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Posts Tagged ‘Flat Tax’

Some statements are so lame that they now serve only as punch lines.

Nobody, after all, would ever claim to a teacher that “the dog ate my homework.”

Moreover, surely few if any people ever actually assert to bill collectors that “the check is in the mail.”

And I have to imagine that no guy would be dumb enough to think a girl would fall for the line that “I’ll still love you in the morning.”

But we now have a new champion in the contest for the most laughable and pathetic assertion ever made.

But first some background. Congressional investigators have been trying to figure out the level of criminality and malfeasance in the IRS’s campaign to interfere with the 2012 election by targeting Tea Party groups. Much of the attention has focused on the activities of Lois Lerner, a left-wing ideologue at the center of the scandal.

And it is because of this investigation that we have a winner in the most-preposterous excuse contest. The political hacks at the IRS are now claiming, with straight faces, that they can’t turn over thousands of emails sent and received by Lois Lerner because of a “computer mishap.”

Here’s some of what’s been reported by the Washington Times.

The IRS has told Congress that it has lost some of former employee Lois G. Lerner’s emails from 2009 through 2011, including those she sent to other federal agencies… Rep. Dave Camp, chairman of the Ways and Means Committee, said he was stunned… “The fact that I am just learning about this, over a year into the investigation, is completely unacceptable and now calls into question the credibility of the IRS’s response to congressional inquiries,” Mr. Camp said. “There needs to be an immediate investigation and forensic audit by Department of Justice as well as the Inspector General.” …the emails lost were “critical years” from the beginning of the targeting of conservative groups.

At this point, I suppose I should acknowledge that there’s an infinitesimally tiny chance that the IRS is being honest. Maybe, just maybe, the IRS’s immense computer infrastructure and multiple levels of redundant back up happened to fail. And, by an amazing coincidence, they can recover everything except the emails from Lois Lerner that were sent at precisely the time she was instrumental in the IRS’s harassment campaign.

Yeah, right, there’s a chance the IRS is being honest. Just like the Nixon White House could have accidentally erased 18-1/2 minutes of tape.

That being said, there’s a chance I’ll be playing center field next month for the New York Yankees. And an even bigger chance that the models from Victoria’s Secret will invite me for a weekend orgy (and just in case the Princess of the Levant is reading this, I naturally would say no).

Let me now detour into the world of public policy.

The IRS’s venal and corrupt behavior is only possible because the tax code is a Byzantine nightmare of about 75,000 pages. And that doesn’t even include all the tax court decisions and IRS letter rulings that also govern the internal revenue code.

It is this thicket of special-interest sleaze that enables hacks like Lois Lerner to wield unjustified power.

So if we want to actually reduce the chances of similar malfeasance in the future, then action is needed.

But I’m not just talking about prison for the crooks who tried to misuse the power of government.

We also need to rip up the internal revenue code and replace it with a simple and fair flat tax.

As you can see in this video, I’m mostly a fan of tax reform because it will help the American economy. But I’m also delighted the flat tax will reduce the discretionary power of politicians and bureaucrats.

In the long run, of course, it would be even better if we shrank the federal government so much that we didn’t need any broad-based tax of any kind.

 

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I’m ecumenical on tax reform. I’ll support any plan that rips up the internal revenue code and instead lowers tax rates, reduces double taxation, and cuts out distorting loopholes.

And as I explain in this interview, both the flat tax and national sales tax have a low tax rate. They also get rid of double taxation and they both wipe out the rat’s nest of deductions, credits, exclusions, preferences, and exemptions.

You’ll notice, however, that I wasn’t very optimistic in the interview about the possibility of replacing the IRS with a simple and fair tax system.

But perhaps I’m being needlessly gloomy. New polling data from Reason-Rupe show that there’s very strong support for reform. At least if you favor a flat tax.

This doesn’t mean we can expect genuine tax reform tomorrow or the next day.

President Obama is viscerally committed to class-warfare tax policy, for instance, and special interest groups would vigorously resist if there was a real possibility (they would say threat) of scrapping the current tax code.

But it does suggest that tax reform – at least in the form of a flat tax – could happen if there was real leadership in Washington.

So maybe my fantasies will become reality!

And one of the best arguments for reform is that the internal revenue code is an unfair mess.

Consider how rich people are treated by the tax code. The system is so complicated that we can’t tell whether they’re paying too much (because of high rates and pervasive double taxation) or paying too little (because of special preferences and tax shelters).

Regardless, we do know that they can afford lots of lobbyists, lawyers, and accountants. So even though they are far more likely to be audited, they have ample ability to defend themselves.

But the real lesson, as I explain in this CNBC interview, is that the right kind of tax reform would lead to a simple system that treats everyone fairly.

I’m also glad I used the opportunity to grouse about the IRS getting politicized and corrupted.

But I wish there had been more time in the interview so I could have pointed out that IRS data reveal that you get a lot more revenue from the rich when tax rates are more reasonable.

And I also wish I had seen the Reason-Rupe poll so I could have bragged that there was strong support for a flat tax.

Unfortunately, I wouldn’t have been able to make the same claim about the national sales tax. I haven’t seen any recent public opinion data on the Fair Tax or other similar plans, but a poll from last year failed to find majority support for such a proposal.

And a Reason-Rupe poll from 2011 showed only 33 percent support for a national sales tax.

That won’t stop me from defending the national sales tax. After all, it is based on the same principles as a flat tax.

But the polls do suggest (as do anecdotes from the campaign trail) that a flat tax is a more politically viable option for reformers.

The moral of the story is that it makes more sense to push for the flat tax. After all, if I have an easy route and a hard route to get to the same destination, why make life more difficult?

Though the ultimate libertarian fantasy is shrinking government back to what the Founding Fathers had in mind. Then we wouldn’t need any broad-based tax of any kind.

P.S. Here’s my choice for the strangest-loophole award.

P.P.S. Since I shared a poll today with good news, I may as well link to a tax poll that left me somewhat depressed.

P.P.P.S. Let’s end with some IRS humor.

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I realize this may be a thought crime by DC standards, but it sure would be nice to eliminate the high tax rates that undermine economic growth and reduce American competitiveness.

At the risk of sharing too much information, I fantasize about a world without the internal revenue code. In addition to getting rid of high tax rates, I also want to abolish the pervasive double taxation of income that is saved and invested.

Tax Code PagesJust as important, I want to wipe out the distorting loopholes that tilt the playing field in favor of politically connected interest groups. And I daydream about how much easier tax day would be if ordinary people didn’t have to figure out how to comply with an ever-changing tax code.

