Tax
Structure
In the future the
United States will be constrained financially with paying down its considerable
debt and paying increasing medical costs for retiring baby boomers. In this new world of financial constraint, it
will be important for the United States to be as efficient as possible with its
resources. Efficiency will be more
important than quantity. From my
analysis, and I am not alone, the United States tax code leaves much to be
desired. In addition to being the
longest document in human history, the United States tax code is very
inefficient at utilizing the resources of the United States. The current United States tax code and larger
tax system is horribly inefficient for raising revenue, contributes to the
lobbying phenomena of elected public servants, hinders the efficient allocation
of capital, and is disadvantageous to those without a financial education and
those who can afford financial counseling.
I believe to assuage these problems, the United States should move
towards a tax system that utilizes a flat tax, both for income and corporate
income. The United States should also
adopt a federal sales tax to be applied on top of state sales taxes as well. The adoption of a combination flat tax and
national sales tax will put the United States on found financial footing, will
represent the most significant effort to contain lobbying in the modern era,
make the tax system more accessible to citizens by reducing the financial
education bias, and helps facilitate efficient allocation of capital.
From an economic
perspective, tax breaks to the extent that they are currently employed by the
United States hurt the efficient allocation of capital in the US on a corporate
and individual level. If tax breaks
influence the operations of a business or how a business spends its revenues,
this creates a distortion. A business
should be making decisions based primarily on what is best for their business
operations, not by saving money through certain tax loopholes. If a business makes a decision on production
methods based on a desired tax loophole and not on what is best for their
overall operational efficiency, this business is making decisions counter to
its nature. These perverse incentives
can lead businesses to invest too much or too little, to shift production to
certain areas, and/or issue unneeded debt[1]
all in the name of saving money from taxes.
These loopholes and tax breaks distort the normal business operations
and allocation of capital.
On a personal income
level, tax breaks can cause altered savings rates, consumption habits, and many
other aspects as individuals choose to allocate their resources to more tax
friendly areas and instruments. From an
economic perspective, these tax breaks create distortions in the normal flow of
the market and affect the efficient allocation of capital by artificially
pushing capital into other areas. A flat
corporate and personal income tax would eliminate these distortions and force
people to make decisions less because of tax reasons and more on normal economic
rational.
It is important to note
that a tax break is, in absolute terms, equivalent to a subsidy payment for the
amount of the tax break. Either way, the
firm or person has the amount of money specified and the government does
not. This has produced and fuelled
lobbing efforts by wealthy individuals, corporations, and unions, amongst many
others, to take advantage of our current malleable tax code. These individuals and entities invest very
heavily in lobbying firms and PACs in order to curry favor with elected
officials. A possible by product of
excessive lobbying efforts could be the end result of elected public servants
making decisions based more on large campaign contributions then than the needs
of their constituents. This creates a
distortion in democracy in the US and contributes to the dysfunction within the
government. By removing these tax breaks
(subsidies) from the US tax code, one removes financial incentives for lobbying
and we can go a long way to reducing the influence of lobbyists, corporations,
and wealthy individuals on our elected officials and the democratic
process. Also, a flat tax would
eliminate any government favoritism for certain firms or industries through tax
breaks. Since there would be very few
tax breaks, it would remove a vehicle from which corporations influence elected
officials and decrease their power over the electoral process by eliminating
their financial incentive to influence officials and the electoral process.
The tax code is
littered with exceptions and conditions which are very difficult for the
average person to interpret, much less understand to a degree to take advantage
of them. The United States tax code is
the longest document in human history.
It is over 17,000 pages long. It
is huge and incredibly difficult to navigate sufficiently. The size and complexity of the US tax code
severs to disenfranchise those who are not financial sophisticated (through
financial education or family knowledge) and those who cannot afford the
services of a tax and/or finance professional.
Much is said about the unfairness of the tax code, favoring the wealthy,
recently this criticism has come due to historically low top marginal rate that
the highest income earners in the United States pay. But the unfairness of the complexity of the
tax code, which favors the wealthy, is not discussed as often or with the same
amount of candor and seriousness. Many
wealthy citizens of the US have sophisticated knowledge of finance and the US
tax code, which allows them to minimize their tax payments. Or if a person is sufficiently wealthy they
may hire a person with sophisticated finance and tax knowledge to help them
take advantage of the tax code. The
uneducated, the reasonably educated, and the poor are at an inherit
disadvantage with the current tax code.
Creating a flat tax for personal income would eliminate tax breaks and
make the tax code much more manageable.
A few tax breaks could be kept, but the US could surly shrink the tax
code down to a 12 to 15 page document, a length any high school graduate could
navigate. Without multiple tax breaks, a
person could simply apply their income amount to the flat tax percentage and
easily calculate their tax payment, again something any high school graduate
could perform.
The US has the second
highest corporate tax rate in the industrialized world. When factoring in state corporate income tax
rates on top of the national sales tax rate, the US has the highest corporate
tax rates in the industrialized world.
Due to tax breaks in the current US tax code, there is much variety on
what rate US corporations actually or effectively pay.[2] No matter one’s political persuasions, it
does not seem likely the US can be competitive in the world with US companies
carrying such a high tax burden. In the
era of globalization with its ease of capital and human flows across borders, it
is imperative that the US become an attractive place for companies to do
business in all aspects, especially in regards to tax policy. The US needs to be an attractive place for
companies in order to retain the companies and their operations that are
currently in the US but also to attract new companies operating outside the US
to the US and to encourage new companies to be founded in the US. A flat corporate tax would eliminate almost
every tax break currently offered to US firms.
