2014/03/Ziad K Abdelnour Addressing FPC Event.jpg
Print Print This Page

Blog

Why Reshaping our Tax System is today an Absolute Must

By : Ziad K. Abdelnour| 20 September 2010
Please Share!TwitterFacebooktumblrGoogle+PinterestLinkedIn

With income tax rates set to go up on January 1, 2011, Congress is hotly debating what to do next. Most economists though agree: Keep them where they are.

One option, to let the tax cuts passed during the Bush administration expire for only the richest 3% of taxpayers while renewing them for everyone else, is popular among Democrats and the choice of the Obama administration.

I personally believe that the current tax system is frankly a complicated failure that hinders the nation’s growth while allowing the politically well-connected to manipulate the system to get special breaks that are not available to average workers and businesses. As a matter of fact, we at Blackhawk strongly propose shifting to a simple fair tax or flat tax.

In a competitive global economy, jobs and capital flow to jurisdictions with better tax law. Traditionally, this process of “tax competition” has benefited the United States, but there is growing evidence that America is falling behind. Nations around the world are lowering tax rates and reforming their tax systems. Indeed, nine countries that were part of the former Soviet Bloc have adopted versions of the flat tax. These pro-growth reforms are yielding impressive results and should be a road map for U.S. policymakers.

Unlike the current system, a flat tax is simple, and good for growth. Instead of the 893 forms required by the current system, a flat tax would use only two postcard-sized forms: one for labor income and the other for business and capital income.

The Fair Tax is even more compelling. This tax system is based on consumption entirely. There are no forms to fill out, whatsoever. The Fair Tax abolishes all federal, personal & corporate income taxes, gift, estate, capital gains, alternative minimum, social security, Medicare, & self employment taxes. It replaces these taxes with a simple retail tax from 15-20%.

Unlike the current system, which discriminates based on the source, use, and level of income, a fair or flat tax treats all taxpayers equally, fulfilling the “equal justice under law” principle etched above the main entrance to the U.S. Supreme Court building.

And unlike the current system, which punishes people for contributing to the nation’s wealth, a flat or fair tax would lower marginal tax rates and eliminate the tax bias against saving and investment, thus ensuring better economic performance in a competitive global economy.

Other major benefits of a flat or fair tax:

A Single Flat Rate. All flat tax proposals have a single rate, usually less than 20 percent. The low, flat rate solves the problem of high marginal tax rates by reducing penalties against productive behavior, such as work, risk taking, and entrepreneurship.

Elimination of Special Preferences. Both Flat tax & Fair tax proposals would eliminate provisions of the tax code that bestow preferential tax treatment on certain behaviors and activities. Getting rid of deductions, credits, exemptions, and other loopholes also helps solve the problem of complexity, allowing taxpayers to file their tax returns on a postcard-sized form or with the Fair tax, no forms at all.

No Double Taxation of Saving and Investment. Flat tax proposals would eliminate the tax code’s bias against capital formation by ending the double taxation of income that is saved and invested. This means no death tax, no capital gains tax, no double taxation of saving, and no double tax on dividends. By taxing income only one time, a flat tax is easier to enforce and more conducive to job creation and capital formation.

Territorial Taxation. Flat tax proposals are based on the common sense notion of “territorial taxation,” meaning that governments should tax only income that is earned inside national borders. By getting rid of “worldwide taxation,” a flat tax enables U.S. taxpayers and companies to compete on a level playing field around the world. In addition, the Fair tax would also ensure that the approximately 20 Million illegal immigrants currently living in the US pay taxes. The Fair tax also requires the estimated 55 Million tourists to the United States each year to pay taxes too.

Family-Friendly. The flat tax proposal has one “loophole.”Households receive a generous exemption based on family size. For instance, a family of four would not begin to pay tax until its annual income reached more than $30,000. The Fair tax also offers a probate up to the poverty line.