But perhaps you’re a normal person and you don’t dwell on these topics. Your fantasies probably have nothing to do with fiscal policy and instead involve that hottie in your neighborhood.

That’s fine. I’m actually envious of well-adjusted people who don’t fixate on the cesspool of Washington.

But – at the very least – I want you to agree that America needs fundamental tax reform. And to help persuade you,  here are some fresh stories to remind you that the tax code and the IRS are a blight on society.

For instance, how do you feel about the IRS engaging in partisan politics, as reported by the Washington Times.

Even as the IRS faces growing heat over Lois G. Lerner and the tea party targeting scandal, a government watchdog said Wednesday it’s pursuing cases against three other tax agency employees and offices suspected of illegal political activity in support of President Obama and fellow Democrats. …the Office of Special Counsel…said it was “commonplace” in a Dallas IRS office for employees to have pro-Obama screensavers on their computers, and to have campaign-style buttons and stickers at their office. In another case, a worker at the tax agency’s customer help line urged taxpayers “to re-elect President Obama in 2012 by repeatedly reciting a chant based on the spelling of his last name,” the Office of Special Counsel said in a statement. …Another IRS employee in Kentucky has agreed to serve a 14-day suspension for blasting Republicans in a conversation with a taxpayer.

For more information about this nauseating scandal, read the wise words of Tim Carney and Doug Bandow.

Or what about the time, expense, and anxiety that the tax code causes for small businesses? Heck, even the Washington Post has noticed this is a big issue.

More than half of small employers say the administrative burdens and paperwork associated with tax season pose the greatest harm to their businesses, according to a new survey by the National Small Business Association. Forty-seven percent say the actual tax bill hits their companies the hardest. On average, small-business owners spend more than 40 hours — the equivalent of a full workweek — filing their federal taxes every year. One in four spends at least three full weeks on the annual chore. There is also the expense of doing that work. Only 12 percent of employers filed their taxes on their own this year, down from 15 percent last year — and hiring help can be pricey. Half spent more than $5,000 on accountants and administrative costs last year. One in four spent more than $10,000.

I was tempted to say compliance costs add insult to injury, except that understates the problem. Watch this video if you want to understand why the tax code needs to be junked.

And let’s not forget that high tax rates are pointlessly destructive and bad for America. Dozens of companies have redomiciled in other jurisdictions to get out from under America’s punitive corporate tax system. And more are looking at that option. Here are some excerpts from a report in the U.K.-based Financial Times.

Walgreens has come under pressure from an influential group of its shareholders, who want the US pharmacy chain to consider relocating to Europe, in what would be one of the largest tax inversions ever attempted. …The move, known as an inversion, would dramatically reduce Walgreens’ taxable income in the US, which has among the highest corporate tax rates in the world. …In a note last month, analysts at UBS said Walgreens’ tax rate was expected to be 37.5 per cent compared with 20 per cent for Boots, and that an inversion could increase earnings per share by 75 per cent. They added, however, that “Walgreens’ management seems more hesitant to pull the trigger near-term due to perceived political risks.”

By the way, “perceived political risks” is a polite way of saying that the team at Walgreens is worried that the company might be targeted by the crowd in Washington. In other words, it will be attacked if it does the right thing for workers, consumers, and shareholders.

But that’s blaming the victim. All you really need to know is that America’s corporate tax system is so harsh that companies don’t just escape to Ireland, Switzerland, the Cayman Islands, and Bermuda. They even find better fiscal policy in Canada and the United Kingdom!

Last but not least, do you trust the IRS with your confidential financial data? If you answer yes, seek help right away from a mental health professional and check out these stories.

According to the Washington Times:

A new cost-saving computer technology being implemented by the IRS has left the agency vulnerable to hacking, putting taxpayers’ info at risk, an investigative report has found. …although the IRS has developed cybersecurity guidelines, many of the servers aren’t following them, said a report by the agency’s internal watchdog, the Inspector General for Tax Administration. In fact, the servers failed 43 percent of the tests investigators put them through, though they aren’t releasing what those tests and settings are due to security concerns.

According to a Bloomberg report:

A U.S. Internal Revenue Service employee took home a computer thumb drive containing unencrypted data on 20,000 fellow workers, the agency said in a statement today. …The IRS said it’s working with its inspector general to investigate the incident. The IRS statement didn’t say why the incident was discovered now, didn’t include the name of the employee who used the thumb drive and didn’t say whether the employee still works at the IRS.

And National Review has reported:

The Internal Revenue Service stole and improperly accessed 60 million medical records after raiding a California company, according to a legal complaint filed in March with the California superior court for San Diego. …“No search warrant authorized the seizure of these records; no subpoena authorized the seizure of these records; none of the 10,000,000 Americans were under any kind of known criminal or civil investigation and their medical records had no relevance whatsoever to the IRS search.”

So what’s the bottom line? I suppose there are different interpretations, but my view is that the system is irretrievably broken. It needs to be shredded and replaced.

What are the options?

My real fantasy is to have a very small federal government. Then we wouldn’t need a broad-based tax of any kind.

But I also have incremental fantasies. Until we can shrink the federal government to its proper size, let’s at least figure out ways of collecting revenue that are much less destructive and much less unfair.

The flat tax is one possible answer.

I’m also a fan of the national sales tax, though only if we first amend the Constitution to ensure that politicians don’t pull a bait-and-switch and burden us with both an income tax and sales tax!

To be more specific, I’m a fan of the Fair Tax, but only if we make sure that politicians never again have the ability to impose an income tax.

P.S. Since we’re on the subject of taxes, folks in Northern New Jersey, Southern New York, and New York City may be interested in a tax symposium this Thursday at Ramapo College in Mahway, New Jersey. Along with several other speakers, I’ll be pontificating on the following question: “The Income Tax:
Necessary Evil, Or the Root of All Evil?”

The college is convenient to I-287 near the New York/New Jersey border. Say hello if you attend.

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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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Obamacare may not be good news for taxpayers or consumers, but let’s look at the bright side. At least the law has generated some superb political humor, including funny videos.

*The head of the National Socialist Workers Party finds out he can’t keep his health plan.

*A creepy version of Uncle Sam wants to know about your sex life.

*Young people discover that they’re screwed by Obamacare.

*One of the biggest statists of the 20th century is angry that the Obamacare exchanges don’t work.

We have another addition to this amusing collection. This cartoon video employs lots of snark to expose the illogical underpinnings of Obamacare.

