Tag: flat tax

One Simple Reason (and Two Easy Steps) to Show Why Obama’s Soak-the-Rich Tax Hikes Won’t Work

It’s hard to keep track of all the tax hikes that President Obama is proposing, but it’s very simple to recognize his main target – the evil, nasty, awful people known as the rich.

Or, as Obama identifies them, the “millionaires and billionaires” who happen to have yearly incomes of more than $200,000.

Whether the President is talking about higher income tax rates, higher payroll tax rates, an expanded alternative minimum tax, a renewed death tax, a higher capital gains tax, more double taxation of dividends, or some other way of extracting money, the goal is to have these people foot the bill for a never-ending expansion of the welfare state.

This sounds like a pretty good scam, at least if you’re a vote-buying politician, but there is one little detail that sometimes gets forgotten. Raising the tax burden is not the same as raising revenue.

That may not matter if you’re trying to win an election by stoking resentment with the politics of hate and envy. But it is a problem if you actually want to collect more money to finance a growing welfare state.

Unfortunately (at least from the perspective of the class-warfare crowd), the rich are not some sort of helpless pinata that can be pilfered at will.

The most important thing to understand is that the rich are different from the rest of us (or at least they’re unlike me, but feel free to send me a check if you’re in that category).

Ordinary slobs like me get the overwhelming share of our income from wages and salaries. The means we are somewhat easy victims when the politicians feel like raping and plundering. If my tax rate goes up, I don’t really have much opportunity to protect myself by altering my income.

Sure, I can choose not to give a speech in the middle of nowhere for $500 because the after-tax benefit shrinks. Or I can decide not to write an article for some magazine because the $300 payment shrinks to less than $200 after tax. But my “supply-side” responses don’t have much of an effect.

For rich people, however, the world is vastly different. As the chart shows, people with more than $1 million of adjusted gross income get only 33 percent of their income from wages and salaries. And the same IRS data shows that the super-rich, those with income above $10 million, rely on wages and salaries for only 19 percent of their income.

This means that they – unlike me and (presumably) you – have tremendous ability to control the timing, level, and composition of their income.

Indeed, here are two completely legal and very easy things that rich people already do to minimize their taxes - but will do much more frequently if they are targeted for more punitive tax treatment.

  1. They will shift their investments to stocks that are perceived to appreciate in value. This means they can reduce their exposure to the double tax on dividends and postpone indefinitely taxes on capital gains.  They get wealthier and the IRS collects less revenue.
  2. They will shift their investments to municipal bonds, which are exempt from federal tax. They probably won’t risk their money on debt from basket-case states such as California and Illinois (the Greece and Portugal of America), but there are many well-run states that issue bonds. The rich will get steady income and, while the return won’t be very high, they don’t have to give one penny of their interest payments to the IRS.

For every simple idea I can envision, it goes without saying that clever lawyers, lobbyists, accountants, and financial planners can probably think of 100 ways to utilize deductions, credits, preferences, exemptions, shelters, exclusions, and loopholes. This is why class-warfare tax policy is so self-defeating.

And all of this analysis doesn’t even touch upon the other sure-fire way to escape high taxes - and that’s to simply decide to be less productive. Most high-income people are hard-charging types who are investing money, building businesses, and otherwise engaging in behavior that is very good for them - but also very good for the economy.

But you don’t have to be an Ayn Rand devotee to realize that many people, to varying degrees, choose to “go Galt” when they feel that the government has excessively undermined the critical link between effort and reward.

Indeed, if Obama really wants to “soak the rich,” he might want to abandon his current approach and endorse a simple and fair flat tax. As explained in this video, this pro-growth reform does lead to substantial “Laffer Curve” effects.

But you don’t have to believe the video. You can check out this data, straight from the IRS website, showing how those evil rich people paid much more to the IRS after Reagan cut their tax rate from 70 percent to 28 percent in the 1980s.

White House to Propose 26 Percent Corporate Tax Rate?!? Look before You Leap

According to an article in the New York Times, the Obama Administration is seriously examining a proposal to reduce America’s anti-competitive 35 percent corporate tax rate.