Consumption-Based. A tax code that does not discriminate against saving and investment is considered a consumption-based tax system, regardless of whether taxes are deducted from the paycheck or collected at the cash register. In this respect, a flat tax is a type of consumption tax. The difference between a flat tax, a national sales tax , & a fair tax is where the tax is collected. A flat tax is levied on income-but only once and at one low rate-as it is earned. The fair tax is collected like a traditional sales tax. You only pay the tax on the goods and services you consume. The fair tax is not like the VAT in Europe. The government cannot hide the fair tax into the price of the goods or services. It also prevents the government from adding taxes at every stage of production, like they do with the VAT tax system.

Both the flat tax and the fair tax differ dramatically from the U.S. Internal Revenue Code. The current tax code has numerous forms of double taxation, such as its treatment of saving and corporate income. The current tax code also has several forms of wealth taxation or asset taxation, such as the capital gains tax and the death tax. The current tax code even has provisions that force taxpayers to overstate their income, such as forcing businesses to “depreciate” the cost of new investment instead of allowing immediate and full deduction (a policy known as “expensing”) when costs are incurred.

None of these forms of double taxation, wealth taxation, or over taxation exist in either a flat tax or a fair tax, which is why public finance economists categorize both systems as consumption-based taxes.

There are two last principal arguments for a flat tax-growth and fairness. Many economists are attracted to the idea because the current tax system, with its high rates and discriminatory taxation of saving and investment, reduces growth, destroys jobs, and lowers incomes.

A flat or fair tax would not eliminate the damaging impact of taxes altogether, but by dramatically lowering rates and ending the tax code’s bias against saving and investment, it would boost the economy’s performance when compared with the present tax code.

When the United States was founded in 1776, the citizenry believed that the government didn’t have any business in their private economic affairs. It wasn’t until the ratification of the 16th Amendment, 137 years later, in 1913, that the government placed itself squarely between you and your money.

In the new Frank- Dodd “financial reform bill” the US government now has a right to be involved in any PRIVATE transaction over $600. Unfortunately, most of this bill has yet to be written. We haven’t even begun to grasp it’s affects.

The most persuasive feature of a flat tax for many Americans is its fairness & transparency. The complicated documents, instruction manuals, and numerous forms that taxpayers struggle to decipher every April would be replaced by a brief set of instructions and two simple postcards; or with the fair tax, no forms at all. This radical reform appeals to citizens who not only resent the time and expense consumed by filing their own tax forms, but also suspect that the existing maze of credits, deductions, and exemptions gives a special advantage to those who wield political power and can afford expert tax advisers.

If enacted, a flat tax or fair tax would yield major benefits to the nation, including:

Faster Economic Growth. A flat tax would spur increased work, saving, and investment. By increasing incentives to engage in productive economic behavior, it would also boost the economy’s long-term growth rate. Even if a flat tax boosted long-term growth by only 0.5 percent, the income of the average family of four after 10 years would be as much as $5,000 higher than it would be under current tax laws. In addition, a fair or flat tax would drive capital from all over the world to the US economy. Either one of these tax systems make the United States the most favorable climate for business in the world. As a nation we are almost 14 Trillion in debt & have approximately $220 Trillion in unfunded liabilities. One of these tax systems, in my opinion, is the only hope to pull the United States back from the brink of bankruptcy.

Instant Wealth Creation. According to Harvard economist Dale Jorgenson, tax reform would boost national wealth by nearly $5 trillion. It would do this in part because all income-producing assets would rise in value since the flat tax would increase the after-tax stream of income that they generate.

Simplicity. Complexity is a hidden tax amounting to more than $100 billion. This is the cost of tax preparation, lawyers, accountants, and other resources used to comply with the Internal Revenue Code. The Internal Revenue Service even admits that the current tax code requires taxpayers to devote 6.6 billion hours each year to their tax returns. Yet even this commitment of time is no guarantee of accuracy. The code is so complex that even tax experts and the IRS often make mistakes. All taxpayers, from General Motors to a hamburger-flipping teenager, would be able to fill out their tax return on a postcard-sized form, and compliance costs would drop by tens of billions of dollars.