My one complaint with this video, though, is that it merely scratches the surface.

Yes, Obamacare is a cluster-you-know-what, but there are many other government programs and policies that cause inefficiency and high costs

Here’s some of what I wrote on this topic back in 2009, starting with an explanation of how government intervention in the tax code has distorted the insurance market and turned it into an inefficient form of pre-paid healthcare.

Insurance is supposed to be for unforseen major expenses, such as a heart attack. But our gold-plated health plans now mean we use insurance for routine medical costs. This means, of course, we have the paperwork issues discussed above, but that’s just a small part of the problem. Even more problematic, our pre-paid health care system is somewhat akin to going to an all-you-can-eat restaurant. We have an incentive to over-consume since we’ve already paid. Except this analogy is insufficient. When we go to all-you-can-eat restaurants, at least we know we’re paying a certain amount of money for an unlimited amount of food. Many Americans, by contrast, have no idea how much of their compensation is being diverted to purchase health plans.

I then ask readers to contemplate what car insurance would look like if government also intervened in that market. Or to think about the consequences if insurance for houses also was subject to government-caused distortion.

Imagine if auto insurance worked this way? Or homeowner’s insurance? Would it make sense to file insurance forms to get an oil change? Or to buy a new couch? That sounds crazy. The system would be needlessly bureaucratic, and costs would rise because we would act like we were spending other people’s money.  But that’s what would probably happen if government intervened in the same way it does in the health-care sector.

The best way of fixing the mess in health insurance, for what it’s worth, is a flat tax. This is because the “healthcare exclusion” is repealed and compensation in the form of fringe benefits is taxed at the same (low) rate as other forms of income.

This presumably will end the incentive for gold-plated Cadillac health plans since workers – once the playing field is level – will prefer a greater amount cash compensation. So health plans gradually will be scaled back so they offer genuine insurance.

This video from the Center for Freedom and Prosperity offers a good explanation.

You also should watch this Reason TV video that shows a real-world example of how prices fall and the system is more efficient when consumers are in charge of healthcare.

For the same reason, I also recommend this story from North Carolina, as well as this example of capitalism from Maine.

It’s also worth noting that there are a few tiny parts of our healthcare system where markets are allowed to operate and consumers are in charge of spending their own money, and in these areas – such as cosmetic surgery, laser eye surgery, and abortion (regardless of whether you approve or disapprove) – we find stable prices and rising quality.

Free markets work…when they’re allowed to function.

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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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It’s not easy being a libertarian, particularly if you follow public policy.

Thomas Jefferson almost certainly was right when he wrote that “The natural progress of things is for liberty to yield, and government to gain ground.”

Heck, just look at how small government used to be in the developed world compared to where it is now. Public sectors used to consume only about 10 percent of economic output during the 1800s when nations became rich, but now the burden of government spending averages more than 40 percent of GDP.

And if you really want to get depressed, then look at the long-run fiscal forecasts for the United States and other industrialized countries. Things are going to get worse. Much worse.

Most nations are heading toward a Greek-style fiscal crisis. And while the United States is in better shape than many European welfare states today, our long-run outlook is actually worse according to the International Monetary Fund.

Even the Bank for International Settlements and Organization for Economic Cooperation and Development agree with the IMF’s grim prognosis.

Speaking of the IMF, let’s discuss some very bad news. It’s about Albania, so it may not seem very important, but it’s quite symbolic of the destructive impact of international bureaucracies.

As you can see from this Reuters report, the IMF basically bribed Albania to get rid of its flat tax.

“The IMF staff and the authorities reached an agreement on the IMF supporting their economic programme with financial assistance which could be delivered over a period of three years under an extended fund facility with access of about 300 million euros,” the IMF’s mission chief, Nadeem Ilahi, told reporters. …The three-month-old Socialist government will scrap a flat tax of 10 percent in the next fiscal year in January and raise the corporate tax to 15 percent from 10 percent. Also, the income tax for high-earners will rise to rates of 13 percent and 23 percent from 10 percent currently. …”The package of economic policies … supported by the IMF programme should make Albania an economy that is reforming, is open to foreign investors. … A lot of the reforms the authorities are planning are consistent with what the European Union has been asking for,” Ilahi said.

So think about what this means. The IMF is hurting global growth by distorting the allocation of capital. It’s hurting Albanian growth by enabling more government spending. And it’s hurting Albanian growth by forcing higher tax rates.

And then the IMF bureaucrat in charge, Mr. Ilahi, actually has the nerve to assert that all this bad policy will make Albania “open to foreign investors.” Yeah, sure. Investors are always flocking to nations that are actively increasing the burden of government. I guess that’s why France is such an economic dynamo and Hong Kong is suffering from stagnation…at least according to the IMF model anyway.

Keep in mind, by the way, that Mr. Ilahi (like all international bureaucrats) gets a tax-free salary! So I guess we shouldn’t be too surprised that he is completely clueless about the real-world impact on the destructive policies he has foisted upon Albania.

By the way, Albanian politicians are not exactly blameless. They doubled government spending over the past 10 years, with outlays climbing from less than 200 million leks in 2003 to more than 400 million leks this year.

And then these profligate politicians decided to throw their taxpayers under the bus in exchange for a pile of additional loot from the IMF.

The real victims are the people of Albania. They suffered decades of communist enslavement. But even after the collapse of the Soviet Empire, they’ve never enjoyed a free-market, small-government economy. But with the flat tax, they had at least one pro-growth policy.

Now they don’t even have that.

P.S. The IMF is an equal-opportunity proponent of bad policy. The tax-free bureaucrats have advocated lots of tax hikes on Americans, including a value-added tax, a financial transactions tax, and class-warfare tax rate increases. Oh, and let’s not forget they urged a giant energy tax on American consumers. IMF KevorkianIt’s nice to know that the bureaucrats are so industrious at developing policies to hurt the United States when American taxpayers underwrite the biggest share of the IMF budget.

P.P.S. But I don’t want to be unfair. The IMF did provide – albeit by accident – very powerful evidence showing why the United States should not have a value-added tax. So I guess that was one useful thing the bureaucrats did, even if it wasn’t their intention. And the bureaucracy has published some good studies about the economic benefits of reducing government spending and others warning that tax increases can be self defeating.

P.P.P.S. Since this has been a depressing post, let’s close by noting that the IMF doesn’t always succeed. The bureaucrats unsuccessfully tried to pressure Latvia into abandoning the flat tax.

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There’s an off-year election today in the United States. There are no contests for the White House or Congress, but that doesn’t mean there aren’t any important choices being made.

