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Posts Tagged ‘Double Taxation’

I generally get very suspicious when rich people start pontificating on tax policy.

People like Warren Buffett, for instance, sometimes advocate higher taxes because they’re trying to curry favor with the political elite. Or maybe they feel compelled to say silly things to demonstrate that they feel guilty about their wealth.

Tax SystemRegardless, I don’t like their policy proposal (as you can see from TV debates here and here).

That being said, I also realize that stereotypes can be very unfair, so it’s important to judge each argument on the merits and not to reject an idea simply because it comes from a rich guy.

That’s why I was very interested to see that Bill Gates, the multi-billionaire software maker, decided to add his two cents to the discussion of tax reform.

Here’s what Gates said at an American Enterprise Institute forum (transcript here and video here).

…economists would have said that a progressive consumption tax is a better construct, you know, at any point in history. What I’m saying is that it’s even more important as we go forward.

He doesn’t really expand on those remarks other than to say that it’s important to reduce the tax on labor.

That part of Gates’ remarks doesn’t make much sense for the simple reason that workers are equally harmed whether the government takes 20 percent of their income when it’s earned or 20 percent of their income when it’s spent.

But his embrace of a “progressive consumption tax” is very intriguing.

I don’t like the “progressive” part because that’s shorthand for high marginal tax rates, and that type of class-warfare policy is a gateway to corruption and is also damaging to growth (see here, here, here, here, and here).

But the “consumption” part is one of the key features of all good tax reform plans.

For all intents and purposes, a “consumption tax” is any system that avoids the mistake of double-taxing income that is saved and invested.

Both the national sales tax and the value-added tax, for instance, are examples of consumption-based tax systems.

But the flat tax also is a consumption tax. It isn’t collected at the cash register like a sales tax, but it has the same “tax base.”

Under a flat tax, income is taxed – but only one time – when it is earned. Under a sales tax, income is taxed – but only one time – when it is spent. They’re different sides of the same coin.

Most important, neither the flat tax nor the sales tax has extra layers of tax on saving and investment. And that’s what makes them “consumption” taxes in the wonky world of public finance economists.

This means no death tax, no capital gains tax, no double taxation of interest or dividends. And businesses get a common-sense cash-flow system of taxation, which means punitive depreciation rules are replaced by “expensing.”

So Bill Gates is halfway on the path to tax policy salvation. His endorsement of so-called progressivity is wrong, but his support for getting rid of double taxation is right.

If you like getting into the weeds of tax policy, it’s interesting to note that Gates is advocating the opposite of the plan that was proposed by Congressman Dave Camp.

Camp wants to go in the right direction regarding rates, but he wants to exacerbate the tax code’s bias against capital. Here’s what I said to Politico.

Dan Mitchell, an economist at the libertarian Cato Institute, said he didn’t see it as an individual versus business issue, but rather took issue with Camp’s punitive treatment of savings and investment. “The way Camp is extracting more money from businesses — more punitive depreciation and the like — is he is making the tax system more biased against savings and investment,” said Mitchell, who worked for Republican Sen. Bob Packwood after the historic 1986 tax act that Packwood helped negotiate as chair of the Finance Committee.

By the way, this doesn’t mean Camp’s plan is bad. You have to do a cost-benefit analysis of the good and bad features.

Just like that type of analysis was appropriate in 1986, when the bad provisions that increased taxes on saving and investment were offset by a big reduction in marginal tax rates.

The 1986 law did take aim at some popular business benefits, including a lucrative investment tax credit. But the reward was a lot sweeter. “At least then, we got a big, big reduction in tax rates in exchange,” Mitchell said.

Here’s an interview I did with Blaze TV on Congressman Camp’s plan. If you pay attention near the beginning (at about the 2:00 mark), you’ll see my matrix on how to grade tax reform plans.

Now let’s circle back to the type of tax system endorsed by Bill Gates.

We obviously don’t know what he favors beyond a “progressive consumption tax,” but that bit of information allows us to say that he wants something at least somewhat similar to the old “USA Tax” that was supported by folks such as former Senators Sam Nunn and Pete Domenici.

Is that better than the current tax system?

Probably yes, though we can’t say for sure because it’s possible they may want to increase tax rates by such a significant amount that the plan becomes a net minus for the economy.

Not that any of this matters since I doubt we’ll get tax reform in my lifetime.

P.S. Speaking of taxes and the rich, you’ll enjoy this very clever interview exposing the hypocrisy of wealthy leftists.

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To make fun of big efforts that produce small results, the famous Roman poet, Horace, wrote “The mountains will be in labor, and a ridiculous mouse will be brought forth.”

That line sums up my view of the new tax reform plan introduced by Congressman Dave Camp, Chairman of the House Ways & Means Committee.

To his credit, Congressman Camp put in a lot of work. But I can’t help but wonder why he went through the time and trouble. To understand why I’m so underwhelmed, let’s first go back in time.

Back in 1995, tax reform was a hot issue. The House Majority Leader, Dick Armey, had proposed a flat tax. Congressman Billy Tauzin was pushing a version of a national sales tax. And there were several additional proposals jockeying for attention.

To make sense of this clutter, I wrote a paper for the Heritage Foundation that demonstrated how to grade the various proposals that had been proposed.

As you can see, I included obvious features such as low tax rates, simplicity, double taxation, and social engineering, but I also graded plans based on other features such as civil liberties, fairness, and downside risk.

Tax Reform Grading Matrix

There obviously have been many new plans since I wrote this paper, most notably the Fair Tax (a different version of a national sales tax than the Tauzin plan), Simpson-Bowles, the Ryan Roadmap, Domenici-Rivlin, the Heritage Foundation’s American Dream proposal, the Baucus-Hatch blank slate, and – as noted above – the new tax reform plan by Congressman Dave Camp.

Given his powerful position as head of the tax-writing committee, let’s use the 1995 guide to assess the pros and cons of Congressman Camp’s plan.

Rates: The Top tax rate for individual taxpayers is reduced from 39.6 percent to 35 percent, which is a disappointingly modest step in the right direction. The corporate tax rate falls from 35 percent to 25 percent, which is more praiseworthy, though Camp doesn’t explain why small businesses (who file using the individual income tax) should pay higher rates than large companies.

Simplicity: Camp claims that he will eliminate 25 percent of the tax code, which certainly is welcome news since the internal revenue code has swelled to 70,000-plus pages of loopholes, exemptions, deductions, credits, penalties, exclusions, preferences, and other distortions. And his proposal does eliminate some deductions, including the state and local tax deduction (which perversely rewards states with higher fiscal burdens).

Saving and Investment: Ever since Reagan slashed tax rates in the 1980s, the most anti-growth feature of the tax code is probably the pervasive double taxation of income that is saved and invested. Shockingly, the Camp plan worsens the tax treatment of capital, with higher taxation of dividends and capital gains and depreciation rules that are even more onerous than current law.

