A Bad Idea Made Better for Tax Reform
Although most people are aware of the "tax cuts" enacted by the Republican Congress at the behest of the Bush Administration, perhaps not as many understand that these obvious changes in the tax code were only part of a systematic and subtle re-alignment of that tax code to shift the burden of taxes toward income generated by labor and away from income generated by capital. The degradation of estate taxes enacted in the last Congress is an example: while publicly using anecdotal evidence of people of modest means suffering heavy taxation on the modest estates of their deceased benefactors, little was said about the overwhelming benefit of eliminating estate taxes accruing to the massive estates of the very wealthy in intergenerational transfer.
Another example of the shift of the tax burden to labor can be found in the elimination of the so-called "double tax" on dividends. Those in favor of this "reform" pointed to the obvious unfairness of taxing income at the corporate level and then taxing as ordinary income upon stockholders any part of those corporate earnings that were received as by individuals as dividends. Virtually no mention was ever given in the run-up to that vote the fact that dividends accruing to corporations that hold stock in other corporations were already partially exempt from taxation. Moreover, despite the claim that some substantial amount of all dividend distributions accrue to "ordinary" people investing in the stock market, a number of financial instruments already exist that cause dividends to roll back into investments and thereby avoid taxation. Effectively, the vast majority of the benefit from elimination of the double taxation of dividends was realized by those who are large-scale shareholders and/or insiders in corporations, along with those corporations that hold subsidiaries from which they want to drain cash flow through dividends issued by the subsidiaries.
From Here to There
The current tax system in the United States is based upon progressivity of the marginal tax rate for both individuals and corporations: as taxable income rises, the last dollar of that income is subject to a higher and higher tax rate. As pointed out last week, this does not mean that all income gets taxed at a higher and higher rate as income rises: it means only that higher and higher tiers ("brackets") of income get so taxed.
That progressivity has as one of its consequences the taxation of capital in a focused way: individuals who make more money are more likely to have a larger percentage of that income generated by investments rather than by the sweat of their brow. Anecdotally, the wealthy entrepreneur George Soros, whose financial portfolio is estimated in the billions, declared that the elimination of the double taxation on dividends alone was a boon in the tens of millions dollars to him, indicating that an extraordinary amount of his annual income is generated by capital investments he has made, primarily, it must be presumed, by acquiring ownership positions in corporations.
It must, therefore, be an important feature of tax reform for the neo-conservatives that progressivity be drained from the tax structure. That has already been in the works for years. The number of tiers of income subject to higher and higher marginal tax rates in the United States was in overall decline at the point where the Reagan Administration and a compliant Congress reduced to three the number of tax brackets. Furthermore, the highest marginal tax rate has been falling, as well.
Even though the number of tax brackets is now higher than it was during the Reagan Administrationthanks in no small part to none other than President George Herbert Walker Bushthe desire to level out the tiers is just as strong as ever, but there is just not enough political will to do away entirely with tiers of progressively higher marginal tax rates, and that indicates something quite important about how the neo-conservatives must proceed if they are to switch the U.S. tax system from one that is progressive to one that is not. This article will conclude with a means by which that neo-conservative fear of openly attacking progressive taxation can be used against them as they attempt to furtively do away with it via a national sales tax.
As the dynamics are now moving, though, the tax structure is slipping decidedly toward something closer and closer to a straight, proportional income tax, while at the same time easing down the tax rates on the upper tiers of income, where it is more likely to be the result of investments rather than labor. It could be argued, then, that a proportional income tax structure, rather than a progressive one, is just a matter of time. It would, therefore, seem to be in the interest of those who want this kind of a tax system to merely bide their time: simply get sympathetic politicians to continually press for more "tax cuts" and "tax relief" as a pretext for eventually, quietly, and without undue notice, achieving the final goal of a perfectly proportional tax structure that assesses the same percentage tax rate on all income, no matter how large it might be.