The Obama administration is preparing to inject an unpredictable new variable into its economic policy clash with Republicans: a plan to overhaul corporate taxes. Economic advisers have nearly completed the process initiated in January by the Treasury secretary, Timothy F. Geithner, at President Obama’s behest. That process, intended to make the United States more competitive internationally, has explored the willingness of business leaders to sacrifice loopholes in return for lowering the top corporate tax rate, currently 35 percent. The approach officials are now discussing would drop the top rate as low as 26 percent, largely by curbing or eliminating tax breaks for depreciation and for domestic manufacturing.

This may be a worthwhile proposal, but this is an example where it would be wise to “look before you leap.” Or, for fans of Let’s Make a Deal, let’s see what’s behind Door Number 2.

To judge Obama’s plan, it is important to have the right benchmark. An ideal corporate tax system obviously should have a low tax rate. And it also should have no double taxation (tax corporate income at the business level or tax it at the individual level, but don’t tax it at both levels).

But it’s also important to have a simple and neutral system. The right definition of corporate income for any given year is (or should be) total revenue minus total costs. What’s left is income.

This may seem to be a statement of the obvious, but it’s not the way the corporate tax code works. The system has thousands of complicated provisions, some of which provide special loopholes (such as the corrupt ethanol credit) that allow firms to understate their income, and some of which impose discriminatory penalties by forcing companies to overstate their income.

Consider the case of depreciation. The vast majority of people understandably have no idea what this term means, but it sounds like a special tax break. After all, who wants big corporations to lower their tax bills by taking advantage of something that sounds so indecipherable.

In reality, though, depreciation simply refers to the tax treatment of investment costs. Let’s say a company buys a new machine (which would increase productivity and thus boost wages) for $10 million. Under a sensible and simple tax system, that company would include that $10 million when adding up all their costs, which then would be subtracted from total revenue to determine income.

But the corporate tax code doesn’t let companies properly recognize the cost of new investments. Instead, they are only allowed to deduct (depreciate) a fraction of the cost the first year, followed by more the next year, and so on and so on depending on the specific depreciation rules for different types of investments.

To keep the example simple, let’s say there is “10-year straight line depreciation” for the new machine. That means a company can only deduct $1 million each year and they have to wait an entire decade before getting to fully deduct the cost of the new machine.

Ultimately, the firm does deduct the full $10 million, but the delay (in some cases, about 40 years) means that a company, for all intents and purposes, is being taxed on a portion of its investment expenditures. This is because they lose the use of their money, and also because even low levels of inflation mean that deductions are worth significantly less in future years than they are today.

To put it in terms that are easy to understand, imagine if the government suddenly told you that you had to wait 10 years to deduct your personal exemption!

Let’s now circle back to President Obama’s proposal. With the information we now have, there is no way of determining whether this proposal is a net plus or a net minus. A lower rate is great, of course, but perhaps not if the government doesn’t let you accurately measure your expenses and therefore forces you to overstate your income.

I’ll hope for the best and prepare for the worst.

P.S. It’s also important to understand that a “deduction” in the business tax code does not imply loophole. If you remember the correct definition of business income (total revenue minus total costs), this means a business gets to “deduct” its expenses (such as wages paid to workers) from total revenue to determine taxable income. Some deductions are loopholes, of course, which is why a  simple, fair, and honest system should be based on cash flow. Which is how business are treated under the flat tax.

The IRS: Even Worse Than You Think

Since it is tax-filing season and we all want to honor our wonderful tax system, let’s go into the archives and show this video from last year about the onerous compliance costs of the internal revenue code.

Narrated by Hiwa Alaghebandian of the American Enterprise Institute, the mini-documentary explains how needless complexity creates an added burden - sort of like a hidden tax that we pay for the supposed privilege of paying taxes.

Two things from the video are worth highlighting.

First, we should make sure to put most of the blame on Congress. As Ms. Alaghebandian notes, the IRS is in the unenviable position of trying to enforce Byzantine tax laws. Yes, there are examples of grotesque IRS abuse, but even the most angelic group of bureaucrats would have a hard time overseeing 70,000-plus pages of laws and regulations (by contrast, the Hong Kong flat tax, which has been in place for more than 60 years, requires less than 200 pages).

Second, we should remember that compliance costs are just the tip of the iceberg. The video also briefly mentions three other costs.