Social Engineering: Some of the worst distortions in the tax code are left in place, including the healthcare exclusion for almost all taxpayers. This means that people will continue to make economically irrational decisions solely to benefit from certain tax provisions.

Civil Liberties: The Camp plan does nothing to change the fact that the IRS has both the need and the power to collect massive amounts of private financial data from taxpayers. Nor does the proposal end the upside-down practice of making taxpayers prove their innocence in any dispute with the tax authorities.

Fairness: In a non-corrupt tax system, all income is taxed, but only one time. On this basis, the plan from the Ways & Means Chairman is difficult to assess. Loopholes are slightly reduced, but double taxation is worse, so it’s hard to say whether the system is more fair or less fair.

Risk: There is no value-added tax, which is a critically important feature of any tax reform plan. As such, there is no risk the Camp plan will become a Trojan Horse for a massive expansion in the fiscal burden.

Evasion: People are reluctant to comply with the tax system when rates are punitive and/or there’s a perception of rampant unfairness. It’s possible that the slightly lower statutory rates may improve incentives to obey the law, but that will be offset by the higher tax burden on saving and investment.

International Competitiveness: Reducing the corporate tax rate will help attract jobs and investment, and the plan also mitigates some of worst features of America’s “worldwide” tax regime.

Now that we’ve taken a broad look at the components of Congressman Camp’s plan, let’s look at a modified version of my 1995 grades.

Camp Tax Matrix

You can see why I’m underwhelmed by his proposal.

Congressman Camp’s proposal may be an improvement over the status quo, but my main reaction is “what’s the point?”

In other words, why go through months of hearings and set up all sorts of working groups, only to propose a timid plan?

Now, perhaps, readers will understand why I’m rather pessimistic about achieving real tax reform.

We know the right policies to fix the tax code.

And we have ready-made plans – such as the flat tax and national sales tax – that would achieve the goals of tax reform.

Camp’s plan, by contrast, simply rearranges the deck chairs on the Titanic.

P.S. If you need to be cheered up after reading all this, here’s some more IRS humor to brighten your day, including the IRS version of the quadratic formula, a new Obama 1040 form, a list of tax day tips from David Letterman, a cartoon ofhow GPS would work if operated by the IRS, an IRS-designed pencil sharpener, a sale on 1040-form toilet paper (a real product), and two songs about the tax agency (hereand here),  and a PG-13 joke about a Rabbi and an IRS agent.

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Back in the 1960s, Clint Eastwood starred in a movie entitled The Good, the Bad and the Ugly.

I was thinking that might be a good title for today’s post about some new research by Michelle Harding, a tax economist for the OECD. But then I realized that her study on “Taxation of Dividend, Interest, and Capital Gain Income” doesn’t contain any “good” news.

At least not if you want the United States to be more competitive and create more jobs. This is because the numbers show that the internal revenue code results in punitive double taxation of income that is saved and invested.

But it’s not newsworthy that there’s a lot of double taxation in America. What is shocking and discouraging, however, is finding out that our tax code is more punitive than just about every European welfare state.

This is the “bad” part of today’s discussion. Indeed, the tax burden on dividends, interest, and capital gains in America is far above the average for other industrialized nations.

Let’s look at some charts from the study, starting with the one comparing the tax burden on dividends.

OECD Study Dividend Tax Rates

As you can see, the United States has the dubious honor of having the sixth-highest overall tax rate (combined burden of corporate and personal taxes) among developed nations.

Though maybe we should feel lucky we’re not in France or Denmark.

The next chart looks at the tax burden on capital gains.

OECD Study Cap Gains Tax Rates

Once again, the United States has one of the most onerous tax systems among OECD countries, with only four other nations imposing a higher combined tax rate on capital gains.

By the way, if you want to know why this is a very bad idea, click here.

Last but not least, let’s look at the tax burden on interest.

OECD Study Interest Tax Rates

I’m sure you’ve already detected the pattern, but I’ll state the obvious that this is another example of the United States being on the wrong side of the graph.

So the next time you hear somebody bloviating about Americans being too short-sighted and not saving enough, you may want to inform them that there’s not much incentive to save when the IRS gets a big share of any interest we earn.

Not that any of us are getting much interest since the Fed’s easy-money policy has created an atmosphere of artificially low interest rates, but that’s a topic for another day.

Let’s now move to the “ugly” part of the analysis.

Some of you may have noticed that the charts replicated above are based on tax laws on July 1, 2012.

Well, thanks to Obamacare and the fiscal cliff deal, the IRS began imposing higher tax rates on dividends, capital gains, and interest on January 1, 2013.

And because of the new surtax on investments and the higher tax rates on dividends and capital gains, the United States will move even further in the wrong direction on the three charts.

I don’t know if that means we’ll overtake France in the contest to have the most anti-competitive tax treatment of dividends and capital gains, but it’s definitely bad news.

Oh, and let’s add another bit of “ugly” news to the discussion.

The OECD study didn’t look at death tax rates, but a study by the American Council for Capital Formation shows that the United States also has one of the world’s most punitive death taxes.

Even worse than France, Greece, and Venezuela, which is nothing to brag about.

I don’t want to be the bearer of nothing but bad news, so let’s close with some “good” news. At least relatively speaking.

It’s not part of the study, but it’s worth pointing out that the overall burden of taxation – measured as a share of GDP – is higher in most other nations. The absence of a value-added tax is probably the most important reason why the United States retains an advantage in this category.

Needless to say, this is why we should fight to our last breath to make sure this European version of a national sales tax is never imposed in America.

P.S. One of the big accounting firms, Ernst and Young, published some research last year that is very similar to the OECD’s data.

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I’m a big proponent of tax reform, so at first I was very excited to learn that Senators Max Baucus (D-MT) and Orrin Hatch (R-UT) were launching an effort to clean up the tax code.

But on closer inspection, I don’t think this will lead to a simple and fair system like the flat tax. Or even a national sales tax (assuming we could trust politicians not to pull a bait-and-switch, adding a new tax and never getting rid of the income tax).

But judge for yourself. Here’s some of what’s contained in a letter they sent to their colleagues, starting with some language about the growing complexity of the tax code and the compliance cost for taxpayers.

…since then, the economy has changed dramatically and Congress has made more than 15,000 changes to the tax code. The result is a tax base riddled with exclusions, deductions and credits. In addition, each year, it costs individuals and businesses more than $160 billion to comply with the tax code. The complexity, inefficiency and unfairness of the tax code are acting as a brake on our economy. We cannot afford to be complacent.

Sounds good, though they also could have mentioned other indicators of nightmarish complexity, such as the number of pages in the tax code, the number of special tax provisions, or the number of pages in the 1040 instruction manual.

