Recommended Goals and Policies for United States Tax Reform

I recently had a phone conversation with a staffer for Senator Murkowski, who specializes in tax issues.  Here are my talking points for the conversation.  A few graphs can be found at the end of this article, showing basic facts regarding American tax policy.

Goals of tax reform, in priority order

1. Increase Federal tax revenue; run a surplus until gross Federal debt is less than 75% of GDP.
2. Simplify the tax code. 
3. Reduce the burden of Social Security and Medicare on young workers and their families.
4. Create a tax system which is generally acknowledged as fair to all.
5. Eliminate subsidies and market-distorting tax incentives.
6. Tax capital that replaces labor.
7. Tax unrealized capital gains, if estate tax is repealed.
8. A tax policy that reduces wealth inequality.

Wish List

1. A greatly simplified tax system.
2. Collect more Federal tax revenues; run a budget surplus.
3. Higher tax rates on the wealthy, to raise total tax revenues.
4. Make investment income subject to Social Security and Medicare taxes.  Eliminate the tax cap, and have a progressive tax to raise rates on the wealthy.
5. Make minimum SS benefits standard for all elderly people. 
6. Broaden the income tax base to include everyone, so that everybody pays some Federal tax.
7. Eliminate the Bush investment income tax exemption, and raise taxes on dividends and capital gains.
8. Reduce Social Security and Medicare taxes for the working poor.
9. Compensate for any revenue lost in reduced business taxes with additional taxes on something else.
10. Stop using rhetoric that suggests that the United States has high personal or business taxes.  It isn’t true.
11. Implement a carbon tax.
12. Eliminate business subsidies, especially agricultural and ethanol subsidies.
13. Institute a tax on businesses which do not provide enough good jobs (full-time, well-paying jobs) relative to the amount of capital employed

Discussion and Talking Points

Sufficient Tax Revenue

Tax rates are too low.  We have undergone a 37-year experiment in underfunding the Federal Government.  In some ways, the experiment has been a success; the American Federal government is arguably the most efficient in the world.  But the consequence of underfunding the government is a gross Federal debt that exceeds GDP.  In a number of other nations (e.g., Greece, Italy, Ireland, Portugal) that level of debt has represented a tipping point marking a breakdown in the economy, markets, and in the ability of the government to govern. 

We now have a national debt that threatens our security and stability.  We might argue whether the reason for the debt is too much military spending or too much social spending, but the spending is now history.  The scale of the problem exceeds any solution through cost cutting, except drastic cuts to the military, which is not going to happen.  To raise more revenue, higher taxes need to be placed on the wealthy (because that's where the money is).  The wealthy have benefitted from 37 years of under-taxation; it is time to pay back some of the gains.

We also have a situation of rising wealth inequality, especially impacting young people.  We shouldn't make problems worse for the next generation -- which is what we are doing by not paying our bills.  We are stealing from our children to leave such a massive government debt.  

There are times when deficit spending is necessary.  Deficit spending is one of the best policies for pulling the economy out of recession.  (The proposed balanced budget amendment is economic stupidity.)  However, the converse to deficit spending is that budget surpluses are necessary during good times, to avoid ratcheting up debt over time.  Deficit spending without ever running surpluses leads to crippling debt, which impairs the ability to deal with future crises. 

Most Republicans argue that low taxes are necessary to stimulate the economy and create jobs, supply-side economics, Laffer Curve, yada, yada, yada.  This can be true when the economy is significantly underperforming, but is not true when the economy is at full employment.  Also, to be successful in stimulating the economy, tax cuts need to apply to the lower middle class, to increase consumption and demand.  Tax cuts for the wealthy are not effective in stimulating the economy; these only produce asset inflation, followed by a crash, as we have seen twice in the last 20 years.  If tax cuts were going to produce an economic miracle, don’t you think it would have happened by now? 

Social Security and Medicare Taxes

Social Security and Medicare taxes have more than tripled since I was a young man, placing an unreasonable burden on young working families and businesses.  Wage-earners pay significant payroll taxes on the first dollar of income; these taxes disprove Mitt Romney’s myth that 47% of Americans pay no tax. 