The problem is that this would be like trying to move a large pig sty into the living room of the American House of Tax Code. It might work to put some of the walls in, convincing everybody that it's merely redecoration for functionality. It might even work to put the slop troughs in, convincing everybody that it's a dining room for unwanted relatives; but sooner or later, the pigs have to be brought in, and everybody's going to notice them, even when folks are assured that the pigs are nothing but house maids hired to make life easier. Pigs are not people, and just about everybody can tell that: a proportional tax is not a progressive tax, and just about everybody can tell that, too. Sooner or later, the American Electoratefully and for almost a century living in a country that taxes the rich more than the pooris going to see that the system has fundamentally changed to the favor of the rich. Eventually, those good voters might also figure out, were the tax rate the same for everybody, that people who make a lot of money without lifting a finger to do a day's real work get to pay the same tax rate as those who bust their hump and have barely enough to cover their bills. And perhaps just as importantly, this favor is accruing to a tiny, powerful class of folks, while the vast majority of tax revenues the government is pulling in come from a staggering majority of people in the United States, taxpayers who make less than a tenth of what the small, American aristocracy makes, as evidenced by the income distribution graphic at left.
Plastic Surgery for Pigs
Enter the national sales tax. In last week's installment in this series, the story of two brothers, Byron and Barton Binkwater, was told. These brothers made significantly different incomes; but under a national sales tax, the wealthier of the two actually paid a lower tax rate on income, simply because poorer people use far more of their total income on consumption, which would be what is taxed under a national sales tax. This example went to the heart of the old saying in macroeconomics that a proportional tax on sales is a regressive tax on income.
In this way, a national sales tax is more than a dream-come-true for wealthy people: it's not even a proportional income tax; it's a regressive income tax. That means, the richer a person is, the smaller the percentage of his total income that gets paid in federal taxes: this would be a tax structure that actually rewards the rich for their propensity to save at higher rates, which by no small coincidence means rewarding future income generated from capital rather than from actual work. This, then, is a prescription for the rich to get richer, year over year and generation over generation. Better still, in its relatively purer forms, a national sales tax could be sold as an enormous tax simplification since a check-out register tax wouldn't require people to go through the yearly nightmare of filing federal income tax forms that sometimes vex even tax professionals. And for one more thing, a national sales tax would promote that old-fashioned notion that saving is better than consuming. A national sales tax has so many promotable features that lower income folks might not notice that it's a regressive tax on income.
The Smell Comes Through
Under a national sales tax, purchases would be socked with some added percentage of the retail price, but income put into long-term savings would not be taxed. This would give people at least some incentive to put more money into savings. People who don't make much would have more of a problem with this than people who make a lot, since every dollar saved would be a larger percentage of disposable income, and few would be so bold as to argue that saving money is a good substitute for consumption. More importantly, even though that money in the savings accounts could be used later for consumption, "later" is not a good substitute for "now." It just isn't. Whereas a well-to-do person is going to have plenty of money both now and in the future, the poorer person isn't going to have both at the same time. Creating a tax incentive for future consumption constitutes a coëercion to accept more of a less desirable good and less of a more desirable one.
But businesses and individuals who are capital investors by virtue of their greater disposable income are going to have a field day. As the amount of savings rises, banks and other lending institutions will have a greater supply of lendable funds; and with greater supply will comes lower interest rates. That means businesses will have a lower cost of capital, and individuals with the means to invest will be able to use more leverage in their long-term investments, which will enhance the so-called "gains to leverage" they realize by using more debt in their total investment money. It will also serve to give businesses more of the same incentive: rather than issuing equity to grow, they will be able to use more debt because it is becoming cheaper.
Ah, but this same lower interest rate environment should help the less well-off, too, since lower interest rates mean mortgage-backed loans should be cheaper. Well, that would depend upon whether or not houses are subjected to the national sales tax. If they are, they become just another consumption item whose purchase gets deterred by that tax. If they aren't, a whole world of complications arise. New homes would start to be sold as packages including all manner of big-ticket consumption items that would otherwise be exposed to the national sales tax; money borrowed to "improve" a home could be the subject of redirection as exempt expenditures having nothing to do with the house and land, themselves; and the wealthy would howl that they need exemption from tax on two, three, or maybe more properties they want to own. Yes, purchases of homes would probably end up being exempted, but that will turn into a way by which the wealthy can turn the national sales tax to their advantage, making it even more regressive than by its nature it already is.
