This talk was given on May 18 at the monthly meeting of the Gulf Coast Economics Club in Pensacola, Florida.
According to the Tax Foundation, tax freedom day came on April 12th this year. This means that everything the typical American taxpayer earned from January 1 to April 11 went toward meeting his total federal, state, and local tax burden.
Of all the taxes Americans are saddled with, the federal income tax is the most objectionable. Like most, if not all of you, I grudgingly filed my 2010 income tax return before the April 15th deadline last month. And although most other Americans did likewise, many people who filed an income tax return didn’t actually pay any income taxes.
According to the most recently released IRS data, the top one percent of taxpayers (in terms of adjusted gross income) paid 38 percent of all federal income taxes in tax year 2008. The top 10 percent of taxpayers paid 70 percent of the taxes and the top 50 percent paid a whopping 97 percent. The “rich” are not only paying more than their “fair share,” they are also paying the share of many other Americans as well. And not only do the bottom 50 percent of taxpayers pay little or no income taxes, many of them actually get tax refunds anyway thanks to what are called refundable tax credits.
Clearly, something is wrong with the U.S. tax code.
Our current income tax system, inaugurated in 1913 with the adoption of the Sixteenth Amendment, began with a 1 percent tax on taxable income above $3000 ($4,000 for married couples). A series of surcharges of up to 6 percent were applied to higher incomes, with the maximum rate being 7 percent on taxable income over $500,000. In actuality, less than a half a percent of the population actually paid an income tax.
From these humble beginnings, the income tax soon blossomed, thanks to World War I, into a tax with a minimum rate that doubled and a maximum rate that reached 77 percent on income of over $1 million. The rates did not fall significantly until 1925. In the middle of the Great Depression, the top rate rose to 79 percent. During World War II, the tax rate for those in the highest income bracket reached an astounding 94 percent. The complexity of the code also increased. The Internal Revenue Code of 1954 established 24 brackets with rates ranging from 20 to 91 percent. The top rate remained at 91 percent until 1964. Under the Economic Recovery Tax Act of 1981 and the Tax Reform Act of 1986, the top marginal tax rates were lowered to 50 and 28 percent respectively. The Economic Growth and Tax Relief Reconciliation Act of 2001 established the tax brackets of 10, 15, 25, 28, 33, and 35 percent.
The detrimental change in these tax brackets that was set to take effect at the beginning of this year was averted by a deal reached between the president and congressional Republicans late last year. The so-called Bush Tax Cuts were extended for all income groups for two years. Additionally, certain tax credits were also continued, and payroll taxes were reduced for this year. All of this came with a price, though, as unemployment benefits were also extended.
Nothing about any of this, however, changes the fact that the federal tax code is still too long, too complex, too intrusive, too confusing, and too inequitable. The members of Congress responsible for the tax code would not even disagree. As a consequence of the monstrosity that is the tax code, cries for tax reform are continually heard from every quarter – and especially around election time. There are even organizations dedicated solely to tax reform like Americans for Tax Reform, Reform AMT, Citizens for Tax Justice, and Americans for Fair Taxation. And since the federal government is always looking to increase its revenue while at the same time making Americans feel better about paying their taxes, it too has climbed aboard the tax reform bus, such as when President Bush formed the President’s Advisory Panel on Federal Tax Reform.
Other than some libertarians who oppose taxes on principle – while at the same time welcoming real tax reform or tax-rate reductions that move toward the goal of substantially reducing or abolishing the income tax – no one seems to have much of a problem with paying taxes per se.
Liberals, who want to use the tax code for their social engineering and income redistribution schemes, are not opposed to taxes on principle. Barack Obama ran campaign commercials openly boasting that no taxes would be raised on any American making under $250,000. This, of course, means that he intended to fleece any American making over this amount. And that is exactly what he and the Democrats are still talking about doing.
Conservatives are not generally opposed to taxes on principle either. They have no problem taxing the American people to fund foreign aid, bloated defense budgets, U.S. military adventures around the world, the CIA, FBI, and anything related to law enforcement or homeland security, faith-based welfare programs, educational vouchers, abstinence education programs, farm subsidies, the space program, the war on drugs, and various conservative pork projects.
As explained by Jacob Hornberger, the president of the Future of Freedom Foundation: “The left-right debate in America over income-tax policy assumes the continued existence of the welfare-warfare state way of life, along with the continued existence of the income tax that funds this way of life.”
But what’s up with some libertarians?
