11 January 2003 - Real Tax Reform?

I guess George Bush’s dad reminded him of what can happen to presidents who focus on wars instead of economic policy. Just as American troops began to gather near the Persian Gulf in early January, Bush unveiled a set of bold proposals to cut $674 billion in taxes over the next decade. And nothing could be more welcome. Whether we’re talking corporations or individuals, we pay far too much in taxes.

Paying so much in taxes right now might not bother me so much if I sensed that the money was being put to good use, toward productive goals. Given the current state of the economy-a widening trade deficit, growing debt levels, inefficient government, and an unimpressive manufacturing sector – taxes don’t seem to be doing much good. If the president succeeds in accelerating cuts scheduled for three years out, and raises the floor for the ludicrously convoluted alternative minimum tax, investors will have that much more money to invest in the economy. Eliminating the tax on dividends would go a long way to addressing current injustices, and has already woken up the stock market. But even with Republicans controlling both houses, the president will be forced to compromise. Chances are, the reforms that pass will amount to little more than a nip here, and a tuck there.

 Well, Congress, I think it’s time to think big. Think overhaul. Think throwing out the bath water and giving the baby a new diaper. The current U.S. tax code is too complicated. The Internal Revenue Service has got to be the most inefficient arm of government. (Okay, the Immigration and Naturalization Service runs a close second.) The current system allows everyone ways to jigger their books. Americans need a system in place that encourages people to invest and save, and discourages our impulsive spending and borrowing habits. Such ideas have been the mantra of successful economies throughout history and should be ours too, if Americans want this country to compete globally in the 21st century.

 Clearly, the current tax system doesn’t work. A few people out there say they support our tax code, but I guarantee you that no one completely understands it. I’m not even sure the people working at the IRS get it. That hasn’t been the taxpayer experience. The government claims that the IRS is a user-friendly operation, filled with knowledgeable people who can walk you through your tax dilemmas. But if you call the IRS for help on a tax issue and they give you incorrect information, you’re still liable. Only with the IRS are you guilty until proven innocent.

 The bigger problem is that the tax code penalizes savings and investment. Consider this: If you earn money from a job, it’s taxed. If you take that money and put it in the bank, any interest you earn is taxed. What if you want to invest that money in the stock market? Unless George W. gets his way, your dividends will be taxed even though the paying company has already paid taxes on the profits they are distributing. Any capital gains are then taxed, too. God forbid you should die and want to leave your money to someone; it will be taxed a fourth time. Though the estate tax is being phased out, it is scheduled to come back in full force in 2011. The only way your heirs can get away without risking any tax on your savings is if you die in the year 2010 so the best estate planning is to arrange to die in that year. I’m not talking about money you’ve borrowed or stolen. I’m talking about your hard-earned dollars, which the government partakes of at least three times before it is sated. Loan sharks don’t have it so good.  Ideas to overhaul the current tax system include everything from a flat-tax (one rate for all people) to eliminating the capital gains tax yes!). I’m for anything that’s going to make the system easier to use, more efficient and more conducive to saving and investing. A national sales tax to dampen consumption would be best.

 That means that people would be taxed only on when they spend and not on the money they earn or save or invest. Instead of the type of sales tax that states impose on the retail prices of goods and services, I would advocate a value-added tax, or VAT. In European countries, the VAT is built directly into the costs of goods and services so consumers don’t see it directly. Most items would be priced higher (estimates for the U.S. range from 1% to 14% higher), but if the VAT replaced the current system, the government would save all the money it currently spends collecting income tax and chasing after cheats. And think how much we citizens would save if we never had to file tax returns? Contrary to popular opinion, a value-added tax wouldn’t benefit the wealthy over the poor. In fact, the rich would bear most of the burden because they spend more. Crooks and drug dealers would also be subject to the tax whenever they bought anything, whereas they pay no federal taxes now. It would be impossible to pad your deductions, to hide cash income, or to commit any of the other acts of fraud that make April 15 the highest crime day of the year.

 It is possible that Americans may spend less. But right now, Americans are not spending money that they have. They are spending money they don’t have–to the tune of $1.7 trillion in collective personal debt. And while consumer profligacy has carried the economy through the past two difficult years, it won’t be able to for much longer. Sooner or later, the house of credit cards we have built will come falling down on us. A value-added tax won’t eliminate consumer spending altogether. People will always have to buy goods and services. But repealing taxes on savings and investments will encourage Americans to put money away for difficult times. The banks that get our savings will be able to loan that cash to companies to grow, which means more capital spending, higher employment and a stronger economy. And companies can put the financial strength they gain from greater investment to work for them and the country as a whole.

 Some of the world’s greatest success stories have gotten that way because of how much their inhabitants saved and invested. In China, the savings rate is about 30%. The tiny island nation of Singapore was a backwater swamp 40 years ago. Its citizens have been forced to save roughly 40% of their income by having it deducted from their salaries. The savings were, in effect, put into individual accounts and were eventually made available to the depositor at age 55. (This is a marked difference from our Social Security system, which is a Ponzi scheme taking from today’s workers to pay today’s retirees.) While I don’t condone forcing people to save, Singapore has certainly emerged as one of the great success stories of the past 35 years. They have conclusively demonstrated the approach of favoring saving and investment over encouraging consumption. Its per capita gross domestic product is roughly $25,000, on par with Western nations like Germany or France.

Another proposal that has got me excited is Bush’s plan to eliminate tariffs on all manufactured imports by 2015. That’s the most intriguing idea to come out of Washington in decades. Tariffs are nothing more than an enormous tax, typically designed to drive up prices of goods from abroad. Rather than telling our farmers to pull up their socks and compete, we protect them by making foreign goods more expensive. By eliminating tariffs, the government would force, say, steel manufacturers either to beat Asian countries’ prices and quality, or give up steel in favor of an industry where we could actually be competitive. Obviously some people would lose their smelting jobs, but many others would find employment manufacturing pharmaceuticals.

 Do I think the government will eliminate tariffs? Probably not. After all, we even protect chickpeas and lentils here; I expect to be eating expensive soup for decades. Nor do I believe the government can make any radical reform of tax policy. There are too many interests involved, from lobbyists to tax attorneys to accountants to the many companies that make tax software. Tax compliance, if you can call it that, is a multi-billion dollar industry, and there are too many powerful people with a hand in the till. But at least someone down in Washington, D.C. is finally talking about change, which, at the very least, is a step in the right direction.