Friday, April 15, 2005

Happy April 15th...

Tax reform has long been a traditional issue of contention between the Republican and Democratic parties. The 2004 presidential election was no different. Always a staple of the Republican platform, tax reform is a key component to President Bush’s second term domestic agenda. With the re-election of President Bush and the Republican domination of Congress, the possibilities for reform have taken a new turn in the form of consumption taxes, specifically a national retail sales tax.

However, the push for a sweeping transformation of the current tax system will be difficult to achieve in the near future. Despite overwhelming support by GOP Congressional candidates to abolish income taxes in favor for the increasingly popular national retail sales tax, the prevailing institutional forces of the current tax system are too deeply entrenched. Yet, significant reform—such as a switch to a consumption tax—is possible in the long term.

In fact, President Bush’s tax cuts may have prodded the country down the path of reform. Although tax cuts have reached a political glass ceiling due to a record budget deficit, this has propelled the President and Congress to advocate significant reform. Earlier last summer while on the campaign trail, the President created an uproar in his acknowledgement that the national retail sales tax was an “interesting idea.” Moreover, two days after re-election he clearly stated, “We must reform our complicated and outdated tax code.”

Currently, the consensus among the dissatisfied is that the system is burdensome, complex and full of loopholes. Considered a burden upon society, Americans are spending up to 6.1 billion hours filing tax returns, meeting with financial planners, and keeping records. True to its complexity, the Internal Revenue Service has roughly 97,000 employees and a 2005 budget of $10.7 billion. Fees for business compliance and tax preparation accounted for 29 percent of revenue for the top 100 accounting firms in the nation.

Opponents have identified a deadweight loss, as this effort could otherwise produce services and products of greater use. Indeed, the intricacies of the tax system have created a huge industry devoted to its implementation and an incentive in the exploitation of loopholes and tax shelters.

The national retail sales tax may be the long-term solution. Levied at the retail stage where the final transaction occurs, the national retail sales tax allows the retailer to collect the designated percentage markup and submit it to the proper tax authority. The most prominent of its legislation is the Fair Tax Act of 2003, which would substitute a 23 percent national retails sales tax for individual and corporate income taxes, as well as all payroll, estate, and gift taxes. This Act proposes a rebate on spending up to the federal poverty level (dependent on family size) as a means to counter the regressive nature of a consumption tax on lower-income families.

Many economists defend its efficiency over income taxes because consumption taxes eliminate the distortion between present and future consumption. Supporters view it as a tax on wages as it removes the automatic penalty incurred by the current system on savings. It also serves as a “lump-sum tax” on overall wealth by guaranteeing that all persons pay taxes upon consumption regardless of the amount earned.

According to supporters, the income tax is an inferior measure of wealth since it only taxes wages and return on capital. However, the ability to consume serves as a better measure as it is directly proportional to the amount of wealth available. A wealthy individual can escape the full payment of income taxes through clever schemes and shelters. For example, Teresa Heinz-Kerry, wife of 2004 presidential candidate John Kerry, best epitomizes the scenario: In 2003, she paid an effective income tax rate of 12.8 percent, which is much lower than the average middle-class rate of 20 percent. Under the consumption tax, Heinz-Kerry could not escape paying taxes.

The consumption tax concept is not brand new and traces its roots to the musings of one of America’s Founding Fathers, Alexander Hamilton. Revolutionary for his time (and certainly ahead of his contemporary peers), Hamilton supports consumption taxes in Federalist #21:

“…all duties upon articles of consumption, may be compared to a fluid, which will in time find its level with the means of paying them. The amount to be contributed by each citizen will be in a degree be at his own option, and can be regulated by an attention to his resources. The rich may be extravagant, the poor can be frugal, and private oppression may always be avoided by a judicious selection of objects proper for such impositions.”

The innovative Secretary of Treasury possessed incredible foresight by recognizing the merit of a consumption tax. It would leave to the individual the choice of economic decision and provide the fairest means of taxation.