Brink Lindsey, of the Cato Institute, supposedly a libertarian think tank, wrote in an online article for the New Republic that also appeared on the Cato Institute website:
Tax reform also offers the possibility of win-win bargains. The basic idea is simple: Shift taxes away from things we want more of and onto things we want less of. Specifically, cut taxes on savings and investment, cut payroll taxes on labor, and make up the shortfall with increased taxation of consumption. Go ahead, tax the rich, but don’t do it when they’re being productive. Tax them instead when they’re splurging – by capping the deductibility of home-mortgage interest and tax incentives for purchasing health insurance. And tax everybody’s energy consumption. All taxes impose costs on the economy, but at least energy taxes carry the silver lining of encouraging conservation – plus, because such taxes exert downward pressure on world oil prices, foreign oil monopolies would wind up getting stuck with part of the bill.
Shift taxes? Increase taxes? Tax the rich? Impose new taxes? Use the tax code to influence public policy? What kind of libertarian tax reform plan is this? Libertarians are generally known for advocating that taxes be reduced, cut, eliminated, or abolished. Not deductions, exemptions, credits, shelters, and loopholes – but taxes.
Two specific tax reform plans that many conservatives and some libertarians have fallen for are the Flat Tax and the FairTax. Both plans promise to invigorate the economy, increase employment, and raise everyone’s standard of living. But neither one is true to its name, and neither one is an incremental step toward lower overall taxes. Both are fraught with problems and contradictions, and both are revenue-neutral plans that would fund the federal government at the same obscene level that it is now.
The Flat Tax is an income tax. It is the tax-reform idea that has been around the longest. First proposed by economist Milton Friedman in 1962, the Flat Tax entered the mainstream through a 1981 Wall Street Journal article by Hoover Institution economists Robert Hall and Alvin Rabushka called “A Proposal to Simplify Our Tax System.” This article grew into a 1985 book published by the Hoover Institution Press called The Flat Tax. A second edition was published in 1995, and an “updated revised edition” in 2007 that can hardly be called either.
Aside from this book, the Flat Tax gained national prominence when House Majority Leader Dick Armey (R-TX) pushed the idea of a flat tax after the Republicans gained control of Congress during the Clinton administration. A few bills based on the Hall-Rabushka plan were introduced in Congress, but they came to nothing. Other incarnations of the Flat Tax were pushed by both Democrats and Republicans. Another version of the Flat Tax is that of former Republican presidential candidate Steve Forbes. His 2005 book is called Flat Tax Revolution.
Under a flat tax, everyone’s income is taxed at the same rate (Hall and Rabushka say 19 percent; Forbes says 17 percent). But not only are there no tax brackets, there are generally no tax deductions either, other than those for personal and dependent allowances. Social Security and Medicare taxes would remain as they are now. The appeal of the Flat Tax is simplicity. You can do your taxes on a postcard-sized form says Forbes. Goodbye anxiety and compliance costs.
The main problem with the Flat Tax is a simple one: the Flat Tax is not flat. And furthermore, no one actually pays 19 or 17 percent. In fact, taxpayers don’t even pay the same percentage. The Flat Tax is actually a highly progressive tax. It is more progressive than our current system, and effectively has more tax brackets. Who said progressivity requires graduated tax rates?
Under the Forbes plan, a family of four would pay no federal income tax on its first $46,165 of income; a family of six would owe nothing until its income exceeded $65,930. And those figures are sure to have increased since they were first proposed back in 2005. But not only would many families pay no income tax, they still might get a refund anyway because the Forbes plan includes a refundable child credit and earned income credit.
The Social security tax is sometimes touted as an example of a flat tax. This, however, is incorrect. The 12.4 percent Social Security tax (split between employer and employee) is not assessed on income over $106,800. If you want an example of a real flat tax, look no further than the 2.9 percent Medicare tax. Everyone pays 2.9 percent (split between employer and employee), on every dollar earned, no matter one’s marital status, number of dependents, or income level. I am in favor of neither the Medicare tax nor Medicare, but if you are looking for a genuine flat tax, then the Medicare tax is your tax.
Because the Flat Tax is still an income tax, it deserves the scorn heaped upon the income tax by Old Right stalwart Frank Chodorov in his book The Income Tax: Root of All Evil. As explained in this classic work, with an income tax the state says to its citizens: “Your earnings are not exclusively your own; we have a claim on them, and our claim precedes yours; we will allow you to keep some of it, because we recognize your need, not your right; but whatever we grant you for yourself is for us to decide. . . . The amount of your earnings that you may retain for yourself is determined by the needs of government, and you have nothing to say about it.”
