Nearing 100 years of the unfair tax
Our current tax system is nettlesome, outdated and laughably overcomplicated.
1913 was a big year for financial politics; the Department of Commerce and Labor was separated into two entities, the Federal Reserve System was established, and Congress passed the 16th Amendment to the Constitution allowing Congress to, "have the power to lay and collect taxes on incomes." It would seem that Americans could mark this year as a financial enlightenment period. To be fair, the Federal Reserve and income tax have now existed for nearly 100 years, supporting our infrastructure while receiving only little serious public outcry. Be that as it may, times have changed from the 400-page tax code of 1913 to the more than 60,000-page tax code we see today.
Income in itself is becoming more complex and the tax code just can't keep up. For example, since 1922 there have been 25 major alterations to the capital gains tax. Despite the current logistical problems of our current tax system, switching to a consumption tax makes as good of a case in philosophy as it does in economics. A consumption tax encourages personal investment by abolishing the capital gains tax (which is either 35 or 15 percent depending on how long the investor holds their position). This additional investment would provide Americans with more power to invest in companies they believe in. For example, if someone believes in clean energy, they could buy stock in solar energy companies with zero tax penalties upon sale of their investment. More importantly, the income tax penalizes the most basic economic function, labor.
Thus far, the most popular consumption tax, the fair tax, has received rapidly increasing support from primarily a Republican base (two of the few House Democrats who support the fair tax are from Minnesota). However, it seems odd that the party that touts income equality is hesitant to support the fair tax which would be a step toward doing exactly that. Inequality seems to be the favorite term of every critic, but the fact remains that equality is a loosely defined subjective word. True enough, but economists can come to an agreement in stating that income equality is best achieved through taxation of consumption and not income.
Countries that attain a low Gini coefficient (tool used to measure income equality; a coefficient of zero is perfect equality) do so not primarily through taxation, but through government transfers. This suggests that lowering income inequality does not lie within the progressivity of the tax structure, (meaning the wealthy are taxed increasingly more) but with total amount of tax revenues. Countries like Sweden and Denmark that do attain lessened income inequality do so by heavy taxation via systems which are no more progressive than the United States. So for those who dream of Gini, or a low one rather, a consumption tax may be just the solution.
The most common critique of the fair tax is that it burdens the poor with a higher tax premium. This would be true if it was not for the prebate portion of the fair tax bill. Citizens pay zero taxes up to the level of poverty and necessities such as food are not taxed. Currently, the fair tax is the only tax bill that makes any economic demographic tax exempt.
Another popular condemning comment is to claim the fair tax would bring the individual tax burden into the 30 percent range. It is important to remember that a revenue neutral system does not raise taxes; it simply changes where taxes are levied. Your correspondent suggests that this would invoke three major shifts. First, the current system has the top 1 percent of the population (with respect to income) paying around 25 percent of the total tax revenue. This demographic would see a lessened tax burden with the fair tax system (granted they keep spending constant). However, the wealthiest 1 percent, or those who have "old" money would have an increased liability. Rockefeller and his kin folk would no longer have the loophole options. Second, the tax burden on the middle class would become more diverse. Those with low personal discount rates who save and invest will see a lower tax rate. Correspondingly, those who spend nearly everything they earn will have a higher tax rate of 23 percent. Third, the fair tax would tax everybody. It taxes illegal workers (who would not see the prebate that would encourage legal immigration) and those who work in black markets.
The United States Treasury deems the income tax, "our voluntary tax system." On average, the Internal Revenue Service assesses 32 million penalties, and audits are continually increasing. This system is anything but voluntary. The fair tax liberalizes taxation freedom. It abolishes all federal personal and corporate income taxes, capital gains, alternative minimum, gift, Social Security, Medicare, estate and self-employment taxes, and replaces them with one simple, transparent, federal retail sales tax. In short, you keep your entire paycheck and are only taxed when you purchase goods or services.
The need for tax simplification is validated by the size of the tax army that is needed to facilitate the current system. Currently, there is an estimated 1.2 million paid tax preparers in the United States from accountants to lawyers. These are troops that the United States has been supporting for too long. Saving for retirement or education shouldn't require an advanced accounting degree. The IRS guide to individual retirement accounts alone is 109 pages long. Congress has constructed hundreds of special savings rules, such as for 401(k)s, traditional IRAs, Coverdell IRAs, Roth IRAs, traditional pension plans, annuities, rollovers, simplified employment pension IRAs, and the list continues.
There is a better system, but the 16th Amendment started a financial empire that is entangled in every part of society. This is not the role of government, nor was this intended when the income tax was conceived. If tax reform has any chance of taking place, as with any great change, it needs to be done through bipartisan support. Our current tax system is nettlesome, outdated and laughably overcomplicated. It is time Americans take a firm stance and say no more tax season, no more audits, no more tax ambiguity, no more IRS, and no more income tax.
Those at St. James' Street welcome comments at email@example.com.
This commentary was originally published by The Minnesota Daily, http://www.mndaily.com/articles/2008/02/25/72165764