PRIORITIES FOR INCREMENTAL FEDERAL TAX REFORM
CRITERIA FOR TAX REFORM Whether one is considering near term tax relief or longer term substantiative reform of the tax code, the following standards should determine priorities: 1. 2. 3. 4. 5. 6. Marginal rates no higher than average rates. Eliminate double taxation of incomes Eliminate discriminatory taxation and tax preferences. More visible and efficient, while less complex and invasive taxation. Tax consumption rather than savings and investment. Territorial taxation of goods and services, and corporations.
The economic evidence is persuasive in showing that the above criteria would enable a simple, neutral, and transparent tax code which will provide the incentives and capital to fuel more rapid growth of productivity and incomes for all Americans. The principle problem in achieving tax reform is how to provide the additional revenue in order to fund revenue reductions. This must be done with sufficiently acceptable apparent tax incidence to enable a broad coalition of political support. The proposals for incremental tax reform which follow are intended to provide the road to tax reforms with political realism as it regards to their attainment. PROPOSAL I: REPLACE THE CORPORATE INCOME TAX WITH A RETAIL SALES TAX The first incremental step toward fundamental tax reform should be elimination of the corporate income tax. By so doing the principal source of double taxation of incomes and high marginal rates that retard saving would be remediated along with the principal source of competitive disadvantage in foreign trade. The adoption of a federal retail sales tax is the ideal basis for replacing the corporate income tax because its effective incidence will be comparable, and the tax base will be the broadest possible, resulting in the lowest possible marginal rate. Furthermore, as a consumption tax it by definition exempts savings, a major step in the direction of reform. But of perhaps the greatest importance, the retail sales tax is territorial in its effect on imports and exports of goods and services, and on corporations, which will reverse the decline of United States manufacturing and reverse the flight of multinational corporations overseas. The advantages offered by the retail sales tax over its flat business tax equivalents are its visibility; the availability of state collection capabilities. The sales tax provides the least politically painful way to extend the tax to the outputs of Sub-Chapter “S” corporations, proprietorships, and partnerships not now paying the corporate income tax. Whatever political problems are involved in selling the concept that corporations don’t pay taxes—that is, people do—will not likely be as difficult as trying to spread the corporate tax burden to Sub-Chapter “S” corporations, proprietorships, and partnerships via a business tax. However, a subtraction method value added
Created 6/15/2002
tax under whatever guise—“flat business tax”, “business transfer”, or you name it, would be an acceptable alternative if applicable to all business enterprises. The political coalitions in support of trading the corporate income tax for a retail sales tax should be broadly based. The manufacturing and finance sectors, trade unions, and investors should be the strongest supporters. The objection would be the regressive effect on middle incomes and below. The remedy should be a tax credit based on the equivalent of the retail sales tax on necessities as measured by the tax applicable to consumption of poverty level incomes. PROPOSAL II: END TAXATION OF SAVINGS Allowance of unlimited deduction of savings from personal income taxation should be the companion to elimination of the corporate income for ending double taxation of incomes. It should be implemented at the same time in order to provide the savings necessary for replacement of the foreign investment currently being financed from the trade deficit, which would diminish under border adjustable taxation. Unlimited deduction of savings should have great popularity among payers of income tax at all levels. Furthermore, the vital role that increased domestic savings must play in any positive resolution of the Social Security problems in the future should be a strong political source of support. PROPOSAL III: ELIMINATE DISCRIMINATORY TAXATION The economic record shows that high marginal rates on income do not redistribute income. They harm economic performance to the detriment of all citizens, but most particularly affect the wages of labor that depend upon capital to drive the productivity that provides their security and growth incomes. In order to drive down marginal rates, the graduated rates on income should be eliminated. At the same time inequitable “phase outs” which disallow the same deductions, exemptions, and credits for upper incomes allowed all other taxpayers should be abolished as well. Alternative Minimum Tax, another way to arbitrarily deny taxpayers equality of treatment under tax laws, should be terminated. And the confiscatory “death tax”, one more example of arbitrary taxation, should be sunsetted now—not in 2011. A principal step in lowering marginal rates would result from flattening the federal income tax rate schedule, taxing every taxpayer’s income at the same flat rate. By removing the graduated rate schedule, married couple families who pay the lion’s share of the federal income tax would be relieved of the marriage tax penalty, and the married parenthood penalty as well. The married couple families who pay the lion’s share of federal income taxes would be strong supporters of such reform. Here again, it is proposed that lost revenue from elimination of discriminatory taxation would be funded by the retail sales tax, and that regressive effects be remedied by the sales tax credit.
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PROPOSAL IV: ELIMINATE TAX PREFERENCES Given the elimination of double taxation of capital as proposed above and eliminating graduated rates, there would be no justification for a preferentual tax rate on capital gains. After allowing indexing for inflation, capital gains should then be taxed at ordinary income rates. The practice of removing an alarming number of taxpayers from the tax roles threatens viable public policy, as does gratuitously handing out cash taken from taxpayers to people who do not pay taxes, but do collect welfare. The Earned Income Tax Credit, along with the proposed retail sales tax credit, should be transformed into Medicaid Vouchers for assistance in funding medical savings accounts, in relief of taxation supporting federal health care entitlements. COMPLETING TAX REFORM Most tax reform proposals select either consumed income or consumption expenditures as the base. The reform proposed incrementally above results in dividing the tax burden between both. This is a less radical approach which provides in lower tax rates on each, with less danger of insufficient revenue from tax avoidance or from economic adjustment effects. The beauty of the dual tax approach is the opportunity to determine the public bias toward each, with the possibility that one or the other may be phased out over time. The potential objection is that two broad based taxes may make it easier to raise taxes and does not achieve the goal of eliminating the IRS. But it does make reform appear less risky to the politicians who will determine whether or not tax reform ever happens. Even incremental tax reform at some point will require a radical departure from the nature of the present tax code if it is to avoid the futile trap of continual tax-tinkering. The adoption of a federal retail sales tax to provide a new broad tax base in order to end double taxation of capital and incomes provides that radical departure from of the code under this proposal. Henceforth federal taxation would be shared by consumption taxation in the form of a retail sales tax or a consumption tax equivalent, and a consumed income tax. Given this broad based tax it is possible to remediate the high marginal tax rates which discourage economic growth. Double taxation of capital caused by the corporate income tax, and of savings caused by taxing income saved in addition to returns to savings, and graduated income taxes as well, can all be abolished either sequentially or at the same time. The remaining reforms can precede or follow as the benefits of more efficient taxation become more politically saleable.
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