The FairTax is a consumption tax. It is the most radical tax reform plan, bar none. It also has the most vocal and intolerant proponents. The FairTax is the brainchild of three businessmen concerned about the crippling effects on the economy of the federal tax code. After adopting the name “FairTax” for their tax-reform plan, they formed Americans for Fair Taxation in 1997 and enlisted then Representative John Linder (R-GA) to introduce FairTax legislation in Congress. Linder first sponsored the “Fair Tax Act” in the House in July of 1999, and reintroduced a FairTax bill at the beginning of every congressional term since then until his retirement in 2010.
Although Linder’s FairTax bill always languished in the House Committee on Ways and Means after it was introduced, it always had a number of cosponsors, including Tom Tancredo, Duncan Hunter, and our own Jeff Miller, but never Ron Paul, the acknowledged taxpayers’ best friend. The FairTax also has its share of supporters outside of Congress, including Mike Huckabee and Neal Boortz. The latter is the author, with congressman Linder, of The FairTax Book, published in 2005. A paperback version of The FairTax Book was issued in 2006 with some notable changes to correct false statements made in the original hardcover release of the book. Boortz and Linder also published a sequel, FairTax: The Truth, Answering the Critics, in 2008.
Although the idea of the FairTax has been around since 1997, I don’t think I ever heard of it until after I wrote an article for the Mises Institute in 2005 on the evils of the withholding tax. It was only after my inbox was bombarded with mail from FairTaxers trying to sell me on the FairTax that I looked into it. If you have read any of my articles on the subject you know that I didn’t like what I saw. I don’t consider myself to be an expert on the FairTax, but I have written more articles on the subject than I can remember and have reviewed in great detail Boortz’s books on the subject.
The FairTax is a national retail sales tax of 30 percent on the final sale of all new goods and services. All new goods are included – from cars and houses to prescription drugs and food. And with the exception of college tuition, all services are included – from heart operations and funerals to rent and haircuts. Purchases for business purposes would be exempt. Because it would replace the personal income tax, there would also no longer be withholding tax, capital gains tax, the alternative minimum tax, or taxes on interest and dividends. Even your gambling winnings would no longer be taxed. Of course, with no income tax, there would be no income tax deductions or credits either: no mortgage interest or charitable contribution deductions, and no earned income or child credits. The FairTax would likewise eliminate the corporate income tax, estate tax, gift tax, unemployment tax, Social Security tax, and Medicare tax.
The appeal of the FairTax is obvious: no more complex tax code, no more taxes withheld from paychecks, no more arcane tax forms and schedules, no more April 15th, and, so we’re told, no more record keeping, no more compliance costs, and no more IRS audits. And if that weren’t enough, the FairTax also includes a monthly payment called a “prebate” to offset the taxes paid on basic necessities.
But for a plan that promises such a utopia, the problems with the FairTax are legion. The FairTax plan creates new taxes, new taxpayers, and new tax collectors. The stated rate of the FairTax is too low to achieve the promised revenue neutrality. The amount by which it is claimed prices would fall under a FairTax system has been grossly exaggerated. There is nothing to prevent an income tax from being reinstituted, giving us a two-headed hydra of an income tax and a consumption tax. The institution of a FairTax would not abolish the IRS – if there were no IRS then why would businesses bother to collect a national sales tax? The FairTax’s monthly prebate would put all Americans on the dole – from Bill Gates on down – and require a vast welfare apparatus to oversee its payment. The FairTax has unknown and potentially huge transition costs. The FairTax double-taxes the savings of retirees who worked their whole life and paid taxes and then need to begin spending the money accumulated in their after-tax savings accounts. And not only would the FairTax require state and local governments to pay a national sales tax to the federal government on all their purchases, the federal government would have to pay sales taxes to itself on all its new purchases. How ludicrous is that? Since I have already written extensively about the problems with the FairTax, and that is not the focus of my talk, I will stop with its problems here and focus on why the FairTax, like the Flat Tax, is not true to its name.
So why is the FairTax not fair? Well, first of all, what’s fair about a consumption tax? Why is it that people who rightly criticize the income tax are so quick to accept a national sales tax on consumption? The FairTax perpetuates the fallacy that the government has a right to confiscate a percentage of the value of each new good sold and every service rendered. This is no different than claiming that the government has a right to the portion of each American’s income. As the late economist Murray Rothbard explained:
The consumption tax, on the other hand, can only be regarded as a payment for permission-to-live. It implies that a man will not be allowed to advance or even sustain his own life, unless he pays, off the top, a fee to the State for permission to do so. The consumption tax does not strike me, in its philosophical implications, as one whit more noble, or less presumptuous, than the income tax.