I say that notwithstanding the fact that the big races between politicians at the state and local level aren’t expected to be close.

Governor Christie in New Jersey is poised for a landslide victory in his race for a second term. The only interesting aspect of this race is whether he will use his reelection as a springboard for a run at the White House in 2016. That may please you, depending on whether you focus on his rhetoric (here and here) or his record (here and here).

Bill de Blasio is going to be elected Mayor of New York City, replacing a politically correct Napoleonic busy-body (see here, here, here, here, and here) with a hard-left statist. I expect many productive people will be fleeing in the next few years. Given what will happen, I suspect Detroit-on-the-Hudson will be the future name of NYC.

Terry McAuliffe, a former Clinton fundraiser, will probably become Governor of Virginia. The GOP in the state has been dispirited and weak every since the corrupt Republican governor imposed a big tax hike, though the GOP candidate has a slight chance for an upset because of growing anti-Obamacare sentiment.

The contest that should command our attention is Amendment 66 in Colorado, a ballot initiative that would eliminate the state’s 4.63 percent flat tax and replace it with a so-called progressive tax regime with rates of 5 percent and 5.9 percent.

Here’s how the Wall Street Journal describes the proposal.

Colorado has veered to the political left in recent years, and on November 5 it may take another leap toward California. The Democrats and unions who now run state government are promoting a ballot initiative that would raise taxes and unleash a brave new era of liberal governance. …a $950 million revenue increase for politicians in the first year alone.

The real problem is what happens once the flat tax is gutted and politicians can play divide and conquer with the tax code.

…the real prize is down the road. Once a graduated tax code is in place, unions and Democrats will try again and again to raise tax rates on “the rich.” This has happened everywhere Democrats have run the show in the last decade, from Maryland to Connecticut, New York, Oregon and California. Within a decade, the top tax rate will be closer to 8% or 9%.  …that won’t make the state any more competitive in its interior U.S. neighborhood, where states like Kansas and Oklahoma are cutting tax rates. High-tax states created one net new job for every four in states without an income tax from 2002-2012, according to a study for the American Legislative Exchange Council.

So which side will win this vote?

As recently as 2011, Colorado voters voted down a state sales and income-tax increase, but the unions keep coming. And it’s no surprise they’ve already put $2 million behind Amendment 66. If it passes, they know they’ll get a big return on that political investment for decades to come. If it does pass, we’ll also know that millions of Coloradans have taken to smoking that marijuana they legalized last year.

Hmmm…that’s probably the strongest argument I’ve heard in favor of drug prohibition.

For what it’s worth, I’m predicting Colorado voters will reject this foolish class warfare scheme. Jerry Brown Promised LandThough I realize that may be a foolish guess. After all, 54 percent of crazy Oregon voters approved a tax hike in 2010 and their southern neighbors in the suicidal state of California voted by a similar margin for a class-warfare tax hike in 2012.

I’d feel a lot more confident, however, if we could replace Colorado’s voters with some sensible people from Switzerland. When faced with a class-warfare tax hike referendum in 2010, they voted against it by a very strong 58.5-41.5 margin.

And it was Swiss voters who overwhelmingly voted (84.7 percent) for the “debt brake” in 2001. And as I noted just yesterday, that de facto spending cap has been quite effective in controlling the burden of government spending.

Anyhow, if you know any Colorado voters, you may want to send them this video.

Regardless of how they vote, they should understand the potential consequences if Amendment 66 is approved.

P.S. Some Colorado voters just made a very sensible decision to defend the Second Amendment, but it’s unclear whether they have a similar attitude about economic liberty.

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I shared a presidential debate fantasy in 2012 and a Texas sovereignty fantasy in 2011, and I even shared a fantasy two years ago involving about 50 percent of the population.

None of those fantasies have become reality, and I suspect that the message of this Branco cartoon also is an unattainable fantasy.

Flat Tax Crisis

Simply stated, a flat tax would be a wonderful outcome to this latest IRS scandal. But for reasons I’ve already explained, I’m not holding my breath waiting for that to happen, either now or in the future.

Doesn’t mean I’ll give up on the fight for tax reform, but I always try to be realistic.

P.S. I’ve already confessed that I have very abnormal fantasies. And I have admitted on TV that my fantasies are rarely fulfilled.

P.P.S. There is such a thing as a libertarian-specific fantasy.

P.P.P.S. For fans of the national sales tax, I’d also be delighted to get something like the Fair Tax (as you can tell from my position in this debate), but I think a national sales tax faces even greater uphill odds than a flat tax.

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Did President Obama and his team of Chicago cronies deliberately target the Tea Party in hopes of thwarting free speech and political participation?

Was this part of a campaign to win the 2012 election by suppressing Republican votes?

Perhaps, but I’ve warned that it’s never a good idea to assume top-down conspiracies when corruption, incompetence, politics, ideology, greed, and self-interest are better explanations for what happens in Washington.

Writing for the Washington Examiner, Tim Carney has a much more sober and realistic explanation of what happened at the IRS.

If you take a group of Democrats who are also unionized government employees, and put them in charge of policing political speech, it doesn’t matter how professional and well-intentioned they are. The result will be much like the debacle in the Cincinnati office of the IRS. …there’s no reason to even posit evil intent by the IRS officials who formulated, approved or executed the inappropriate guidelines for picking groups to scrutinize most closely. …The public servants figuring out which groups qualified for 501(c)4 “social welfare” non-profit status were mostly Democrats surrounded by mostly Democrats. …In the 2012 election, every donation traceable to this office went to President Obama or liberal Sen. Sherrod Brown. This is an environment where even those trying to be fair could develop a disproportionate distrust of the Tea Party. One IRS worker — a member of NTEU and contributor to its PAC, which gives 96 percent of its money to Democratic candidates — explained it this way: “The reason NTEU mostly supports Democratic candidates for office is because Democratic candidates are mostly more supportive of civil servants/government employees.”

Tim concludes with a wise observation.

As long as we have a civil service workforce that leans Left, and as long as we have an income tax system that requires the IRS to police political speech, conservative groups can always expect special IRS scrutiny.

And my colleague Doug Bandow, in an article for the American Spectator, adds his sage analysis.

The real issue is the expansive, expensive bureaucratic state and its inherent threat to any system of limited government, rule of law, and individual liberty. …the broader the government’s authority, the greater its need for revenue, the wider its enforcement power, the more expansive the bureaucracy’s discretion, the increasingly important the battle for political control, and the more bitter the partisan fight, the more likely government officials will abuse their positions, violate rules, laws, and Constitution, and sacrifice people’s liberties. The blame falls squarely on Congress, not the IRS.