In Defense of Pigs: The Classical Economists and Economic Growth
Before the world of Keynesian economists, who held that government had a duty to help the poor and to stabilize the economy, Classical economists ruled the world of economics. They believed first and foremost that long-run growth was all that mattered. Regardless of whether or not there were short-term business cycles, as long as the economy was on a long-run growth path, the situation was just fine. This meant that they were unconcerned about the misery and poverty of the working class; and structural shifts in the economy that left millions of people starving were irrelevant because, in the long run, the labor supply would adapt to the new technologies and become complementary to them. Technological change that displaced workers, families, households, even entire classes of people were merely the necessary way of an economy as it grew. The government had no business interfering with business by burdening it with regulations and laws, in general, and consumer protection and labor considerations in particular.
The labor supply would adjust, even if it required time measured in generations and wrecked lives measured in the tens or hundreds of millions.
To this end, then, any structure of taxation that attends to differentially taking capital from the rich is certainly bad because it is the wealthy who finance the engine of entrepreneurial innovation, business formation, and enterprise growth. Without those who can afford to invest, there will be no jobs for those who choose a lesser life.
And yes, the Classical economists firmly believed that unemploymentand that means all unemploymentis voluntary. This point is pressed home in most principles of macroeconomics textbooks; for example, in Chapter 6 ("Economic Growth, Business Cycles, Unemployment, and Inflation") of the popular undergraduate textbook, Economics, 5th Ed. (2003), McGraw Hill/Irwin, author David Colanderby no means a "liberal" economistthe point is pounded in with eerily parsimonious objectivity.
More to the point of the Classical economists' philosophy was a "law" of economics that years ago, under the onslaught of the progressive, demand-side Keynesians, fell into much-deserved disrepute but has now managed to become unassailably doctrinal to their neo-conservative progeny. It's called "Say's Law": Supply creates its own demand; and on the face of it, the logic is deceptively reasonable.
When investment is made by those capable of such endeavors, factory capacity expands; and in so growing, the need for labor is increased. As more workers are employed, their households have more income with which to demand the very goods and services that are being produced by the factories that gave them jobs in the first place. As they want and can afford more goods and services, those in a position to invest can add capacity, which will create even more jobs, which will increase demand even more.
Supply creates its own demand.
Nice proposition, but it doesn't work. First, providing the wealthy with the means to invest in enterprises that will create jobs doesn't mean they will actually do that; and even if they do invest, there is no assurance at all that they will invest in technologies that are labor intensive. In fact, they would be crazy to invest in technologies that require large numbers of workers when they can invest in machinery that will actually replace workers. Moreover, even if those wealthy, entrepreneurial sorts actually do invest in technologies that need lots of workers, they're going to put those factories where they can draw from a labor supply curve that provides the lowest prevailing wage rates possible consistent with the skills needed. That means factories and other hotbeds of employment will be built where labor is cheap.
And guess where labor is not cheap. That's right: here in the United States.
So if wealthy people invest, they're going to invest in the substitutes for labor like machinery, computers, and robotics. If they must invest in industries that are labor intensive, they're going to do so in other countries where they can exploit workers who have not a clue that they could have better lives if they organized and resisted the temptation of subsistence wages.
This is, of course, fine to the current breed of Republicans. Although they'll pander for votes to the working class, they draw their inspiration from those who saw individuals and households of workers as distractions worthy of the academic considerations only of the socially conscious who didn't understand that the process is what matters, not the state of the economy and the difficulties of its laborers at any given moment or in any given generation.
Moving the Pigs into the Living Room
Given the utter resolution with which historical taxation trends seem to be moving toward some kind of regressive tax on income masquerading as a proportional tax on sales, it would be a favor to the neo-conservatives and their Republican political enablers to perhaps allow the national sales tax to become the system for the United States. This might seem at first wrong to simply surrender one of the most basic parts of the whole economic world of the 20th Century; but a relatively modest twist might make it not only fair in some national sense, but also preserve the core value the neo-cons were claiming to promote.
To show how this would be done, the continuing saga of the brothers Byron and Barton Binkwater must be revived. Recall that Byron makes $20,000 a year, and Barton makes $80,000 a year. Both of them need to spend $8,000 just to keep going, and any expenditures over and above this fulfill consumptive wants, not actual needs. As demonstrated in the last installment in this series, in a world where a 15% national sales tax was applied to their consumption, and both Byron and Barton saved every penny they didn't simply have to spend to keep body and soul together, the numbers worked out as follows:
Byron spends his $8,000, on which is assessed a 15% tax; so his national sales tax bill is
15%×$8,000 = $1,200,
so this means Byron pays an income tax rate of
$1,200÷$20,000 = 6%.
