There’s Not Much Hope for Tax Reform

In recent months, I’ve displayed uncharacteristic levels of optimism on issues ranging from Obamacare to the Laffer Curve.

But this doesn’t mean I’m now a blind Pollyanna. We almost always face an uphill battle in our efforts to restrain the power and greed of the political class.

I don’t see this simple system in America’s future

And in some areas, such as the fight for pro-growth and humane tax reform, I see very little reason for hope.

In honor of tax day, I explained my pessimism in an article for The Daily Caller.

I outlined four reasons to be glum, starting with the fact that tax reform yields big benefits in the long run, but that isn’t a very compelling argument for politicians that rarely think past the next election.

Our tax code is now a 74,000-page monstrosity, and it seems that politicians make the system more convoluted every year with new credits, deductions, exemptions, preferences, exclusions, and other special provisions. …In theory, it makes sense to scrape off these barnacles and restore the ship… Our political system, though, is dominated by lawmakers who tend not to think past the next election cycle.

I then mention that too many people now see the tax code as a tool for directly taking money from others.

…a growing number of Americans now see tax returns as a vehicle for getting money from the government. I’m not talking about the fiscal illusion that results when some people over-pay their taxes and then are happy to get a refund. …I’m talking about a different crowd. There are now millions of Americans who benefit from redistribution programs that are laundered through the tax code. …“refundable” credits allow people to get checks from the government even if they didn’t pay any tax. …Needless to say, those people don’t have much incentive to oppose the current system.

My third concern deals with the under-appreciated fact that the Washington establishment gets rich from the current system.

The metropolitan DC area is now the wealthiest region of the nation; it includes 10 of America’s 15 richest counties. …One of the main sources of that unearned — and undeserved — prosperity is the tax code… many people make big bucks manipulating the tax code. Lobbyists obviously would hate a simple and fair flat tax… Many of these insiders are former politicians and former Capitol Hill staffers — particularly those that worked on the tax-writing committees. They make big bucks, and the current staffers look forward to the day when they can cash in on their “government service” and start “earning” huge salaries. Needless to say, these people are not exactly advocates of reform.

Last but not least, I explain that high-tax governments are undermining tax competition with financial protectionism, thus giving them more leeway to impose bad policy.

Beginning with the Reagan and Thatcher tax cuts, the world experienced a virtuous period of tax competition that lasted for about 30 years. Even politicians in statist nations such as France and Germany felt compelled to lower tax rates… In recent years, however, high-tax nations and left-wing international bureaucracies such as the Paris-based Organization for Economic Cooperation and Development have worked to undermine tax competition and make it easier for politicians to impose class-warfare tax policy. They first went after so-called tax havens… Now the OECD has a new plan to go after multinational companies and significantly boost their tax burdens, presumably through the creation of a global tax return and a policy called “formula apportionment.” …every time they make progress, politicians feel less pressure to lower tax rates and reform tax systems. Why bother improving the tax code, after all, if you think that taxpayers have no choice but to submit?

I also should have added another big challenge. In the absence of good entitlement reform, the burden of government spending will dramatically increase in coming decades and create pressure for additional tax hikes. That’s not an environment conducive to tax reform.

Unless, of course, you’re a politician and you somehow think adding a value-added tax on top of the current income tax can be considered reform.

P.S. I’ve referenced the flat tax in this post, but all of these obstacles also explain why there’s even less chance of a national sales tax.

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New GAO Study Mistakenly Focuses on Make-Believe Tax Expenditures

I’m very leery of corporate tax reform, largely because I don’t think there are enough genuine loopholes on the business side of the tax code to finance a meaningful reduction in the corporate tax rate.

That leads me to worry that politicians might try to “pay for” lower rates by forcing companies to overstate their income.

Based on a new study about so-called corporate tax expenditures from the Government Accountability Office, my concerns are quite warranted.

The vast majority of the $181 billion in annual “tax expenditures” listed by the GAO are not loopholes. Instead, they are provisions designed to mitigate mistakes in the tax code that force firms to exaggerate their income.

Here are the key findings.

In 2011, the Department of the Treasury estimated 80 tax expenditures resulted in the government forgoing corporate tax revenue totaling more than $181 billion. …approximately the same size as the amount of corporate income tax revenue the federal government collected that year. …According to Treasury’s 2011 estimates, 80 tax expenditures had corporate revenue losses. Of those, two expenditures accounted for 65 percent of all estimated corporate revenues losses in 2011 while another five tax expenditures—each with at least $5 billion or more in estimated revenue loss for 2011—accounted for an additional 21 percent of corporate revenue loss estimates.

Sounds innocuous, but take a look at this table from the report, which identifies the “seven largest corporate tax expenditures.”

To be blunt, there’s a huge problem in the GAO analysis. Neither depreciation nor deferral are loopholes.

I wrote a detailed post explaining depreciation earlier this month, citing three different experts on the issue. But if you want a short-and-sweet description, here’s how I described depreciation in my post on corporate jets.

If a company purchases a jet for $20 million, they should be able to deduct – or expense – that $20 million when calculating that year’s taxable income… A sensible tax system defines profit as total revenue minus total costs – including purchases of private jets. But today’s screwy tax code forces them to wait five years before fully deducting the cost of the jet (a process known as depreciation). Given that money today has more value than money in the future, this is a penalty that creates a tax bias against investment (the tax code also requires depreciation for purchases of machines, structures, and other forms of investment).

In other words, businesses should be allowed to immediately “expense” investment expenditures. What the GAO refers to as “accelerated depreciation” is simply the partial mitigation of a penalty, not a loophole.

The same is true about “deferral.” Here’s what I wrote about that issue in February 2010.

Under current law, the “foreign-source” income of multinationals is subject to tax by the IRS even though it already is subject to all applicable tax where it is earned (just as the IRS taxes foreign companies on income they earn in America). But at least companies have the ability to sometimes delay when this double taxation occurs, thanks to a policy known as deferral.

I added to those remarks later in the year.

From a tax policy perspective, the right approach is “territorial” taxation, which is the common-sense notion of only taxing activity inside national borders. It’s no coincidence that all pro-growth tax reform plans, such as the flat tax and national sales tax, use this approach. Unfortunately, America is one of the world’s few nations to utilize the opposite approach of “worldwide” taxation, which means that U.S. companies face the competitive disadvantage of having two nations tax the same income. Fortunately, the damaging impact of worldwide taxation is mitigated by a policy known as deferral, which allows multinationals to postpone the second layer of tax.

Simply stated, the U.S. government should not be trying to tax income earned in other countries. “Deferral” is the mitigation of a penalty, not a loophole.

So why would the GAO make these mistakes? Well, to be fair to the bureaucrats, they simply relied on the analysis of the Treasury Department.

But why does Treasury (and the Joint Committee on Taxation) make these mistakes? The answer is that they use the “Haig-Simons” tax base as a benchmark, and that approach assumes bad policies such as the double taxation of income that is saved and invested. If you want to get deep in the weeds of tax policy, I shared late last year some good analysis on Haig-Simons produced by my colleague Chris Edwards.

By the way, properly defining loopholes also is an issue for reform on the individual portions of the tax code. I’ve previously pointed out the flawed analysis of the Tax Policy Center, which put together a list of the 12 largest “tax expenditure” and included six items that don’t belong.

To conclude, the right tax base is what’s called “consumed income.” But that’s simply another way of saying that the system should only tax income one time, and it’s how income is defined for both the flat tax and national sales tax.

One final comment about GAO. It’s understandable that they used the Treasury Department’s methodology, but they also should have produced a list of tax expenditures based on a consumed-income tax base. That’s basic competence and fairness.

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Identifying the Right “Depreciation” Tax Policy: The Most Boring – but Important – Article You Will Read Today

I’m normally reluctant to write about “depreciation” because I imagine eyes glazing around the world. After all, not many people care about the tax treatment of business investment expenses.

But I was surprised by the positive response I received after writing a post about Obama’s demagoguery against “tax loopholes” for corporate jets. So with considerable trepidation let’s take another look at the issue.

First, a bit of background. Every economic theory agrees that investment is a key for long-run growth and higher living standards. Even Marxist and socialist theory agrees with this insight (though they foolishly think government somehow is competent to be in charge of investments).

Let’s look at two remarkable charts, starting with one that shows the very powerful link between total investment and wages for workers.

As you can see (click the chart to see a larger version), if we want people to earn more money, it definitely helps for there to be more investment. More “capital” means that workers have higher productivity, and that’s the primary determinant of wages and salary.

Our second chart shows how the internal revenue code treats income that is consumed compared to how it penalizes income that is saved and invested. Simply stated, the current system is very biased against capital formation because of the combined impact of capital gains taxes, corporate income taxes, double taxes on dividends, and death taxes.

Indeed, one of the reasons why the right kind of tax reform will generate more prosperity is that double taxation of saving and investment is eliminated. With either a flat tax or national sales tax, economic activity is taxed only one time. No death tax, no capital gains tax, no double tax on dividends in either plan.

All of this background information helps underscore why it is especially foolish for the tax code to specifically penalize business investment. And this happens because companies have to “depreciate” rather than “expense” their investments.

Here’s how I described depreciation in my post on corporate jets.

If a company purchases a jet for $20 million, they should be able to deduct – or expense – that $20 million when calculating that year’s taxable income… A sensible tax system defines profit as total revenue minus total costs – including purchases of private jets. But today’s screwy tax code forces them to wait five years before fully deducting the cost of the jet (a process known as depreciation). Given that money today has more value than money in the future, this is a penalty that creates a tax bias against investment (the tax code also requires depreciation for purchases of machines, structures, and other forms of investment).

And I also addressed the issue when writing about the economic illiteracy in one of the Obama-Romney debates.

Now let’s see what some experts on the topic have to say.

Here’s some very sage analysis from Alan Viard of the American Enterprise Institute.

…a deal that cuts the corporate rate could end up doing more harm than good. The problem is that Congress and the Obama administration are thinking of pairing the rate cut with a slow-down of companies’ depreciation deductions. That’s a bad combination. A key goal of corporate tax reform should be to reduce the tax penalty on business investment. Investments in equipment, factories, and other forms of capital help power the long-run economic growth that boosts wages and living standards for American workers. …If depreciation is slowed down enough to offset the full revenue loss from the rate cut, then there’s no reduction in the investment penalty, on balance. The depreciation changes take back with the left hand everything that the rate cut gives with the right hand. …In fact, the policy makes the tax penalty on new investments bigger. …Why is this bad combination being considered? Maybe because the rate cut is easy to understand and the harm of slower depreciation is easy to overlook. …Yes, let’s cut the corporate tax rate. But, let’s not slow down depreciation to pay for it.

Amen. Proposals to lower America’s destructively high corporate tax rate are needed, but I don’t want politicians “paying for” the change with other policies that are similarly harmful to growth and competitiveness.

Margo Thorning of the American Council for Capital Formation adds some wisdom with her column in today’s Wall Street Journal.

…proposals that would increase the tax burden on capital-intensive industries—which are contributing to U.S. economic growth and employment—should be viewed with caution. …stretching out depreciation allowances reduces a company’s annual cash flow and raises the “hurdle rate” that new investments would have to meet before they are approved. For capital-intensive firms in sectors such as energy, manufacturing, utilities and transportation, the trade-off between delayed cash flow and lower corporate income-tax rates may result in cutbacks in capital spending. …Each additional $1 billion in investment is associated with 23,000 new jobs, according to data from the Department of Commerce and the Bureau of Labor Statistics. …Rather than drawing out depreciation schedules, a better, pro-growth approach to corporate tax reform would be to allow all investment to be expensed—in other words, deducted from income in the first year.

I share Margo’s concerns, which is why I’m very suspicious when the President says he wants to lower the corporate tax rate and “reform” the system.

Last but not least, Matt Mitchell (no relation) of the Mercatus Center recently added his two cents to the discussion.

The idea that “accelerated” depreciation is a loophole can be traced back to Stanley Surrey, the Harvard law professor whose work in the 1950s, 60s, and 70s influenced many…, including Senator Bill Bradley. …immediate expensing would mean abandoning “the attempt to tax business income.” That’s because it would essentially turn the corporate income tax into a corporate consumption tax. And that may be a good thing. Capital taxation is notoriously inefficient. This is one reason why Robert Hall and Alvin Rabushka permitted immediate 100 percent expensing in their famous flat consumption tax.

You should realize, by the way, that the distorted view of what’s a loophole doesn’t just apply to depreciation. The Joint Committee on Taxation (the same folks who basically assume that the revenue-maximizing tax rate is 100 percent) also tells lawmakers that it’s a loophole if you don’t double-tax capital gains, or if you allow people to avoid double taxation by utilizing IRAs.

With advice like that, no wonder the tax code is a mess.

Anyhow, congratulations are in order. If you’ve made it this far, you almost surely know more about depreciation than every single politician in Washington. Though, to be sure, that’s not exactly a big achievement.

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Targeting Multinationals, the OECD Launches New Scheme to Boost the Tax Burden on Business

I’ve been very critical of the Organization for Economic Cooperation and Development. Most recently, I criticized the Paris-based bureaucracy for making the rather remarkable assertion that a value-added tax would boost growth and employment.

But that’s just the tip of the iceberg.

• The OECD has allied itself with the nutjobs from the so-called Occupy movement to push for bigger government and higher taxes.
• The OECD, in an effort to promote redistributionism, has concocted absurdly misleading statistics claiming that there is more poverty in the US than in Greece, Hungary, Portugal, or Turkey.
• The OECD is pushing a “Multilateral Convention” that is designed to become something akin to a World Tax Organization, with the power to persecute nations with free-market tax policy.
• The OECD supports Obama’s class-warfare agenda, publishing documents endorsing “higher marginal tax rates” so that the so-called rich “contribute their fair share.”