I actually think he is letting the IRS off the hook too easily.

But Doug’s overall point obviously is true.

…the denizens of Capitol Hill also have created a tax code marked by outrageous complexity, special interest electioneering, and systematic social engineering. Legislators have intentionally created avenues for tax avoidance to win votes, and then complained about widespread tax avoidance to win votes.

So what’s the answer?

The most obvious response to the scandal — beyond punishing anyone who violated the law — is tax reform. Implement a flat tax and you’d still have an IRS, but the income tax would be less complex, there would be fewer “preferences” for the agency to police, and rates would be lower, leaving taxpayers with less incentive for aggressive tax avoidance. …Failing to address the broader underlying factors also would merely set the stage for a repeat performance in some form a few years hence. …More fundamentally, government, and especially the national government, should do less. Efficient social engineering may be slightly better than inefficient social engineering, but no social engineering would be far better.

Amen. Let’s rip out the internal revenue code and replace it with a simple and fair flat tax.

But here’s the challenge. We know the solution, but it will be almost impossible to implement good policy unless we figure out some way to restrain the spending side of the fiscal ledger.

At the risk of over-simplifying, we will never get tax reform unless we figure out how to implement entitlement reform.

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I joked back in 2010 that Barack Obama had a very simple flat tax proposal.

But as you can see, sometimes simple isn’t the same as good.

Well, satire too often becomes reality in a world of greedy and corrupt politicians who think class-warfare is an acceptable guide to tax policy.

I say this because thousands of French taxpayers now are being subject to this satirical Obama flat tax.

Here are some of the grotesque details from a Reuters report.

More than 8,000 French households’ tax bills topped 100 percent of their income last year, the business newspaper Les Echos reported on Saturday, citing Finance Ministry data. …President Francois Hollande’s Socialist government imposed the tax surcharge last year, shortly after taking office… The government has been forced to redraft a proposed bill to levy a temporary 75 percent tax on earnings over 1 million euros, which had been one of Hollande’s campaign pledges. …Since then, a top administrative court has determined that a marginal tax rate higher than 66.66 percent on a single household risked being considered as confiscatory by the council.

Ironically, President Hollande already made a commitment that no taxpayers should have to surrender more than 80 percent of their incomes, but I guess that promise didn’t mean much.

After all, this is the guy who equates higher taxes with patriotism.

No wonder successful people are fleeing the country.

If you want to understand real tax reform, click here.

And here’s my video describing why the right kind of flat tax is a good idea.

This topic is particularly meaningful to me since I’m in the middle of the Free Market Road Show and I’ve been five flat tax nations – Bulgaria, Romania, Kosovo, Macedonia, and Albania – in the past 36 hours.

Too bad there’s little reason to hope that America will ever be part of the flat tax club.

P.S. I guess it’s good that the French court thinks that a 66.66 percent tax is “confiscatory.” But isn’t that true of any tax – at any rate – that is used to fund illegitimate activities?

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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 a simple system in America's future

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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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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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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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. Tax reform interest ratesThey 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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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.

Charity Giving USAHere’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.

CBO Charitable givingYet 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.

Charity JCTI’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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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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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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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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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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I’m a big fan of fundamental tax reform, in part because I believe in fairness and want to reduce corruption.

But I also think the flat tax will boost the economy’s performance, largely because lower tax rates are the key to good tax policy.

There are four basic reasons that I cite when explaining why lower rates improve growth.

  1. They lower the price of work and production compared to leisure.
  2. They lower the price of saving and investment relative to consumption.
  3. They increase the incentive to use resources efficiently rather than seek out loopholes.
  4. They attract jobs and investment from other nations.

As you can see, there’s nothing surprising or unusual on my list. Just basic microeconomic analysis.

Yet some people argue that lower tax rates don’t make a difference. And if lower tax rates don’t help an economy, then presumably there is no downside if Obama’s class-warfare tax policy is implemented.

Many of these people are citing David Leonhardt’s column in Saturday’s New York Times. The basic argument is that Bush cut tax rates, but the economy stunk, while Clinton increased tax rates and the economy did well.

The defining economic policy of the last decade, of course, was the Bush tax cuts. President George W. Bush and Congress, including Mr. Ryan, passed a large tax cut in 2001, sped up its implementation in 2003 and predicted that prosperity would follow. The economic growth that actually followed — indeed, the whole history of the last 20 years — offers one of the most serious challenges to modern conservatism. Bill Clinton and the elder George Bush both raised taxes in the early 1990s, and conservatives predicted disaster. Instead, the economy boomed, and incomes grew at their fastest pace since the 1960s. Then came the younger Mr. Bush, the tax cuts, the disappointing expansion and the worst downturn since the Depression. Today, Mitt Romney and Mr. Ryan are promising another cut in tax rates and again predicting that good times will follow. …Mr. Romney and Mr. Ryan would do voters a service by explaining why a cut in tax rates would work better this time than last time.

While I’ll explain below why I think he’s wrong, Leonhardt’s column is reasonably fair. He gives some space to both Glenn Hubbard and Phil Swagel, both of whom make good points.

“To me, the Bush tax cuts get too much attention,” said R. Glenn Hubbard, who helped design them as the chairman of Mr. Bush’s Council of Economic Advisers and is now a Romney adviser. “The pro-growth elements of the tax cuts were fairly modest in size,” he added, because they also included politically minded cuts like the child tax credit. Phillip L. Swagel, another former Bush aide, said that even a tax cut as large as Mr. Bush’s “doesn’t translate quickly into higher growth.” Why not? The main economic argument for tax cuts is simple enough. In the short term, they put money in people’s pockets. Longer term, people will presumably work harder if they keep more of the next dollar they earn. They will work more hours or expand their small business. This argument dominates the political debate.

I hope, by the way, that neither Hubbard nor Swagel made the Keynesian argument that tax cuts are pro-growth because “they put money in people’s pockets.” Leonhardt doesn’t directly attribute that argument to either of them, so I hope they’re only guilty of proximity to flawed thinking.

But that’s besides the point. Several people have asked my reaction to the column, so it’s time to recycle something I wrote back in February. It was about whether a nation should reform its tax system, but the arguments are the same if we replace “a flat tax” with “lower tax rates.”

