Rob Sama Grand Plan – Taxation

Rob Sama Grand PlanBecause it would appear that as a country we are most concerned about the economy at the current time, I’d like to start there. There are many facets of economic policy, so let’s start with a big one: taxation. Given that there seems to be some current momentum behind enacting tax reform of some sort on both the right and the left, it seems like a good place to start the Grand Plan.

Taxation was a major facet of the supply sider’s revolution with Reagan’s presidency in the 1980′s, and the issue has been contentious ever since. Walter Mondale wanted to raise taxes and lost in a landslide, and ever since then, the left has attempted to parse the issue as one of fairness, or certain segments not paying their fair share. Unfortunately, intelligent discussion regarding taxes has basically flown out the window some time ago, and what we seem to have today is a “taxes bad” argument from the right and a “class warfare” argument from the left. Let’s try to sort through this a bit and see if we can’t come up with a more intelligent tax policy.

A sound tax policy ought to be governed by a few basic principles. Let’s enumerate them here then see what kind of policy can be derived from those principles:

  • Encourage Capital Accumulation: Free market economies, or “Capitalist” economies, in order to work, require capital to be accumulated in order to be invested. Or, to put it more glibly, capitalism doesn’t work without capital. Any tax policy that confiscates capital accumulation retards economic growth. Therefore, a sound tax policy is one that rewards its citizens for investing earnings rather than spending them.
    As an aside, I should distinguish this from hoarding, which is not at all economically desirable. Hoarding, or stashing gold bars in the basement (or some such equivalent), removes capital from circulation, and is tantamount to consumption.
  • Economically Neutral: Aside from the forementioned principle of encouraging capital accumulation and investment, any tax policy ought to be neutral as to where one should invest or spend one’s earnings. An economy cannot be centrally planned, and any effort to encourage people to invest or spend in one sector or item over another will eventually result in a misallocation of resources, and a boom/bust cycle.
  • Once and Only Once: A tax should be levied once and only once. Earnings should not be subject to multiple taxes. Once a tax is paid, the earnings (and taxpayer) should be free and clear of future taxation on that dollar earned.
  • Everyone Must Pay: It is important that everyone in society feel that they have a stake in how government funds are spent. That means that everyone must pay something, even if it is a nominal amount. Systems where some people pay and others don’t will result in the payors being looted of everything they have by those who pay nothing. Best that everybody pay, even if it’s just a token amount.
  • KISS: You’ll remember the acronym from high school, Keep It Simple Stupid. Complexity favors the rich over the poor, the connected over the disenfranchised. Plus it costs all of us an enormous amount of money to comply with a complex system. So the simpler a tax policy is, the better it is. Simplicity should be preferred over perfection or absolute fairness. Because complexity is by definition overtly unfair.

Our current tax regime fails on all counts. It does nothing to encourage capital accumulation. Indeed, it taxes capital gains as incurred (and taxes inflation on capital gains to boot), it is unbelievably complex, having approximately 4.8 times as many words as the Bible, it enables large swaths of the population to pay nothing at all or worse, get tax “credits” on taxes they never paid, and is anything but economically neutral.

In fact, our current tax code is economically biased in favor of the highest bidder. Each corporation or constituency who wants a minor exemption carved out for itself lobbies congress and more or less gets what they want. The result is a tax code that favors those with the most money, and is incredibly complex, consisting of a trillion and one exemptions for a trillion and one constituencies. An overhaul of our campaign finance laws will be required to fully ameliorate this problem, but that is the subject of another plank in the Grand Plan.

I don’t need to explain to you how devising a tax code by means of creating exemptions for the highest bidder is completely insane, how it relates to a code of insufferable complexity, how complying with that complexity imposes enormous costs on the economy, costs which would both be better spent as capital invested by private enterprise and as revenue collected by the government. But I would like to briefly explain to you, by way of an anecdote, the enormous psychological cost that such a code creates.

My father was the head of the tax department for a number of Fortune 500 companies during his career. When he was first promoted into that position, in the early 1970′s, he happened to find himself in the elevator with the CEO on the way home at the end of the work day. The CEO, trying to make small talk, asked “So, Bob, do you have any good tax shelters to invest in?” To which my father replied, “Yeah, our company’s stock.” The CEO paused for a moment, taken aback, and slowly nodded his head and replied, “Yeah, you’re probably right.”