Although the national retail sales tax is appealing in theory—consequently gaining momentum in its popularity—the difficulty lies in convincing the American people of its merits. Reformers must engage in an aggressive outreach campaign to overcome the entrenched nature of the current system. While a complete system overhaul is impossible, a graduate shift may be what pushes support of a consumption tax over the top. Until then, the best that reformers can hope for is the extension of tax cuts and simplification of tax code.

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1 Comments:

  • The return! Someone must have reinserted this blog's feeding tube. (was that tasteless? Over the line?)
    Ah, The National Sales Tax - today's gold standard - the idee fixe of today's uber-conservatives. There's a few problems with the NST, though, and in my opinion, they're enough to outweight any supposed benefit that would come from a national sales tax.

    Yeah, the IRS as we know it would change, but it would hardly be abolished. Who's going to make sure those ethically challenged businesses submit the correct amount of sales taxes without taking a little of the top, requiring monitoring, and maybe even - uh-oh - regulation! Everything will become a "business expenditure" creating the need for a massive bureaucracy to monitor those expenditures, unless you're okay with corporations cheating. A HUGE incentive will be created to find ways around having to charge sales tax, effectively a black market with all the organized crime that surrounds any black market (see drugs, human organs, liquor under prohibition).

    Oh, and that 23% number is nowhere near the required amount to even be anything close to a revenue-nuetral change. Economist Bill Gale, who actually knows what he's talking about, puts that estimate at around 60%, considering the amount of avoidance that will take place. Add on to this the inevitable lobbying that will arise shortly after the NST is initiated. This is a hypothetical situation, but knowing the tactics of K Street (they've switched mostly all strategy to the tax code - that's your big simplification problem - lobbyists and politicians eagerness to avoid spending anything.) Endless lobbying will begin over classes of products and services that should qualify for reductions of or exemptions from the sales tax. The first exemption to be approved are luxury items, with the rationalization made that they are discretionary purchases that would see severe sales reductions if taxed heavily, throwing a lot of middle-class breadwinners out of work, or some asinine argument like that. Endless lobbying would also begin over which individual products and services meet which definitions of classes and services qualified for reductions of or exemptions from the sales tax. First products switched into reduced/exempted classes are snack foods like delicious Doritos, which now are classified as luxury items with the rationalizations that, in terms of $ per unit of nutritional value, Doritos are much more of a luxury than items like white truffles or Beluga caviar. After all this lobbying, the GOP congress passes and President Bush signs a bill to exempt from sales tax any purchases made with the proceeds of: dividends, capital gains, or inheritances. So we're still left with a huge tax code due to lobbying.

    It's also necessary to discuss who would lose in such a scenario.

    First up, seniors. The elderly would be royally screwed. All their lives their incomes have been taxed away, but at least what's left over is tax free because they've already paid taxes on it. Under Linder's plan, though, they suddenly have to start paying huge taxes again — on rent, medicine, vacations, and cat food. Talk about double taxation, those anti-American leftists at the AARP would kill this thing.

    Second, the housing market. The tax would apply to home purchases, so you could kiss the "ownership society" goodbye, replacing it with the "you're on your own-ership society." Average housing prices would skyrocket, thanks in aprt to the taxes and the disappearance of the home mortgage interest tax deduction. Nobody would own property except the super-rich, the slum lords would move out of the cities, creating a huge class of modern day fuedal lords. Add to this the crippling of local governments becuase when property values plummet, so do local revenue for things like shools and roads. Awesome.

    Lastly, families will suffer as well. Wave goodbye to the tax credits for families. The problem here is that the tax doesn't distinguish between families and individuals. Gale says that the "enactment of a broad-based, flat-rate consumption tax like the sales tax ... would hurt families with incomes less than $200,000, because of the loss of tax preferences, but would help families with income above $200,000, due to the dramatic reduction in the top tax rate."
    More class warfare guys, nice.

    There are a litanny of reasons why this is a bad idea, and also why the VAT is less of a bad idea. The disingenuous 23% is enough for me to hate it.

    By Blogger rabbit, at April 16, 2005 at 9:16 AM  

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