We should abandon the illusion that the Social Security system is an insurance program with benefits scaled to payments.  The truth is that the program will take from wage-earners whatever it takes to pay the scheduled benefits for retirees.   And those benefits have been too high.  Republican Senator Ben Sasse stated, “There are good and bad reasons to be unpopular. A good reason would be to suffer for waging an honorable fight for the long-term that has near-term political downsides – like telling seniors the sobering truth that they’ve paid in far less for their Social Security and Medicare than they are currently getting back.”

The structure of Social Security taxes is completely backwards.  The first dollar of earnings is taxed, there is a cap on taxable income, and there is no tax on investment income.  Instead, Social Security taxes should be structured so that both wages and investment income should be taxed to support the program, with no cap on taxable income.  A lower tax rate should apply to the working poor.

We should recognize that not everyone has an equal opportunity to earn income, and to pay into Social Security.  Some people are like my sister, who gave up a promising high-paying career, to spend her life caring for disabled relatives: first her severely disabled child, and after the death of her child, cared for our elderly aunt, and now my parents.  We should break the link between taxes paid and benefits.  We should provide a living income to old people, because we respect and honor old people.  Period.

Fairness

I think most people would agree that our tax system is too complex, which leads to widespread perceptions of unfairness.  High-income people think that poor people don’t pay their fair share, largely because of Mitt Romney’s myth that 47% pay no taxes.  Romney is ignoring payroll taxes, excise taxes, and sales taxes, which hit the poor harder than the rich.   Poor people think that rich people do not pay their fair share, because of the $75,000 income exclusion of the Bush tax cuts, low tax rates for investment income, and tax-avoidance strategies available only to the wealthy. 

A persistent belief in the unfairness of the system encourages widespread cheating.  It will be important in tax reform to make sure everybody pays something.  And it will be important to eliminate the low tax rates for investment income and eliminate tax loopholes and avoidance strategies.  

Business Taxes

The nominal tax rate for business taxes is 35%, but actual tax paid is much less. Using the President’s Report on the Economy and data from the Federal Reserve database, I calculated that the actual tax paid in business income tax is only 17.8%.   Looking at the OECD database, the United States has the 10^th lowest business tax rate of the 35 member industrialized countries, as a percentage of GDP (2015).  OECD countries with higher corporate taxes include Greece, Spain, Canada, Austria, Italy, France, Ireland, United Kingdom, Mexico, Netherlands, Portugal, Denmark, Sweden, Japan, Korea, Israel, Belgium, Luxembourg, Slovak Republic, Iceland, Czech Republic, Chile, New Zealand, Australia, and Norway. 

I agree with Republicans that businesses might do better with lower business income taxes.  American companies could be more competitive in international markets, and successful companies could put more of their profits into business growth.  But the loss of these tax revenues must be compensated by raising other taxes.  The Bush tax cuts were justified on the basis of double taxation of business income.  If business income taxes are cut, will personal taxes on investment income be restored?

Carbon Tax

Certain businesses produce externalized costs which are borne by all of society.  It is appropriate to levy specific taxes on those businesses to compensate for the damages and costs they incur for others.  An example of such a tax is a carbon tax.  It is appropriate and timely to implement a carbon tax on fossil fuels and cement manufacturing, directly scaled to the amount of carbon emissions caused by the business.  A carbon tax allows the market to reduce the damaging emissions in the most efficient way, through fuel substitution.  The carbon tax would be much easier to implement than other schemes, such as “cap and trade”, and importantly, easier to repeal or adjust, depending upon results.

Subsidies

Certain subsidies, such as ethanol fuel requirements, make no sense whatsoever.  Congress should work to eliminate market-distorting subsidies as part of any tax reform.

Tax reform should eliminate much of the use of the tax code for social engineering.  The main purpose of the tax system is to raise enough money to fund the government.

Unrealized Capital Gains and Retirement Plan Tax Deferrals

Unrealized capital gains are one of the simplest ways to avoid taxes; compounding of unrealized capital gains contributes to wealth inequality.  If the estate tax is eliminated, how will unrealized gains every be taxed?