Now the bureaucrats have concocted another scheme to increase the size and scape of government. The OECD just published a study on “Addressing Base Erosion and Profit Shifting” that seemingly is designed to lay the groundwork for a radical rewrite of business taxation.

In a new Tax & Budget Bulletin for Cato, I outline some of my concerns with this new “BEPS” initiative.

…the BEPS report…calls for dramatic changes in corporate tax policy based on the presumption that governments are not seizing enough revenue from multinational companies. The OECD essentially argues that it is illegitimate for businesses to shift economic activity to jurisdictions that have more favorable tax laws. …The core accusation in the OECD report is that firms systematically—but legally—reduce their tax burdens by taking advantage of differences in national tax policies.

Ironically, the OECD admits in the report that revenues have been trending upwards.

…the report acknowledges that “… revenues from corporate income taxes as a share of gross domestic product have increased over time. …Other than offering anecdotes, the OECD provides no evidence that a revenue problem exists. In this sense, the BEPS report is very similar to the OECD’s 1998 “Harmful Tax Competition” report, which asserted that so-called tax havens were causing damage but did not offer any hard evidence of any actual damage.

To elaborate, the BEPS scheme should be considered Part II of the OECD’s anti-tax competition project. Part I was the attack on so-called tax havens, which began back in the mid- to late-1990s.

The OECD justified that campaign by asserting there was a need to fight illegal tax evasion (conveniently overlooking, of course, the fact that nations should not have the right to impose their laws on what happens in other countries).

The BEPS initiative is remarkable because it is going after legal tax avoidance. Even though governments already have carte blanche to change business tax policy.

…governments already have immense powers to restrict corporate tax planning through “transfer pricing” rules and other regulations. Moreover, there is barely any mention of the huge number of tax treaties between nations that further regulate multinational taxation.

So what does the OECD want?

…the OECD hints at its intended outcome when it says that the effort “will require some ‘out of the box’ thinking” and that business activity could be “identified through elements such as sales, workforce, payroll, and fixed assets.” That language suggests that the OECD intends to push global formula apportionment, which means that governments would have the power to reallocate corporate income regardless of where it is actually earned.

And what does this mean? Nothing good, unless you think governments should have more money and investment should be further penalized.

Formula apportionment is attractive to governments that have punitive tax regimes, and it would be a blow to nations with more sensible low-tax systems. …business income currently earned in tax-friendly countries, such as Ireland and the Netherlands, would be reclassified as French-source income or German-source income based on arbitrary calculations of company sales and other factors. …nations with high tax rates would likely gain revenue, while jurisdictions with pro-growth systems would be losers, including Ireland, Hong Kong, Switzerland, Estonia, Luxembourg, Singapore, and the Netherlands.

Since the United States is a high-tax nation for corporations, why should Americans care?

For several reasons, including the fact that it wouldn’t be a good idea to give politicians more revenue that will be used to increase the burden of government spending.

But most important, tax policy will get worse everywhere if tax competition is undermined.

…formula apportionment would be worse than a zero-sum game because it would create a web of regulations that would undermine tax competition and become increasingly onerous over time. Consider that tax competition has spurred OECD governments to cut their corporate tax rates from an average of 48 percent in the early 1980s to 24 percent today. If a formula apportionment system had been in place, the world would have been left with much higher tax rates, and thus less investment and economic growth. …If governments gain the power to define global taxable income, they will have incentives to rig the rules to unfairly gain more revenue. For example, governments could move toward less favorable, anti-investment depreciation schedules, which would harm global growth.

You don’t have to believe me that the BEPS project is designed to further increase the tax burden. The OECD admits that higher taxes are the intended outcome.

The OECD complains that “… governments are often under pressure to offer a competitive tax environment,” and that “failure to collaborate … could be damaging in terms of … a race to the bottom with respect to corporate income taxes.” In other words, the OECD is admitting that the BEPS project seeks higher tax burdens and the curtailment of tax competition.

Writing for Forbes, Andy Quinlan of the Center for Freedom and Prosperity highlights how the BEPS scheme will undermine tax competition and enable higher taxes.

…the OECD wants to undo taxpayer gains made in recent decades thanks to tax competition. Since the 1980′s, average global income taxes on both individuals and corporations have dropped significantly, improving incentives in the productive sector of the economy to generate economic growth. These pro-growth reforms are the result of tax competition, or the pressure to adopt competitive economic policies that is put on governments by an increasingly globalized society where both labor and capital are mobile. Tax competition is the only force working on the side of taxpayers, which explains the organized campaign by global elite to defeat it. …If taxpayers want to preserve gains made thanks to tax competition, they must be weary of the threat posed by global tax cartels though organizations such as the OECD.

Speaking of the OECD, this video tells you everything you need to know.

The final kicker is that the bureaucrats at the OECD get tax-free salaries, so they’re insulated from the negative impact of the bad policies they want to impose on everyone else.

That’s even more outrageous than the fact that the OECD tried to have me thrown in a Mexican jail for the supposed crime of standing in the public lobby of a public hotel.

P.S. I just gave a speech to the Anguilla branch of the Society for Trust and Estate Professionals, and much of my remarks focused on the dangers of the BEPS scheme.

I took this picture from my balcony. As you can see, there are some fringe benefits to being a policy wonk.

And I travel to Nevis on Sunday to give another speech.

Tough work, but somebody has to do it. Needless to say, withe possibility of late-season snow forecast for Monday in the DC area, I’m utterly bereft I won’t be there to enjoy the experience.

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Corporate Jet Loopholes, Depreciation, and Common-Sense Tax Policy

I’m not a fan of loopholes in the tax code.

I’ve complained about the number of pages in the tax code, the number of provisions in the tax code, and I’ve even groused about the rising number of pages in the instruction manual for the 1040 tax form.

And I’ve specifically come out against tax preferences for ethanol, housing, municipal bonds, charity, and state and local taxes.

But just as you don’t necessarily know whether someone is tall or short without knowing the average height of a population, you can’t automatically identify loopholes without first defining an ideal tax system. In other words, you need a benchmark (referred to as “the tax base” or “taxable income”) in order to measure what’s a loophole.

Unfortunately, that’s not an easy task because there are two competing visions of the ideal benchmark. I’ve addressed this issue previously, in this post on the “tax expenditure con job,” but let’s dig into the weeds a bit.

1. Those on the left, including the Joint Committee on Taxation, use what is sometimes called the “Haig-Simons” definition of a tax base. Also known as the “comprehensive income tax base,” this system assumes that there should be double taxation of income that is saved and invested (as shown by this startling chart). Another way of saying this is that the Haig-Simons approach assumes the government should tax income plus changes in the value of assets. Moreover, the Haig-Simons system assumes “worldwide taxation” and that businesses can’t deduct investment costs as they occur.
2. Those on the right, by contrast, support what is generally called “consumption-based” taxation. This doesn’t mean a tax collected at the cash register (though a national sales tax is an example of a tax with a “consumption base”). Instead, it simply refers to a system where income is taxed only one time. So, for example, a flat tax is a consumption-base tax since income is taxed only one time as it is earned, just as a national sales tax is a consumption-base tax since income is taxed only one time as it is spent. Moreover, a consumption-base system assumes “territorial taxation” and that business expenses should be deductible in the year the money changes hands.

While some features of the tax code – such as the healthcare exclusion – are loopholes according to both the Haig-Simons system and the consumption-base system, you get a divergence of opinion in key areas.

a) In a consumption-base world, there’s no double taxation and the capital gains tax therefore doesn’t exist. But from the perspective of the Haig-Simons tax base, the fact that capital gains are taxed at 23.8 percent instead of 39.6 percent is characterized as a loophole.

b) In a consumption-base world, there’s no double taxation and all savings gets the equivalent of IRA or 401(k) treatment. But from the perspective of Haig-Simons tax base, IRAs and 401(k)s are loopholes.

c) In a consumption-base world, there’s territorial taxation and no attempt to impose tax on income earned (and subject to tax) in other countries. But the Haig-Simons tax base assumes “worldwide taxation,” which means that “deferral” is a loophole rather than a way of mitigating a discriminatory penalty.

So why am I getting into boring details on this wonky issue? In part, because it helps people understand that tax reform is not just a matter of having a low tax rate. It’s also very important to define income correctly.

But I also think some background knowledge is necessary to explain why the White House is blowing smoke when they relentlessly demagogue against “corporate jets” as part of their never-ending campaign for class-warfare tax policy.

Let’s examine some excerpts from an ABC News report.

Listening to the White House, you’d think the key to averting the across-the-board spending cuts (the dreaded “sequester”) set to in place on March 1 is closing the tax break for owners of private jets. …Carney has brought up the corporate jet tax break at every single briefing this week. Listening to the White House, you might think that the “balanced” Democratic plan to avert the spending cuts would close that loophole for private jets. But you would be wrong. The Senate Democratic plan – which has been endorsed by the White House and is, in fact, the only Democratic plan actively under consideration right now – doesn’t touch corporate jets. …The tax break…allows the owners of private jets to depreciate their airplanes over five years instead of the standard seven years for commercial airplanes.

I don’t want you to focus on the demagoguery or the potential hypocrisy. Instead, consider the final sentence of the excerpt.

It turns out that the supposed “loophole” is really a penalty from a consumption-base perspective. If a company purchases a jet for $20 million, they should be able to deduct – or expense – that $20 million when calculating that year’s taxable income (after all, what is profit other than total revenue minus total costs?).

A sensible tax system defines profit as total revenue minus total costs – including purchases of private jets

But today’s screwy tax code forces them to wait five years before fully deducting the cost of the jet (a process known as depreciation). Given that money today has more value than money in the future, this is a penalty that creates a tax bias against investment (the tax code also requires depreciation for purchases of machines, structures, and other forms of investment).

Anyhow, because the tax bias imposes a five-year wait rather than a seven-year wait, the Obama White House would like us to believe that companies are getting some sort of egregious loophole.

Nonsense. In a good tax regime, companies should be able to deduct expenses in the year they are incurred. The fact that they have to wait five years is a penalty. But the White House wants us to perceive this penalty as a loophole or subsidy because it could be even more onerous.

By the way, if we’re worried about actual subsidies that benefit corporate jets, Tim Carney’s already explained that we should focus on the cronyists at the Export-Import Bank. And I heartily agree.

P.S. Defining the right “tax base” doesn’t imply anything about tax rates. You can have a so-called progressive rate structure or a single rate with either the Haig-Simons system or a consumption-base system.

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The Tax Code Shouldn’t Steer Capital to State and Local Governments at the Expense of Private Investment

I’m a proponent of a pro-growth and non-corrupt tax code.

I mostly write and talk about the flat tax, though I’d be happy to instead accept a national sales tax if we could somehow get rid of the 16th Amendment and replace it with something so ironclad that even Justices such as John Roberts and Ruth Bader Ginsburg couldn’t rationalize that the income tax was constitutional.

But since there’s no chance of any good tax reform with Obama in the White House, there’s no need to squabble over the best plan. Instead, our short-term goal should be to educate voters so that we create a more favorable intellectual climate for genuine reform in 2017 and beyond.

That’s why I’ve argued in favor of lower tax rates and shared the latest academic research showing that tax policy has a significant impact on economic performance.

But tax reform also means getting rid of the rat’s nest of deductions, credits, exemptions, preferences, exclusions, shelters, loopholes, and other distortions in the tax code.

Why? Because people should make decisions on how to earn income and how to spend income on the basis of what makes economic sense, not because they’re being bribed or penalized by the tax code. That’s just central planning through the back door.

And if you don’t think this is a problem, I invite you to peruse three startling images, each of which measures rising complexity over time.

1. The number of pages in the tax code.
2. The number of special tax breaks.
3. The number of pages in the 1040 instruction booklet.

Today’s Byzantine system is good for tax lawyers, accountants, and bureaucrats, but it’s bad news for America. We need to wipe the slate clean and get rid of this corrupt mess.

But as I explain in this appearance on Fox Business News, we won’t make progress until we control the burden of government spending and unless we make sure that deductions are eliminated only if we use every penny of revenue to lower tax rates.

I’ve previously explained why it’s okay to get rid of itemized deductions for mortgage interest, charitable contributions, and state and local tax payments.

Let’s now take a moment to explain why the internal revenue code shouldn’t be artificially steering capital toward state and local governments at the expense of private investment.

Under current law, there’s no federal income tax imposed on interest from municipal bonds. No matter how rich you are, Uncle Sam doesn’t tax a penny of the interest you receive if you use your wealth to lend money to state and local governments.

Should the tax code steer money to Detroit politicians?

This “muni-bond exemption” has two unfortunate effects.

• It makes it easier and cheaper for state and local governments to incur debt, thus encouraging more wasteful spending by cities such as Detroit and states such as California.
• By making the debt of state and local governments more attractive than private business investment, the loophole undermines long-term growth by diverting capital to unproductive uses.

The politicians at the state and local level certainly understand what’s at stake. They’re lobbying to preserve this destructive tax break. Here are some excerpts from a story in the New York Times.