My father, of course, did not literally mean that investing in his company’s stock constituted a tax shelter. Rather, what he meant was that you’re always better off concentrating your efforts on how to make money, rather on how to avoid having it taken by the government. But while the former will always yield you more profits at the end of the day, the latter that has an inexorable psychological draw, a draw strong enough to suck in the CEO of a Fortune 500 company. Personally, I’ve seen would-be entrepreneurs spend hours trying to understand the complexities of taxation when they should be growing their business. It’s extremely damaging, and the only way to get people to focus on their businesses is to make the tax code economically neutral.

So having said that, let’s enumerate the Grand Plan tax proposal and then discuss each point individually:

  • Eliminate the corporate income tax.
  • Tax capital gains as ordinary income.
  • Construct one and only one tax code.
  • Allow individuals to defer income tax by (re)investing their capital.
  • Eliminate death and inheritance taxes.
  • Eliminate ALL deductions and credits other than for individual and dependents.
  • Everyone must pay at least $500/year.

Ok, let’s take each of these at a time:

Eliminate the Corporate Income Tax:

I really wanted to do an analysis of how many dollars of revenue the Federal Government raises annually per word of corporate income tax code, vs the personal income tax code. I would guess that the difference would be of an order of magnitude, but when I went to attempt a word count on the code, I found it was too unwieldy and spaghetti like to be able to easily break apart the code into the two components. Regardless, the corporate income tax is a bevy of complexity, and it only accounts for 7.5% of the Federal Government’s annual revenue.

Surprised?

Don’t be. From all appearances, the purpose of the corporate income tax code is NOT to raise revenue for the treasury, but rather to give congressmen influence to peddle. Who better to peddle your influence to than to moneyed corporations. And what would you expect after said influence has been peddled? You have a code that is full of holes and isn’t all that effective at raising revenue.

But the corporate income tax code isn’t just insidious because of its corrupting effect upon congress. It’s insidious because it constitutes a double tax on earnings (capital gains being the other tax) and it discourages capital accumulation. A business that is retaining earnings to reinvest in its operations should be encouraged to do so.

But our current tax regime encourages businesses to spend money on any and all expense items possible (meaning not physical plants), including interest payments. In other words, the corporate income tax encourages businesses to finance their operations with debt instead of equity. This may be good for the banking industry, but it isn’t particularly good for business. And we can see the effects of an economy built on debt instead of equity today, namely that in a downturn the debt cannot be rolled over and businesses fail.

Best to eliminate the corporate income tax, and tax distributions made from dividends.

Tax Capital Gains As Ordinary Income (And Adjust Gains For Inflation):

The most obvious way to make up for the loss of revenue from eliminating the corporate income tax is to tax capital gains as ordinary income. There is no reason why capital gains ought to be treated as a special category that receives a preferential income tax rate. Taxing capital gains at a special rate only serves to encourage people do do contortions to get their earnings structured as capital gains.

Moreover, it creates a wedge between the “investor class” and everyone else in that the investor class is relatively immune from changes in the overall tax rates and complexity of the tax code. Investors ought to feel the pinch of tax rates that are raised too high just like everyone else does. Trust fund children ought not be spared from high tax rates. Psychologically, sparing them allows them to live in a fantasy world where tax rates don’t matter. And just in terms of having people pay their fair share, it’s manifestly unfair to exempt society’s richest people from paying the payroll taxes that everyone else has to pay.

So make earnings all taxed at the same rate. What’s earned is earned, and it shall be taxed according to one code.

Finally, capital gains should be adjusted for inflation. People should not be asked to pay taxes on the rate of inflation. Of course, we could eliminate the need for this calculation by having a more stable currency, but that is the subject for a different plank of the Grand Plan.