I’m a bit mystified, however, at the low-ball estimate of $160 billion of compliance costs. As explained in this video, there are far higher estimates that are based on very sound methodology.

But perhaps I’m nit-picking. Let’s see with Senators Baucus and Hatch want to do.

In order to make sure that we end up with a simpler, more efficient and fairer tax code, we believe it is important to start with a “blank slate”—that is, a tax code without all of the special provisions in the form of exclusions, deductions and credits and other preferences that some refer to as “tax expenditures.”

I don’t like the term “tax expenditure” since it implies that the government taking money from person A and giving it to person B is equivalent to the government simply letting person B keep their own money. These two approaches may be economically equivalent in certain cases, but they’re not morally equivalent.

Once again, however, I may be guilty of nit-picking.

That being said, there is a feature of the “blank slate” approach which does generate legitimate angst. There’s a footnote in the letter that states that the Joint Committee on Taxation is in charge of determining so-called tax expenditures.

A complete list of these special tax provisions as defined by the non-partisan Joint Committee on Taxation.

This is very troubling. The JCT may be non-partisan, but it’s definitely not non-ideological. These are the bureaucrats, for instance, who assume that the revenue-maximizing tax rate is 100 percent! Moreover, the JCT uses the “Haig-Simons” tax system as a benchmark, which means they start with the assumption that there should be pervasive double taxation of income that is saved and invested.

This is not nit-picking. The definition of “tax expenditure” is a critical policy decision, not something to be ceded to the other side before the debate even begins.

As illustrated by this chart, the tax code is very biased against saving and investment.

Between the capital gains tax, the corporate income tax, the double tax on dividends, and the death tax, it’s possible for a single dollar of income to be taxed as many as four different times.

This is a very foolish policy, particularly since every school of thought in the economics profession agrees that capital formation is a key to long-run growth. Even the Marxists and socialists!

To make matters worse, double taxation puts America at competitive disadvantage. To get a sense of how the U.S. tax system is a self-inflicted wound, check out these sobering international comparisons of death tax burdens and the degree of double taxation of dividends and capital gains.

Here’s what the Haig-Simons tax base means.

1. An assumption that new business investment should be penalized with depreciation instead of being treated neutrally with expensing.

2. An assumption that IRAs and 401(k)s are loopholes to be eliminated, when they’re actually ways to protect against double taxation.

3. An assumption that various other forms of double taxation – such as the capital gains tax – should be retained.

But that’s not the only preemptive capitulation to bad policy.

The “blank slate” assumes that the class-warfare bias in the tax code also should be part of the benchmark against which possible reforms will be judged.

…we asked the nonpartisan Joint Committee on Taxation and Finance Committee tax staff to estimate the relationship between tax expenditures and the current tax rates if the current level of progressivity is maintained. …The blank slate approach would allow significant deficit reduction or rate reduction, while maintaining the current level of progressivity.

Since the internal revenue code already imposes a disproportionate burden on upper-income taxpayers – even when compared to European welfare states, it doesn’t make sense to automatically assume an ideological agenda such as progressivity.

This has been a very long answer to a simple question, but it’s very important to realize that tax reform is a three-legged stool. If we want to minimize the economic damage of generating revenue for government, we should have 1) a low tax rate, 2) no distorting tax preferences, and 3) no distorting tax penalties such as double taxation.

Unfortunately, too many people focus only on the first and second legs of the stool. And while tax rates and deductions are important, so is double taxation.

I’m not asserting that the “blank slate” should have assumed no double taxation (sometimes referred to as the “Fisher-Ture” tax base or “consumption” tax base).

But I don’t think it would have been unreasonable for Senators Baucus and Hatch to have told other Senators that one of their choices would be to pick either the Haig-Simons approach or the Fisher-Ture approach.

Heck, even the Congressional Budget Office acknowledged that there are two ways of measuring tax expenditures. To reiterate, the choice of tax base should be a policy decision, not a built-in assumption.

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As a long-time advocate of tax reform, I’m not a fan of distortionary loopholes in the tax code. Ideally, we would junk the 74,000-page internal revenue code and replace it with a simple and fair flat tax – meaning one low rate, no double taxation, and no favoritism.*

The right kind of tax reform would generate more growth and also reduce corruption in Washington. Politicians no longer would have the ability to create special tax breaks for well-connected contributors.

But we won’t get to the right destination if we have the wrong map, and this is why a new report about “tax expenditures” from the Congressional Budget Office is so disappointing.

As you can see from this excerpted table, CBO makes the same mistake as the Tax Policy Center and assumes that there should be double taxation of income that is saved and invested. As such, they list IRAs and 401(k)s as tax expenditures, even though those provisions merely enable people to avoid being double-taxed.

Likewise, the CBO report assumes that there should be double taxation of dividends and capital gains, so provisions to guard against such destructive policies also are listed as tax expenditures.

CBO Tax Expenditure List

The CBO report says that tax expenditures will total about $12 trillion over the next 10 years, but about one-third of that amount (which I’ve marked with a red X) don’t belong on the list.

By the way, at least the Tax Policy Center has an excuse for putting its thumb on the scale and issuing a flawed estimate of tax expenditures. It’s a project of the Brookings Institution and Urban Institute, both of which are on the left side of the political spectrum. So it’s hardly a surprise that they use a benchmark designed to promote punitive tax policy.

But what’s CBO’s excuse?

To be fair, at least CBO admitted in the report that there’s a different way of seeing the world.

…tax expenditures are measured relative to a comprehensive income tax system. If tax expenditures were evaluated relative to an alternative tax system—for instance, a comprehensive consumption tax, such as a national retail sales tax or a value-added tax—some of the 10 major tax expenditures analyzed here would not be considered tax expenditures. For example, because a consumption tax would exclude all savings and investment income from taxation, the exclusion of net pension contributions and earnings would be considered part of the normal tax system and not a tax expenditure.

But admitting the existence of another approach doesn’t let CBO off the hook. At the very least, the bureaucracy should have produced a a parallel set of estimates for tax expenditures assuming no double taxation. That basic competence and fairness.

By the way, the Government Accountability Office is worse than CBO. When GAO did a report on corporate tax expenditures, that bureaucracy didn’t even acknowledge that there was an alternate way of looking at the data.

*Actually, the ideal approach would be to dramatically reduce the burden of government spending, shrinking the size and scope of the federal government back to what the Founding Fathers had in mind. Under that system, there presumably wouldn’t be a need for any broad-based tax.

P.S. This new report is not even close to being the worst thing produced by CBO. The bureaucrats on several occasions have asserted that higher taxes are good for growth, even to the point of implying that the growth-maximizing tax rate is 100 percent! And CBO is slavishly devoted to Keynesian economics, notwithstanding several decades of evidence that you can’t make an economy richer by taking money out of one pocket and putting it in another pocket.