Mr. Firestine [of Montgomery County, MD] is on the front lines of a lobbying campaign by local and state governments, bond dealers, insurers and underwriters that is trying to pre-empt any attempt to limit or even kill the tax exemption. …At present, the federal government forgoes about $32 billion a year in taxes by exempting the interest that investors earn from municipal bonds. …The National Commission on Fiscal Responsibility and Reform, known as the Simpson-Bowles commission, has suggested taxing all municipal bond interest, not just the interest paid to people in the top bracket. …Officials of some other government groups, like the New York City Housing Development Corporation, have formed a coalition with Wall Street groups like the Bond Dealers of America to lobby on the issue. But there is the sense of an uphill battle. …Capping the tax exemption would cause high-bracket taxpayers to look for higher-yielding investments, he said, and the county would have to offer more interest to lure them back.

Based on the last sentence in the excerpt, I gather we’re supposed to think it would be bad news if we got rid of this tax preference and taxpayers shifted more of their money to private-sector investments.

Needless to say, that’s misguided. Only in the upside-down world of Washington do people think it is smart to create tax preferences that lead to more wasteful spending by state and local governments, while simultaneously imposing punitive forms of double taxation on saving and investment in the private sector.

By the way, this shouldn’t be an ideological issue. If this amazing chart is any indication, leftists who want workers to enjoy more income should be clamoring the loudest for a tax system that doesn’t tilt the playing field against capital formation.

P.S. While simplicity is a good goal for tax policy, you will understand why it shouldn’t be the only goal if you check out this potential Barack Obama tax reform plan.

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The Great Hillsdale College Debate: Flat Tax or Fair Tax?

I’m at Hillsdale College in Michigan for a conference on taxation. The event is called “The Federal Income Tax: A Centenary Consideration,” though I would have called it something like “100 Years of Misery from the IRS.”

I’m glad to be here, both because Hillsdale proudly refuses to take government money (which would mean being ensnared by government rules) and also because I’ve heard superb speeches by scholars such as Amity Shlaes (author of The Forgotten Man, as well as a new book on Calvin Coolidge that is now on my must-read list) and George Gilder (author of Wealth and Poverty, as well as the forthcoming Knowledge and Power).

My modest contribution was to present “The Case for the Flat Tax,” and I was matched up – at least indirectly, since there were several hours between our presentations – against former Congressman John Linder, who gave “The Case for the Fair Tax.”

I was very ecumenical in my remarks.  I pointed out the flat tax and sales tax (and even, at least in theory, the value-added tax) all share very attractive features.

• A single (and presumably low) tax rate, thus treating taxpayers equally and minimizing the penalty on productive behavior.
• No double taxation of saving and investment since every economic theory agrees that capital formation is key to long-run growth.
• Elimination of all loopholes (other than mechanisms to protect the poor from tax) to promote efficiency and reduce corruption.
• Dramatically downsize and neuter the IRS by replacing 72,000 pages of complexity with simple post-card sized tax forms.

For all intents and purposes the flat tax and sales tax are different sides of the same coin. The only real difference is the collection point. The flat tax takes a bite of your income as it is earned and the sales tax takes a bite of your income as it is spent.

That being said, I do have a couple of qualms about the Fair Tax and other national sales tax plans.

First, I don’t trust politicians. I can envision the crowd in Washington adopting a national sales tax (or VAT) while promising to phase out the income tax over a couple of years. But I’m afraid they’ll discover some “temporary” emergency reason to keep the income tax, followed by another “short-term” excuse. And when the dust settles, we’ll be stuck with both an income tax and a sales tax.

As we know from the European VAT evidence, this is a recipe for even bigger government. That’s a big downside risk.

I explore my concerns in this video.

To be sure, there are downside risks to the flat tax. It’s quite possible, after all, that we could get a flat tax and then degenerate back to something resembling the current system (though that’s still better than being France!).

My second qualm is political. The Fair Tax seems to attract very passionate supporters, which is admirable, but candidates in competitive states and districts are very vulnerable to attacks when they embrace the national sales tax.

On dozens of occasions over the past 15-plus years, I’ve had to explain to reporters that why anti-sales tax demagoguery is wrong.

So I hope it’s clear that I’m not opposed to the concept. Heck, I’ve testified before Congress about the benefits of a national sales tax and I’ve debated on C-Span about how the national sales tax is far better than the current system.

I would be delighted to have a national sales tax, but what I really want is a low-rate, non-discriminatory system that isn’t biased against saving and investment.

Actually, what I want is a very small federal government, which presumably could be financed without any broad-based tax, but that’s an issue for another day.

Returning to the issue of tax reform, there’s no significant economic difference between the flat tax and the sales tax. What we’re really debating is how to replace the squalid internal revenue code with something worthy of a great nation.

And if there are two paths to the same destination and one involves crossing an alligator-infested swamp and the other requires a stroll through a meadow filled with kittens and butterflies, I know which one I’m going to choose. Okay, a slight exaggeration, but I think you get my point.

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Governor Jindal’s Bold Plan to Abolish Louisiana’s Income Tax

I’m a big fan of the flat tax as a way of neutering the punitive and convoluted internal revenue code in Washington.

But I’m even more aggressive at the state level.

That’s why I’m very excited about a new proposal from Governor Bobby Jindal of Louisiana.

He’s already implemented some good school choice reform, notwithstanding wretched and predictable opposition from the state’s teachers’ union.

Now he wants to get rid of the state’s personal and corporate income taxes.

This would be a big and bold step, and I shared some evidence recently showing that states with no income tax grow faster and create more jobs.

I also discussed Jindal’s proposal last week on Fox Business News.

Some people probably think Jindal is pushing this agenda merely because he may run for President in 2016.

My attitude is “so what?”

Income Tax? The answer is NO

So long as he implements better policy, I don’t care if he’s motivated by a Ouija board.

But since he has a reputation for being a policy wonk, I suspect his motivations are to make Louisiana a more prosperous state.

And if bold reform also happens to increase his national stature, I’m sure he’s more than happy to reap any political benefits.

If he succeeds, Louisiana will enjoy more growth.

Equally important, as I stated in the interview, his success would show that Obama’s class-warfare agenda may have some appeal in basket-case states such as California, but it doesn’t have much support among people who understand that growth is the only effective (and moral) way of achieving a better life.

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The “National Taxpayer Advocate” at the IRS Is Advocating for the Government, not Taxpayers

I’m not a big fan of the Internal Revenue Service, though I try to make sure that politicians get much of the blame for America’s convoluted, punitive, and unfair tax code.

Heck, just look at these three images – here, here, and here – and you’ll find startling evidence that politicians make the tax system worse with each passing year.

But there is an office at the IRS that ostensibly exists to defend the interests of taxpayers. The Taxpayer Advocate Service, according to the government website, “an independent organization within the IRS and helps taxpayers resolve problems with the IRS and recommend changes that will prevent the problems.” The head of this office, Nina Olson, has the title of National Taxpayer Advocate.

Sounds good, right?

Well, not so fast. The TAS does some good things, but Ms. Olson spends at least part of her time advocating for the government.

The TAS just released its annual report, and here’s some of what the bureaucracy recommended, according to a Bloomberg story.

Among the other problems Olson identifies in the report are…the underfunding of the Internal Revenue Service… The IRS, which Olson compares to the accounts receivable department of a company, should be fenced off from more budget cuts by Congress, she writes in the report.

Don’t rub your eyes or clean your glasses. You read correctly. The folks at the IRS who supposedly are advocating for you are instead advocating for a bigger IRS budget.

I debunked this silly argument last year, explaining why Congress should reject the Obama Administration’s assertion that more money for the IRS would be an “investment” that would yield big returns.

But I want to be fair. Some of what the TAS does is worth applauding. The report also discusses the grotesque levels of complexity in the code. Here’s more of the Bloomberg story.

The U.S. tax system’s most serious problem is the 4-million-word code’s excessive complexity that makes it tough for taxpayers to comply with and difficult for the government to administer, National Taxpayer Advocate Nina Olson wrote in an annual report to Congress. The tax code cost taxpayers and businesses $168 billion in compliance in 2010… “Lowering rates in exchange for broadening the tax base would be an excellent bargain,” says the report, released today in Washington. “We are confident that in the end, public support for a simpler code will be strong and deep.”

The TAS also produced this very depressing infographic (click to enlarge). It’s absolutely disgraceful that complying with the tax code requires the equivalent of 3 million full-time workers. It’s a vast understatement to call this a counterproductive misallocation of labor.

Or how about the fact that just the guidance for the income tax, when printed out, creates a stack of paper more than 12 inches high? And what about the nauseating little tidbit that the tax code has been changed more than once per day since 2001?

No wonder it’s such a corrupt mess. Isn’t it time we rip up the entire tax code and put in place something simple and fair like a flat tax? Here’s my case for real tax reform.

By the way, I’m also more than willing to replace the tax code with a national sales tax, perhaps something like the Fair Tax. I’m given speeches, testified to Congress, appeared on TV, and done all sorts of things to promote that idea.

But the one huge caveat is that we need to make sure that the politicians don’t pull a bait and switch and stick us with both an income tax and national sales tax. Which is what happened in Europe when governments implemented the value-added tax without repealing income taxes.

That’s why we would first need to get rid of the income tax and repeal the 16th Amendment. But then, because I don’t trust the Supreme Court (gee, I wonder why?), I would also want to replace the 16th Amendment with new language that would be so ironclad that even Chief Justice John Roberts couldn’t fabricate reasons why an income tax could ever return to plague the nation.

But since we can’t even get the votes to approve a watered-down balanced budget amendment, I’m not holding my breath for the day that the Constitution is amended to permanently kill the income tax.

And that’s why I think the flat tax is a safer option.

The worst thing that happens if we get a flat tax is that politicians change their mind and we degenerate back to the current system.

The worst thing that happens if we get a national sales tax is that politicians “forget” to eliminate the income tax, we wind up with both, and become France.

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Yes, We Should “Reform” Payroll Taxes, but only if that Means Personal Retirement Accounts

Washington is filled with debate and discussion about the economic burden of the federal income tax, which collected $1.13 trillion in FY2012 ($1.37 trillion if you include the corporate income tax).

Yet politicians rarely consider the economic impact of payroll taxes, even though these levies totaled $.85 trillion during the same fiscal year.

Yes, we had a gimmicky payroll tax holiday for the past few years. And it’s true that Obama has signaled that he wants to increase the payroll tax burden at some point to prop up the Social Security system.

But there’s rarely, if ever, a discussion of wholesale reform.

That’s actually a good thing. Compared to the income tax, the payroll tax does far less damage. And it’s not just because it collects less money. On a per-dollar-raised basis, the payroll tax is considerably less destructive than the income tax.

Why? Because it’s actually a form of flat tax.

• It has only one tax rate. There’s a 12.4 percent tax for Social Security and a 2.9 percent tax for Medicare, which means a flat tax of 15.3 percent.
• There’s almost no double taxation. The payroll tax applies to wage and salary income, as well as personal earnings from business activities (sometimes known as “Schedule C” income). But dividends, interest, and capital gains are generally spared – other than the 3.8 percent Obamacare surtax.
• There are no loopholes or deductions for politically connected interest groups.

And because of these three features, the tax is remarkably simple and doesn’t even require a tax form unless taxpayers have Schedule C income.

None of this, by the way, means the payroll tax is a good or desirable levy.

• It takes for too much money from the American people and is far and away the biggest tax paid by the majority of American workers.
• Those revenues are used for two programs – Social Security and Medicare – that are actuarially bankrupt and contributing to the nation’s long-run fiscal collapse.
• The 15.3 percent tax undermines work incentives by driving a wedge between pre-tax income and post-tax consumption.
• And the tax is very non-transparent, particularly since many taxpayers don’t even realize that the “F.I.C.A.” tax on their pay stub only reflects 50 percent of their payroll tax burden. In a hidden form of pre-withholding, employers pay an equal amount to the government on behalf of their workers – funds that otherwise would be part of worker compensation.

In other words, the payroll tax is a bad imposition. That being said, it still does considerably less damage, on a per-dollar-collected basis, than the income tax.

With that in mind, I’m puzzled that some folks want to keep the income tax and get rid of the payroll tax.

My friends at the Heritage Foundation, for instance, have a tax reform proposal that would fold the payroll tax into the income tax. Since they’re also proposing to turn the income tax into a form of flat tax, with one rate and no double taxation, the overall proposal clearly is a big improvement over today’s tax system. But all of the improvement is because of reforms to the income tax.

The Washington Examiner has an even stranger position. The paper recently editorialized in favor of abolishing the Social Security portion of the payroll tax and expanding the income tax.

The payroll tax — 12.4 percent, split between workers and their employers to help finance Social Security – is one of the worst taxes on the books for several reasons. A basic economic principle is that when the government taxes something, the nation gets less of it. Because the payroll tax makes it more expensive and administratively burdensome for businesses to hire workers, it’s a drag on employment. Also, even the employer’s share of the tax is effectively passed on to workers in the form of lower salaries and benefits.

There’s nothing overtly wrong with the above passage. The tax does all those bad things. But the income tax does all those things as well, but in an even more destructive fashion.

The editorial addresses a couple of potential objections, starting with the notion that the payroll tax is a revenue dedicated to social Security.

There are two main objections to scrapping the payroll tax. The first is the theoretical idea that payroll taxes are a dedicated revenue stream for Social Security. In practice, it just isn’t true. All government expenditures ultimately come from the same place. Payroll taxes help subsidize other government functions, and the government will use other tax revenue and borrowing to pay for Social Security when revenues are short.

They’re right that all taxes basically get dumped into the same pile of money and that the relationship between payroll taxes and Social Security benefits is imprecise.

But since my argument has nothing to do with this issue, I don’t think it matters.

Here’s the part of the editorial that doesn’t make sense.