This would intern raise revenue the federal government collects. The US could then in turn drastically lower
the corporate tax rate to accommodate the new raise in revenues collected. Given that current federal revenues from
corporate income taxes amount to approximately 8% of total federal revenues,
any fluctuation in revenue collected from the new flat tax corporate structure
would have a very minimal impact on the federal budget. Also on that same line of thinking, a 2% or
3% drop in revenue, as a percentage of the entire federal revenue total, from
corporate taxes would be relative insignificant when compared to the benefits
from creating a more competitive and encouraging business environment within
the United States. Perhaps the better
and more competitive business environment within the US, as a result of lowered
corporate tax rates, might spur greater business growth and thus higher tax
revenues as a result of growing the amount of business done in the US or more
colloquially, growing the size of the business pie instead of the percentage of
the total of the slice. Simply, creating
a more business friendly environment should take precedence over any lost
corporate tax revenue because the loss of revenue will undoubtedly be very
minimal in regards to the overall US federal revenues.
Due to states having corporate
income taxes as well, if a reduction in the federal corporate income tax was to
be implemented, thought must be given to state tax rates as well. A state in a less than desirable fiscal
situation[3],
might find it favorable to increase its corporate tax in conjunction with a
lowered federal tax in order to raise more revenue for the state. A state could justify this by raising their
rate less than the drop in the federal rate, therefore proclaiming that the corporation
is still better off than they were before.
This practice must be curtailed or the point of dropping the federal
corporate tax rate will be for not.
Therefore a cap on state corporate income tax should somehow be imposed
on states by the federal government.
This can be achieved either by creating a hard cap percentage number or
by limiting state corporate income tax rates to a certain proportion of the
federal. The currently average US state
corporate income tax rate is approximately 7.5%. It would be suggested that the federal government
cap the state rate around 7.5%. If the
federal government were to lower the corporate tax rate to 10%, a proportionate
cap of ¾ of the federal level could be imposed for states as an example.
With a flat tax for
personal income, a person who has a higher income would pay more in taxes than
someone with a lower income, their payment would just be proportional to their
income. Many people would find this a
more ‘fair’ tax policy, that everyone should pay the same proportion of their
income and that a graduated income system penalized those who are successful. This is admittedly a subjective argument, but
one that will most likely resonate with many Americans. A flat tax for personal income may also serve
as a logical relief to the wealthy who have lost their educational and wealth
advantage from the old (current US) tax code.
A Federal sales tax is
very similar to a value-added tax. A
sales tax is a much more feasible option in the US because of the prevailing
political climate in the US. Given a large
section of the US’s population aversion to anything considered to be even
remotely related to socialism or government control it would be very difficult
to get a value-added tax passed. Many
would see a value-added tax as creeping European socialism, since it is most
commonly seen in widespread use in Europe.
However irrational this argument may be, it would carry much weight and
prevent the adoption of a value-added tax in the United States. Simply put, a value-added tax is unfamiliar
to the American public and thus would face opposition, also due to its
unfamiliarity, it would be considered foreign by many Americans. A sales tax is a concept and terminology that
is already in use in the US through state sales taxes. This familiarity with and acceptance of the
state sales tax would make the adoption of a national sales tax much
easier. It is much easier to argue for
something on the national level that is already in place on the state level.
A national sales tax
would further benefit those who save and consume less. After the 2007 financial crisis, much was
made of the negative attributes of Americans’ over consumption and incredibly
low historical savings rates.[4] By imposing a national sales tax on
non-essential items, those who choose to spend more will pay more in
taxes. Those who utilize their income
for mostly essential means such as food, transport, education, and other
essentials (what most of the poor spend their limited means on) will pay less
in taxes. Those who over indulge on huge
televisions, yachts, and luxury cars will pay more in taxes. Those who save will pay less. A national sales tax also means that the
wealthy will pay more in taxes than the poor.
A 5% sales tax on a 100,000 dollar Mercedes is much more than a 5% sales
tax on a 15,000 dollar Honda, a 5000 dollar to 750 dollar comparison. As well, when the federal government derives
revenue from a federal sales tax, they will be able to lower the flat tax rate
to compensate. This will further benefit
those who save, since the flat tax rate is reduced and they pay less in income
taxes because of the federal sales tax.
Ultimately
one must assign percentages to the various new tax rates. It goes without saying that much research and
intellect must be spent determining the appropriate percentages for these
taxes. Due to the difficulty in adopting
a new tax at a national level where one of its kind did not previously exist,
it would be better to keep the national sales tax at a lower level. A suggestion of 2% to 5% would be appropriate
for a national sales tax. A national
flat income tax rate could exist between 15% and 20%. A corporate income tax rate of 10% would be
advisable with a state rate capped at ¾ of the federal rate, creating an
effective upper limit of the state rate at 7.5%, the current national
average. This would create a 17.5% max
effective tax rate for US corporations.
Given that the current US federal tax rate is 35%, before any tax
deductions, (without adding in state tax rates, which would make the average
tax rate 42.5% before tax deductions) 17.5% would be very favorable and go a
long way to creating a more encouraging environment for business in the US.
While
the adoption of a flat tax and national sales tax will certainly not solve all
of the tax related problems currently confronting the United States, it will
provide the United States with a simpler more efficient tax system. The combination of a flat tax and national
sales tax is more efficient in raising revenues, removes major incentives for
lobbying, removes a financial knowledge bias, may raise more money, and
promotes economic growth over the current tax structure and system. The ideas presented in this essay are not
meant as a hard and fast plan that is immediately actionable. They are meant to provoke thought and
discussion on improving the current the United States tax code.
[1] As
Apple recently did with their debt offering.
[2]
For example, in recent years Goldman Sachs paid a 33% tax rate while General
Electric paid 0.5%.
[3]
Such as California or Illinois to name just two of many.
[4] At
one point before the financial crisis the US savings rate dipped below zero, it
became negative.
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