Retirement plans, such as 401K plans and IRAs, allow workers to save for retirement.  But these plans discriminate against lower wage workers, who do not have enough discretionary income to save into those plans.  Also, fewer and fewer businesses are offering or supporting such plans.  Given the popularity of the plans, and entrenchment in terms of established value, it would seem impossible to modify or eliminate these plans.  But these plans complicate the tax code, and offer tax advantages that only the wealthy can take advantage of, leaving the rest of the workforce to make up the difference.

Taxing Capital

A few months ago, I undertook an effort to calculate the total Federal tax paid by Capital and Wages.   Capital pays tax through business income taxes; capital gains, dividends and interest, personal income taxes; business’ contribution to payroll taxes; and other (mineral royalties and rents). 

Wages pay taxes through payroll taxes, personal income taxes on wages, and most excise taxes.

Using figures from the Tax Policy Center and the President’s Report on the Economy, I calculated that wages pay about 25% of gross income in Federal tax, and capital pays about 28% in Federal tax.  I expected that capital would be higher. 

In a 27-year career with a major oil company, I saw that capital does not create jobs – capital and technology destroy jobs.  A workstation allows a geologist to do the work of 4 geologists working without the computer, so the number of geologists employed at my company was reduced by two-thirds during my career.  Desktop PCs made secretaries irrelevant and PCs made the entire drafting department obsolete.  Enterprise-wide accounting software allowed us to lay-off hundreds of accountants.  In my department, over five years, the number of accountants was reduced from 27 to 1.  Looking forward, in the transportation industry, self-driving trucks will soon make 1.5 million long-haul truck drivers unemployed, and 2 million other professional drivers soon afterwards. 

Robots have considerable advantages over human workers.  Companies can avoid paying payroll tax, and avoid providing health and retirement benefits.  And yet – people in society still need work, healthcare, and funding for retirement.  After all, the importance of business to society is not to make as much money as possible, but to provide what society needs, not only in terms of products for purchase, but also employment for workers.  Bill Gates proposed taxing robots, just enough to put humans on an even playing field with the robots.  But in a broader sense, the problem is not robots, but capital.  Business Capital should be taxed if it doesn’t provide an appropriate number of good jobs in relation to the amount of working capital.  

Basic Facts

Gross Federal Debt is now about 20 trillion dollars, or 112% of GDP.    Debt held by the public is $14.3 trillion, or 76% of GDP.  The difference ($5.7 trillion) is essentially debt that the government owes to itself, through arrangements between government agencies.  Much of the government-held debt is the trust fund for Social Security.  It might be possible to say that Social Security is in great shape, thanks to the set of IOUs from the Treasury, but then you would have to say that the country is in deep trouble because of the debt load.  Or you might say that the country’s debt load is not so bad, but you would have to say that Social Security is going broke.  You can’t have it both ways.

 Here is a graph of gross Federal debt and GDP.

Federal Deficits have been large and persistent since 1980, in Reagan’s first term.

Federal Tax Comparison to Other Countries

United Stats Federal Taxes are among the lowest in the world.  The government accomplishes a great deal with less revenue than other nations.  The US government is also burdened by the highest rate of military spending in the world, further cutting into other government programs.

The OECD database places the US consistently 34th out of 35 industrialized countries.  The only countries with occasional lower Federal taxes (Japan, Switzerland) have no significant military obligations.  Japan also has a massive debt problem.  US Federal taxes (from all sources) are among the lowest in the OECD.

http://stats.oecd.org/Index.aspx?DataSetCode=REV

US total tax burden is among the lowest of the OECD.

US Federal Taxes are among the lowest in the world.

For the year 2011 (the recent year with the most complete reporting), the United States had the fourteenth-lowest Federal tax rate of 123 countries in the World Bank database.  Countries with lower taxes than the United States are as follows (2011):

Ethiopia, Pakistan, India, Afghanistan, Bangladesh, Central African Republic, West Bank and Gaza, Lithuania, Oman, Nigeria, Bahrain, Estonia, United Arab Emirates.  These countries are the peers of the United States in terms of Federal taxation. 

http://data.worldbank.org/indicator/GC.TAX.TOTL.GD.ZS