The other objection is the massive revenue hit to the federal government. In 2010 (the last year before the recent payroll tax holiday), social insurance taxes raised $865 billion in revenue, according to the Congressional Budget Office. But there are a number of ways to recoup that revenue. As stated above, eliminating the payroll tax would make it easier to get rid of a lot of credits, loopholes and deductions. Also, if lower-income Americans aren’t paying payroll taxes, they can pay a bit more in income taxes. This would also deal with a conservative complaint that the income tax system needs to be reformed so everybody has at least some skin in the game.

This passage has a policy mistake and a political mistake.

The policy mistake is that the proposed swap almost surely would make the overall tax code more hostile to growth. The Examiner is proposing to get rid of an $865 billion tax that does a modest amount of damage per dollar collected, and somehow make up for that foregone revenue by collecting an additional $865 billion from the income tax system – which we know does a very large amount of damage per dollar collected.

To be sure, it’s possible to collect that extra money by eliminating distortions such as the state and local tax deduction or the healthcare exclusion. Compared to raising marginal tax rates, those are much-preferred ways of generating more revenue. But even in a best-case scenario – with politicians miraculously trying to collect an extra $865 billion without making the income tax system even worse, it’s hard to envision a better fiscal regime if we swap the payroll tax for a bigger income tax.

The political mistake is the assumption that more people will have “skin in the game” if the income tax is expanded. That’s almost surely not true. The poor don’t pay income tax, but the payroll tax grabs 15.3 percent of every penny earned by low-income households. And since very few taxpayers pay attention to which tax is shrinking their paychecks, it doesn’t really matter whether the “skin” is a payroll tax or an income tax.

Since the Examiner isn’t proposing a specific plan, there’s no way of making a definitive statement, but it’s 99 percent likely that eliminating the Social Security payroll tax would result in low-income households paying even less money to Washington. I think everybody should send less to Washington, but I don’t think shifting a greater share of the tax burden onto the middle class and the rich is the right way of achieving that goal.

I have one final objection, and this applies to both the Heritage Foundation plan and the Examiner proposal.

Notwithstanding everything I just wrote, I actually agree with them that we should eliminate the Social Security payroll tax. But we should get rid of the tax as part of a transition to a system of personal retirement accounts.

This is a reform that has been successfully implemented in about 30 nations and it also should happen in the United States. But an integral feature of this reform is that workers would be allowed to shift their payroll taxes into personal accounts. Needless to say, that’s not possible if the payroll tax has disappeared.

This video explains why genuine Social Security reform is so desirable.

And let’s not forget that the Medicare portion of the payroll tax could and should be part of a broader agenda of entitlement reform. But that’s also less likely if the payroll tax is folded into the income tax.

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What Was the Most Tragic Policy Development of 2012?

I’m not sure I could pick out a significant victory for human freedom in 2012.

Maybe I’m missing something, but the only good policy that’s even worth mentioning was the decision in Wisconsin to rein in the special privileges and excessive compensation for government workers.

But there definitely have been lots of sad developments.

The hard part is picking the most disappointing story.

1. Was it the craven decision by John Roberts to put politics before the Constitution and cast the deciding vote for Obamacare? This certainly could be the most disappointing event of the year, but technically it didn’t represent a step in the wrong direction since the Supreme Court basically gave a green light to unlimited federal power back in the 1930s and 1940s. The Obamacare case is best characterized as a failure to do the right thing. A very tragic decision, to be sure, but it maintained the status quo.

2. Was it the lawless decision by the Internal Revenue Service to impose a horrible regulation that forces American banks to put foreign law above U.S. law? This was a very bad development in the battle for tax competition, financial privacy, and fiscal sovereignty. But in the grand scheme of things, it’s just another in a long line of policies (such as FATCA) designed to increase the power of governments to impose and enforce bad tax policy.

3. Was it the Japanese government’s decision to double the value-added tax? I’m definitely not a fan of adding a VAT on top of the income tax, but Japan made that mistake years ago. The choice to increase the tax rate just shows why it’s dangerous to give politicians any new source of revenue. So this isn’t the worst policy development of 2012, particularly since the new Japanese government may suspend the tax hike.

4. Was it the delusional decision by 54 percent of California voters to impose a big, class-warfare tax hike? I thought the vote for Prop 30 was a very troubling development since it signaled that voters could be tricked into enacting class-warfare tax policy, even though they should have realized that more revenue for the state’s politicians would simply exacerbate the eventual fiscal collapse. But since I think this will be a learning experience on what not to do, I can’t put this at the top of my list.

5. Was it the French government’s punitive decision to impose a 75-percent top tax rate? This is a spectacularly misguided policy, and it’s already resulting in an exodus of entrepreneurs and other successful people. But just as I enjoy have California as a negative role model, I like using France as an example of bad policy. So it would be a bit hypocritical for me to list this as the worst policy of 2012.

6. Or was it the envy-motivated decisions by politicians in both Slovakia and the Czech Republic to replace flat tax systems with so-called progressive tax regimes? This is a strong candidate for the worst policy of the year. It’s very rare to see governments do the right thing, so it’s really tragic when politicians implement good reforms and later decide to reinstate class-warfare policies.

All things considered, I think this last option is the worst policy development of 2012. To be sure, I’m a bit biased since my work focuses on public finance issues and I’ve spent 20 years advocating for tax reform.

But I think there’s a strong case to be made, by anyone who believes in freedom, that politicians from Slovakia and the Czech Republic deserve the booby prize for worst public policy development of 2012.

Alvin Rabushka, sometimes referred to as the Father of the Flat Tax , summarizes the grim news.

On December 4, 2013, the center-left parliament of Slovakia modified the country’s historic 19% flat-rate tax…  Effective January 1, 2013, the income tax rate for corporations was raised from 19% to 23%, while that on individuals earning more than €39,600 (€1=$1.30) a year was raised to 25%, thereby creating two brackets of 19% and 25%. …On November 7, 2012, the lower house (Chamber of Deputies) of the national parliament approved a proposal to impose a second higher rate of 22% on annual income exceeding Czech Koruna (CZK) 100,000 ($5,200) per month.  President Vaclav Klaus signed the bill on December 22, 2012, which will take effect on January 1, 2013.

What’s especially depressing about these two defeats is that the supposedly right-wing parties deserve the blame.

Two nations filled with brain-dead conservative politicians

In Slovakia, all but one of the right-leaning parties in the old government decided to support the Greek bailout, leading to the collapse of the government and the election of a new socialist government that then sabotaged tax reform.

And in the Czech Republic, the current right-of-center government decided to scrap the flat tax for “fairness” reasons. I’m sure that will really be comforting to the Czech people as the economy suffers from less growth.

To understand what the people of those nations are losing, here’s my video on the flat tax.

Now for a bit of good news. There are still more than 25 flat tax jurisdictions in the world, including two of my favorite places – Hong Kong and Estonia.

So there are still some pockets of rationality. It’s just very unfortunate that the scope of human liberty is getting smaller every year.

P.S. The absolute worst thing that happened in 2012, if we look beyond public policy, was Georgia falling 4 yards short of beating Alabama in the Southeastern Conference Championship.

P.P.S. Speaking of sports, the best thing about 2012 occurred in Virginia Beach back in October.

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Once Obama’s Policies Are Implemented Next Year, U.S. Capital Gains Tax Rate Will be 70 percent Higher than Global Average

Back in September, I shared a very good primer on the capital gains tax from the folks at the Wall Street Journal, which explained why this form of double taxation is so destructive.

I also posted some very good analysis from John Goodman about the issue.

Unfortunately, even though the United States already has a very anti-competitive system – as shown by these two charts, some folks think that the tax rate on capital gains should be even higher.

And it looks like they’re going to succeed, either because we go over the fiscal cliff or because Republicans acquiesce to Obama’s punitive proposal.

But this won’t be good for American competitiveness. Here’s some of what my colleague Chris Edwards just wrote about the issue.

Nearly every country has reduced tax rates on individual long-term capital gains, with some countries imposing no tax at all. …If the U.S. capital gains tax rate rises next year as scheduled, it will be much higher than the average OECD rate. …Capital gains taxes raise less than five percent of federal revenues, yet they do substantial damage. Higher rates will harm investment, entrepreneurship, and growth, and will raise little, if any, added federal revenue. …Figure 1 shows that the U.S. capital gains tax rate of 19.1 percent in 2012 is higher than the OECD average rate of 16.4 percent.  These figures include both federal and average state-level tax rates on long-term capital gains. Next year, the expiration of the Bush tax cuts will push up the U.S. rate by 5 percentage points, and the new investment tax imposed under the 2010 health care law will push up the rate another 3.8 percent. As a result, the top U.S. capital gains tax rate will be 27.9 percent, which will be far higher than the OECD average. The federal alternative minimum tax and other provisions can increase the U.S. capital gains tax rate even higher.

The worst country is Denmark, at 42 percent, followed by France (32.5 percent), Finland (32 percent), Sweden and Ireland (both 30 percent), and the United Kingdom and Norway (both 28 percent).

Every other developed nations will have a capital gains tax rate below the United States level. And even some of those above the U.S. level often have provisions that spare many taxpayers from this pernicious form of double taxation.

Some countries have exemptions for smaller investors. In Britain, for example, individuals can exempt from tax the first $17,000 of capital gains each year. Eleven OECD countries do not impose taxes on longterm capital gains, nor do some jurisdictions outside of the OECD, such as Hong Kong, Malaysia, and Thailand.

The nations on the list that don’t tax capital gains are Belgium, Czech Republic, Greece, Luxembourg, Mexico, Netherlands, New Zealand, Slovenia, South Korea, Switzerland, and Turkey.

I’m not surprised to see Switzerland on that list since that nation has some very sensible fiscal policies. And the Netherlands, notwithstanding its welfare state and long-run fiscal challenges, is very focused on global competitiveness.

But who would have thought Greece had any good policies?!? Or Belgium? Though maybe that’s one of the reasons why many successful French taxpayers are choosing that nation as a refuge.

Heck, even Russia has abolished its capital gains tax.

In his paper, Chris also gives a good explanation of the underlying tax theory in the capital gains tax debate. Simply stated, the statists like the “Haig-Simons” approach because it justifies class-warfare tax policy.

To maximize growth, we should “tax the fruit of the tree, but not the tree itself.” That is, we should tax the flow of consumption produced by capital assets, not the capital that will provide for future consumption. A Haig-Simons tax base—which includes capital gains—taxes the tree itself.  Why does a Haig-Simons tax base garner support if it is impractical and anti-growth? It appears to be because the liberal idea of “fairness” includes heavy taxation of high earners. Since high earners save more than others, they would be taxed heavily under a Haig-Simons tax base. …Today, many economists favor shifting from an income to a consumption tax base… Under a consumption tax base, savings would not be double-taxed, and capital gains would not face separate taxation because the cashflow from realized gains would be taxed when consumed. With regard to “fairness,” a Haig-Simons tax base penalizes frugal people and rewards the spendthrift. That’s because earnings are taxed a second time when saved, while immediate consumption does not face a further tax. That makes no sense because it is frugal people—savers—who are the benefactors of the economy since their funds get invested in the new businesses and new capital equipment that generates growth.

The right approach is to have a “consumption tax base,” which simply is another way of saying that income shouldn’t be taxed more than one time (as shown in this flowchart).

My video elaborates on all these issues and explains why the right capital gains tax rate is zero.

Writing about the death tax yesterday, I mentioned that it also is a perverse form of double taxation. And just as with the death tax, it’s worth noting that all the major pro-growth tax reform plans  – such as the flat tax or national sales tax – also have no capital gains tax.

It’s bad enough when the IRS gets to tax our income one time. They shouldn’t be allowed more than one bite of the apple.

P.S. Chris makes a very important point about higher capital gains taxes collecting little, if any revenue. Simply stated, there’s a large Laffer Curve effect since investors can choose not to sell an asset if the tax penalty is too high.

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Time to Get Rid of Tax Preferences for Housing in the Internal Revenue Code

Even though I knew some people would call me Scrooge, I wrote a few days ago about why we should get rid of the tax deduction for charitable contributions in exchange for lower tax rates.

Simply stated, I’m a big advocate of fundamental tax reform, and I would like to scrap the corrupt internal revenue code and replace it with a simple and fair flat tax.

Needless to say, that also means getting rid of tax preferences for housing. I make the case against the home mortgage interest deduction in this interview on the Fox Business Network.

Since a short TV interview doesn’t allow much time for a detailed and wonky analysis of tax policy, this is a good time to explain why tax reform doesn’t really change the tax treatment of housing. But also I’ll explain why it is a big change.

I realize that makes me sound like a politician, talking out of both sides of my mouth, but bear with me.

One of the key principles of tax reform is that there no longer should be any double taxation of income that is saved and invested. As you can see in this chart, people who live for today and immediately consume their after-tax income are basically spared any additional layers of tax. But if you save and invest your after-tax income (which is very good for future growth and necessary to boost workers’ wages), then the government tries to whack you with several additional layers of tax.

The solution is a system that taxes income only one time. And that means all saving and investment should be treated the way we currently treat individual retirement accounts. If you have a traditional IRA (or “front-ended” IRA), you get a deduction for any money you put in a retirement account, but then you pay tax on the money – including any earnings – when the money is withdrawn.

If you have a Roth IRA (or “back-ended” IRA), you pay tax on your income in the year that it is earned, but if you put the money in a retirement account, there is no additional tax on withdrawals or the subsequent earnings.

From an economic perspective, front-ended IRAs and back-ended IRAs generate the same result. Income that is saved and invested is treated the same as income that is immediately consumed. From a present-value perspective, front-ended IRAs and back-ended IRAs produce the same outcome. All that changes is the point at which the government imposes the single layer of tax.