…even though I’m a big advocate for better tax policy, the lesson from the Economic Freedom of the World Index…is that adopting a flat tax won’t solve a nation’s economic problems if politicians are doing the wrong thing in other areas.

There are five major policy areas, each of which counts for 20 percent of a nation’s grade.

  1. Size of government
  2. Regulation
  3. Monetary Policy
  4. Trade
  5. Rule of Law/Property Rights

Now let’s pick Ukraine as an example. As a proponent of tax reform, I like that lawmakers have implemented a 15 percent flat tax.

But that doesn’t mean Ukraine is a role model. When looking at the mix of all policies, the country gets a very poor score from Economic Freedom of the World Index, ranking 125 out of 141 nations.

Conversely, Denmark has a very bad tax system, but it has very free market policies in other areas, so it ranks 15 out of 141 countries.

In other words, tax policy isn’t some sort of magical elixir. The “size of government” variable accounts for just one-fifth on a country’s grade, and keep in mind that this also includes key sub-variables such as the burden of government spending.

Yes, lower tax rates are better for economic performance, just as wheels matter for a car’s performance. But if a car doesn’t have an engine, transmission, steering wheel, and brakes, it’s not going to matter how nice the wheels are.

Not let’s shift from theory to reality. Here’s the historical data for the United States from Economic Freedom of the World. As you can see, overall economic policy moved in the right direction during the Clinton years and in the wrong direction during the Bush-Obama years.

To be more specific, the bad policy of higher tax rates in the 1990s was more than offset by good reforms such as lower trade barriers, a lower burden of government spending, and less regulation.

Similarly, the good policy of lower tax rates last decade was more than offset by bad developments such as a doubling of the federal budget, imposition of costly regulations, and adoption of two new health entitlements.

This is why I have repeatedly challenged leftists by stating that I would be willing to go back to Bill Clinton’s tax rates if it meant I could also go back to the much lower levels of spending and regulation that existed when he left office.

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I periodically mock Republicans for being the stupid party. Yes, some of them probably mean well, but they have this lemming-like instinct to throw themselves on hand grenades.

But I noted back in April that the supposedly right-wing Christian Democrat party in Slovakia put on a display of stupidity that was so mind-boggling that it made GOPers look like rocket scientists.

Notwithstanding their original protestations to the contrary, the Christian Democrats (who were the lead party in the governing coalition) decided to support the bailout of Greece.

And when Slovakia’s pro-freedom SAS Party (part of the governing coalition) refused to support this terrible idea, the top Christian Democrat politicians decided that the bailout was so important that they struck a deal with the Social Democrats to get their votes in exchange for early elections.

Which, of course, meant that Social Democrats prevailed and the Christian Democrats lost power. And, much to my dismay, the Social Democrats are now poised to repeal the flat tax.

But that terrible development is only happening because the Christian Democrats were so breathtakingly stupid that they threw away power in the first place. And they gave up power so they could do something bad for Slovakia. Amazing.

It seems stupidity is infectious, because something similar is now happening next door in the Czech Republic.

Just as was the case in Slovakia, there’s a supposedly right-wing government in charge of the Czech Republic. So you would think that this government would be focused on controlling spending and lowering tax rates.

But that’s based on the assumption of competence, intelligence, and principles. Those characteristics seem to be in short supply. Here’s an excerpt from a report in the Washington Post.

The lower house on Wednesday rejected a 1 percent increase in the sales tax on retail goods and a 7 percent income tax increase for the highest-earners. The parliamentary refusal came after six lawmakers from the conservative Civic Democratic Party of Prime Minister Petr Necas voted against because they said the tax hikes are against their party’s values. Necas said Thursday a new vote should take place in three months and the government is linking it to a confidence vote. If that vote also fails, the coalition government will fall.

Just in case you’re not familiar with the workings of parliamentary systems, the Prime Minister of the Czech Republic is throwing a tantrum and threatening to have an election (which he almost certainly will lose) and turn the country back over to the leftists.

“Read my lips, let’s screw the people”

Unless, of course, he can convince a handful of principled lawmakers from his own party decide to stab taxpayers in the back and support a big tax hike. But not just a big tax hike. The Prime Minister wants to get rid of the flat tax by imposing a special, Obama-style class-warfare tax rate on the so-called rich.

I hope the six lawmakers mentioned in the news report hold firm, even if they’re only doing the right thing for non-principled reasons. It soon will be very obvious that they are/were on the side of the angels and that the Prime Minister and the other members of the party are a bunch of hacks who are willing to screw taxpayers in a lame and pathetic effort to buy votes with other people’s money.

I’m not sure which politician is most deserving of scorn. Is it Prime Minister Necas, who is channeling the spirit of George H.W. “read my lips” Bush as he leads his party over the cliff? Or is it Prime Minister Radicova of Slovakia, who got her party tossed from power because she decided her nation’s taxpayers should support the corrupt vote-buying schemes of Greek politicians?

Or maybe I should augment the list by including other supposed right wingers of Europe, such as Sarkozy, Merkel, Cameron, and Rajoy, all of whom seem to specialize in betraying taxpayers.

I’ve had friends tell me that this is inevitable because smart right wingers go into business, leaving the dregs for politics. It’s just the opposite for the left, they say. The smart leftists have no desire to dirty their hands with real work (Obama viewed his tiny bit of experience with the private sector “working for the enemy”), so they gravitate to government.

I think that’s way too simplistic of an explanation. I suspect the answer can be found in the insights of public choice economics, which explains that government and politics are corrupting institutions.

Perhaps that’s why it is so rare to find right-wing politicians – such as Reagan and Thatcher – who generally do the right thing.

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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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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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I have great fondness for Estonia, in part because it was the first post-communist nation to adopt the flat tax, but also because of the country’s remarkable scenery.

Most recently, though, I’ve been bragging about Estonia (along with Latvia and Lithuania, the other two Baltic nations) for implementing genuine spending cuts. I’ve argued that Estonia is showing how a government can reignite growth by reducing the burden of government.

Not surprisingly, some people disagree with my analysis. Paul Krugman of the New York Times criticized Estonia yesterday, writing that the Baltic nation suffered a “Depression-level slump” in 2008 and has only managed an “incomplete recovery” over the past few years.

He blames this supposedly weak performance on “austerity.”

I have a positive and negative reaction to Krugman’s post. My positive reaction is that he’s talking about a nation that actually has cut spending, so there’s real public-sector austerity (see Veronique de Rugy’s L.A. Times column to understand the critical difference between public-sector and private-sector austerity).

