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Why Reshaping our Tax System is today an Absolute Must

By : Ziad K. Abdelnour| 20 September 2010
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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.

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