Yet for inexplicable reasons, Republicans failed to deal with CBO bias back when they were in charge.

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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.

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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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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My friends at Americans for Tax Reform have received a bunch of attention for a new report entitled “Win Olympic Gold, Pay the IRS.”

In this clever document, they reveal that athletes could face a tax bill – to those wonderful folks at the IRS – of nearly $9,000 thanks to America’s unfriendly worldwide tax system.

The topic is even getting attention overseas. Here’s an excerpt from a BBC report.

US medal-winning athletes at the Olympics have to pay tax on their prize money – something which is proving controversial in the US. But why are athletes from the US taxed when others are not? The US is right up there in the medals table, and has produced some of the finest displays in the Olympics so far. … But not everyone is happy to hear that their Olympic medal-winning athletes are being taxed on their medal prize money. Athletes are effectively being punished for their success, argues Florida Senator Marco Rubio, a Republican, who introduced a bill earlier this week that would eliminate tax on Olympic medals and prize money. …This, he said, is an example of the “madness” of the US tax system, which he called a “complicated and burdensome mess”.

It’s important to understand, though, that this isn’t a feel-good effort to create a special tax break. Instead, Senator Rubio is seeking to take a small step in the direction of better tax policy.

More specifically, he wants to move away from the current system of “worldwide” taxation and instead shift to “territorial” taxation, which is simply the common-sense notion of sovereignty applied to taxation. If income is earned inside a nation’s borders, that nation gets to decided how and when it is taxed.

In other words, if U.S. athletes earn income competing in the United Kingdom, it’s a matter for inland revenue, not the IRS.

Incidentally, both the flat tax and national sales tax are based on territorial taxation, and most other countries actually are ahead of the United States and use this approach. The BBC report has further details.

The Olympic example highlights what they regard as the underlying problem of the US’ so-called “worldwide” tax model. Under this system, earnings made by a US citizen abroad are liable for both local tax and US tax. Most countries in the world have a “territorial” system of tax and apply that tax just once – in the country where it is earned. With the Olympics taking place in London, the UK would, in theory, be entitled to claim tax on prize money paid to visiting athletes. But, as is standard practice for many international sporting events, it put in place a number of tax exemptions for competitors in the Olympics – including on any prize money. That means that only athletes from countries with a worldwide tax system on individual income are liable for tax on their medals. And there are only a handful of them in the world, says Daniel Mitchell, an expert on tax reform at the Cato Institute, a libertarian think tank – citing the Philippines and Eritrea as other examples. But with tax codes so notoriously complicated, unravelling which countries would apply this in the context of Olympic prize money is a tricky task, he says. Mitchell is a critic of the worldwide system, saying it effectively amounts to “double taxation” and leaves the US both at a competitive disadvantage, and as a bullyboy, on the world stage. “We are the 800lb (360kg) gorilla in the world economy, and we can bully other nations into helping enforce our bad tax law.”

To close out this discussion, statists prefer worldwide taxation because it undermines tax competition. This is because, under worldwide taxation, individuals and companies have no ability to escape high taxes by shifting activity to jurisdictions with better tax policy.

Indeed, this is why politicians from high-tax nations are so fixated on trying to shut down so-called tax havens. It’s difficult to enforce bad tax policy, after all, if some nations have strong human rights policies on privacy.

For all intents and purposes, a worldwide tax regime means the government gets a permanent and global claim on your income. And without having to worry about tax competition, that “claim” will get more onerous over time.

P.S. Just because a nation has a right to tax foreigners who earn income inside its borders, that doesn’t mean it’s a good idea to go overboard. The United Kingdom shows what happens if politicians get too greedy and Spain shows what happens if marginal tax rates are reasonable.

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Considering that every economic theory agrees that living standards and worker compensation are closely correlated with the amount of capital in an economy (this picture is a compelling illustration of the relationship), one would think that politicians – particularly those who say they want to improve wages – would be very anxious not to create tax penalties on saving and investment.

Yet the United States imposes very harsh tax burdens on capital formation, largely thanks to multiple layers of tax on income that is saved and invested.

But we compound the damage with very high tax rates, including the highest corporate tax burden in the developed world.

And the double taxation of dividends and capital gains is nearly the worst in the world (and will get even worse if Obama’s class-warfare proposals are approved).

To make matters worse, the United States also has one of the most onerous death taxes in the world. As you can see from this chart prepared by the Joint Economic Committee, it is more punitive than places such as Greece, France, and Venezuela.

Who would have ever thought that Russia would have the correct death tax rate, while the United States would have one of the world’s worst systems?

Fortunately, not all U.S. tax policies are this bad. Our taxation of labor income is generally not as bad as other industrialized nations. And the burden of government spending in the United States tends to be lower than European nations (though both Bush and Obama have undermined that advantage).

And if you look at broad measures of economic freedom, America tends to be in – or near – the top 10 (though that’s more a reflection of how bad other nations are).

But these mitigating factors don’t change the fact that the U.S. needlessly punishes saving and investment, and workers are the biggest victims. So let’s junk the internal revenue code and adopt a simple and fair flat tax.

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Mitt Romney is being criticized for supporting “territorial taxation,” which is the common-sense notion that each nation gets to control the taxation of economic activity inside its borders.

While promoting his own class-warfare agenda, President Obama recently condemned Romney’s approach. His views, unsurprisingly, were echoed in a New York Times editorial.

President Obama raised…his proposals for tax credits for manufacturers in the United States to encourage the creation of new jobs. He said this was greatly preferable to Mitt Romney’s support for a so-called territorial tax system, in which the overseas profits of American corporations would escape United States taxation altogether. It’s not surprising that large multinational corporations strongly support a territorial tax system, which, they say, would make them more competitive with foreign rivals. What they don’t say, and what Mr. Obama stressed, is that eliminating federal taxes on foreign profits would create a powerful incentive for companies to shift even more jobs and investment overseas — the opposite of what the economy needs.

Since even left-leaning economists generally agree that tax credits for manufacturers are ineffective gimmicks proposed for political purposes, let’s set that topic aside and focus on the issue of territorial taxation.

Or, to be more specific, let’s compare the proposed system of territorial taxation to the current system of “worldwide taxation.”

Worldwide taxation means that a company is taxed not only on it’s domestic earnings, but also on its foreign earnings. Yet the “foreign-source income” of U.S. companies is “domestic-source income” in the nations where those earnings are generated, so that income already is subject to tax by those other governments.

In other words, worldwide taxation results in a version of double taxation.

The U.S. system seeks to mitigate this bad effect by allowing American-based companies a “credit” for some of the taxes they pay to foreign governments, but that system is very incomplete.