Construct One And Only One Tax Code

Today’s tax code has become so complex that it has become difficult even to debate about it. For one thing, the Alternative Minimum Tax is beyond obnoxious, both in its intent and its implementation. Requiring citizens to complete their tax compliance calculations twice according to two different sets of rules is not only overly burdensome from a compliance perspective, but it renders tax planning impossible at the margin when people slip from paying ordinary income tax to the AMT. Our principle of KISS demands that the AMT be done away with.

But that’s not all it demands. It demands that we eliminate all distinctions between payroll and income taxes. Today, the right makes absurd claims that the lower classes don’t pay a proportionate amount of income taxes while the left says a disproportionate amount of income taxes goes to pay for defense spending. But both complaints amount to accounting slight of hand. If you were to look at the paystub of the average person paying “no” income taxes, you’d find he is paying a substantial amount in what are called “payroll” taxes, namely FICA and Medicare, etc. Similarly, if you look at the Federal Government budget, you’ll find that social spending easily eclipses defense spending. By splitting up what is taken out of your paycheck into two different classes of taxes, each side is able to make absurd claims about how much money is being collected and spent.

So call all taxes collected “income taxes” because that’s how they’re thought of and that’s how they’re collected. And collect them according to one and only one tax code.

Allow Individuals To Defer Income Tax By (Re)investing Their Capital:

One thing that has always bothered me about the Capital Gains tax is that it amounts to a transaction tax on moving capital. That is stupid, and only impedes proper resource allocation across the economy.

Another thing that bothers me about the income tax is that it is based on income taken in one year. In a progressive income tax system, that means that you get taxed the highest rate when you’re at the end of your career. But that is unfair. One may have skimped out on income for years, slaving away in school, in order to get a high paying job later. That person’s lifetime income may be the same as someone who didn’t go to school, but they are penalized because they are making their money over a shorter number of years.

The obvious way to rectify these problems, while simultaneously encouraging people to put their money to work as invested capital, is to enable people to defer taxes on ANY income invested, and to allow any withdrawal from an investment to be deferred as income so long as the money is reinvested within a short amount of time, say 3 months. This way, individuals can save money up for retirement, school or whatever, and pay taxes only as the money is withdrawn and not re-invested. And they can do this without worrying about paying a transaction tax as they move money from one business to another, or one fund to another.

Oh, and one minor point, investment in land for business purposes would be shielded form taxation so long as the land is actually put to use for a legitimate business purpose, but investing in your primary residence would not be subject to any tax shield. That expenditure would be an after-tax use of cash.

Since I’ve kind of described the basics at this point, let me walk through two examples:

  • Bob earns $150k/year, and socks $50k/year away in mutual funds. That is invested capital, so he’s only taxed at the appropriate rate for $100k/year. He reinvests any dividends he receives, and so he pays no tax on those. He owns a house, but receives no tax shield on mortgage interest, nor is his investment in his house viewed as an investment; it’s an expense. When Bob goes to retire, he withdraws $50k/year out of his mutual funds. At that time, he’s taxed as having an income of $50k. Thus his income is smoothed out. He pays taxes appropriate for his lifetime of earnings, and pays as he withdraws capital from the economy to be consumed.
  • Jane is a trust fund child, and earns no money in the traditional way. She does not have a job, but spends her days attending sit-ins, rallys and the like. Jane has $5 million in an investment account, from which she withdraws $350k/year, or 7% of her principal. Jane pays tax on her $350k/year at the appropriate rate for that bracket. Instead of paying tax on transactions as her trust fund manager buys and sells investments, she simply pays money on the withdrawls she makes, whether or not there is a gain or loss. If her fund earns more than 7% in a year, she pays on $350k. If the fund earns less, she still pays on the $350k she withdraws. She can, of course, always withdraw less and thus keep her principal amount in check.

In effect, this plan would allow for infinite investing without taxation, so long as investments are not liquidated to be consumed. And that’s the idea: encourage as must investment in the economy as possible so as to generate a maximum amount of economic growth. In effect, we never tax the stock seed, only the crop that is to be consumed.

Eliminate Death and Inheritance Taxes:

Death and inheritance taxes force individuals to liquidate their investments when it would not necessarily make economic sense to do so. This fact alone makes the death tax disruptive to the economy. For this reason alone, it ought to be abolished.

