally. (The tax rates and multiples are for illustrative purposes only given that budgetary requirements – including a significant reduction in the cost of administration – will ultimately determine the necessary rates and multiples.)
Couples subject to the “marital estate” laws of their state of residency will be allowed to treat income as if earned equally by both partners. Capital gains will be taxed at one-half the rate of ordinary income – better said is that only one-half of capital gains will be subject to taxation. No tax on C-corporations, rather income earned by C-corporations will be treated exactly as income by S-corporations and taxed as if received by its shareholders.
The one exception that I would recommend to such a simplified tax system would be the continuation of special treatment for retirement savings. According to a 2014 study by the Tax Foundation:
“However, over the last fifty years, U.S. saving and investment have eroded substantially, and during the most recent financial crisis, they collapsed almost completely. At the national level, the U.S. is essentially treading water. Citizens are barely running enough household surplus to make up for government deficits, and businesses are barely investing enough new capital to make up for the depreciation of old capital.”
The degree to which we provide for our own retirement has a direct and significant impact on the amount required from tax funded sources – welfare, Social Security, etc. I would suggest that a “Roth IRA” treatment be provided for all retirement savings (Individual Retirement Accounts, 401k plans, private and public pension plans, etc.) where the earnings but not the contributions are tax free so long as they are not accessed or used prior to retirement age. With regard to current retirement accounts, a method should be adopted to tax amounts previously contributed and deferred from taxation and allow the amounts earned on those contributions to be accessed tax free.
And finally, adoption of a simplified tax system will reduce the number and influence of the lobbying class. The army of lobbyists and their supporting experts (lawyers, accountants, economists and statisticians) currently concentrate on gaining advantage for their clients and/or imposing burdens on their competition. Their favorite target is the tax code and the multitude of exemptions, deductions, credits and deferrals offered. Elimination of those tax treatments will result in a reduction in the power of the lobbying class and level the playing field for a market driven economy.
So long as the tax code remains a haven for special interests there will be no meaningful tax reform. There are significant benefits to be had from a simplified process. Only the president can drive real reform by refusing to accept the multitude of exceptions, exemptions, deductions, tax credits and deferrals that will be included in a Congress wholly beholden to the special interests lobby. President-elect Donald Trump should make sure his veto pen is filled with ink.