The FairTax is also not fair because of the rate. What is fair about the government taking a 30 percent cut on every transaction? I know the FairTaxers claim that the rate is only 23 percent, but when I buy an item for $1.00 and end up paying $1.30, the basic math I learned in elementary school tells me that I paid a tax rate of 30 percent. But regardless of whether the rate is 23 or 30 percent, why should the bloated, pork-laden leviathan we call the U.S. government get anywhere near this much of our income? And finally, maintaining that the FairTax is a “fair” tax system, or one that is “fairer” than our current system, is highly subjective. Neal Boortz himself even acknowledges this in his newest book on the FairTax: “Whether a tax system is u2018fair’ is a complicated economic and philosophical question, one that inevitably involves oversimplification and subjective judgment.”
If you want an example of a real fair tax, then consider the equal tax. I first saw this proposed by the late Joe Sobran. Let every American pay the same amount – no deductions, no exemptions, and no exceptions. Sobran reasons: “The billionaire doesn’t use the police or the streets any more than the pauper. Maybe less, since he presumably hires private guards to protect him and has less need of the police, and he is less likely to drive long distances than to fly.” Now, I wouldn’t like paying this tax any more than I like paying income tax, but it is certainly a fair tax.
But not only is the Flat Tax not flat and the FairTax not fair, the Flat Tax is not fair and the FairTax is not flat. Let me repeat that: not only is the Flat Tax not flat and the FairTax not fair, the Flat Tax is not fair and the FairTax is not flat.
According to Hall and Rabushka, the flat-tax system they propose is both “fair and progressive – the poor pay no tax, and the amount that a family pays rises with income.” They say their Flat Tax is fair because it is based on the principle that “income should be taxed exactly once, as close as possible to its source.” But how can a system that punishes success and fosters class envy be considered “fair”? And why should it be considered “fair” that income is taxed “exactly once, as close as possible to its source”? Just because every American would pay the same rate under the Flat Tax doesn’t necessarily make it a fair tax. Making the tax code less progressive is not enough. As Rothbard again explains:
The flat-tax movement is part of a process by which the government and its allies have been able to split and deflect the tax protest movement from trying to lower the taxes of everyone, into trying to force everyone into paying some arbitrarily defined “fair share.”
It is no consolation to a wealthy person who is stripped of his money by the federal government that a poorer person is likewise relieved of his money by the same percentage.
One of the reasons FairTax supporters claim that their tax is fair is that it has a flat rate that everyone would pay. But the FairTax is about as flat as it is fair. I have already mentioned that the FairTax includes a monthly payment to offset the taxes paid on basic necessities. This “prebate” is based on the government poverty level and family size. Thus, although everyone would pay the same rate under the FairTax, the end result would be that some Americans would pay no taxes at all, some would have most of their taxes offset, and some would get more money back than they paid in taxes. This makes the FairTax an income redistribution scheme under the guise of tax reform.
Although the Flat Tax is an income tax and the FairTax is a consumption tax, they have something important in common that in the end makes them virtually identical. Each of these tax-reform plans is revenue neutral. They allow the federal government to raise more efficiently the same amount of revenue that it does currently. The Flat Tax and the FairTax merely change the way that taxes to fund a federal budget fast approaching $4 trillion are collected. They shift the debate from how much wealth the federal government confiscates to how the wealth is confiscated. Yet, as Congressman Ron Paul has remarked on several occasions: “The real issue is total spending by government, not tax reform.”
Under either the Flat Tax or the FairTax, all federal departments, all federal programs, all federal agencies, all federal projects, all earmarks, all pork-barrel spending – they would all continue just as now. Thus, Congress could continue its spending orgy while taking credit for simplifying and making the tax code fairer. The winner in these tax-reform proposals is clearly the federal government, not the American people. The root of the problem is clearly taxation itself, not the tax code. The problem with the code is not that it is too complex, too intrusive, too long, too full of loopholes, too unfair, or too progressive. The problem is that it is used to fund trillion-dollar budgets.
Any revenue-neutral tax-reform scheme can, by definition, only shift taxes, not lower them. Neither the Flat Tax nor the FairTax is a step toward the goal of relieving Americans of their tax burden; neither tax-reform plan is an incremental step toward lower overall taxes. They could be, however, if their promoters recognized that the root of the problem is taxation itself, not the tax code. We don’t need compassionate tax reform that makes people feel better about paying their taxes; we need radical tax reform that reduces, cuts, eliminates, and abolishes taxes without replacing them with other taxes. With the United States heading toward financial collapse, I can’t think of anything that is more of a waste of time than quibbling about how the government can make the tax rates flatter or fairer while it confiscates and redistributes the wealth of its citizens. Talk about rearranging the deck chairs on the Titanic!