The death tax constitutes a double tax as well. Under the current tax code, all assets being passed from one generation to the next have already been taxed at the time they’ve been earned. And under the Grand Plan system, they will be taxed at whatever point investments being passed down are liquidated (and not reinvested). So taxing the investment just because it’s being passed form one generation to the next constitutes a double tax as well.

The only impetus for an inheritance tax is envy. Envy is a bad reason for any public policy. Tax income once when it’s about to be consumed, and leave capital invested in the economy as long as its owners are willing to let it go to work. Interrupting invested capital amounts to eating stock seed, a foolish proposition in nearly any circumstance.

Eliminate ALL Deductions And Credits Other Than For Individuals And Dependents

This is pretty basic. Keep the tax code simple. Stop trying to influence behavior. Attempting to influence behavior is inconsistent with a belief in freedom, and just causes mis-allocation of resources in the marketplace. Give people a deduction for themselves and their dependents (only because we need successive generations to perpetuate the species and thus society) and leave the rest be.

Everyone Must Pay At Least $500/year

I know Ari Fleisher just wrote a piece on this (just as I was authoring this plank of the Grand Plan) but his justifications are all wrong. It’s not that the poor aren’t paying their fair share (though they may well not be). Rather, it’s just the principle that everyone benefits just from living in the United States, and therefore every able bodied adult ought to pay in a minimum amount, regardless of how the rest of their taxes come out.

Frankly, I don’t care if you don’t even earn any money. You still ought to incur a de minimus tax debt to the government every year. Paying a de mimimus amount makes everyone a stakeholder in society, and incurring the debt motivates one to get up and get to work. I don’t know if $500 is the right amount, that’s not really the point. The point is about social cohesion, and about caring how the government spend money.

Conclusion:

You will note here that I have said nothing about particular rates. That is because congress should manage rates on an annual basis, seeking to generate a small surplus when the country is in debt (namely, for the forseeable future) and otherwise do its best to break even. Whatever rates accomplish that feat are the rates that should be charged, no more, no less. Congress should feel free to manage rates, and refrain from generating an infinite number of exemptions, rebates, refunds and credits instead.

Another thing you may have noticed is that this plan is not functionally all that much different from a consumption tax. So why not just go for a consumption tax, you may ask? The answer is two-fold. Firstly, I fear creating a consumption tax and then having the income tax return, at which point we are burdened with double taxation on a whole new scale. But secondly, I do not think the country really wants a flat tax, as in one rate for everybody. So to reconcile that desire with a consumption tax would involve income tax like calculations anyway, and people applying for tax refunds from the government… in short it would be a mess. And it would be anything but simple for taxpayers. Better to let them withhold based on what they earn less what they plan to stash away, and leave it at that.

Instituting this tax plan would raise the savings rate of the country, make more capital available for investment generally, encourage people to save for retirement, eliminate complexity, reduce corruption on Capitol Hill, and radically reduce compliance costs across the country. It would be more fair than our current system, and be economically neutral, letting the economy allocate resources according to the collective wisdom of the market rather than the political pulls of Washington. The only people to lose out would be those in congress and those who have their ear.

And they deserve to lose out.

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2 Responses to “Rob Sama Grand Plan – Taxation”

  Da Goddess Says:

And you haven’t run for office yet because????

 
  calzone Says:

brilliant. I would of course love to see economists of every flavor debate this piece and get an idea of what kinds of counterarguments might exist. But from where I’m sitting, this is truly the best taxation proposal I have ever heard.

One small question: if someone is destitute, how do we collect $500 from them and what do we do with someone who refuses or is simply utterly unable to pay that $500? Or does your proposal exclude the “truly poor” like homeless people on the street who often have mental or substance abuse problems? So, there are people who are truly poor and do not choose to be that way, and there are those who are truly poor and do choose to be that way, and then there are masses of people who are not really “truly poor”, but just have trouble making ends meet are always struggling just to get by. I think taxing the last group $500 is actually doable. But it’s the first two I can’t figure out, and I also can’t tell if taxing adult in the US $500 would in effect encourage people in dire straits to just ‘drop off the radar’ and become homeless to avoid paying that tax.

 
 

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