Tax Reform (Update 11/11/11)


Intro:

Version 2 – some more emphasis on Fair Tax. Why? With 7:1 ratio of our total federal government debt (approx $15 Trillion to annual tax revenues (approx $2.25) US desperately needs to lower this. Otherwise US will risk foreign investors fleeing our debt markets. A quick $430 billion reduction per year to our debt would be passage of the Fair Tax. $430 is the cost of current Tax Code compliance. Less debt means foreigners will be less apt to exit our debt markets. Other tax reform proposals also address this wasteful tax compliance cost. Please read and evaluate for yourself then share your perspectives with me.

Article:

With tax reform interest growing we must examine tax reform alternatives in comprehensive ways. Following is one attempt.

We need to analyze Flat, Fair, Cain’s 9-9-9, Obama’s planned 2013 increases on high income earners, and Romney’s proposed corporate tax decrease. Below are priority criteria to rate all tax reform proposals.

1 – Progressive The current tax system is progressive and therefore tax reform must remain similarly progressive. In part due to the Great Recession, 47% of our populace pays no federal income taxes. Tax reform should at least in the short term match this so that low income earner discretionary income remains about the same. Tax reform however must stimulate economic growth so that this 47%ile drops to 40% and lower.

“Prebates” or “rebates” to the low income must be a central feature up to and maybe beyond the poverty level and ideally with flexibility given geography (ex: $40,000 in Texas buys much more than Manhattan).

2 – Entrepreneur and business friendly: Tax reform must entice domestic and foreign investors so US can increase competitiveness, keep jobs in the US.

3 – Revenue Neutral – US needs to live within its means while not exacerbating our debt. Hence, keep US Treasury revenues at post WW2 norms of 16% to 19% of GDP, currently at near 16% due to our weak economy.

4 – Eliminate special tax breaks (level the playing field). This is especially critical for tax breaks that are lobbied for. It is hard for anyone to prove any special interest tax break meets a return on investment (ROI) criteria. Ex: if tax break == $10 billion for one special interest, the special interest should prove the tax break increased GDP by at least $10.5 billion (and then project further ROI benefits before renewing any further breaks). Special interests limit available capital for entrepreneurs. They have repeatedly have had positive ROI. Proof: Over 65% of all new jobs that sustain themselves are created by private entrepreneurs and small companies (those with staff of 500 or less). Source: Steve Lohr, NY Times Sep 2011.

5 – Reduce or (better) eliminate complex tax code compliance. Technology is in place now to eliminate a majority of IRS functions, if not all. If we eliminate most or all deductions there will be no need for an IRS. Per Economists Art Laffer, Wayne Winegarden, and John Childs, US taxpayers will spend $431 billion for 2011 for tax compliance. This is 3% of our GDP. This is also about a shocking third of all income taxes collected! Imagine one-third of your discretionary income going to waste! This is a huge drain on GDP growth prospects. A ROI analysis for tax code compliance is clearly very, very negative -33%.

6 – Predictable, Stable Private entrepreneurial investments are both more extensive and more successful when a tax system is predictable long term (at least 4 years) as many investment returns take time to generate a profitable return – at times a few years or more. Therefore tax reform must implemented in a way to provide stable expectations.

Can anyone challenge any of these 6 criteria? Or add additional? Please add to the debate.

Next, let’s assess tax reform alternatives against these 6 criteria.

A – Obama Tax Plan:
This is composed of raising taxes on those earning over $250,000 and increasing taxes on capital gains. This is even more progressive than current but at what cost? It is not entrepreneurial friendly. These job creators will have less capital. It is not revenue neutral and will add to our Nanny State mentality and punish success. It does not level the playing field as numerous tax breaks for special interests will remain. It may even increase tax code compliance given concurrent increasing regulations on business. It will not be predictable or stable. Rather it will increase suspicions of further increases given the socialist leaning politicians to tax and spend more. Finally it will decrease our GDP. Christina Romer, before she accepted position of Head of Council of Economic Advisors for BO (then subsequently resigned in disgrace) published an elaborate analysis of the impact of tax increases on GDP growth in the US since the end of WW2. Her conclusion was that a tax increase of 1% GDP will subtract 2% to 3% of GDP. Are the Socialist leaning unaware of this and oblivious of what a 40% to 60% tax rate did to Europe?