And even if it worked perfectly, America’s high corporate tax rate still puts U.S. companies in a very disadvantageous position. If an American firm, Dutch firm, and Irish firm are competing for business in Ireland, the latter two only pay the 12.5 percent Irish corporate tax on any profits they earn. The U.S. company also pays that tax, but then also pays an additional 22.5 percent to the IRS (the 35 percent U.S. tax rate minus a credit for the 12.5 percent Irish tax).

In an attempt to deal with this self-imposed disadvantage, the U.S. tax system also has something called “deferral,” which allows American companies to delay the extra tax (though the Obama Administration has proposed to eliminate that provision!).

Romney is proposing to put American companies on a level playing field by going in the other direction. Instead of immediate worldwide taxation, as Obama wants, he wants to implement territorial taxation.

But what about the accusation from the New York Times that territorial taxation “would create a powerful incentive for companies to shift even more jobs and investment overseas”?

Well, they’re somewhat right…and they’re totally wrong. Here’s what I’ve said about that issue.

If a company can save money by building widgets in Ireland and selling them to the US market, then we shouldn’t be surprised that some of them will consider that option.  So does this mean the President’s proposal might save some American jobs? Definitely not. If deferral is curtailed, that may prevent an American company from taking advantage of a profitable opportunity to build a factory in some place like Ireland. But U.S. tax law does not constrain foreign companies operating in foreign countries. So there would be nothing to prevent a Dutch company from taking advantage of that profitable Irish opportunity. And since a foreign-based company can ship goods into the U.S. market under the same rules as a U.S. company’s foreign subsidiary, worldwide taxation does not insulate America from overseas competition. It simply means that foreign companies get the business and earn the profits.

To put it bluntly, America’s tax code is driving jobs and investment to other nations. America’s high corporate tax rate is a huge self-inflected wound for American competitiveness.

Getting rid of deferral doesn’t solve any problems, as I explain in this video. Indeed, Obama’s policy would make a bad system even worse.

But, it’s also important to admit that shifting to territorial taxation isn’t a complete solution. Yes, it will help American-based companies compete for market share abroad by creating a level playing field. But if policy makers want to make the United States a more attractive location for jobs and investment, then a big cut in the corporate tax rate should be the next step.

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It seems that there’s nothing but bad news coming from Europe. Whether we’re talking about fake austerity in the United Kingdom, confiscatory tax schemes in France, or bailouts in Greece, the continent seems to be a case study of failed statism.

But that’s not completely accurate. Every so often I highlight good news, such as Switzerland’s successful spending cap, Sweden’s shift to the right on spending, Germany’s wise decision not to be Keynesian, and Portugal’s admission that “stimulus” doesn’t work.

Admittedly, the good news from Europe is oftentimes merely the failure to do something bad. But I’ll take victories in any form.

And that’s why I’m happy that Austria and Luxembourg are blocking a misguided European Commission plan to undermine financial privacy in order to increase double taxation of income that is saved and invested.

Here are some cheerful passages from a story in the EU Observer.

“Completely unjustifiable … grossly unfair … a mystery” – the European Commission and the Danish EU presidency have given Austria and Luxembourg a tongue-lashing for protecting tax evaders. The harsh words came after the two countries on Tuesday (15 May) blocked the commission from holding talks with Switzerland on a new savings tax law designed to recoup some of the estimated €1 trillion a year lost to EU exchequers in tax fraud and evasion. Tax commissioner Algirdas Semeta in a press conference in Brussels said: “The position that Austria and Luxembourg have taken on this issue is grossly unfair. They are hindering 25 willing member states from improving tax compliance and finding additional sources of income.” …Danish economic affairs minister Margrethe Vestager took his side. “It is a mystery why we shouldn’t move on making people pay the taxes that they should pay,” she noted. She described Austria and Luxembourg’s decision as “unfortunate.” For their part, Luxembourg and Austria have declined to publicly explain why they are against the move. Semeta on Tuesday indicated they object to “automatic transfer” of tax data between EU countries and Switzerland, even though the alternative is trusting Switzerland to decide which data it gives and which it withholds. He added that automatic exchange is becoming the international gold standard in the field, with “the US moving in the same direction.”

The quote from the Danish economic affairs minister is especially nauseating. It’s not the “taxes that they should pay.” It’s the “taxes that greedy politicians demand.”

Good tax policy is predicated on the notion that there should not be a bias against income that is saved and invested. This is because double taxation undermines capital formation and thus reduces long-run growth.

Yet European politicians, like many of their American counterparts, are drawn to class warfare tax policy and can’t resist trying to penalize the “evil rich.”

So let’s tip our proverbial hats to Austria and Luxembourg. This is probably just a short-term victory over the unrelenting forces of statism, but let’s enjoy it while it lasts.

P.S. This European kerfuffle is a fight over tax competition vs. tax harmonization. To understand why financial privacy and fiscal sovereignty are desirable, watch the four-part video series at this post.

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A good tax system (like the flat tax) does not impose extra layers of tax on income that is saved and invested.

I’ve tried to emphasize this point with a flowchart, and I’ve defended so-called trickle-down economics, which is nothing more than the common-sense notion that investment boosts wages for workers by making them more productive.

But if you doubt this relationship, just take a look at this chart posted by Steve Landsburg.

(H/T: Cafe Hayek)

That’s an amazingly powerful relationship. Wages for workers are very much tied to the amount of capital that’s invested. In other words, capitalists are the best friends of workers.

Something to think about with the President proposing big increases in the double taxation of capital gains. And something to consider since he wants America to have the highest level of dividend double taxation in the industrialized world.

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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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I’ve already explained why Warren Buffett is either dishonest or clueless about tax policy. Today, on CNBC, I got to debate the tax scheme that President Obama has named after the Omaha investor.

One of my big points was that the United States already has a self-destructive set of tax laws for investment. As such, it would be very foolish to increase the double taxation of income that is saved and invested.

And my closing point, which I snuck in before they could go off air, was that the left should want lower tax rates if they want more revenue from the rich. It’s called the Laffer Curve.

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American companies are hindered by what is arguably the world’s most punitive corporate tax system. The federal corporate rate is 35 percent, which climbs to more than 39 percent when you add state corporate taxes. Among developed nations, only Japan is in the same ballpark, and that country is hardly a role model of economic dynamism.

But the tax rate is just one piece of the puzzle. It’s also critically important to look at the government’s definition of taxable income. If there are lots of corrupt loopholes – such as ethanol – that enable some income to escape taxation, then the “effective” tax rate might be rather modest.

On the other hand, if the government forces companies to overstate their income with policies such as worldwide taxation and depreciation, then the statutory tax rate understates the actual tax burden.

The U.S. tax system, as the chart suggests, is riddled with both types of provisions.