So why am I boring you with all this arcane tax info? Because the home mortgage interest can be considered as a front-ended IRA involving more than one party. The interest paid by the homeowner is deductible, and the interest received by the mortgage company is taxable.

Under a flat tax, the system gets switched to something akin to a back-ended IRA. The homeowner no longer deducts the interest and the recipient of the interest no longer pays tax.

Some of you may be thinking that this is a good deal for financial institutions, but a ripoff for homeowners. But here are two very important points.

• First, homeowners that already have mortgages presumably would be grandfathered, thus allowing them to continue taking the deduction. They made a contract under the old rules and shouldn’t have the rug pulled out from under them.
• Second, people taking out new mortgages would benefit since mortgage interest would get the same tax treatment now reserved for tax-free municipal bonds. And because there’s no federal income tax on municipal bonds, that means there’s no tax wedge built into the interest rate.

In other words, homeowners or homebuyers in the new system won’t be able to deduct mortgage interest, but they’ll benefit from lower interest rates. Six of one, half dozen of another.

So why, then, is the housing lobby against the flat tax?

In part, they don’t know what they’re talking about. But what about the smart ones, the ones who understand that there’s no meaningful change in the after-tax cost of getting a mortgage in a flat tax world? Why are they opposed to tax reform.

The answer is very simple. They understand that housing isn’t directly affected by a flat tax, but they are very concerned about the indirect impact. More specifically, they understand that the flat tax eliminates all forms of double taxation in the tax code, and that would mean a level playing field.

In other words, the housing sector is now taxed rationally, and other investments are taxed punitively. Under a flat tax, by contrast, all would be taxed rationally.  So the housing sector would lose its relative advantage. 

So if your industry or sector is the beneficiary of a tilted playing field, then it’s understandable that you’ll be worried about tax reform even if there’s no real change in how you get taxed.

And I suspect the impact of tax reform wouldn’t be trivial.

To get an idea about the potential impact, let’s look at some academic research. Professor Dale Jorgenson of Harvard and another economist from Yonsei University in South Korea estimate that most of the economic benefit of tax reform occurs because capital shifts out of owner-occupied housing and into business investment.

…progressivity of labor income taxation is another major source of inefficiency in the U.S. tax system. This produces marginal tax rates on labor income that are far in excess of average tax rates. A high marginal tax rate results in a large wedge between the wages and salaries paid by employers and those received by households. A proportional tax on labor income would equalize marginal and average tax rates and would sharply curtail the losses in economic efficiency due to high marginal rates. An important challenge for tax reform is to eliminate the barriers to efficient capital allocation arising from ―double‖ taxation of assets held in the corporate sector and the exclusion of owner-occupied housing from the tax base… If both income taxes and sales taxes are replaced by a Flat Tax, and a lump sum tax is used to compensate for the revenue shortfall, the welfare gains are very substantial, $5,111.8 billion U.S. dollars of 2011 for HR and $5,444.3 billion for AS. …Our overall conclusion is that the most substantial gains from tax reform are associated with equalizing tax burdens on all assets and all sectors and eliminating the progressive taxation of labor income… We have shown that the most popular Flat Tax proposals would generate substantial welfare gains.

I don’t pay much attention to the estimates in the study about an extra $5 trillion-plus of wealth. That number is very sensitive to the structure of the model and the underlying assumptions.

But I do agree that tax reform will generate big benefits and that much of the gain will occur because there will be less tax-induced over-investment in housing and more growth-generating investment in business capital.

But as I note in the interview, that’s a good thing. It means more prosperity for the American people and a more competitive American economy.

Government shouldn’t be trying to lure us into making economically irrational decisions because of tax or regulatory interventions. Didn’t we learn anything from the Fannie Mae-Freddie Mac fiasco?

The clowns in Washington have been mucking around in the economy for decades and they keep making things worse. Perhaps, just for a change of pace, we should try free markets and small government and see what happens.

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Everything that’s Wrong with the Tax System, in a Single Picture

I used to think this image was a damning indictment of the internal revenue code. Or here’s another chart showing how the tax system has become more convoluted over time.

But this new image may be the most effective of all of them. We don’t know what’s in the other 72,000 pages of tax code, but we’re all familiar with the basic 1040 tax form. Look at what the politicians have done to it over the past several decades.

The only answer, needless to say, is to throw the entire mess in the trash can and replace it with a simple and fair flat tax.

Here’s my brief explanation of how the flat tax would work and why it’s a good idea.

Tax reform would give us more growth, but it also would reduce one of the major source of corruption in Washington.

It’s also based on the notion that discrimination is wrong and that class-warfare policy should be rejected.

So what’s not to like?

P.S. I always get a lot of email and comments from people who wonder whether we should adopt a national sales tax instead. That’s fine with me, for reasons I explain here, but you better make sure to first amend the Constitution so that scheming politicians don’t pull a bait-and-switch and saddle us with both an income tax and a sales tax.

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We Need More Growth and Prosperity to Boost Charitable Contributions, not Bribery in the Tax Code

I’m a strong believer in fundamental tax reform. We need a system like the flat tax to improve economic performance.

No tax system is good for growth, of course, but the negative impact of taxation can be reduced by lowering marginal tax rate(s), eliminating double taxation of saving and investment, and getting rid of loopholes that encourage people to make decisions for tax reasons even if they don’t make economic sense.

While the general public is quite sympathetic to tax reform and would like to de-fang the IRS, there are three main pockets of resistance.

1. The class-warfare crowd is opposed to the flat tax for ideological reasons. They want high tax rates and punitive double taxation – even if the government winds up collecting less money.
2. The lobbyists and special interest groups also are opposed to tax reform, along with the politicians that they cultivate. The tax code is a major source of political corruption, after all, and there would be a lot fewer opportunities to game the system and swap loopholes for political support if the 72,000 page tax code was tossed in a dumpster.
3. Beneficiaries of certain tax preferences such as the mortgage interest deduction, the charitable deduction, and the state and local tax deduction are worried about tax reform, either because they are taxpayers who utilize the preferences or because they represent interest groups that benefit because the government has tilted the playing field.

This post is designed to allay the fears of this third group, specifically the folks who worry that tax reform might be bad news for charities.

The Wall Street Journal today published a pro-con debate on the charitable deduction. As you might expect, my role is to argue in favor of a simple and fair system that would eliminate all tax preferences.

Here’s some of what I wrote on the charitable deduction, beginning with the key point that economic growth is key because the biggest determinants of charitable giving are disposable income and net wealth.

…the best way to help charities is to boost economic growth, which leaves people with more money to donate. And I think the best way to do that is to replace our current system with a simple and fair flat tax. …I don’t think there’s a compelling argument for the charitable deduction. …Over the decades, there have been major changes in tax rates and thus major changes in the tax treatment of charitable contributions. At some points, there has been a big tax advantage to giving, at others much less. Yet charitable giving tends to hover around 2% of U.S. gross domestic product, no matter what the incentive.

The final sentence in the above excerpt is key. The value of a tax deduction is determined by the tax rate. So in 1980, when the top tax rate was 70 percent, it only cost 30 cents to give $1 to charity. By 1988, though, the top tax rate was down to 28 percent, which means that the cost of giving $1 had jumped to 72 cents.

Yet charitable giving rose during the 1980s. Why? Because Reagan implemented reforms – such as lower tax rates – that produced a healthier economy.

Some may wonder whether the example I just cited is appropriate since it focuses on the tax rate (and therefore the value of the tax deduction) for upper-income taxpayers.

But there’s a good reason for that choice. The charitable deduction overwhelmingly goes to the rich.

Upper-income households are the biggest beneficiaries of the deduction, with those making more than $100,000 per year taking 81% of the deduction even though they account for just 13.5% of all U.S. tax returns. The data are even more skewed for households with more than $200,000 of income. They account for fewer than 3% of all tax returns, yet they take 55% of all charitable deductions.

I’m not against rich people, or against them lowering their tax liabilities. But I do want a tax system that generates more prosperity because that’s good news for the entire economy – including the nonprofit sector.

Speaking of which, I think tax-deductible groups will become better and more efficient without the deduction.

Charities, meanwhile, get fatter and lazier because of that dynamic. Think of all the exposés in recent years about charities that devote an overwhelming share of their budgets to administrative costs and marketing expenses. No system will create perfect nonprofit groups, but cutting back or cutting out the deduction would break the cycle of inefficiency that now exists.

My debating partner is Diana Aviv, the head of Independent Sector, which is basically a trade associate in DC for charities. Here are the most relevant excerpts from her piece.

…more than 80% of those who itemized their tax returns in 2009 claimed the charitable deduction and were responsible for more than 76% of all individual contributions to charitable organizations.

That’s all fine and well. What she’s basically saying is that almost all rich people itemize and those rich people get the lion’s share of the benefit from the deduction.

But that’s not the key issue. What matters is whether the deduction makes  a big difference for the amount that people contribute. Diana addresses that point.

According to a 2010 Indiana University survey, more than two-thirds of high-net-worth donors said they would decrease their giving if they did not receive a deduction for donations.

I don’t put complete faith in public opinion data, but let’s assume that this poll is a completely accurate snapshot of how rich people think they would react. But let’s balance that off with the real-world evidence from the 1980s, which shows that rich people gave more money in the 1980s after Reagan cut tax rates and dramatically lowered the value of the tax deduction.

I’m not saying the lower tax rates caused the increase in giving, but I am saying that the lower tax rates and other reforms helped boost the economy. And I’m saying that rich people gave more to charity because they had more income and more wealth.

I also can’t resist a comment about this excerpt.

Finally, there’s another important consideration. The charitable deduction is unique in that it’s a government incentive to sacrifice on behalf of the commonweal. Unlike incentives to save for retirement or buy a home, it encourages behavior for which a taxpayer gets no direct, personal, tangible benefit.

Huh?!? Diana’s entire article is based on the notion that people need to be bribed in order to contribute, yet she simultaneously says that taxpayers get “no direct, personal, tangible benefit.”

Let me close by tying this debate to the fiscal cliff negotiations. There is some discussion of capping itemized deductions as a way of extracting more money from the rich. That creates a bit of a quandary. Here’s something else I wrote for my part of the debate.

I don’t want to give more revenue to Washington. That’s like putting blood in the water with hungry sharks around. But if politicians are going to extract more money from the private sector anyway, reducing or eliminating the deduction is much less damaging to growth than imposing higher marginal tax rates.

That being said, that type of change – while not as bad for the economy – probably would have a negative impact on charitable giving.

My argument is that real tax reform can benefit the nonprofit sector because the loss of the deduction is more than offset by the pro-growth impact of lower tax rates, less double taxation, etc.

But if all politicians are doing is limiting the deduction as part of a money grab, then nonprofits get some pain and no gain.

Incidentally, this is why the nonprofit community should join the rest of us in fighting against an ever-climbing burden of government spending. If we don’t rein in Leviathan, it’s just a matter of time before politicians get rid of the deduction as part of a relentless search for more revenue.

I think it would be better for nonprofits – and for the rest of us – if we limit the size and scope of government and enact a tax system that produces the kind of prosperity that is beneficial for all sectors of the economy.

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New Evidence Shows States with No Income Tax Grow Faster and Create More Jobs

One of the key ways of controlling state and local tax burdens, according to this map from the Tax Foundation, is to not have an income tax.

But that’s not too surprising. States have just a couple of ways of generating significant tax revenue, so it stands to reason that states without an income tax would have relatively low tax burdens.

Light-blue states have no broad-based income tax

The more important question is whether this approach leads to better economic performance. The evidence is pretty clear that zero-income-tax states grow faster and create more jobs.

I’ve already shared some important research on this topic, including this review of research in the Cato Journal by Richard Rahn, as well as this summary of similar analysis in Rich States, Poor States by Art Laffer and Steve Moore.

There’s even some evidence that people in low-tax states are happier than those in high-tax states, though I’m not sure that I trust that kind of subjective research since there’s also a study showing people are happier in high-tax nations.  (at least, unlike Brazil, nobody in the U.S. is talking about making happiness a responsibility of government).

Let’s return to the more substantive topic of taxes and economic performance. There’s a column examining this issue in today’s Wall Street Journal. Authored by two experts from the Kansas Policy Institute, it finds that states with no income tax have a lower burden of government spending.

In the midst of a dismal recovery where every job counts, one fact stands out: States that tax less achieve better economic performance. …The secret to having low taxes is controlling spending, and that’s exactly what low-tax-burden states do. States with an income tax spent 42% more per resident in 2011 than the nine states without an income tax. …Every state has public schools, social-service programs, prisons, etc. Some just find ways to provide essentially the same basket of services at lower prices.

They also reveal that lower taxes and lower spending translate into more growth and prosperity.

States that allow taxpayers and employers to keep more of their earnings are reaping the benefits. States without an income tax have significantly better growth in private sector GDP (59% versus 42%) over the last 10 years. They increased the number of jobs by 4.9% while jobs in the rest of the states declined by 2.6%. States without an income tax gained population (+5.5%) from domestic migration (U.S. residents moving in and out of states) while all other states as a whole lost 1.3% of population between 2000 and 2009.

The migration data is particularly powerful, and it’s one of the reasons why California’s class-warfare tax policy is so suicidal and why Texas is growing so rapidly. As I’ve said many times before, tax competition is a critical way of disciplining profligate governments and rewarding jurisdictions with more responsible fiscal policy.

Last but not least, if you want a powerful example of why income taxes are economic poison, read this research showing how Connecticut’s economic performance dropped after imposing a state income tax about 20 years ago.