Twenty years ago federal spending was only about one-third as much as it will be in fiscal year 2011. Congressional spending is clearly out of control. We only “need” an income tax because of the federal government’s insatiable desire for money. There was no permanent income tax in the United States for 125 years. Can anyone possibly say that the government didn’t have enough revenue to function during that time? Before then the federal government operated successfully with the revenue it received from tariffs, fees, land sales, and excise taxes. It wasn’t until the adoption of the Sixteenth Amendment in 1913 that the redistributionist road was paved for an income tax. And what benefits has the increased government revenue from the income tax given us? It is the income tax that has made possible World War I, the New Deal, World War II, the Great Society, the Vietnam War, and our current welfare-warfare state.
All the proposals put forth by the Democratic and Republican parties to rein in government spending are nothing but band aids and window dressing: baseline budgeting, a Balanced Budget Amendment, automatic across-the-board spending cuts, sunset provisions, spending increases limited to the rate of inflation, spending caps based on GDP, deficit reduction targets, elimination of earmarks, deficit commissions, temporary freezes on certain categories of spending, rollbacks to some previous level, non-binding public voting on spending cuts, and, of course, cutting waste, fraud, abuse, and unnecessary spending.
What Republicans want is a slight reduction in the welfare state with an increase in the warfare state. Democrats regularly call for just the opposite: a slight reduction in the warfare state with an increase in the welfare state.
The only way to really rein in government spending is by dismantling the illegitimate functions of the federal government. This means the wholesale elimination of departments, agencies, commissions, administrations, corporations, councils, boards, and bureaus with all of their programs and personnel.
Of the sixteen executive branch Cabinet-level departments, a limited Constitutional case could be made only for the departments of State, Treasury, Justice, and Defense. Any legitimate operations of the Departments of Homeland Security and Veterans Affairs could be subsumed under the Department of Defense. This means that the functions and bureaucracies of the Departments of Agriculture, Commerce, Education, Energy, Health and Human Services, Housing and Urban Development, Interior, Labor, and Transportation should be eliminated in their entirety. The original four departments might conceivably serve some useful purpose – but only if they were scaled down considerably, and especially the Defense Department, which spends most of its budget on offense.
Next to go would have to be the alphabet soup of government agencies like the DEA, ATF, EEOC, LSC, TVA, NEA, NEH, FHA, CPB, SBA, NLRB, FEMA, OSHA, and USAID.
This also means no more funding for income redistribution schemes like food stamps, WIC, TANF, SCHIP, housing subsidies, foreign aid, refundable tax credits, Head Start, the National School Lunch Program, scientific research, unemployment benefits, farm subsidizes, and climate change studies.
Oh, and do I need to say that there should be no office of surgeon general or those of drug czar, AIDS czar, or faith-based czar?
In other words, strictly limit government spending to only what is constitutionally authorized.
Consider just two issues that are always in the news: health care and education. Because the proper role of government is not the issue that it should be, the debate over health care and education among liberals and conservatives and Democrats and Republicans is always how government should fix or reform health care and education instead of why the government should do it. It is precisely because of government intervention into health care and education that they are in the condition they are in.
In Article I, Section 8 of the Constitution there are delegated specific powers to the federal government. In Amendment Ten it says that whatever is not delegated to the central government is reserved to the states. The national government has been delegated no authority concerning the areas of health care and education. Because state constitutions have provisions regarding health care and education, we can and should debate on the state level the necessity of the states to provide, control, or regulate these things. On the national level, however, everything is perfectly clear. There should be no federal laws relating to health care or education. There should be no federal regulations concerning health care or education. There should be no federal funding of health care or education. It is that simple.
Limiting government to its proper role will automatically cause the spending problem to disappear. The government needs to be gotten completely out of the places it doesn’t belong. In his powerful pamphlet Common Sense, Thomas Paine remarked: “Government, even in its best state, is but a necessary evil; in its worst state, an intolerable one.” Although the federal government in the early years of the American republic may not have been government at its best state, the federal government as it exists today is certainly an intolerable one. It is intolerable because it embodies the role of government as described by Voltaire: “The art of government is to make two-thirds of a nation pay all it possibly can pay for the benefit of the other third.”
The income tax system is a vast income redistribution and social engineering scheme. But the income tax code doesn’t just need to be simplified, shortened, fairer, or less intrusive. And neither do the income tax rates just need to be made lower, flatter, equal, or less progressive. The income tax should be repealed, not replaced. The IRS should be abolished, not given a new name. Tax reform should result in revenue reduction, not revenue neutrality. The only fair tax is a tax low enough to flatten skyrocketing congressional spending. Like educational vouchers and the privatization of Social Security, the Flat Tax and the FairTax are gimmicks that conservatives and libertarians should avoid.