B – Flat Tax
There have been and are multiple variations. For the most part flat tax plans assign one and sometimes two or three rates while eliminating many or all deductions and special tax breaks. These plans address federal personal taxes only and not payroll taxes. Hence these plans will likely be less progressive than current, even some to the point of regressive. Flat tax plans, however will be more entrepreneurial friendly mainly since they will level the playing field eliminating special interest tax deductions and substantially decrease tax code compliance costs. Flat tax plans can be set up to be revenue neutral. Also once set, a flat tax can be predictable and stable thereby increasing private investment. Nevertheless its propensity to significantly alter the progressive nature of our current system is a serious flaw.

C – Romney Tax Plan
Romney at present needs to be more specific on his tax reform plans. What we know so far is that he favors overall lower taxes and particularly touts lower corporate taxes to improve our global economic competitiveness. He also favors lowering capital gain taxes but maybe only for those earning less than $250,000. We’ll wait for more specifics. However, at present, indications are that a Romney Tax Plan will remain progressive and possibly even more progressive with his capital gains proposal. Romney’s plan will be moderately more entrepreneurial friendly given the moderate proposed decrease in corporate tax rate to 20% or 15%. His plan may become revenue neutral given the extra GDP growth of his corporate tax rate and capital gains decrease proposals. It will not or maybe slightly level the playing field as we do not have many specifics about this yet. The IRS may therefore be approximately the same and tax compliance costs likewise may be the same. Romney’s plan can likely be predictable and stable and position the US for improved GDP growth from the current Obama economic and tax plans. However, Romney tax plan has gaps so far in not addressing special interests and the $430 billion cost of tax compliance. We hope Romney elaborates more about his tax plan and addresses these gaps.

D – Cain’s 9-9-9
Essentially the 9-9-9 plan creates a 9% federal consumption tax and decreases federal income and corporate income taxes to 9%. An analysis by Art Laffer quantified the 9-9-9 against our current annual rates of $9.5 trillion business revenues, $7.7 billion income, and $8.3 billion consumption . Laffer concluded that the 9-9-9 would generate revenues in the historic 16% to 19% rate of GDP. Therefore one can argue that the 9-9-9 is revenue neutral. However it will struggle greatly to prove it is progressive enough. Cain will need to be more specific about the prebates to low income. A popular think tank, Tax Policy Center predicted that 84% would pay more. 9-9-9 will be more entrepreneurial friendly with its lower corporate tax rate. Also helping this will be the leveling of the playing field by eliminating all tax deductions except charitable. However, although the 9-9-9 will make a significant dent to tax code compliance costs, it will not go all the way and eliminate the IRS. Finally, 9-9-9 most glaring flaw is its lack of predictability. It is judged as not stable by many entrepreneurs. Not eliminating the personal, corporate and not touching the payroll taxes means that we may be on first step of a European tax system where all three are high – personal, corporate and consumption. Has not Cain followed European economics. If he understood the consequences of European tax policy he would never propose the 9-9-9.

E – Fair Tax (in Congress as HR 25).
The Fair Tax eliminates all federal personal and corporate income and payroll taxes and replaces that with a revenue-neutral tax of 23 percent (for now) for all “new” products. It is progressive, provides “prebates” to lower-income earners. It eliminates the IRS, which alone will boost our GDP annually by at least $430 billion (tax code compliance). That money in the private sector will further generate economic growth and jobs. Gone also are dubious (at best) tax write offs per lobbyist efforts that do little if any to generate additional income or economic growth. The 0% federal corporate tax rate will position the US overnight as an entrepreneurial friendly haven. Foreign and domestic investors and venture capitalists will take advantage of this; this will lead to much less incentive to create jobs overseas.

All of the above measures will increase real disposable income and thus jobs The Fair Tax framework is very well detailed and can be passed and benefit all immediately.

In sum the Fair Tax at its core is progressive with prebates up to and perhaps (if and when passed) greater than the poverty level. A graduated decreasing prebate is planned for those making over the poverty level is also core to the Fair Tax.

Below is proof of progressive nature of the Fair Tax. With prebates a family of with income of $34,110 will not pay any more to the government as it spends its $34,110. Even at $51,165, with the family receiving partial prebate, the amount they would be paying to the federal government would be only 7.7%

A not well known but very interesting part of the proposed Fair Tax is that it will tax state and local services. Why is this a positive for the economy? The government should not have special advantages over the private economy. There will be incentive therefore for state and local governments to reduce costs by outsourcing core services to private companies. This has been proven to lower costs and improve service (if only we mandated that TSA be private!). CNBC reported on November 7 that more states are using contractors to cut costs. The Fair Tax will accelerate this.

