IRSThe Sledge Hammer or the Scalpel

Since 1913 Americans have had a love-hate relationship with the income tax.  As federal spending has grown from 2.5% of GDP in 1913, to 10% of GDP during the New Deal era, to 19% (average spending) of GDP during post WWII era and finally to 23% (average spending) of GDP during the age of Obama, the Income tax has become the primary means to fund our obsessive spending appetite.

We have historically fallen short of funding our spending obsession by ~1.5% (on average).  In recent years, due to a weak economy and explosive spending, our tax receipts have fallen short of our spending by 6.6% (excluding the financial bailout).  Despite this funding shortage and numerous imperfections, on average, as a government funding vehicle, the Federal Income Tax is effective.

The Progressives have also used the Federal Income Tax along with federal spending to “right the wrongs of capitalism”.  To this end, the Federal Income Tax has failed.  Despite extreme disparity in both tax rates and amounts paid in taxes, the income disparity between the top earner and the bottom is nearing the age of the Robber Barons.  Even though a significant portion of the population pays no direct income tax, the embedded or hidden tax as a result of the income tax incorporated into products accounts for ~23% of the entire product cost.  The lack of visible contribution has led to the perception that government and its programs are free.  While to Progressive’s use of the Income Tax has won them votes, the impact of substantial increase in product costs and eroding industry and thus employment has gone virtually unnoticed.

Finally, the tax code has been used by Progressives to manage the economy.  From enticing home ownership, to inspiring higher education, to encouraging investment, the tax code, only second to direct investment (spending), is a favorite economic tool of the Progressive.  The tax code as an economic tool is like using a sledge hammer where a scalpel is required.  Because the tax code is based on income earned over time, and incentives are often written broadly, in addition to the legislative delay, the economic impact is often dubious.

To recap the above observations the current income tax is:

  1. As a means to provide funds for the government it is sufficient.
  2. As a means to right the inequity, the income tax has proven inadequate.
  3. As a means to managing the economy and thus employment, the Income tax is slow, clumsy, expensive and unreliable.

Overall, the modern income tax is ineffective for anything but funding some of the government.  Yet both parties cling to this progressive tool of ruination.  Some believe that the only problem with this progressive monstrous tax code is that it needs refined.  They favor solutions like the flat tax.  Is it any better to take some of everyone’s earnings (before they see it?) or take the earnings of some citizens?  Yes, both Republicans and Democrats have a love affair with the 100 year old income tax.

Is there an alternative.  Of course there is.  There are numerous forms of taxation.  I favor a step approach.  I favor taxing trade, consumption and wealth over income.  I prefer you to see your income before the government takes it.  Then and only then will one truly appreciate the cost of government.  Repeal the Federal income tax and the thirteenth amendment and replace it with:

  1. A national consumption (sales) tax
  2. Import/export tax
  3. User fees/break-even enterprise entities

We will not dive into details of each tax component for this is for another discussion but we will examine how embracing consumption instead of income taxation will address the needs to fund the government, reduce inequities and manage the economy.

The income tax has proven as a reliable means to raise money for the government.  It has done this by taking its taxes from its citizens before they see it.  This has numbed the tax payer to the cost of government but has also provided a reliable and constant source of funding.  The consumption tax would be applied to everyday purchases.  Its reliability, as a source of funding, would rival the income tax.  The only difference between the consumption and income tax is its visibility.  Unlike the income tax where the citizen becomes numbed to the cost of governance, the consumption tax would be a constant reminder to its cost.  Perhaps more fragile governance will result from a more vigilant citizenry.

Consumption taxation would probably do little to fight the “inequities” of capitalism but could accelerate the benefits and blessing of a capitalistic society.  By taxing income, the government embeds cost into products built domestically.  Increased cost has resulted in business slowly and contently moving business to lower cost and in many cases lower taxed countries.  By taxing everything consumed, equally, domestic companies and domestic jobs share the same burden as imported products.  Today, because incomes are taxed, jobs are tax.  Foreign countries often fund their governments through a VAT tax.  There is no VAT tax on exported goods.  This means that the goods we import have a significant advantage over domestically produced products.  Every country should promote their own economies and every country does except the US which is fixated on incomes and redistribution.

When it comes to the economy, fiscal policy through spending and income tax incentives have been the primary tool of the Progressives in managing the economy.  These tools are expensive and clumsy.  Their deployment tends to be late and miss-applied.  Both government spending and tax cuts will stimulate an economy, but after nearly a 100 years of constant economic stimulant, their effectiveness and our fiscal sanity is greatly reduced.  Not every economic bump requires massive intervention by the government.  When an economy begins to weaken, it seldom weakens across all sectors at the same time.  Often a sector will weaken, and due to the imperfection and delay of our stimulants, consumer confidence wanes and other sectors will begin to fall.  Because our taxation is based on income, a derivative of productivity, the market is slow to react to the stimulants.  If we applied consumption taxation instead on income taxation, the precision, speed and effectiveness of tax incentives would be greatly enhanced.  If an industry weakens it could be shored up by a reduction in the consumption tax for a short period in an industry.  The effect of the stimulant could be quickly measured based on the increase in sales.  Yes, inventories and other noise in the economy my still delay the impact on employment but the effect on initial economic activity would be easily assessed and adjusted.  The ability to target specific parts of the economy may not replace economic stimulus through spending and long term tax reform, but it should reduce our reliance on these very expensive tools.  America no longer has the will to endure market corrections nor can we afford to continue to spend ourselves to prosperity.  Consumption taxation offers us an alternative.

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