  1. The money we send to Washington, which is a direct cost to our pocketbooks and also an indirect cost since the money often is used to finance counterproductive programs that further damage the economy.
  2. The budgetary burden of the IRS, which is a staggering $12.5 billion. This is the money we spend to employ an army of tax bureaucrats that is larger than the CIA and FBI combined.
  3. The economic burden of the tax system, which measures the lost economic output from a tax system that penalizes productive behavior.
  4. The way to fix this mess, needless to say, is to junk the entire tax code and start all over.

    I’ve been a big proponent of the flat tax, which would mean one low tax rate, no double taxation of savings, and no corrupt loopholes. But I’m also a big fan of national sales tax proposals such as the Fair Tax, assuming we can amend the Constitution so that greedy politicians don’t pull a bait and switch and impose both an income tax and a sales tax.

    But the most important thing we need to understand is that bloated government is our main problem. If we had a limited federal government, as our Founding Fathers envisioned, it would be almost impossible to have a bad tax system. But if we continue to move in the direction of becoming a European-style welfare state, it will be impossible to have a good tax system.

Time to Get Rid of the Corporate Income Tax?

Here’s a video arguing for the abolition of the corporate income tax. The visuals are good and it touches on key issues such as competitiveness.

 

I do have one complaint about the video, though it is merely a sin of omission. There is not enough attention paid to the issue of double taxation. Yes, America’s corporate tax rate is very high, but that is just one of the layers of taxation imposed by the internal revenue code. Both the capital gains tax and the tax on dividends result in corporate income being taxed at least two times.

These are points I made in my very first video, which is a good companion to the other video.

There is a good argument, by the way, for keeping the corporate tax and instead getting rid of the extra layers of tax on dividends and capital gains. Either approach would get rid of double taxation, so the economic benefits would be identical. But the compliance costs of taxing income at the corporate level (requiring a relatively small number of tax returns) are much lower than the compliance costs of taxing income at the individual level (requiring the IRS to track down tens of millions of shareholders).

Indeed, this desire for administrative simplicity is why the flat tax adopts the latter approach (this choice does not exist with a national sales tax since the government collects money when income is spent rather than when it is earned).

But that’s a secondary issue. If there’s a chance to get rid of the corporate income tax, lawmakers should jump at the opportunity.

Tax Lawyers, Tax Complexity, and the Broader Problem of a Self-Serving Legal Profession

The Internal Revenue Code is nightmarishly complex, as illustrated by this video. Americans spend more than 7 billion hours each year in a hopeless effort to figure out how to deal with more than 7 million words of tax law and regulation.

Why does this mess exist? The simple answer is that politicians benefit from the current mess, using their power over tax laws to raise campaign cash, reward friends, punish enemies, and play politics. This argument certainly has merit, and it definitely helps explain why the political class is so hostile to a simple and fair flat tax.

But a big part of the problem is that tax lawyers dominate the tax-lawmaking process. Almost all the decision-making professionals at the tax-writing committees (Ways & Means Committee in the House and Finance Committee in the Senate) are lawyers, as are the vast majority of tax policy people at the Treasury Department and the Internal Revenue Service.

This has always rubbed me the wrong way. Yes, some lawyers are needed if for no other reason than to figure out how new loopholes, deductions, credits, and other provisions can be integrated into Rube-Goldberg monstrosity of existing law.

But part of me has always wondered whether lawyers deliberately or subconsciously make the system complex because it serves their interests. I know many tax lawyers who are now getting rich in private practice by helping their clients navigate the complicated laws and regulations that they helped implement. For these people, the time they spent on Capitol Hill, in the Treasury, or at the IRS was an investment that enables today’s lucrative fees.

I freely admit that this is a sour perspective on how Washington operates, but it certainly is consistent with the “public choice” theory that people in government behave in ways that maximize their self interest.

There’s now an interesting book that takes a broader look at this issue, analyzing the extent to which the legal profession looks out for its own self interest. Written by Benjamin H. Barton, a law professor at the University of Tennessee, The Lawyer-Judge Bias in the American Legal System explains that the legal profession has self-serving tendencies.

Glenn Reynolds, of Instapundit fame, interviews Professor Barton about his new book.