This is a sign of progress. In the past, he launched a silly attack on the U.K. for a “government pullback” that never happened, so what he wrote about Estonia at least is based on real events.

My negative reaction is that Krugman is very guilty of cherry-picking data. If you look at the chart that accompanies his post, Estonia’s economic performance isn’t very impressive, but that’s because he’s only showing us the data from 2007-present.

The numbers are accurate, but they’re designed to mislead rather than inform (sort of as if I did a chart showing 2009-present).

But before exposing that bit of trickery, there’s another mistake worth noting. Krugman presumably wants us to think that the downturn coincided with spending cuts. But his own chart shows that the economy hit the skids in 2008 – a year in which  government spending in Estonia soared by nearly 18 percent according to EU fiscal data!

It wasn’t until 2009 that Estonian lawmakers began to reduce the burden of spending. So I guess Professor Krugman wants us to believe that the economy tanked in 2008 because of expectations of 2009 austerity. Or something like that.

Returning now to my complaint about cherry picking data, Krugman makes Estonia seem stagnant by looking only at data starting in 2007. But as you can see from this second chart, Estonia’s long-run economic performance is quite exemplary. It has doubled its economic output in just 15 years according to the International Monetary Fund. Over that entire period – including the recent downturn, it has enjoyed one of the fastest growth rates in Europe.

This doesn’t mean Estonia is perfect. It did experience a credit/real estate bubble, and there was a deep recession when the bubble burst. And the politicians let government spending explode during the bubble years, almost doubling the budget between 2004 and 2008.

But Estonia reacted to the overspending and the downturn in a very responsible fashion. Instead of using the weak economy as an excuse to further expand the burden of government spending in hopes that Keynesian economics would magically work (after failing for Hoover and Roosevelt in the 1930s, Japan in the 1990s, Bush in 2008, and Obama in 2009), the Estonians realized that they needed to cut spending.

And now that spending has been curtailed, it’s worth noting that growth has resumed.

What makes Krugman’s rant especially amusing is that he wrote it just as the rest of the world is beginning to notice that Estonia is a role model. Here’s some of what CNBC just posted.

Sixteen months after it joined the struggling currency bloc, Estonia is booming. The economy grew 7.6 percent last year, five times the euro-zone average. Estonia is the only euro-zone country with a budget surplus. National debt is just 6 percent of GDP, compared to 81 percent in virtuous Germany, or 165 percent in Greece. Shoppers throng Nordic design shops and cool new restaurants in Tallinn, the medieval capital, and cutting-edge tech firms complain they can’t find people to fill their job vacancies. It all seems a long way from the gloom elsewhere in Europe. Estonia’s achievement is all the more remarkable when you consider that it was one of the countries hardest hit by the global financial crisis. …How did they bounce back? “I can answer in one word: austerity. Austerity, austerity, austerity,” says Peeter Koppel, investment strategist at the SEB Bank. …that’s not exactly the message that Europeans further south want to hear. …Estonia has also paid close attention to the fundamentals of establishing a favorable business environment: reducing and simplifying taxes, and making it easy and cheap to build companies.

Good policy makes a difference. But it also helps to have rational citizens (unlike France, where people vote for economic illiterates and protest against reality).

While spending cuts have triggered strikes, social unrest and the toppling of governments in countries from Ireland to Greece, Estonians have endured some of the harshest austerity measures with barely a murmur. They even re-elected the politicians that imposed them. “It was very difficult, but we managed it,” explains Economy Minister Juhan Parts. “Everybody had to give a little bit. Salaries paid out of the budget were all cut, but we cut ministers’ salaries by 20 percent and the average civil servants’ by 10 percent,” Parts told GlobalPost. …As well as slashing public sector wages, the government responded to the 2008 crisis by raising the pension age, making it harder to claim health benefits and reducing job protection — all measures that have been met with anger when proposed in Western Europe.

It’s worth noting, by the way, that government is still far too big in Estonia. The public sector consumes about 39 percent of economic output, almost double the burden of government spending in Hong Kong and Singapore.

But, unlike certain American politicians, at least the Estonians understand the problem and are taking steps to move in the right direction. I hope they continue.

P.S. The President of Estonia, a Social Democrat named Toomas Hendrik Ilves, used his twitter account to kick the you-know-what out of Krugman yesterday. For amusement value, check out this HuffingtonPost article.

P.P.S. A few other nations, such as Canada and New Zealand, also imposed genuine spending restraint in recent decades and they also got good results.

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Tax day is just around the corner, and we even get a one-day reprieve since April 15 falls on a Sunday.

And since everyone knows that I’m a big fan of the current tax system and the IRS (speaking of which, here’s a very good joke), let’s celebrate by digging into the Jeff MacNelly archives for these two tax cartoons.

First, here’s what many of us will be doing next weekend. Click to enlarge the cartoon. Every line is worth reading.

It would be nice to have a simple and fair system like the flat tax, requiring a 10-line return that can fit on a postcard. But be wary of some “simple” plans, as shown by Barack Obama’s two-line plan for a flat tax.

And here’s another cartoon showing how tax laws are developed. Very appropriate when you think about the IRS’s proposed interest-reporting regulation or the new FATCA law.

Jeff MacNelly was my favorite political cartoonist during my formative years. Sadly, he passed away far too early.

For good political cartoons today, I recommend starting with Michael Ramirez and Lisa Benson.

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What do the flat tax and national sales tax (and even the value-added tax) have in common?

As I explain in this Senate Budget Committee testimony, they are all single-rate, consumption-base, loophole-free tax systems that fulfill the key principles of good tax policy.

But good theory doesn’t operate in a vacuum, which is why I make several additional points.

1. Echoing George Will, something like a VAT should never be implemented unless the income tax is completely abolished.

2. It’s impossible to have good tax policy if government is too big.

3. A proper definition of taxable income is necessary to understand what’s a loophole and what’s not.

4. Tax revenues already are projected to significantly increase over the next few decades because of “real bracket creep,” meaning than a rising burden of spending accounts for more than 100 percent of America’s long-run fiscal challenge.

5. If you want the rich to pay more tax, keep tax rates reasonable.

On a personal note, I’m irked that my jacket is riding up on my shoulders. I’ve been trained to sit on the tail of my jacket when doing TV interviews, and I should have remembered that lesson during my testimony.

But at least I’m wearing my Bulldawg tie, so that compensates.

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Early in 2010, I wrote about a reprehensible IRS plan to create a cartel in the tax preparation industry, which would screw small firms and entrepreneurs to help line the pockets of big companies such as H&R Block.