Fairness. A flat tax or the fair tax would treat people equally. A wealthy taxpayer with 1,000 times the taxable income of another taxpayer would pay 1,000 times more in taxes. No longer would the tax code penalize success and discriminate against citizens on the basis of income. Tax burdens would no longer depend on the number of lawyers, lobbyists, and accountants on the payroll.

An End to Micromanaging and Political Favoritism. A flat tax or fair tax gets rid of all deductions, loopholes, credits, and exemptions. Politicians would lose all ability to pick winners and losers, reward friends and punish enemies, and use the tax code to impose their values on the economy. Not only does this end a major source of political corruption, but it is also pro-growth since companies would no longer squander resources lobbying politicians or making foolish investments just to obtain favorable tax treatment.

Increased Civil Liberties. Under current law, people charged with murder are presumed innocent and thus have more rights than taxpayers dealing with the Internal Revenue Service. By contrast, a flat tax would eliminate almost all sources of conflict between taxpayers and the government. Moreover, infringements on freedom and privacy would fall dramatically since the government would no longer need to know the intimate details of each taxpayer’s financial assets.

Global Competitiveness. In a remarkable development, former communist nations are leading a global tax reform revolution. Estonia was the first to adopt a flat tax, implementing a 26 percent rate in 1994, just a few years after the collapse of the Soviet Union. The other two Baltic republics of the former Soviet Union enacted flat taxes in the mid-1990s, with Latvia choosing a 25 percent rate and Lithuania picking 33 percent. Along with other free-market reforms, the flat tax significantly improved economic growth, and the “Baltic Tigers” became role models for the region. Learning from its neighbors, Russia stunned the world by adopting a 13 percent flat tax, which went into effect in 2001.

In a global economy, it is increasingly easy for jobs and capital to escape high-tax nations and migrate to low-tax nations. This means that the reward for good tax policy is greater than ever before, but it also means that the penalties for bad policy are greater than ever before. This is why so many nations are lowering tax rates and reforming their tax systems. A fair or flat tax will make America a magnet for investment and job creation. It is imperative we get there sooner than later.

Conclusion

The current income tax system punishes the economy, imposes heavy compliance costs on taxpayers, rewards special interests, and makes America less competitive.

A flat tax would dramatically reduce these ill effects. Perhaps more important, it would reduce the federal government’s power over the lives of taxpayers and get the government out of the business of trying to micromanage the economy.

There will never be a tax that is good for the economy, but the flat tax moves the system much closer to where it should be-raising the revenues that government demands, but in the least destructive and least intrusive way possible.

The public now understands that our tax system is an archaic one that sooner than later will only lead to crashing the system (which is what is happening now).

Just as the fundamentalist priests, stripped of the arcane scriptures and rituals, stand exposed … so too the Internal Revenue Service, stripped of its arcane equations and theories, stand exposed.

This circus has got to stop …. Enough is enough.

Your feedback as always is greatly appreciated.

Thanks much for your consideration.

Comments

  1. Robert ClarkRobert Clark

    Interestingly, the Fair Tax would collect from illegal immigrants. They aren’t filing but they are consuming. Is that $ amount calculated into the collection figures under a Fair Tax scheme?

  2. Joshua Hadley- Serial EntreprenuerJoshua Hadley- Serial Entreprenuer

    Ziad a great start to a very past due disscussion, can you also elaborate on the APT Tax (Automated Payment Transactional Tax) I feel it is also a great contender for a replacement of our current system. http://www.apttax.com