This information is important because there are good and not-so-good ways of lowering tax rates as part of corporate tax reform. If politicians decide to “pay for” lower rates by eliminating loopholes, that creates a win-win situation for the economy since the penalty on productive behavior is reduced and a tax preference that distorts economic choices is removed.

But if politicians “pay for” the lower rates by expanding the second layer of tax on U.S. companies competing in foreign markets or by changing depreciation rules to make firms pretend that investment expenditures are actually net income, then the reform is nothing but a re-shuffling of the deck chairs on the Titanic.

Now let’s look at President Obama’s plan for corporate tax reform.

*The good news is that he reduces the tax rate on companies from 35 percent to 28 percent (still more than 32 percent when state corporate taxes are added to the mix).

*The bad news is that he exacerbates the tax burden on new investment and increases the second layer of taxation imposed on American companies competing for market share overseas.

In other words, to paraphrase the Bible, the President giveth and the President taketh away.

This doesn’t mean the proposal would be a step in the wrong direction. There are some loopholes, properly understood, that are scaled back.

But when you add up all the pieces, it is largely a kiss-your-sister package. Some companies would come out ahead and others would lose.

Unfortunately, that’s not enough to measurably improve incomes for American workers. In a competitive global economy, where even Europe’s welfare states recognize reality and have lowered their corporate tax rates, on average, to 23 percent, the President’s proposal at best is a tiny step in the right direction.

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As discussed yesterday, the most important number in Obama’s budget is that the burden of government spending will be at least $2 trillion higher in 10 years if the President’s plan is enacted.

But there are also some very unsightly warts in the revenue portion of the President’s budget. Americans for Tax Reform has a good summary of the various tax hikes, most of which are based on punitive, class-warfare ideology.

In this post, I want to focus on the President’s proposals to increase both the capital gains tax rate and the tax rate on dividends.

Most of the discussion is focusing on the big increase in tax rates for 2013, particularly when you include the 3.8 tax on investment income that was part of Obamacare. If the President is successful, the tax on capital gains will climb from 15 percent this year to 23.8 percent next year, and the tax on dividends will skyrocket from 15 percent to 43.4 percent.

But these numbers understate the true burden because they don’t include the impact of double taxation, which exists when the government cycles some income through the tax code more than one time. As this chart illustrates, this means a much higher tax burden on income that is saved and invested.

The accounting firm of Ernst and Young just produced a report looking at actual tax rates on capital gains and dividends, once other layers of tax are included. The results are very sobering. The United States already has one of the most punitive tax regimes for saving and investment.

Looking at this first chart, it seems quite certain that we would have the worst system for dividends if Obama’s budget is enacted.

The good news, so to speak, is that we probably wouldn’t have the worst capital gains tax system if the President’s plan is enacted. I’m just guessing, but it looks like Italy (gee, what a role model) would still be higher.

Let’s now contemplate the potential impact of the President’s tax plan. I am dumbfounded that anybody could look at these charts and decide that America will be in better shape with higher tax rates on dividends and capital gains.

This isn’t just some abstract issue about competitiveness. As I explain in this video, every single economic theory – even Marxism and socialism – agrees that saving and investment are key for long-run growth and higher living standards.

So why is he doing this? I periodically run into people who are convinced that the President is deliberately trying to ruin the nation. I tell them this is nonsense and that there’s no reason to believe elaborate conspiracies.

President Obama is simply doing the same thing that President Bush did: Making bad decisions because of perceived short-run political advantage.

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Never let it be said I back down from a fight, even when it’s the other team’s game, played by the other team’s rules, and for the benefit of the wrong person.

And that definitely went through my mind when U.S. News & World Report asked me to contribute to their “Debate Club” on the topic of “Should Mitt Romney pay higher taxes?”

I’m not a Romney fan, and it irks me to defend good tax policy on behalf of someone who is incapable and/or unwilling to make the same principled arguments.

But my job is to do the right thing and bring truth to the economic heathens, so I agreed to participate. And I’m glad I did, because it gave me a chance to try out a new argument that I hope will educate more people about the perverse impact of double taxation.

Let me know what you think of this approach, which asks people whether they would think it would be fair if they couldn’t take credit for withheld taxes when filling out their 1040 tax return.

Capital gains taxes and dividend taxes are both forms of double taxation. That income already is hit by the 35 percent corporate income tax. So the real tax rate for people like Mitt Romney is closer to 45 percent. And if you add the death tax to the equation, the effective tax rate begins to approach 60 percent.  Here’s a simply analogy. Imagine you make $50,000 per year and your employer withholds $5,000 for personal income tax. How would you feel if the IRS then told you that your income was $45,000 and you had to pay full tax on that amount, and that you weren’t allowed to count the $5,000 withholding when you filled out your 1040 form? You would be outraged, correctly yelling and screaming that you should be allowed to count those withheld tax payments.  Welcome to the world of double taxation.

By the way, if you like my argument, feel free to vote for my entry, which you can do on this page.

I won my previous debate for U.S. News, so I’m hoping the keep a good thing going. As they say in Chicago, vote early and vote often.

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Last night’s GOP debate did nothing to change my sour opinion of Mitt Romney.

During a discussion about tax reform, he attacked Newt Gingrich for the supposed crime of not wanting to double tax capital gains. Here’s how Politico reported the exchange.

Newt Gingrich joked about Romney’s 15 percent tax rate, saying: “I’m prepared to describe my flat tax as the Mitt Romney flat tax.” Romney jumped in to ask: Do you tax capital gains at 15 percent or zero percent? Gingrich’s answer: Zero. “Under that plan, I’d have paid no taxes in the last two years,” Romney said, alluding to the fact that all his income is from investments.

Romney’s remarks are amazingly misguided. Getting rid of the capital gains tax doesn’t result in a tax rate of zero. It simply means that there is no second layer of tax on top of the punitive 35 percent corporate income tax.

I’ve had to correct Warren Buffett when he makes this mistake. One would think, though, that GOP presidential candidates would have a better understanding of taxation.

In addition to being wrong on policy, Romney also is politically tone deaf. By demagoguing against Gingrich’s tax plan, he lends credibility to the dishonest claims that his personal tax rate is “too low.”

In a column for today’s Wall Street Journal, John Berlau and Trey Kovacs of the Competitive Enterprise Institute explain how the GOP candidates should deal with this issue.