And, earlier this year, I specifically criticized the IRS Commissioner for moving ahead with this scheme, which I also suspect is motivated by a desire on the part of the IRS to have a group of captive tax preparers who will be timid about protecting the interests of taxpayers.

With thuggish moves like that, no wonder the IRS wants to flush $15 million of our tax dollars down the toilet in a futile effort to improve its public image.

But there is some good news. The Institute for Justice has filed suit against the IRS for its disgusting behavior. This video explains.

One point from the video that should be emphasized is that the IRS is taking this step without any congressional authorization or instruction. But if you read this link about an IRS regulation that would force American banks to put foreign law above US law, you’ll know that the tax agency is capable of rogue behavior.

By the way, the Institute for Justice is a great organization that effectively fights for individual rights. Check out this IJ video on asset forfeiture laws (which basically enable stealing by the government).

And since we’re on the topic of theft by government, this IJ video on property rights, eminent domain, and the Kelo decision also is very much worth watching.

P.S. I’m not interested in protecting the interests of the tax preparation industry. Indeed, I want a simple and fair flat tax, which would decimate all tax preparation firms. But I don’t want the thugs at the IRS to decide which firms are allowed to operate.

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Last year, while lounging on the beach in the Caribbean…oops, I mean while doing off-site research, I developed the first iteration of a rule to describe how fiscal policy should operate.

Good fiscal policy exists when the private sector grows faster than the public sector, while fiscal ruin is inevitable if government spending grows faster than the productive part of the economy.

My motivation was to help people understand that America’s fiscal problem is excessive government spending, not red ink. Deficits and debt are undesirable, of course, but they are best understood as symptoms. The underlying disease is a bloated federal budget that diverts resources from the productive sector of the economy and subsidizes dependency.

But after getting feedback, I realized that the rule was too wordy. So, after a bit of tweaking and market testing, I came up with “Mitchell’s Golden Rule.”

The purpose of this rule isn’t to make me famous, like Art Laffer with the Laffer Curve. Instead, I’m hoping that this simple construct will help policymakers focus on the most important variable.

Countries that follow the Golden Rule, such as Hong Kong and Singapore, enjoy long-run prosperity. But the Golden Rule also shows how nations in fiscal trouble can get back on the right track with periods of spending restraint, as shown in this video featuring Canada, Slovakia, New Zealand, and Ireland. And this video shows how the United States made progress during both the Reagan years and the Clinton years.

Governments that take the opposite approach, however, eventually wind up in fiscal chaos. Just look at the data from Greece. Or other crumbling welfare states.

All this discussion about how to measure good fiscal policy may seem esoteric, but it provides the foundation to understand why Senator Rand Paul’s new budget proposal is so admirable. Joined by Senators Jim DeMint and Mike Lee, Senator Paul has a comprehensive proposal to curtail big government.

1. An immediate cut of $500 billion of wasteful spending.

2. A five-year freeze on total government spending.

3. Limiting average annual spending growth to 2.2 percent over the next ten years.

Last but not least, taxpayers get a big reward from Senator Paul’s budget with a simple and fair 17 percent flat tax. This pro-growth policy is desperately needed to boost the economy and improve competitiveness. And while a flat tax theoretically could be enacted without accompanying spending restraint, it’s far more likely to happen if lawmakers show they’re serious about restraining the federal behemoth.

The accompany chart shows the 10-year projections for spending and revenue if Senator Paul’s budget is enacted.

A few additional thoughts. Senator Paul and his colleagues are highlighting the fact that the plan generates a balanced budget in just five years. That’s a good outcome, but it should be a secondary selling point. All the good results in the plan – including the reduction in red ink and the flat tax – are made possible because the overall burden of federal spending is lowered. That should be the main selling point.

This doesn’t mean that Senator Paul is in any danger of winning a Bob Dole Award, but it’s nonetheless unfortunate since a focus on deficits gives an opening for leftists to claim that they can achieve the same outcome with tax increases. This is why sponsors should focus on the importance of spending restraint, and then add explanations of how this eliminates red ink. This is the approach I took in this video showing how limits on the growth of spending would lead to a balanced budget.

Also, I have two minor disagreements with Senator Paul’s budget proposal.

1. He does not modernize Social Security system with personal retirement accounts. He does have reforms to rein in the program’s long-run outlays, thus addressing the system’s fiscal crisis. But this generally means workers will pay more and get less, thus exacerbating the system’s other crisis, which is the anemic ratio of benefits received compared to taxes paid.

2. He retains the home mortgage interest deduction in the flat tax plan. This may sound like nit-picking since I should be happy to get 99 percent of what I want, but I worry that allowing one deduction will pave the way for more deductions. Remember the old advertisement by Lay’s potato chips (at least I think) with the saying that “I bet you can’t eat just one”? Well, that’s how politicians would be with a flat tax. Once they allowed one horse out of the barn (I realize I’m mixing my metaphors here, but you get the point), it would be just a matter of time before the entire herd escaped.

But I’m not here to make the perfect the enemy of the very, very good. I wrote a lot last year about the Ryan budget, which was quite an achievement (particularly since it actually passed the House).

The Paul budget is the Ryan budget, but even better.

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I shared my thoughts about tax reform with the Senate Budget Committee earlier today.

Not surprisingly, I testified that the ideal tax system should have the lowest-possible rate, no double taxation of income that is saved and invested, and no corrupt and inefficient loopholes. In other words, a flat tax.

You can peruse my entire testimony on the Cato website.

In addition to talking about the flat tax, I also focused on the importance of economic growth – something that will be less likely if the tax burden is increased. Here’s a table from the Congressional Budget Office’s recent Economic and Budget Outlook, showing how even tiny differences in economic growth have a big impact on tax revenue.

Another point I made is that the government will collect more revenue, even if tax rates stay the same. This is because of something called “real bracket creep,” which occurs under a “progressive” tax system even if economic growth is mediocre.

Here’s a chart from the CBO long-run forecast, showing how the burden of taxation will climb in coming decades.

And here’s a chart showing how income tax receipts will reach record levels – even if the 2001/2003 tax cuts are made permanent.

One last point. I was impressed by Senators Ron Johnson of Wisconsin and Kelly Ayotte of New Hampshire. I hadn’t seen either of them in action.

Sen. Johnson’s comments and questions showed that he was fully aware of the DC scam of fake spending cuts. And Sen. Ayotte was completely aware of the self-destructive impact of America’s worldwide corporate tax regime.

Let’s hope they stay hard core and don’t “grow in office.”

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