Barton spends his $8,000, on which the same 15% tax is assessed; so his national sales tax bill is the same
15%×$8,000 = $1,200,
so this means Barton pays an income tax rate of
$1,200÷$80,000 = 1.5%.
This demonstrates that, by any measure one would choose for a definition of "fairness," this national sales tax is beating up poor Byron quite a bit more than it's bothering his brother Barton.
It will serve the purposes of what is about to be proposed if we now introduce the Binkwater brothers' old friend, Mary Ann Mirthmutton, a wealthy entrepreneur who earns $240,000 per year. Now, Mary Ann has a darned good argument that she deserves every penny of what she makes, considering that she grew her business from the ground up, working long days and nights to the end of ensuring that her business flourished and she was able to employ a number of people, one of whom is Byron, whom readers might recall works at the EZ-Lube on the south-east side of town, a franchise that Mary Ann just happens to own. As coincidence would have it, even Barton owes his job to Mary Ann, considering that she's a significant shareholder in Purcell's Parts, where Barton is a junior executive primarily because Mary Ann saw to it that he was given a shot at the executive ranks.
If Mary Ann is an extraordinarily frugal woman who spends only that which is absolutely necessary, shejust like Byron and Bartonwill spend $8,000 and thereby be exposed to the 15% national sales tax only on that part of her earnings. Doing the numbers for Mary Ann returns the following:
She spends her $8,000, on which is assessed a 15% tax; so her national sales tax bill is
15%×$8,000 = $1,200.
This means she pays an income tax rate of
$1,200÷$240,000 = 0.5%.
That's right: under a consumption tax designed as a 15% national sales tax, Mary Ann's income tax rate is just half-a-percent.
Of course, this means Mary Ann is going to have incentive to save quite a bit of the $232,000 she doesn't absolutely need to spend, thereby contributing to the pool of lendable funds that can be borrowed by other businesses to grow. But even the most stalwart of the New Right Republicans are not going to want their low-income constituents to hear about this kind of nonsense.
Recall that Barton Binkwater would have to have used $32,000 in consumption spending before he would have hit Byron's 6% income tax rate; and the problem is magnified in Mary Ann's situation: she could spend a whopping $96,000 before she'd be paying the same 6% tax rate on income that Byron pays just by purchasing his necessities of life. (Mary Ann spending $96,000 and paying 15% sales tax would pay a total of $14,400 in sales tax, which is 6% of her $240,000 income.)
Any politician worth his or her most earnest and righteous bluster could hammer the point of this unfairness like a wood stake through the heart of a Republican standing up for such an obviously, egregiously anti-working class tax outrage. But a compromise is available, one that would accept a national sales tax, encourage savings, discourage consumption, and yet still retain at least some hint of the old gospel of progressive income taxes that the neo-conservatives fear killing off in broad daylight.
Let the Pork Barbeque Begin
First, regardless of how a consumption tax would actually work, there would have to be a sound definition of what constituted "savings": throwing money into a checking account for 29 days isn't savings. Neither is putting money into the stock market for six months.
Buying something like a house is controversial because the primary purpose of a home is to consume the flow of amenities arising from living there. The capital gain realized through sale is not the primary reason for purchasing shelter, or at least it shouldn't be. That having been noted, the gain is, in retrospect, the product of a long-term capital investment decision, even though in most cases a considerable amount of the money used for the capital investment came from a lender, with actual income of the homeowner only slowly replacing that huge punch of someone else's money that was used up front to make the buy.
One way or the otherand there would be a whole lot of wrangling on what asset purchases were true savings rather than consumptionsolutions would be found that were palatable to disagreeing tax writers and politicians, and a list of what were actually uses of income for "savings" would be brought forth.
Now, here's the radical part. The Internal Revenue Service would no longer have as its best-known role the bullying tax collector of the federal government. Instead, it would be the tax rebater. To see how this would work, first note that the IRS would have no idea how much a given taxpayer had spent on consumption, and therefore, it would have no idea how many dollars any given taxpayer had paid in national sales tax over the course of a given year. However, because every last taxpayer could demonstrate net additions to or depletions of savings through statements from their financial institutions, the IRS could be shown how much each taxpayer spent on consumption: it would be total income minus net additions to or depletions of qualifying savings. That means the IRS would be able to determinepretty closely, anywayhow much a taxpayer had paid in consumption taxes in a given year.