  3. KickerKicker

    Good job of demonstrating the differences between the Flat and the FairTax. Both seem to be better than what we have now, but the FairTax seems a much better choice. We’ve had the “flat” tax system before, and each time it’s manipulated by members of Congress to favor lobbyists or special interests. The FairTax strips Congress of this power. The Flat tax leaves the IRS intact, with all it’s power, costs of operation, and intrusiveness. The FairTax turns the IRS into an office of clerks, without the power to persecute the public. The Flat tax still requires extensive recordkeeping and reporting of income, with the attendant costs. The FairTax eliminates the need to track, or report, any form of income except for Social Security credits. The Flat tax still uses income as the basis for tax collection. This is a much smaller base, both in size and number of people included, than consumption (FairTax). Income is also much more volatile than consumption, meaning the revenue to the government will have larger “swings” and be less stable. The Flat tax still misses taxation of illegal aliens, legal visitors/tourists, the underground economy, and illegal activities (drugs, prostitution, etc). The FairTax does a much better job of collecting taxes from these groups as they make their daily purchases… reducing the taxes that have to be paid by everyone else. The Flat tax continues to fund Social Security and Medicare with payroll deductions, as system currently headed for fiscal ruin. The FairTax funds Social Security and Medicare out of general revenues, from the much broader base of national consumption. This means that the FairTax prevents the financial disaster predicted for SS and Medicare. While the Flat tax isn’t bad, it just isn’t as good as the FairTax. And worst of all, it leaves Congress with the power to re-impose everything we hate about the present system. Congress has demonstrated they can’t be trusted. Take away their power and make sure they can never do it again.

  4. William A. HollonWilliam A. Hollon

    Great post. I have been a fan of a flat tax system for the U.S. Tax System since business school. Taxation without representation is what the current U.S. Tax System is. One of my mentors, once told me that the U.S. Tax System would not change until the U.S. Financial System totally failed. Well, we had a financial melt down in October 2009, but a total failure did not occur. Therefore, the top 3% of the U.S. taxpayers did not feel enough pain from the October 2009 financial melt down to change the U.S. Tax System. Also, this top 3% is being rewarded by the large bonuses that are being paid out by banks, who received financial bailout money. The three hundred ($300) dollars stimulus that 97% of the U.S. taxpayers received. Is like comparing, one drop of water to all of the water on earth. There is no comparison. In reality, the lower 97% of the U.S. taxpayers got screwed over by the top 3% of the U.S. Taxpayers. This is how I see both the U.S. Financial System and the U.S. Tax System.

  5. Gary R. AndersonGary R. Anderson

    As a venture capitalist you can understand the negative ramifications of any drag on the productivity of the investment. It seems however, that you fail to appreciate the stark differences between a flat-(ish, er, or tend) type of tax system and the FairTax, which you seem to understand much better. ANY “flat” tax can be UN-flattened at their whim, just as the ways & means sees fit. The TRUE beauty of the FairTax is in that it isn’t an “Income” tax at all, but rather an excise, which requires more disclosure in jacking up the rates. After all the trouble of enacting sweeping tax reform to save the economy,wouldn’t it be a shame to end up with still just an “Income” tax hosted by your friendly IRS (Income Redistribution Service) ??? In 1913 we had “Excise”(s) according to Article 1, but we got duped into literally throwing out a section of the main body of our Constitution –WITH AN AMENDMENT?? What WERE they smoking? karl Marx danced in his grave that day. And now we have a chance to “make amends” for that error, but can’t seem to see the difference between inherent beauty and vain “FLAT”tery! You CAN’T have it REALLY FLAT, unless you get it FAIR, the FairTax – and ONLY the FairTax will save our economy. One last thing, is that you said we’ll never have a tax that is GOOD for the economy. Oh contrere’, FairTax will untax exports making US goods cost less, and profit more. Foreign producers will flock to HQ in the US, to super-charge OUR economy with jobs galore! Maybe not so good for other economies. (we win)