P.S. Here’s a list of America’s greediest state and local governments, as measured by top income tax rates and most onerous sales tax systems.

P.P.S. Here’s the famous Moocher Index of state dependency, and you’ll notice that states with no income tax are more likely to be near the bottom of the list (with Alaska being a notable – but not surprising – exception).

P.P.P.S. And if you like state fiscal data, the Cato Institute’s Fiscal Policy Report Card on America’s Governors shows which states are moving in the wrong direction and right direction.

P.P.P.P.S. According to this map from a left-wing group, it also seems that states with no income tax do a better job of controlling welfare spending.

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The Link Between High Tax Rates and Corruption

I’ve been very critical of Obama’s class-warfare ideology because it leads to bad fiscal policy. But perhaps it is time to give some attention to other arguments against high tax rates.

Robert Samuelson, a columnist for the Washington Post, has a very important insight about tax rates and sleaze in Washington.

His column is mostly about Obama’s anti-tax reform agenda, but it includes this very important passage.

…many politicians support tax breaks for favored groups (the elderly, the poor, small business) and causes (homeownership, attending college, “green” industries). This enhances their power. The man who really pronounced the death sentence for the Tax Reform Act of 1986 was Bill Clinton, who increased the top rate to 39.6 percent rather than broadening the base. As the top rate rose, so did the value of generating new tax breaks. Ironically, many of the people who complain the loudest about Washington influence-peddling and lobbying are the same people who support higher tax rates, which stimulate more influence-peddling and lobbying.

The last sentence is key. Higher tax rates are good news for the politicians, interest groups, bureaucrats, and lobbyists that dominate Washington.

Here’s a simple example. Let’s pretend we have a modest tax rate of 20 percent. Now imagine you are part of an industry with $200 million in profits and you want a special tax break. How much are you willing to pay to get that loophole?

Well, with a 20 percent tax, the most you can save (assuming the loophole is huge and you wipe out all your tax liability) is $40 million.

So how much would you spend on lobbyists, campaign contributions, etc, in order to get that loophole? That’s hard to answer, because it would require some estimate of the probability of success. But one thing we can safely assume is that the industry would never spend more than $40 million.

But let’s now assume you live in a world with 50 percent tax rates. Does that change the incentive for influence peddling in Washington? Of course it does. The industry’s tax bill is now $100 million, so it now has an incentive to spend up to that amount to get special treatment.

So now let’s consider a couple of additional hypothetical questions.

• First, imagine you’re a lobbyist. Do you think you will get more business if tax rates are high, or if tax rates are low?
• Second, imagine you are a politician. Do you think you will get more campaign contributions if tax rates are high, or if tax rates are low?

The answers are obvious, and so are the implications. Yes, higher tax rates are bad for growth and competitiveness. And, yes, they are unfair and discriminatory.

But they also foment and encourage sleaze in D.C., and that’s something that honest leftists should hate as much as the rest of us.

For more information, here’s my video on the link between big government and corruption, including a section on how a loophole-ridden tax system benefits Washington insiders.

And here’s the video on the flat tax, which explains why low tax rates are good for economic performance.

Both videos have good information (at least I like to think), but kudos to Samuelson for drawing an important link between high tax rates and corruption.

P.S. Robert Samuelson is hard to pin down on the philosophical spectrum. He’s written very good columns denouncing Obama’s manipulation of welfare statistics and criticizing the President’s flirtation with the value-added tax. But he’s also had a couple of columns where he identifies a very real problem, but fails to reach the right conclusion, including this piece that should have been an argument for Austrian economics and this piece on health care inefficiency that should have pinned the blame on third-party payer.

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Richard Epstein Discusses the Flat Tax

In addition to being my former debating partner, Richard Epstein is one of America’s premiere public intellectuals.

You can watch him make mincemeat out of George Soros in this video, for instance, and you can listen to his astute observations about his former law school colleague Barack Obama in this video.

Renaissance man of liberty

Given his stature, I’m glad that he agrees that the flat tax is the ideal way of reforming the corrupt internal revenue code. Here’s some of what he wrote about the topic for the Hoover Institution, beginning with an outline of the fundamental issues at stake.

The central challenge for government is to incur minimum political distortions while allowing taxes to raise the revenues needed to discharge essential government functions. …Without question, the form of taxation that best meets these dual requirements is a flat tax on consumption—a position which enjoys virtually no visible political support today. …Unless something is done to alter the direction of political discourse in the United States, the next four years will be a replay of the last four years. We will witness a slow decline in the standard of living across all groups within the United States.

For those not familiar with the lingo, a “flat tax on consumption” simply means a tax system with one rate and no double taxation of income that is saved and invested. That can be a national sales tax or value-added tax, but it usually refers to the “Hall-Rabushka” flat tax championed by Dick Armey and Steve Forbes. If you want more information, click here and here.

Epstein then gives some of the economic arguments for tax reform.

A sound tax system has as few moving parts as possible. We should scrap the current system in favor of a flat tax on consumption. Radically simplifying the tax system to a flat tax on consumption would facilitate two desirable economic changes. First, it reduces taxes to zero when capital is redeployed from one venture to another, which in turn would induce better investor monitoring of current firms. The ability of investors to sell out without adverse tax consequences thus provides an added incentive for efficient market behavior. Second, it eliminates the need to draw any distinction between ordinary income and capital gains, which is one of the weak points of the current system.

And he gives some reasons why the current system is unpalatable.

Current tax policy puts items like income and deductions into political play, generating deleterious short-term consequences. Evidence of this can be seen in the rapid response of investors, who are anticipating the future tax hikes and scaling back on their investments. The adverse responses are not confined to large firms but also extend to wealthy individuals who will bear the brunt of any tax increase. The proposed increase in the estate and gift taxes, targeted exclusively at high-income taxpayers, has set off an immediate flurry of tax planning efforts by well-to-do individuals to minimize the bite of these unknown and unwelcome tax changes. Typical of the common hijinks are the estate planning tactics recently reported in the Wall Street Journal by Annamaria Andriotis, which should belie the naïve belief that high-income taxpayers don’t respond to incentives. It is not just that people go to extra lengths to alter their patterns of giving in order to take full advantage of the life-time exemption from the gift and estate taxes and annual exclusions (now $13,000 per each donor/donee pair); it is that they engage in the conscious destruction of wealth in order to minimize the impact of taxes.

He also provides the Laffer-Curve argument for better tax policy.

The President thinks that revenue growth from taxes can be reduced to a simple task of addition and multiplication. Start with the current tax base, and multiply it by the increased tax rates in order to determine the added tax revenues. …Since the advent of the income tax in 1913, tax rates have gyrated from high to low and back again. …the typical response to these tax reductions is a spur in economic activity that results in the collection of larger amounts of capital gains taxes from wealthy individuals, who also prosper under the regime by their higher after-tax earnings. …If we sock it to the rich, we run the risk of impoverishing the nation.

Esptein concludes by explaining the world is not a zero-sum exercise. Good tax policy can make everybody better off.

Too many people agree with the implicit supposition of the President that taxation is a zero-sum game, whereby the rest of the population can gain amounts that are taken from the rich through taxation. Not so. The explicit tax increases on the rich will be passed on in a variety of ways to the population as a whole so that everyone is made worse off in the name of income equality.

I certainly agree. Statists assert that people like me and Espstein believe in trickle-down economics. That’s obviously a pejorative term, but we do believe in a system where more entrepreneurship and capital formation leads to higher living standards.

How can anybody look at this chart and think otherwise?

If you want more information, here’s my video on the flat tax.

This system is working in about 30 nations around the world. Isn’t it time America had a tax system that made sense?

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Dissecting Obama’s Record on Tax Policy

The folks at the Center for Freedom and Prosperity have been on a roll in the past few months, putting out an excellent series of videos on Obama’s economic policies.

• A look at the President’s failure to control government spending.
• A review of the Obama’s dismal track record on jobs and growth.
• A video showing how the auto bailout has been a costly mistake.

Now we have a new addition to the list. Here’s Mattie Duppler of Americans for Tax Reform, narrating a video that eviscerates the President’s tax agenda.

I like the entire video, as you can imagine, but certain insights and observations are particularly appealing.

1. The rich already pay a disproportionate share of the total tax burden – The video explains that the top-20 percent of income earners pay more than 67 percent of all federal taxes even though they earn only about 50 percent of total income. And, as I’ve explained, it would be very difficult to squeeze that much more money from them.

2. There aren’t enough rich people to fund big government – The video explains that stealing every penny from every millionaire would run the federal government for only three months. And it also makes the very wise observation that this would be a one-time bit of pillaging since rich people would quickly learn not to earn and report so much income. We learned in the 1980s that the best way to soak the rich is by putting a stop to confiscatory tax rates.

3. The high cost of the death tax – I don’t like double taxation, but the death tax is usually triple taxation and that makes a bad tax even worse. Especially since the tax causes the liquidation of private capital, thus putting downward pressure on wages. And even though the tax doesn’t collect much revenue, it probably does result in some upward pressure on government spending, thus augmenting the damage.

4. High taxes on the rich are a precursor to higher taxes on everyone else – This is a point I have made on several occasions, including just yesterday. I’m particularly concerned that the politicians in Washington will boost income tax rates for everybody, then decide that even more money is needed and impose a value-added tax.

The video also makes good points about double taxation, class warfare, and the Laffer Curve.

Please share widely.

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What’s the Best Way of Achieving Good Fiscal Policy?

The half-joking response to the question in the title of this post is that policymakers should look at what’s happening in poorly run jurisdictions such as California, France, Illinois, and Greece – and then do just the opposite.

In other words, steer clear of punitive class-warfare tax rates and make sure to control the burden of government spending.

But there’s an even simpler rule that is very correlated with good fiscal policy, at least at the state level. Governments should not impose income taxes.

If you look at this map from the Tax Foundation, you’ll notice that there is a heavy overlap between the 10 states with the lowest overall tax burdens and the 9 states (Alaska, Florida, New Hampshire, Nevada, South Dakota, Tennessee, Texas, Washington, Wyoming) that don’t have income taxes.

More specifically, 7 of the non-income tax states are among the 10 states with the lowest tax burdens. Only Florida and Washington are outside the top 10.

It’s also worth noting that some of the states with the most “progressive” income tax systems are well represented on the list of the 10-worst states – including California, New York, New Jersey, Maine, and Rhode Island.

One important implication of this data is that proponents of limited government should never give politicians a new source of revenue, which is why fighting the value-added tax is one of my main priorities (and why advocates of small government should be worried not just about Obama winning re-election, but also worried about Romney winning).

P.S. New Hampshire and Tennessee impose income taxes on certain forms of capital income, so they are only probationary and tenuous members of the no-income-tax club.

P.P.S. Politicians from Illinois will probably complain that they didn’t make the 10-worst list, but they shouldn’t be too worried. The Tax Foundation was looking at 2010 data and Illinois almost surely will be closer to the bottom when the 2011 data gets released and includes the impact of the midnight, end-of-session, post-2010 election tax hike imposed by the state’s kleptocrat politicians.

P.P.P.S. For a humorous – but accurate – perspective on the VAT, take a look at these clever cartoons (here, here, and here).

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Debunking Obama’s Flawed Assertions on Tax Deductions and Corporate Welfare

In a violation of the 8th Amendment’s prohibition against cruel and unusual punishment, my brutal overseers at the Cato Institute required me to watch last night’s debate (you can see what Cato scholars said by clicking here).

Tweedle Dee and Tweedle Dum

But I will admit that it was good to see Obama finally put on the defensive, something that almost never happens since the press protects him (with one key exception, as shown in this cartoon).

This doesn’t mean I like Romney, who would probably be another Bush if he got to the White House.

On the specifics, I obviously didn’t like Obama’s predictable push for class warfare tax policy, but I’ve addressed that issue often enough that I don’t have anything new to add.

I was irked, though, by Obama’s illiteracy on the matter of business deductions for corporate jets, oil companies, and firms that “ship jobs overseas.”

Let’s start by reiterating what I wrote last year about how to define corporate income: At the risk of stating the obvious, profit is total revenues minus total costs. Unfortunately, that’s not how the corporate tax system works.

Sometimes the government allows a company to have special tax breaks that reduce tax liabilities (such as the ethanol credit) and sometimes the government makes a company overstate its profits by not allowing it to fully deduct costs.

During the debate, Obama was endorsing policies that would prevent companies from doing the latter.

The irreplaceable Tim Carney explains in today’s Washington Examiner. Let’s start with what he wrote about oil companies.

…the “oil subsidies” Obama points to are broad-based tax deductions that oil companies also happen to get. I wrote last year about Democratic rhetoric on this issue: “tax provisions that treat oil companies like other companies become a ‘giveaway,’…”

I thought Romney’s response about corrupt Solyndra-type preferences was quite strong.

Here’s what Tim wrote about corporate jets.

…there’s no big giveaway to corporate jets. Instead, some jets are depreciated over five years and others are depreciated over seven years. I explained it last year. When it comes to actual corporate welfare for corporate jets, the Obama administration wants to ramp it up — his Export-Import Bank chief has explicitly stated he wants to subsidize more corporate-jet sales.

By the way, depreciation is a penalty against companies, not a preference, since it means they can’t fully deduct costs in the year they are incurred.

On another matter, kudos to Tim for mentioning corrupt Export-Import Bank subsidies. Too bad Romney, like Obama, isn’t on the right side of that issue.

And here’s what Tim wrote about “shipping jobs overseas.”