Now comes the new role of the IRS as rebater.
Establish income brackets that reflect greater and greater ability to cover basic necessities of life without beating up total income. For a fellow like Byron, since he blew $8,000 of his lousy $20,000 total income, he ended up paying $1,200 in national sales tax. The New Tax Code would rebate this entire amount to him. In fact, just to bend over backwards, give Byron the benefit of the doubt about how much he simply must spend to keep going and say it's $16,000 instead of $8,000. The IRS would send Byron a check for $16,000×15%, or $2,400.
Notice that Byron has a huge incentive not to spend nearly $16,000 in consumption of goods and services, since for every dollar less than $16,000 that he saves instead of using for purchases, he's getting money back from the government that he didn't even pay in national sales tax.
Let's go on to Barton. No slack for this boy, but nothing adverse, either. Out of absolute necessity, he spent $8,000, so the IRS rebates to him $8,000×15%, or $1,200.
Now, what to do about Mary Ann. The answer is simple: nothing. The woman's making $240,000 a year, for cryin' out loud. Even if she got the same $1,200 that Barton received, she'd probably put it in her Chump Change Purse. But that's not the real reason she doesn't qualify for a rebate: the real reason she doesn't get money back in recognition of some of the national sales tax she paid during the year is because she is wealthy, and it's the neo-conservatives and the ghosts of the Classical economists who possess them who keep howling about how we should recognize that it's the well-off people who are the big investors in future productivity. Why on Earth would the New Tax Code give them any reason at all not to fulfill their destiny as the great providers of capital investment? Rebating national sales tax to Mary Ann is nonsense: she's a saver by virtue of her economic standing. It would be illogical for the government that wants each and every citizen to save at the maximum of his or her ability and nature to give a certain class of people any incentive at all not to do what it wants them to do and what they would do by the socio-economic nature.
The lobbyists and the political apologists for people of wealth would bawl at the top of their lungs about the "unfairness" of this. Shutting their pie holes would be a matter of demonstrating that, if the system doesn't work this way, the entire tax structure becomes exactly the regressive income tax that neo-conservatives for decades have hoped for but cowered at the prospect of forcing into open, public debate.
Cleaning Up the Mess the Pigs Left
A massive, fundamental tax overhaul that strips the Internal Revenue Service of its most well-known role as muscleman tax collector, scaring the wits out of taxpayers, would be hugely popular in and of itself. Effectively, the IRS's role in collecting taxes would be reduced to a mechanized organ of overseeing retail operations that would be charged with collecting a national sales tax of 15% on every non-exempt purchase. This is precisely what state and local government tax agencies do all the time. And retailers understand quite well how to manage sales taxes. And the IRS would learn quickly enough how to act like a state sales tax collection operation to do the same thing that states and municipalities have been doing for decades. In its role as a rebater, the IRS would find that its entire reason for interacting with the public would change fundamentally.
As far as the details of such a New Tax Code would be concerned, there would have to be ramp-ups in rebatable income in recognition of dependents. Life-saving and life-preserving medical care and prescriptions would have to be exempt, although a well thought-out national sales tax could be an effective disincentive to people spending on wholly elective surgeries and certain types of medications that neither save nor preserve life. Lobbies for other industries would line up for their exemptions, too; it would require a will of iron to resist every petition for exemption from the national sales tax, and that means a whole lot of unnecessary exemptions would be granted.
Beyond the national sales tax on private consumption would be the need for something equivalent in the corporate world. This would be partially addressed just because businesses would be paying the tax on their purchases in the same way that individuals would. The difficulty would lie in dealing with corporations that purchase through "wholesale" and foreign channels that could slip through the net of a poorly designed sales tax.
A national sales tax would be difficult to construct, of that there is no doubt. But everyone should recognize that it's something the neo-conservatives want, and it's something the President's commission on tax reform might very well recommend; as such, refusing to consider its merits, as modified in outline in this article, not only defeats the hopes of the luminaries of neo-conservatism, but also defies the earnest desires of the President of the United States, himself.
It is, then, worth considering a national sales tax to replace the current income tax system in this country, if for no other reason than that such a national sales tax could end up being a much worse deal for the rich than they ever imagined as they were sending in their campaign contributions to the Republican radicals in Congress and to their inspirational leader, President George W. Bush.
The Dark Wraith has spoken.