Thursday, August 1, 2013

How About A Real Radical And Revolutionary Tax Reform Plan?

Sam Adams 'Sons of Liberty' flag, 1765
With some muted talk coming out of Washington, D.C about 'tax reform' again (for about the 10,000th time since who knows when...1913 probably), we thought we would take this opportunity to talk about what 'real' tax 'reform' would really mean.

Let's see what Webster's Dictionary and others have to say about the word 'reform', what it means and where it came from:
The word 'reform' seems to have arisen around the year 1300, "to convert into another and better form," from Old French 'reformer' meaning to "rebuild, reconstruct, recreate"; from Latin 'reformare' meaning "to form again, change, transform, alter," from re- "again" (see re-) + formare "to form" 
Whatever President Obama was talking about Tuesday  when he announced his 'corporate tax reform' package, well, that just didn't cut the mustard of even coming close to being considered true 'reform' in any way, shape, fashion or package. His proposal doesn't 're-build' or change anything. Same old same old.

In short, his proposal is a waste of time to even discuss. Not even close to a true 'reform' of the US tax code.

Now, if you really want to talk about 'tax reform' in the context of what the word 'reform' really means: 'to bring about change from an evil form of corruption' as it exists today, let's talk about adding two words familiar to the Founders of our nation:

'Revolution' and 'Radical'.

The fellas who started the War Against Britain were 'crazy'. Flat-out 'nutcases'. There was absolutely no common sense reason why a bunch of backwoods farmers and hunters could or should stand up to the most powerful military and King in the world at the time and say this: 'We think you are wrong and we don't want to be part of your kingdom any more!'

But they wanted their freedom and independence. When you want something bad enough, sometimes you do the craziest things to get it. Such as attacking the most powerful military the world had ever known to that time.

They believed in the words 'revolution' meaning roughly 'to turn or roll back' and 'radical' which means 'going back to the roots' of a situation.

Washington, Jefferson, Madison, Franklin..they were all 'radical revolutionaries'. They wanted to change the status quo tax-wise at the time.

So the Revolution came. And they won.

What has that got to do with 'tax reform' in the 21st century?

Everything it seems. Getting back to the core reasons why we have taxation in the first place might help us finally really reform the income system in America.

Taxes are supposed to be collected from the citizenry to pay for the collective needs of the nation. Not to punish one group or another. Not to provide special tax benefits to one group versus another. Not to engage in relentless class warfare, which President Obama doesn't seem to mind doing since he was first elected. Not to do anything other than to provide the revenue to pay for on-going government services so we don't have to borrow money from future generations to consume today.

We need tax revenue to pay for the basic core functions of government. National defense is certainly one of them. Unless we move 100% to an electronic toll road system, we need to have good roads and bridges on which to travel and conduct business. The Erie Canal, for example, helped triple the GDP of the USA after completion in a matter of years, not decades. A certain level of social safety net has become part of the American social fabric so that needs to be funded as well.

What would a true tax 'reform' plan look like if introduced in Congress?

Simple. Expand and rename the payroll tax as a 'graduated flat income tax' and do away with every other tax in service today. The payroll tax is essentially the only 'flat-tax' in existence today in America. Everyone from the pauper to the president of GM, Apple and Microsoft pays it on the wages they earn. The payroll tax tops out at $113,700 in earned income for Social Security; it is unlimited for the Medicare share of the payroll tax so there is precedent for a 'flat-tax' across all income levels right there today in the US tax code.

Call it an 'income' flat tax and apply it against all forms of income a person can make during a year from labor, wages, salaries, tips, stock dividends, bond interest, capital gains and any other form of income you can think of.

People now living have had some form of this 'flat tax' concept in payroll taxes paid for their entire lives. It is a concept that can be used to move to a new truly reformed tax system.

We are still in the tank for moving completely to a consumption-based tax for many reasons. However, moving from our existing system to a full consumption-based tax plan would be like the Wright Brothers saying after their historic flight at Kitty Hawk in 1903:

'Hey! Why don't we plan on landing on the moon 66 short years from now in 1969?' 
'One giant step leap for mankind;
next stop, The Moon!'

A consumption tax may replace our income tax system one day. But moving to a modified flat-rate tax plan first would make it easier to move to a consumption-based tax plan later.

How would the modified flat-tax rate plan work?

Here's what it would look like:

  1. Keep the 7.5% tax now in place for FICA but don't call it a payroll tax any longer. (People think it goes into a fund to fund their retirement and health care but it doesn't. Never has. Never will)
  2. Apply the new flat-rate to everyone's reported income on their annual income tax return each year.
  3. Remove every tax deduction for every favored provision in the current tax code. Mortgage interest deduction; charitable deduction; health care premium deduction paid for by the corporation and the individual.
  4. Graduate the flat-rate tax slightly for income levels over $50,000 to say 12% from $50,000 to $200,000 and maybe 22% from $200,000 and above. These would have to be 'effective tax rates' on the whole amount of income you made during the year, not marginal tax rates. Otherwise, the rates have to be higher.
Why could this work?

Because with all of the tax deductions eliminated from the tax code, both individual and corporate, hundreds of billions of dollars will now be exposed to taxation. Lower tax rates and a far simpler tax return each year could be achieved and still produce roughly the same amount of tax revenues as under current law.

Spending still needs to come down substantially in the federal budget. This will not raise trillions in new tax revenues somehow magically to cover all of the excess costs we have incurred since President Obama was elected in 2008.

We as a nation are not under-taxed. We are over-spent. In reckless, shameful, wasteful ways in many cases.

CBO estimates at least $1 trillion per year in tax revenue is now not collected due to our generous tax-deductions in the tax code. (see 'Tax Expenditures') Exposing all of everyone's revenue to taxation would help offset the lower tax rates on wealthy individuals (who hire crafty tax lawyers and accountants and don't pay the full amount based on higher tax rates now)

The new modified flat-rate effective tax rates of 7.5%, 12% and 22% judiciously administered would generate roughly the same amount of income tax revenue as today. You simply can't get there with one single tax rate unless you set an effective tax rate of 14% on every taxpayer and eliminate every single tax deduction there is today.

There are 94 million tax returns filed each year under the gross income level of $50,000. 94 million taxpayers (more like 130 million people since couples file jointly) ain't gonna pay double the income taxes they paid last year under the old plan so you can forget about that happening. Ever.

Shifting to a modified flat-tax plan would be 'radical' tax reform. It would be 'revolutionary' tax reform. It would also be a 'fair' tax reform since everyone would be paying something and there would be no such thing as anyone not paying any taxes in any given year. We would all be in this together as a nation as opposed to our current dilemma of one sector trying to game the system while another sector is engaging in class warfare.

Who knows? Let's see how CBO would score this proposal.

Feel free to comment and debate as much as you want. We need 'real ' tax reform coming out of this White House and this Congress and we aren't getting it right now.

The Founders felt the same way about King George III, didn't they? They put forward a pretty bold radical revolutionary plan back in 1776. Why not do the same thing today?


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