Obama rolled out the canard about tax breaks for “companies that ship jobs overseas.” Romney was right to fire back that this tax break doesn’t exist. Instead, all ordinary business expenses are deductible — that is, you are only taxed on profits, which are revenues minus expenses.

Tim’s actually too generous in his analysis of this issue, which deals with Obama’s proposal to end “deferral.” I explain in this post how the President’s policy would undermine the ability of American companies to earn market share when competing abroad – and how this would harm American exports and reduce American jobs.

To close on a broader point, I’ve written before about the principles of tax reform and explained that it’s important to have a low tax rate.

But I’ve also noted that it’s equally important to have a non-distortionary tax code so that taxpayers aren’t lured into making economically inefficient choices solely for tax reasons.

That’s why there shouldn’t be double taxation of income that is saved and invested, and it’s also why there shouldn’t be loopholes that favor some forms of economic activity.

Too bad the folks in government have such a hard time even measuring what’s a loophole and what isn’t.

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It’s Wrong for Federal Tax Deductions to Encourage Bad Fiscal Policy by State and Local Governments

I have a handful of simple rules for good tax policy.

• Keep government small, since it’s impossible to have a reasonable tax system with a bloated welfare state.
• Keep tax rates low to minimize penalties against income, production, and wealth creation.
• Since capital formation is critical for long-run growth, don’t double-tax income that is saved and invested.
• Eliminate corrupt and distorting loopholes that encourage people to make decisions that are economically irrational.

Some of these principles are interrelated. I don’t like loopholes in part because of the reasons I just listed. But I also don’t like them because politicians often claim that they need to boost tax rates to make up for the fact that they lose revenue due to various deductions, credits, exemptions, and preferences.

And sometimes a deduction in the tax code even leads to bad policy by state and local government. Today, I want to discuss preferences in the internal revenue code for state and local taxes. And I’m motivated to address this issue because some of the politicians on Capitol Hill have pointed out an inequity, but they want to fix it in the wrong way.

Under current law, state and local income taxes are fully deductible, but state and local sales taxes are only temporarily deductible. The right policy is to get rid of any deductibility for any state and local tax. But since that would create a windfall of new tax revenue for the spendaholics in Washington, every penny of that revenue should be used to lower tax rates.

Not surprisingly, the crowd in Washington doesn’t take this approach. Instead, they want to extend deductibility for the sales tax. And they may even be amenable to raising other taxes to impose that policy.

Here are some excerpts from a story in The Hill.

More than five dozen House members are pressing leaders of a tax panel to preserve a deduction for state and local sales taxes. The bipartisan group of lawmakers say it would be unfair to voters in their states not to extend the sales tax deduction, given that taxpayers would still be able to deduct state and local income taxes. …Eight states in all — Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming — currently use a sales tax, but either don’t have or have a very limited state income tax. …The letter comes as many lawmakers hope to finish off an extenders package once Congress returns to Washington after November’s elections. Lawmakers will have to grapple with expiring Bush-era tax rates — just one part of the so-called fiscal cliff — when they return, and tax extenders could be tacked on to a broader package. The Senate Finance Committee has already passed an extenders package of its own, which included a two-year extension — at a cost of an estimated $4.4 billion over a decade — of the sales tax deduction.

I have some sympathy for these members of Congress. They represent states that have wisely decided not to impose income taxes, yet the federal tax system rewards profligate high-tax states such as New York and California with a permanent deduction for state and local income taxes.

This is a very misguided policy. It means that greedy politicians such as Governor Brown of California or Governor Cuomo of New York can raise tax rates and tell voters not to get too upset because they can deduct that additional burden. This means that a $1 tax hike results in a loss of take-home pay of as little as 65 cents.

This is what a fair tax code looks like

But you don’t cure one bad policy with another bad policy. A deduction for state and local sales taxes just augments the IRS-enforced preference for bigger government at the state and local level.

The right answer is the flat tax. Put in place the lowest-possible tax rate, which is feasible because all loopholes are wiped out.

In the case of state and local tax deductibility (or lack thereof, with any luck), that’s a win-win-win situation.

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Here’s What’s Wrong with the Simpson-Bowles Deficit-Reduction Plan

Many people want to believe in Unicorns, the Loch Ness Monster, and Bigfoot. I think those people are rational and reasonable compared to the folks in Washington that spend their days dreaming of “bipartisan” and “balanced” plans to fix the budget mess.

Here are the two things you should understand. First, you need to grab your Washingtonese-to-English dictionary so you can learn that “bipartisan” and “balanced” are almost always code words for “higher taxes.” Second, budget deals with higher taxes (as the New York Times accidentally admitted) don’t “fix” anything.

The Simpson-Bowles budget plan is a good example of why taxpayers should be quite skeptical. Put together by a former Republican Senator from Wyoming and Bill Clinton’s former Chief of Staff as part of President Obama’s Fiscal Commission, the Simpson-Bowles proposal is viewed by the inside-the-beltway crowd as fiscal Nirvana.

Unsurprisingly, Simpson and Bowles are quite fond of their plan. Here’s their key assertion from a column they recently wrote for USA Today.

The Simpson-Bowles commission offered a reasonable, responsible, comprehensive and bipartisan solution that won the support of a majority of Democrats and Republicans on the commission. Most importantly, it would reduce the deficit by $4 trillion over the next decade — enough to put the debt on a clear downward path relative to the economy.

Gee, sounds nice, but let’s look at the details, all of which can be seen by downloading their report.

A main problem is that Simpson and Bowles misdiagnose the problem. I think it’s fair to say that their focus, as they explicitly state in their report, is to “…stabilize and then reduce the national debt.” But as I explain in this video, the real problem is a federal government that is too big and spending too much. Red ink is just a symptom of that problem.

Moreover, the report even includes Keynesian policy, stating that “…budget cuts should start gradually so they don’t interfere with the ongoing economic recovery.”

But let’s set aside rhetorical sins and grade the plan.

Restraining Spending: C+

• The plan does impose some restraint on the budget, but the plan – even after being in place for 10 years – assumes that the federal government should grow by about $1.5 trillion and consume nearly 22 percent of economic output. This is far above the 18.2 percent of GDP when Clinton left office, which should be the minimum target for policymakers.

But the components of the plan make me think they won’t even achieve the plan’s anemic targets.

Eliminating Departments and Programs: D

• The Simpson-Bowles plan does not call for shutting down a single program, agency, or department. Not even cesspools of waste and inefficiency such as the Department of Education or Department of Housing and Urban Development.

Reforming Entitlements: C-

• There are real change in the plan, but they’re the wrong kind of changes. Instead of the structural reforms to Medicare and Medicaid contained in the Ryan budget, the Simpson-Bowles report basically calls for price fixing and means testing – policies that have a track record of ineffectiveness.

Reducing Bureaucratic Bloat: B

• In terms of controlling spending, this is the part of the report that is most admirable. It calls for a three-year freeze on excessive compensation and urges reductions in bureaucratic bloat – albeit only through attrition.

Controlling the Tax Burden and Reforming the Tax Code: C-

The best policy, needless to say, is getting rid of the corrupt tax system and replacing it with a simple and fair flat tax. That obviously wasn’t what Simpson and Bowles decided to propose, but the flat tax is a benchmark that allows us to judge the components of their plan.

They basically get two policies right and two policies wrong. If they were major league baseball players, a .500 average would make them superstars. In Dan Mitchell’s policy world, they’re below average.

Lowering Tax Rates: A-

• This is the best feature of all the revenue provisions. The Simpson-Bowles report proposes a top tax rate of between 23 percent-28 percent, significantly below the current top rate of 35 percent (and well below the 39.6 percent top rate that is part of President Obama’s class-warfare proposal). The corporate tax rate also would be reduced.

Reducing Double Taxation: D

• The plan would increase the double taxation of dividends and capital gains. The U.S. already has a very anti-competitive system and this would be a step in the wrong direction (though ameliorated by a lower corporate tax rate).

Limiting the Tax Burden: D-

• The plan assumes that laws should be changed to increase the federal tax burden to 21 percent of GDP from the long-run average of 18 percent of economic output. That’s unfortunate, but it’s even worse than it seems since the tax burden already is scheduled to rise to record levels because of what’s called “real bracket creep.” The Simpson-Bowles tax hikes would be an additional burden on taxpayers.

Eliminating Corrupt Loopholes: B

• The good news is that some deductions are curtailed and a few are eliminated. The best components are the repeal of the deduction for state and local income and property taxes. So no more indirect preferences that reward profligate states such as California and Illinois. The healthcare exclusion also is capped, which would be a nice step on the long – but important – task of dealing with the third-party payer crisis in the healthcare sector.

I’m not a fan of the Simpson-Bowles plan, but I do give them credit. They decided to focus on the wrong variable and they have some bad policies, but at least it’s a real proposal.

It’s not anywhere close to the Ryan budget, but it’s a heck of a lot better than what the Senate Democrats have produced (nothing) and what the President has proposed (kicking the can down the road).

But doing a better job than the remedial students is damning with faint praise. Just in case you’re tempted to grade them on a curve, just remember that balancing the budget without tax increases doesn’t require any heavy lifting. All policymakers have to do is limit the growth of spending so it grows by an average of 2.5 percent annually over the next decade.

Other nations, such as New Zealand and Canada, got great results when imposing multi-year periods of fiscal restraint. Certainly it’s not asking too much to expect American lawmakers to exercise similar levels of prudence?

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Just in Case You Need another Reason to Support the Flat Tax

I’ve done thorough blog posts highlighting the economic benefits of the flat tax, but I find that most people are passionate about tax reform because they view the current system as being unfair and corrupt.

They also don’t like the IRS, in part because it has so much arbitrary power to ruin lives.

But it’s not just that is has the power to ruin lives. That can be said about the FBI, the DEA, the BATF, and all sorts of other enforcement agencies.

What irks people about the IRS is that it has so much power combined with the fact that the internal revenue code is a nightmare of complexity that can overwhelm even the most well-intentioned taxpayer. Just spend a couple of minutes watching this video if you don’t believe me.

I’ve already shown depressing charts on the number of pages in the tax code and the number of special breaks in the tax law. To make matters worse, not even the IRS understands how to interpret the law. According to a recent GAO report, the IRS gave the wrong answers on matters of tax law more than 530,000 times in 2010.

Yet if you use inaccurate information from the IRS when filing your taxes, you’re still liable. To add insult to injury (or perhaps injury to injury is the right phrase), you’re then guilty until you prove yourself innocent – notwithstanding the Constitution’s guarantee of presumption of innocence.

Now we have some new information showing the difficulty of complying with a bad tax system.

A new report from the Treasury Department reveals that volunteers (who presumably have the best of intentions) make mistakes in more than 50 percent of cases.

Here are some key excerpts from the report.

Of the 39 tax returns prepared for our auditors, 19 (49 percent) were prepared correctly and 20 (51 percent) were prepared incorrectly. The accuracy rate should not be projected to the entire population of tax returns prepared at the Volunteer Program sites. Nevertheless, if the 20 incorrect tax returns had been filed: 12 (60 percent) taxpayers would not have been refunded a total of $3,996 to which they were entitled, one (5 percent) taxpayer would have received a refund of $303 more than the amount to which he or she was entitled, one (5 percent) taxpayer would have owed $165 less than the amount that should have been owed, and six (30 percent) taxpayers would have owed an additional total of $1,483 in tax and/or penalties. …The IRS also conducted 53 anonymous shopping visits during the 2012 Filing Season. Volunteers prepared tax returns for SPEC function shoppers with a 60 percent accuracy rate.

So here’s the bottom line. We have a completely corrupt tax system that is impossibly complex. Yet every year politicians add new provisions to please their buddies from the lobbyist community.

Wouldn’t it be nice if we could rip up all 72,000 pages and instead have a simple and fair tax system?

Sadly, tax reform is an uphill battle for four very big reasons.

• Politicians don’t want tax reform since it reduces their power to micro-manage the economy and to exchange loopholes for campaign cash.
• The IRS doesn’t want tax reform since there are about 100,000 bureaucrats with comfy jobs overseeing the current system.
• Lobbyists obviously don’t want to reform since that would mean fewer clients paying big bucks to get special favors.
• And the interest groups oppose the flat tax because they want a tilted playing field in order to obtain unearned wealth.

But there are now about 30 nations around the world that have adopted this simple and fair system, so reform isn’t impossible. But it will only happen when voters can convince politicians that they will lose their jobs if they don’t adopt the flat tax.

P.S. I’ll also take a national sales tax, like the Fair Tax, as a replacement. But since I don’t trust politicians, that option requires that we first replace the 16th Amendment with something so ironclad that not even Chief Justice John Roberts would be able to rationalize that an income tax was permissible.

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Spending Cuts and Tax Cuts Should Be an All-of-the-Above Option, Not an Either-Or Choice

I’m in Slovenia where I just finished indoctrinating educating a bunch of students on the importance of Mitchell’s Golden Rule as a means of restraining the burden of government spending.

And I emphasized that the fiscal problem in Europe is the size of government, not the fact that nations are having a hard time borrowing money. As explained in this video, spending is the disease and deficits are one of the symptoms.

This is also an issue in the United States, and Steve Moore of the Wall Street Journal is worried that the GOP ticket is debt-obsessed and doesn’t have sufficient enthusiasm for lower tax rates and tax reform.