All other criteria are succinctly met. Zero personal and corporate tax rates will increase entrepreneurial activity tremendously. Revenue neutral, eliminating all deductions and the IRS are by design and core to the Fair Tax. Once the private sector starts again generating new jobs that are self sustaining a momentum will build to keep the Fair Tax long term if not indefinitely. It has been proven by many that it is the private sector that creates new industries, products, jobs, ancillary jobs, and sub industries.

Once passed the Fair Tax will be predictable and stable and increase opportunity for all.

Now is the time to eliminate a major albatross around the US Economy’s neck – our archaic tax system. By our 6 criteria, the Fair Tax is the only one that meets all. Visit http://www.fartax.org, http://www.returntoexcellence.net for more information about the Fair Tax. Contact your Senator and Congressman and advise them of your support. Visit my site Economics501.wordpress.com for a gamut of articles and economic analyses in support of free market capitalism.

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About economics501

1 - free market Capitalist; 2 - Fitness Entrepreneur; 56 years old, VP at an Investment Bank in NYC, ex Venture Capitalist, happily married with 2 girls. Education: Rutgers and NYU. I allow Ted Hruzd, my friend to blog at will here. He has many posts here. I have known Ted since we were both students at NYU. Ted also works for an Investment Bank as a VP in Equity Global Markets. ------------------------- I was very very Socialist leaning as a 22 year old. I then strongly believed in Gov role in helping the poor. However, as a USDA Child Nutrition Programs, I personally accounted for millions of fraud, abuse, and waste of tax payer money. I came to believe that the poor would be best served with less Gov programs and more with direct aid via tax system. Then after 5 years I became a free market capitalist, was a venture capitalist in 2007 and helped start 2 high tech companies. I dedicate this site to champion free market capitalism as the best road to Prosperity. Please join in. If you disagree, fine, but please post with dignity and class and be civil. Argue with facts always.
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5 Responses to Tax Reform (Update 11/11/11)

  1. Linda Little says:

    Sorry to be so tardy in responding, but I just found your site. A couple of comments about your Fairtax piece. First, those compliance cost numbers you talk about are obsolete. In 2006, the IRS adopted a new cost estimating model developed by IBM. Instead of estimating cost factors for each piece of paper in your tax return, the IBM model provides out of pocket costs for each sort of tax filer. The result is a drastically reduced compliance costs for individual filers, and a similar result for corporations. Please read page 95 of your 2010 1040 Instruction booklet for details.

    Next, taxing all government consumption wasn’t necessary to meet your stated objective. HR25 mandates that any government agency that sell $2500 per quarter on the private market will be classified as a “Government Enterprise”, and will have to collect and remit the sales tax. Competition between government agencies and the private sector would be on a level playing field. In addition, federal taxation of State and Local government competition is very likely to be found to be unconstitutional. Under our constitutional republic form of government, we have two sovereign government powers, Federal and State. Sovereign powers do not tax each other. Under the long held doctrine of “intergovernmental tax immunity”, I believe the SC will throw out this feature of the Fairtax plan. Stay tuned!

    Untaxing businesses is certainly a good idea, (only people pay taxes), but relocation of businesses to the US does not hinge just on taxes. For instance, our labor rates are far more important in any decision to relocate.

    There is much else wrong with the Fairtax scheme that you didn’t address. How is it fair to force retirees to resume paying for their SS benefits with their sales tax dollars. How is it fair to double tax everyone’s after tax savings when spent? Are you aware that all 50 Governors, through the National Governors Association, are opposed to any national consumption tax? How can you expect to repeal the 16th Amendment with that kind of headwind? The prebate is actually a $600 billion annual cash grant entitlement, and comes at a time when entitlements are squeezing out discretionary spending in the federal budget. We don’t need such a massive new entitlement! In addition, the prebate creates a group of millions of lower income workers that would pay no net federal tax, yet would still qualify for full retirement health care and pension benefits. Is that fair?
    Stay tuned for more!

  2. I was wondering if you ever considered changing the page layout of your blog?
    Its very well written; I love what youve got to say.
    But maybe you could a little more in the way of content
    so people could connect with it better. Youve got an awful lot of text for only having 1 or two images.
    Maybe you could space it out better?

  3. Howdy! This is my 1st comment here so I just wanted to give a
    quick shout out and say I really enjoy reading your articles.
    Can you recommend any other blogs/websites/forums that cover the same subjects?

    Many thanks!

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