April 15, 1996
RESTRUCTURING THE FEDERAL TAX SYSTEM
(IT'S APRIL 15TH...DO YOU KNOW WHERE YOUR TAXES ARE?)
The deadline for paying Federal income tax is here again, and the fairness of the system is on the minds on many Americans.
The Institute for Research on the Economics of Taxation (IRET), a Washington, D.C. "think-tank" has some very specific ideas about the direction of public policy. The organization, founded by Norman Ture, Under Secretary of the Treasury for Tax and Economic Affairs during the Reagan administration, believes the U.S. system of taxation should be structured to promote the "efficient operation" of a private free market.
In a recent policy bulletin, the IRET states :
The existing federal tax system fails every test of an acceptable tax system for a free society. First and foremost, it fails to perform the basic function of taxation: to tell the public what they must pay for, (and what) services they want government to provide.
We have a tax system that no one believes is fair. For those who favor a redistributive tax policy, the ethical justification appears to be that the rich are rich only because they've deprived the poor. There is no factual or analytical basis for this notion.
One of the acid tests of the acceptability of a tax system is that it imposes the lowest possible costs of compliance, administration, and enforcement. The existing tax system fails this test miserably.
Minimizing tax-induced distortions of the free market's operations is a hallmark of acceptable taxation. The existing tax system is a hodgepodge of provisions that grossly interfere with efficient market operations. Perhaps the worst distortion is the effect of the income tax in raising the cost of saving and investment relative to the cost of current consumption.
Creating a new federal tax system to replace the (current one) should be guided by fundamental principles and should avoid the ad hoc approach that has characterized past reform efforts.
Taxes should be paid directly by real people on whom the burden of all taxes ultimately Tests. Taxes on corporations should be minimized.
Taxes should be designed so that people are acutely aware of paying them.
If taxes are to be effective in telling people what they pay for in government, everyone except the truly destitute should be required to pay.
Because, all taxes are paid out of income, the new tax system must correctly define income for tax purposes. The correct concept is the common sense definition: all of one's revenues less all of the costs one incurs to produce those revenues.
True tax fitness, based on the long-standing basic principle that every person should stand equally before the law, calls for imposing the same marginal rate on every person's income.
To eliminate the tax bias against saving and investment, the multiple layers of income taxes on saving and investment in existing law must be dropped.
The new tax system must minimize costs of compliance, administration and enforcement. Basing the income tax on the correct concept of income for tax purposes will itself eliminate much of the complexity that gives rise to the extraordinary compliance and enforcement costs under the existing system.
Click for relevant NewsHour transcripts on income taxes: House Majority Leader, Congressman Dick Armey (R-Texas), citizens against a flat tax, or Paul Solman on the History of Taxation.
A question from Megan Vandergrift, Severna, MD:
Do income taxes really generate that much revenue? Isn't the fact that corporations get so many tax breaks hurting the overall amount of revenue taxes could be generating?
Income taxes generate the majority of Federal government revenues. In 1995, total Federal revenues were $1,355 billion. Of this, individual income taxes were $590 billion and corporation income taxes were $157 billion. Corporate taxes would have been heavier except that corporations pay many other taxes that reduce their corporate incomes; these other taxes include the employer share of the payroll tax, various excise taxes, and property taxes. With few exceptions, corporate tax deductions reflect legitimate costs of doing business, such as labor costs, costs of raw materials and energy supplies, write-offs of plant and equipment. These deductions are not tax "breaks" from a generous government. If anything, the owners of corporations - which include millions of Americans through mutual funds and individual stocks - are greatly overtaxed because the income their investments earns is taxed at the corporate level when generated and then all over again at the individual level when the owners receive it through dividends and capital gains.
A question from Ben Howard, Silver Spring, MD:
Will we ever see a return to a tax system, like we had under Truman, where the richest Americans were taxed over 50%? How did the policies under Truman effect the country?
Let us hope not! During President Truman's White House tenure, individual income tax rates ranged between 16.6 percent to 22.2 percent on the first $2,000 of taxable income up to 91 percent on taxable income over $200,000. Rates this high generated enormous pressures to legislate escape hatches - "loopholes" - which hugely expanded the size and greatly increased the complexity of the income tax provisions in the Internal Revenue Code. As you might expect, the costs of compliance, enforcement, and administration of the income taxes exploded.
Great care should be taken in evaluating the economic consequences of this tax environment. For one thing, during the first five or six years of the Truman Administration, the country was overcoming the constraints on production, particularly on investment, that had been imposed by World War II. The Korean War also imposed artificial stimuli and constraints on economic activity. As these phased out and as the Kennedy 1962 and 1964-65 income tax cuts took hold, the growth in economic activity accelerated.
A question from Thomas LePage, Richmond, VA:
You talk about trying to avoid an ad hoc approach to reforming the current tax system. How long would it take to change the system on a graduated basis (how many years for effective reform), and is a systematic approach really possible politically?
We shouldn't try to reform the current tax system on a gradual basis. Such "reforms" have never succeeded. Avoiding an ad hoc approach to tax restructuring doesn't call for stretching the reform process out over many years. In fact, that approach opens the door for undermining real reforms. What's called for, instead, is developing a set of clearly stated, realistic reform objectives, together with the principles that should guide reform efforts seeking those objectives. This is the very opposite of an ad hoc approach. It can and should be implemented over the shortest possible time, because nothing is more upsetting to good business and household planning the uncertainty inherent in long drawn-out tax changes.
A question from Joyce Abrahms, San Diego, CA:
Is the "flat tax" really just an euphemism for cutting the federal government? Can a flat tax really generate enough income to continue with all federal programs?
If one wants the current level of Federal programs and Federal spending, a flat tax is perfectly capable of financing it all. The flat tax introduced by Congressman Armey, for example, would be approximately revenue neutral at a 20% rate. If the tax lead to faster economic, a somewhat lower rate would be revenue neutral. Of course, those who believe the government is trying to do too many things, is too wasteful, and is too intrusive, would like to set the tax rate lower and couple the smaller tax revenues with a slowdown in the growth of Federal spending. Congressman Armey, for instance, wants to do this and would combine spending restraint with a reduction of the tax rate to 17%.
A question from Laura Matthews, Boulder, CO:
What do you think of a national consumption tax, like Britain's value added tax (VAT)?
You might ask the British what they think of their value added tax (VAT). It is very unpopular. Canada and Japan recently introduced VATs, and their levies also generated public outrage. The main disadvantage of a VAT for the U.S. are that: (1) it would be a largely hidden tax, collected from every firm along the production chain; (2) it might well become a government "money machine," with seemingly small increases in the tax rate greatly increasing the tax load; (3) instead of replacing existing taxes, it could become a very large additional tax. A VAT has the attraction that unlike the current income tax it is neutral between saving and investment. A retail sales tax also avoids the income tax's bias against saving.