  6. Chuck B.Chuck B.

    Great discussion about the present code vs. the flat and FairTax. Please consider that in 1913 the income tax started as “sort-a’ like a flat tax, with about 400 pages of code. In 2009, the income tax code was over 70,000 pages big with the resulting collection system being totally uncontrollable. It also wastes over $600 Billion a year in tax compliance costs and evasion. All the while, lobbyists collect six figure salaries tinkering with the code for their clients and adding even more pages of confusion. With income being the basis of the flat tax, the same destructive flaw will exist. I wonder how long the flat tax will remain flat and only require one form. The 133 page spending (consumption) based FairTax bill removes the ability of lobbyists to tinker with the code, since it is a one-time tax collected at the point of retail sale only on new goods and services. There will no longer be an income tax code for lobbyists to game for their clients. Since there will no longer an income tax, wage earners keep their whole paycheck and purchase everything with pre-tax dollars. No income tax means no corporate taxes, making the U.S. THE WORLD’S BIGGEST TAX HAVEN. Manufacturing, meaning money and jobs, flow back into the U.S., bringing back most if not all of the $13+ Trillion now parked in dollar denominated accounts overseas avoiding income taxes. The prebate totally untaxes every legal U.S. citizen up to the poverty level set by Health and Human Services each year. The FairTax is defined to be revenue neutral and a proportion goes into real Social Security and Medicare trust funds, not the general fund, and saves both programs in the short term. Evasion would be harder under the FairTax, since it is collected at the point of retail sale. In a nutshell, the FairTax is a new way of collecting taxes that is simple, fair to everyone, untaxes the necessities of life (prebate), saves Social Security and Medicare brings manufacturing and jobs back to the U.S., stimulates increased economic growth without government intervention and returns April 15th to being just another Spring day!

  7. Duane PerryDuane Perry

    Tax reform will never happen until people see the real amount of money they pay. Eliminate witholding and make them pay their tax quarterly or yearly. Once they write the first check, the fair tax would be voted in the next day.

  8. PhilPhil

    Thanks for a very lucid and well reasoned treatment of one of this country’s most important public policy issues. I would like to comment on the reason that fundamental tax reform is so difficult to get passed. Over the past 3-4 decades tax preferences and earmarks have become the currency used to pay for the enormous amounts of campaign cash which must be raised for career politicians to remain in office. Lobbyists, of course, are the principle enablers of this system and they benefit enormously. An excellent explanation of this history is contained in the book So Damn Much Money – the triumph of lobbying and the corrosion of the American government by Robert Kaiser. This is why our tax system is so unbelievably complex and economically destructive – because the current system benefits lobbyists, career politicians and big money special interests.

  9. Frank PonsFrank Pons

    Great discussion issue. As I understand the Fair Tax proposal (FairTax Act, HR 25, S 296) includes an advance credit (called a prebate) that allows for those making less than poverty level income to avoid paying any tax and those slight above this poverty level a tax rate of 11.5% which is less than the combined tax paid for FICA and federal income tax. So… the proposal avoids the regressive nature of sales tax, but has the benefit of taxing consumption versus income. Obviously, free the taxation of capital will make the US significantly more attractive for investment versus European nations, and likely will have the US placed on the OECD “gray list”.

  10. Robert IntileRobert Intile

    Well done. Accountants and lawyers will not support this because they will lose income. Government tax departments will lay off staff, unions will react. The size of government needs to be reduced and this is one way to make it happen. And we wonder why people are leaving the country forever, stating to taxes.

  11. Ed TorresEd Torres

    Great post, a usual. What amazes me is the lack of interest on this subject by the population and by the political class. Most of the politicians are entrepreneurs or had been engaged in entrepreneurship activities. Regardless, when they become politicians the tax reform issue is no longer a priority. Are they being benefited by the loopholes? Their direct and indirect salaries offset their personal tax issues? How about the media? Little or no engagement on the tax reform debate.

  12. David R. PohndorfDavid R. Pohndorf

    The flat tax, aka, tax return on a postcard, has been advocated by many as diverse as Steve Forbes and Bill Bradley. Makes all the sense in the world, as does Steve Forbes’ comment of years ago that dividends should be treated as return of capital. Accountants and tax attorneys hate the idea of tax code simplification. Logic and simplicity rarely triumph in a world of political self interest….

Leave a Reply

Top