The former Bain Capital CEO and Massachusetts governor caused a brouhaha last week when he estimated the tax rate on his investment income at 15%. “How unfair!” pundits exclaimed, noting that the top marginal rate for wage income is more than 30%. The tax rate on investors is unfair, but for the opposite reason. Our tax code layers taxation of dividends and capital gains on top of a top corporate tax rate of 35%—which even President Obama acknowledges is one of the highest in the world. …This double taxation brings the effective tax rate on investment income to as much as 44.75%. In other words, after the combined top tax rates hit $100 of corporate income, $55.25 remains for the investor. And this figure doesn’t even include various state and local taxes, or the death tax. Moreover, like the rest of us, Mr. Romney paid income taxes before investing… Mr. Romney and other presidential candidates should use the opportunity of releasing their tax returns to make an important policy statement. They should include not only their individual returns, but information about the taxes their corporations pay. …In this way the candidates can help explode the myth of the U.S. as a low-tax nation. As Cato Institute tax experts Chris Edwards and Daniel J. Mitchell write in their book, “Global Tax Revolution,” while the U.S.’s “overall tax burden . . . is lower than in many other nations,” the country “imposes more punishing taxes on savings and investment than many advanced economies.” The most popular tax reforms—from the “9-9-9 plan” of former candidate Herman Cain to flat tax proposals—all have in common the reduction or elimination of double taxation on investment. …If the traditional disclosure of tax returns is elevated into a “teachable moment” about the burdens of double taxation, all Americans could be winners.

The authors are very kind to reference the book Chris and I wrote, but I mostly like this article because it does such a good job of explaining double taxation.

I made many of the same points in my video on capital gains taxation.

And keep in mind that the capital gains tax isn’t indexed for inflation, so the rate of double taxation in many cases is far higher than these estimates suggest.

As illustrated by this chart, double taxation is a serious self-inflicted barrier to American growth and competitiveness. Too bad Republicans are too short-sighted to address this issue intelligently.

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Since the Clinton Administration turned out to be much more market-oriented than either his GOP predecessor or successor, this isn’t quite a man-bites-dog story.

Nonetheless, it is still noteworthy that Elaine Kamarck, a high-level official from the Clinton White House, has a column on a left-of-center website arguing in favor of a pro-growth, supply-side corporate tax reform.

Here’s some of what she wrote.

Not only have the OECD countries reduced their corporate tax rates over the years to an average of 25 percent — members of the OECD are starting in on yet another round of cuts. Canada and Great Britain, two of our closest trading partners, are moving in this direction. America has the second highest corporate tax rate of any of the developed nations. We can’t sit by while our competition is changing. A 2008 report by economists at the OECD found that the corporate income tax is the most harmful tax for long-term economic growth. A 2010 World Bank study demonstrated that corporate tax rates have a “large and significant adverse” effect on investment. And investment and economic growth equals jobs. Wage data from 65 countries over 25 years shows that every one percent increase in corporate tax rates leads to a 0.5 to 0.6 percent decrease in wages.

There are things in the rest of the article that rub me the wrong way, but I agree with everything in the above passage, as I explain in this video.

The thing that’s most striking about Ms. Kamarck’s article is that she acknowledges the link between corporate tax rates and workers’ wages, thus agreeing with me – at least implicitly – about “trickle-down economics” and the deleterious impact of double taxation.

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Back in September, I posted a flowchart showing how the current tax system is biased against saving and investment.

Simply stated, the federal government largely leaves you unmolested if you consume your after-tax income, but there are as many as four extra layers of tax on income that is saved and invested (a point I also discuss in this video on the capital gains tax).

But it’s not sufficient to point out that the internal revenue code is biased against saving and investment. Over the years, I’ve had many debates and discussions with leftists, and their reactions range from glee (“good, we’re taxing the rich who have lots of wealth”) to boredom (“big deal” and “so what’s your point?”).

To help people understand why double taxation is misguided, it’s also necessary to explain how such policies undermine economic performance. I had a chance to briefly address this issue in a “Room for Debate” column for the New York Times. The main topic of the piece was how rich people who win lotteries should use their extra cash, and I used the opportunity to explain why the rest of us should want them to do more saving and investment.

…being good entrepreneurs and investors is the best way for rich people to help the rest of us. All economic theories, even Marxism and socialism, are based on the premise that capital formation is a key to economic growth and rising living standards. In other words, we need saving and investing to create the conditions for more jobs and rising wages. And since the world has learned that it’s not a good idea for the government to be in charge of such things, that means we rely on the private sector – including (gasp!) rich people – to set aside some of today’s income to finance tomorrow’s prosperity.

Statists call this “trickle-down economics,” which is an admittedly clever term of derision, but it doesn’t change reality. As I note in the excerpt, every single economic theory agrees that capital formation is necessary if we want more prosperity.

To provide a bit more elaboration, people generally get paid on the basis of what they produce. And workers are able to produce more when there is an increase in the quality and/or quantity of machinery, equipment, tools, and technology. These forms of capital are not the only things that matter, to be sure, but I’d be shocked to find an economist who disagreed with the premise that more saving and investment leads to higher productivity leads to higher wages.

Yet our tax code probably treats saving and investment worse than it treats tobacco. As I noted in 2009, this doesn’t make sense.

Politicians understand the economic impact of taxation when it serves their interests. They often brag about raising tobacco taxes to discourage smoking. It’s not their business to dictate private behavior, of course, but they are right about higher taxes leading to less smoking (they also lead to more cigarette smuggling, but that’s a separate issue). Those same politicians, however, conveniently forget about the economic effect of taxes when they impose high tax rates on work, saving, investment, and entrepreneurship. Or maybe they simply don’t care.

It’s pretty discouraging when you get to the point where the only possible interpretations of political behavior are stupidity or venality.

Or perhaps it’s a combination of both, as I explain in my video on class warfare.

P.S. I did explain to the readers of the New York Times that Obama’s policies are discouraging saving and investment, as illustrated by companies sitting on more than $1 trillion of cash and banks keeping more than $1 trillion of excess reserves at the Federal Reserve.

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Governor Rick Perry of Texas has announced a plan, which he outlines in today’s Wall Street Journal, to replace the corrupt and inefficient internal revenue code with a flat tax. Let’s review his proposal, using the principles of good tax policy as a benchmark.

1. Does the plan have a low, flat rate to minimize penalties on productive behavior?

Governor Perry is proposing an optional 20 percent tax rate. Combined with a very generous allowance (it appears that a family of four would not pay tax on the first $50,000 of income), this means the income tax will be only a modest burden for households. Most important, at least from an economic perspective, the 20-percent marginal tax rate will be much more conducive to entrepreneurship and hard work, giving people more incentive to create jobs and wealth.

2. Does the plan eliminate double taxation so there is no longer a tax bias against saving and investment?

The Perry flat tax gets rid of the death tax, the capital gains tax, and the double tax on dividends. This would significantly reduce the discriminatory and punitive treatment of income that is saved and invested (see this chart to understand why this is a serious problem in the current tax code). Since all economic theories – even socialism and Marxism – agree that capital formation is key for long-run growth and higher living standards, addressing the tax bias against saving and investment is one of the best features of Perry’s plan.