I freely confess that I’m looking at this issue solely through my narrow prism of tax policy. But since Barton’s thesis meshes with my observations that tax lawyers benefit from a corrupt tax system, I’m sympathetic to the notion that the problem is much broader.

One of the most qoted lines from Shakespeare’s Henry VI is, “let’s kill all the lawyers.” But rather than making lawyer jokes, it would be a better idea to figure out how to limit the negative impact of self-serving behavior - whether by lawyers or any other profession that might misuse the coercive power of government.

This is one of many reasons why decentralization is a good idea. If people and businesses have the freedom to choose the legal system with the best features, that restrains the ability of an interest group - including lawyers - to manipulate any one system for their private advantage. This new study by Professors Henry Butler and Larry Ribstein is a good explanation of why allowing “choice of law” yields superior results.

The Barack Obama Tax Reform Plan?


In my fiscal policy speeches, I sometimes try to get a laugh out of audiences by including a Powerpoint slide with this image. Leading up to this slide, I talk about the Armey/Forbes flat tax and explain that it would eliminate the corrupt internal revenue code and replace it with a simple 10-line postcard. But I then warn that simplicity is not the same as low taxes and show the Obama slide.

But maybe jokes about Obama tax reform were a bit premature. According to the New York Times, the White House is giving serious consideration to a sweeping plan to streamline the tax system.

While administration officials cautioned on Thursday that no decisions have been made and that any debate in Congress could take years, Mr. Obama has directed his economic team and Treasury Department analysts to review options for closing loopholes and simplifying income taxes for corporations and individuals, though the study of the corporate tax system is farther along, officials said. The objective is to rid the code of its complex buildup of deductions, credits and exemptions, thereby broadening the base of taxes collected and allowing for lower rates — much like a bipartisan majority on Mr. Obama’s debt-reduction commission recommended last week in its final blueprint for reducing the debt through 2020. Doing so would offer not only an opportunity to begin confronting the growth in the national debt but also a way to address warnings by American business that corporate tax rates and the costs of complying with the tax code are cutting into their global competitiveness.

There’s actually much to like in the Administration’s potential plan. Lower tax rates will help the economy by improving incentives for productive behavior. And getting rid of distortions will further enhance growth since people no longer would have an incentive to make inefficient decisions just for tax purposes. And simplification could have a profound impact on cleaning up the horrible mess at the IRS. Moreover, a plan that trades lower tax rates for fewer tax distortions would be a welcome change from the poisonous soak-the-rich tax policy the White House has been pursuing.

This sounds like good news, but there’s a catch. The White House is looking at this exercise as a way to not only clean up the tax code, but also as a way of getting more money for politicians. This blog post explains why this is the wrong approach from an economic perspective, but politics will be an even bigger obstacle.

The American people want tax reform, but they don’t want more of their money going to Washington. And most Republican politicians have wisely pledged not to support legislation that increases the overall tax burden.

So the ball is in Obama’s court. If he genuinely wants to make America more prosperous and competitive, he should move forward with plans to lower tax rates and eliminate tax distortions, but he needs to tell his staff that tax reform should not a Trojan Horse for a tax increase.

There Ain’t No Such Thing as a Tax Expenditure

The co-chairs of President Obama’s Fiscal Commission propose to eliminate several tax loopholes while reducing marginal rates.  Hear, hear.  But they describe those loopholes as “backdoor spending in the tax code.”  It is incorrect and dangerous to equate tax loopholes with government spending.

The tax code’s countless credits, deductions, and exclusions let people keep a portion of their earnings, provided they use the money how the government wants them to use it.  Tax loopholes therefore have a lot in common with government spending: they give power to politicians, inhibit freedom, reduce economic output, unjustly enrich special-interest groups, et cetera.

But to call them “tax expenditures” or “tax subsidies” or ”backdoor spending in the tax code” is to claim that when the government fails to take a dollar from you, it is spending that dollar.  It implies that your dollar actually belongs to the government, which is graciously letting you keep it.  And it implies that eliminating a tax loophole is not a tax increase, because that dollar already belonged to the government anyway.  The government has simply decided to spend its money somewhere else.

When you hear a politician use the terms tax expenditure, tax subsidy, or backdoor spending in the tax code, beware.  He’s about to raise your taxes.