Stylistically, Paul Ryan’s Republican convention speech last night was a grand slam. …But was it the growth message that supply-siders wanted to hear, or debt-clock obsession? There were clearly apocalyptic claims. “Before the math and the momentum overwhelm us all, we are going to solve this nation’s economic problems,” said Mr. Ryan in reference to the federal rea ink. “I’m going to level with you; we don’t have that much time.” …In fact, he talked about turning around the economy with “tax fairness.” Ugh, that’s an Obama term. …Larry Kudlow of CNBC and a former Reagan economist tells me, “Paul’s speech just didn’t have the growth, tax-cutting message. We didn’t even get the words tax reform. I don’t know what happened, but it worries me.” It’s a question of priorities. Are Mitt Romney and Paul Ryan signaling that they will put spending cuts ahead of pro-growth tax-rate cuts?

I share Steve’s concern, but with a twist.

I’m not worried that the Republicans will put spending cuts ahead of tax cuts. I’m worried that they won’t do spending cuts at all (even using the dishonest DC definition) and therefore wind up getting seduced into some sort of tax-increase deal that facilitates bigger government.

As a general rule, it is always good to do spending cuts (however defined). And it is always good to lower tax rates. And if you can do both at the same time, even better.

But since I have low expectations, I’ll be delighted if we “merely” manage to get entitlement reform during a Romney-Ryan Administration. That would mean some progress on the spending side and presumably reduce the risk of bad things (like a VAT!) on the revenue side.

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Romney is Right that You Can Lower Tax Rates and Reduce Tax Preferences without Hurting the Middle Class

Even though I’m not a Romney fan, I sometimes feel compelled to defend him against leftist demagoguery.

But instead of writing about tax havens, as I’ve done in the past, today we’re going to look at incremental tax reform.

The left has been loudly asserting that the middle class would lose under Mitt Romney’s plan to cut tax rates by 20 percent and finance those reductions by closing loopholes.

That class-warfare accusation struck me as a bit sketchy because when I looked at the data a couple of years ago, I put together this chart showing that rich people, on average, enjoyed deductions that were seven times as large as the deductions of middle-income taxpayers.

And the chart includes only the big itemized deductions. There are dozens of other special tax preferences, as shown in this depressing image, and you can be sure that rich people are far more likely to have the lawyers, lobbyists, and accountants needed to exploit those provisions.

But that’s not a surprise since the internal revenue code has morphed into a 72,000-page monstrosity (this is why I sometimes try to convince honest leftists that a flat tax is a great way of reducing political corruption).

But this chart doesn’t disprove the leftist talking point, so I’m glad that Martin Feldstein addressed the issue in today’s Wall Street Journal. Here’s some of what he wrote.

The IRS data show that taxpayers with adjusted gross incomes over $100,000 (the top 21% of all taxpayers) made itemized deductions totaling $636 billion in 2009. Those high-income taxpayers paid marginal tax rates of 25% to 35%, with most $200,000-plus earners paying marginal rates of 33% or 35%. And what do we get when we apply a 30% marginal tax rate to the $636 billion in itemized deductions? Extra revenue of $191 billion—more than enough to offset the revenue losses from the individual income tax cuts proposed by Gov. Romney. …Additional revenue could be raised from high-income taxpayers by limiting the use of the “preferences” identified for the Alternative Minimum Tax (such as excess oil depletion allowances) or the broader list of all official individual “tax expenditures” (such as tax credits for energy efficiency improvements in homes), among other credits and exclusions. None of this base-broadening would require taxing capital gains or making other changes that would reduce the incentives for saving and investment. …Since broadening the tax base would produce enough revenue to pay for cutting everyone’s tax rates, it is clear that the proposed Romney cuts wouldn’t require any middle-class tax increase, nor would they produce a net windfall for high-income taxpayers. The Tax Policy Center and others are wrong to claim otherwise.

In other words, even with a very modest assumption about the Laffer Curve, it would be quite possible to implement something akin to what Romney’s proposing and not “lose” tax revenue.

This doesn’t mean, of course, that Romney seriously intends to push for good policy. I’m much more concerned, for instance, that he’ll wander in the wrong direction and propose something very bad such as a value-added tax.

But Romney certainly can do the right thing if he wins. Assuming that’s what he wants to do.

Just like he can fulfill his promise the reduce the burden of government spending by implementing Paul Ryan’s entitlement reforms. But don’t hold your breath waiting for that to happen.

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A Primer on the Flat Tax and Fundamental Tax Reform

In previous posts, I put together tutorials on the Laffer Curve, tax competition, and the economics of government spending.

Today, we’re going to look at the issue of tax reform. The focus will be the flat tax, but this analysis applies equally to national sales tax systems such as the Fair Tax.

There are three equally important features of tax reform.

1. A low tax rate – This is the best-known feature of tax reform. A low tax rate is designed to minimize the penalty of work, entrepreneurship, and productive behavior.
2. No double taxation of saving and investment – All major tax reform plans, such as the flat tax and national sales tax, get rid of the tax bias against income that is saved and invested. The capital gains tax, double tax on dividends, and death tax are all abolished. Shifting to a system that taxes economic activity only one time will boost capital formation, thus facilitating an increase in productivity and wages.
3. No distorting loopholes – With the exception of a family-based allowance designed to protect lower-income people, the main tax reform plans get rid of all deductions, exemptions, shelters, preference, exclusions, and credits. By creating a neutral tax system, this ensures that decisions are made on the basis of economic fundamentals, not tax distortions.

All three features are equally important, sort of akin to the legs of a stool. Using the flat tax as a model, this video provides additional details.

One thing I don’t mention in the video is that a flat tax is “territorial,” meaning that only income earned in the United States is taxed. This common-sense rule is the good-fences-make-good-neighbors approach. If income is earned by an American in, say, Canada, then the Canadian government gets to decide how it’s taxed. And if income is earned by a Canadian in America, then the U.S. government gets a slice.

It’s also worth emphasizing that the flat tax protects low-income Americans from the IRS. All flat tax plans include a fairly generous “zero-bracket amount,” which means that a family of four can earn (depending on the specific proposal) about $25,000-$35,000 before the flat tax takes effect.

Proponents of tax reform explain that there are many reasons to junk the internal revenue code and adopt something like a flat tax.

• Improve growth – The low marginal tax rate, the absence of double taxation, and the elimination of distortions combine to create a system that minimizes the penalties on productive behavior.
• Boost competitiveness – In a competitive global economy, it is easy for jobs and investment to cross national borders. The right kind of tax reform can make America a magnet for money from all over the world.
• Reduce corruption – Tax preferences and penalties are bad for growth, but they are also one of the main sources of political corruption in Washington. Tax reform takes away the dumpster, which means fewer rats and cockroaches.
• Promote simplicity – Good policy has a very nice side effect in that the tax system becomes incredibly simple. Instead of the hundreds of forms required by the current system, both households and businesses would need only a single postcard-sized form.
• Increase privacy – By getting rid of double taxation and taxing saving, investment, and profit at the business level, there no longer is any need for people to tell the government what assets they own and how much they’re worth.
• Protect civil liberties – A simple and fair tax system eliminates almost all sources of conflict between taxpayers and the IRS.

All of these benefits also accrue if the internal revenue code is abolished and replaced with some form of national sales tax. That’s because the flat tax and sales tax are basically different sides of the same coin. Under a flat tax, income is taxed one time at one low rate when it is earned. Under a sales tax, income is taxed one time at one low rate when it is spent.

Neither system has double taxation. Neither system has corrupt loopholes. And neither system requires the nightmarish internal revenue service that exists to enforce the current system.

This video has additional details – including the one caveat that a national sales tax shouldn’t be enacted unless the 16th Amendment is repealed so there’s no threat that politicians could impose both an income tax and sales tax.

Last but not least, let’s deal with the silly accusation that the flat tax is a risky and untested idea. This video is a bit dated (some new nations are in the flat tax club and a few have dropped out), but is shows that there are more than two dozen jurisdictions with this simple and fair tax system.

P.S. Fundamental tax reform is also the best way to improve the healthcare system. Under current law, compensation in the form of fringe benefits such as health insurance is tax free. Not only is it deductible to employers and non-taxable to employees, it also isn’t hit by the payroll tax. This creates a huge incentive for gold-plated health insurance policies that cover routine costs and have very low deductibles. This is a principal cause (along with failed entitlement programs such as Medicare and Medicaid) of the third-party payer crisis. Shifting to a flat tax means that all forms of employee compensation are taxed at the same low rate, a reform that presumably over time will encourage both employers and employees to migrate away from the inefficient over-use of insurance that characterizes the current system. For all intents and purposes, the health insurance market presumably would begin to resemble the vastly more efficient and consumer-friendly auto insurance and homeowner’s insurance markets.

P.P.S. If you want short and sweet descriptions of the major tax reform plans, here are four highly condensed descriptions of the flat tax, national sales tax, value-added tax, and current system.

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Since Leftists Don’t Like Corporate Loopholes, They Should Support the Flat Tax

I appeared on CNBC a couple of days ago to discuss a new report which claims that some big U.S. companies “only” paid 9 percent of their income to the government.

While I’m a bit skeptical of the numbers (did it include the taxes paid to foreign governments, for instance, which can be substantial for multinational firms?), I confess I didn’t read the report.

So I focused on the best way of getting rid of corrupt loopholes while simultaneously boosting the competitiveness of America companies.

In other words, I said we should rip up the wretched internal revenue code and implement a simple and fair flat tax.

As is my habit, allow me to emphasize a few points from the interview.

1. It’s good to keep money in the productive sector of the economy because we shouldn’t feed the spending addiction in DC.
2. If tax rates are low, there’s much less incentive for companies to lobby for loopholes.
3. The only feasible and desirable tax reform is to simultaneously eliminate tax breaks while lowering tax rates.
4. The marginal tax rate is what determines incentives for new investment and job creation, which is why America’s highest-in-the-world 35 percent corporate tax rate is a major problem even if average tax rates are much lower.

Sadly, I’m not holding my breath expecting improvements.

Even though tax reform should appeal to well-meaning liberals, Obama seems committed to the class-warfare approach . Romney, meanwhile, mostly wants to tinker with the current system (when he’s not saying worrisome things about a value-added tax).

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The Right Capital Gains Tax Rate Is Zero

The silly debate about the “Buffett Rule” is really an argument about the extent to which there should be more double taxation of income that is saved and invested.

Politicians conveniently forget that dividends and capital gains get hit by the corporate income tax. And since America now has the developed world’s highest corporate income tax rate, it’s adding insult to injury to tax the income again. Actually, it’s adding injury to injury!

No wonder Ernst and Young found that the United States has a very anti-competitive system for taxing dividends and capital gains. (perhaps it’s time to copy the clever British campaign against punitive double taxation)

If you believe in fairness, the right capital gains tax rate is zero. John Goodman of the National Center for Policy Analysis, has a good explanation.

Income tax time is an appropriate moment to go to the heart of President Obama’s complaint about the taxes Warren Buffett and other rich people pay, or don’t pay. What the president is really complaining about is that the tax rate on capital gains is too low. But there is a more basic question to be asked: why tax capital gains at all?

That’s a very good question, because a capital gain isn’t income. It’s an asset that has increased in value. But the tax only applies on the gain if you sell the asset.

But why does an asset, such as shares of stock, rise in value? According to finance research, asset prices rise in value when there’s an expectation that there will be a greater after-tax stream of future income. But that income will be taxed (at least once!) when it materializes, so why tax it before it even happens? John hits the nail on the head.

The companies will realize their actual income and they will pay taxes on it. If the firms return some of this income to investors (stockholders), the investors will pay a tax on their dividend income. If the firms pay interest to bondholders, they will be able to deduct the interest payments from their corporate taxable income, but the bondholders will pay taxes on their interest income. Here is the bottom line: There is no need for the IRS to tax the bets that people make along the way — as stock prices gyrate up and down. Eventually all the income that is actually earned will be taxed when it is realized and those taxes will be paid by the people who actually earned the income.

Amen. John is exactly right. He’s making the same arguments I put forward in my video on capital gains taxation.

By the way, the capital gains tax isn’t indexed for inflation. So if you bought an asset 30 years ago and it’s doubled in value, you’ve actually lost money after adjusting for inflation. Yet the IRS will tax you. Sort of adding injury to injury to injury.

Finally, I like how John closes his column.

…why not avoid all these problems by reforming the entire tax system along the lines of a flat tax? The idea behind a flat tax can be summarized in one sentence: In an ideal system, (a) all income is taxed, (b) only once, (c) when (and only when) it is realized, (d) at one low rate.

In this awful period leading up to tax day, isn’t it nice to at least dream of a tax system that is simple, fair, and non-corrupt?

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Against 3-1 Odds, Promoting Good Tax Policy on Government TV

With the clock ticking ever closer to the tax-filing deadline, this is the time of year we should be especially cognizant of America’s awful tax system.

Disdain for the corrupt tax code certainly motivates me. As such, even though the panel was stacked against me with three proponents of Obama’s class warfare approach, I hope I did a decent job of defending good tax policy against the statists in this debate on government-subsidized TV.

My most effective moment (I think) was when I explained that “rich” taxpayers declared much more income and paid much higher taxes after Reagan reduced the top tax rate from 70 percent to 28 percent.

I also had a couple of good lines when discussing the value-added tax.

Nonetheless, I think I was disadvantaged by the editing process since many of my comments from our hour-long taping got cut out. If you are sufficiently masochistic, you can listen to the entire program at this link.

I’ll close with an observation. If you support freedom and liberty and work in public policy, you better get used to being outnumbered. When I testified to the Ways & Means Committee about the VAT, I was a lone voice against this pernicious tax while the other four witnesses supported making America more like Greece.

And when I appeared on an English-language French TV program to debate tax havens, I had to battle three statists.

But at least I have truth on my side, so that compensates.

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