3. Does the plan get rid of deductions, preferences, exemptions, preferences, deductions, loopholes, credits, shelters, and other provisions that distort economic behavior?

A pure flat tax does not include any preferences or penalties. The goal is to leave people alone so they make decisions based on what makes economic sense rather than what reduces their tax liability. Unfortunately, this is one area where the Perry flat tax falls a bit short. His plan gets rid of lots of special favors in the tax code, but it would retain deductions (for those earning less than $500,000 yearly) for charitable contributions, home mortgage interest, and state and local taxes.

As a long-time advocate of a pure flat tax, I’m not happy that Perry has deviated from the ideal approach. But the perfect should not be the enemy of the very good. If implemented, his plan would dramatically boost economic performance and improve competitiveness.

That being said, there are some questions that need to be answered before giving a final grade to the plan. Based on Perry’s Wall Street Journal column and material from the campaign, here are some unknowns.

1. Is the double tax on interest eliminated?

A flat tax should get rid of all forms of double taxation. For all intents and purposes, a pure flat tax includes an unlimited and unrestricted IRA. You pay tax when you first earn your income, but the IRS shouldn’t get another bite of the apple simply because you save and invest your after-tax income. It’s not clear, though, whether the Perry plan eliminates the double tax on interest. Also, the Perry plan eliminates the double taxation of “qualified dividends,” but it’s not clear what that means.

2. Is the special tax preference for fringe benefits eliminated?

One of the best features of the flat tax is that it gets rid of the business deduction for fringe benefits such as health insurance. This special tax break has helped create a very inefficient healthcare system and a third-party payer crisis. It is unclear, though, whether this pernicious tax distortion is eliminated with the Perry flat tax.

3. How will the optional flat tax operate?

The Perry plan copies the Hong Kong system in that it allows people to choose whether to participate in the flat tax. This is attractive since it ensures that nobody can be disadvantaged, but how will it work? Can people switch back and forth every year? Is the optional system also available to all the small businesses that use the 1040 individual tax system to file their returns?

4. Will businesses be allowed to “expense” investment expenditures?

The current tax code penalizes new business investment by forcing companies to pretend that a substantial share of current-year investment outlays take place in the future. The government imposes this perverse policy in order to get more short-run revenue since companies are forced to artificially overstate current-year profits. A pure flat tax allows a business to “expense” the cost of business investments (just as they “expense” workers wages) for the simple reason that taxable income should be defined as total revenue minus total costs.

Depending on the answers to these questions, the grade for Perry’s flat tax could be as high as A- or as low as B. Regardless, it will be a radical improvement compared to the current tax system, which gets a D- (and that’s a very kind grade).

Here’s a brief video for those who want more information about the flat tax.

Last but not least, I’ve already receive several requests to comment on how Perry’s flat tax compares to Cain’s 9-9-9 plan.

At a conceptual level, the plans are quite similar. They both replace the discriminatory rate structure of the current system with a low rate. They both get rid of double taxation. And they both dramatically reduce corrupt loopholes and distortions when compared to the current tax code.

All things considered, though, I prefer the flat tax. The 9-9-9 plan combines a 9 percent flat tax with a 9 percent VAT and a 9 percent national sales tax, and I don’t trust that politicians will keep the rates at 9 percent.

The worst thing that can happen with a flat tax is that we degenerate back to the current system. The worst thing that happens with the 9-9-9 plan, as I explain in this video, is that politicians pull a bait-and-switch and America becomes Greece or France.

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Whether I’m criticizing Warren Buffett’s innumeracy or explaining how to identify illegitimate loopholes, I frequently write about the perverse impact of double taxation.

By this, I mean the tendency of politicians to impose multiple layers of taxation on income that is saved and invested. Examples of this self-destructive practice include the death tax, the capital gains tax, and the second layer of tax of dividends.

Double taxation is particularly foolish since every economic theory – including socialism and Marxism – agrees that capital formation is necessary for long-run growth and higher living standards.

Yet even though this is a critically important issue, I’ve never been satisfied with the way I explain the topic. But perhaps this flowchart makes everything easier to understand (click it for better resolution).

There are a lot of boxes, so it’s not a simple flowchart, but the underlying message hopefully is very clear.

1. We earn income.

2. We then pay tax on that income.

3. We then either consume our after-tax income, or we save and invest it.

4. If we consume our after-tax income, the government largely leaves us alone.

5. If we save and invest our after-tax income, the government penalizes us with as many as four layers of taxation.

You don’t have to be a wild-eyed supply-side economist to conclude that this heavy bias against saving and investment is not a good idea for America’s long-run prosperity.

By the way, Hong Kong’s simple and fair flat tax eliminate all those extra layers of taxation.

That’s the benefit of real tax reform such as a flat tax. You get a low tax rate, but you also get rid of double taxation so that the IRS only gets one bit at the apple.

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New Jersey gets abused by comedians as being some sort of dump, but there are some scenic parts of the state.

So it actually can be a nice place to live. That being said, it’s not a good place to die. Here’s a chart from the American Family Business Foundation that was featured in a recent Wall Street Journal editorial.

As you can see, New Jersey has the nation’s most punitive death tax. Most of the blame belongs to the 35 percent federal tax, but successful residents of the Garden State lose an additional 19 percent of their assets when they die. As the WSJ opined:

Here’s some free financial advice: Don’t die in New Jersey any time soon. If you have more than $675,000 to your name and you die in the Garden State, about 54% may go to the IRS and the tax collectors in Trenton. Better not take your last breath in Maryland either. The tax penalty for dying there is half of a lifetime’s savings. That’s the combined tab from the new federal estate tax rate of 35% and Maryland’s inheritance and death taxes. Maybe they should rename it the Not-So-Free State. …Family business owners, ranchers, farmers and wealthy retirees can avoid that tax by relocating to Arizona, Florida, Georgia, Idaho, South Carolina and other states that don’t impose inheritance taxes. There are plenty of attractive places to go. New research indicates that high state death taxes may be financially self-defeating. A 2011 study by the Ocean State Policy Research Institute, a think tank in Rhode Island, examined Census Bureau migration data and discovered that “from 1995 to 2007 Rhode Island collected $341.3 million from the estate tax while it lost $540 million in other taxes due to out-migration.” Not all of those people left because of taxes, but the study found evidence that “the most significant driver of out-migration is the estate tax.” After Florida eliminated its estate tax in 2004, there was a significant acceleration of exiles from Rhode Island to Florida.

At the risk of stating the obvious, the correct death tax rate is zero, as I’ve explained for USA Today. Indeed, I also cited evidence from Australia and the United States about how people will take extraordinary steps to avoid this wretched form of double taxation.

New Jersey has lots of problems. All of those problems will be easier to fix if successful people don’t leave the state. Sounds like another issue for Governor Christie to address.

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