Monthly Archives: May 2014

The End of Federal Taxation as We Know It

By Barry Elias

The way we tax is obsolete.

It’s safe to say, in the century since the federal income tax was instated, the system has become broken.  The complex, voluminous tax code (included in the 70,000+ page CCH Standard Federal Tax Reporter) needs a revolutionary overhaul.

The current system doesn’t raise nearly enough money, social security is nearing insolvency, the administrative cost is exorbitant, and economic growth is actually impeded.

The purpose of the federal tax is to collect enough revenues to foot the government’s annual expenditures: nearly $3.5 trillion in fiscal year 2013.  Last year we only collected $2.8 trillion. The shortfall must be borrowed, and we pay interest on that debt.

Furthermore, we forgo tax revenue due to deductions, exclusions and other preferential tax treatments.  Last year alone, that amounted to $1 trillion. New types of transactions have spawned an underground economy that is valued at close to $2 trillion per annum, which goes completely unreported. Consider teenage babysitters, sales on eBay, the room above your garage that you rent to a college student, domestic help, sales of Bitcoin, lemonade stands, illegal drug deals….the list is endless.

We estimate an annual loss of $400 billion of tax revenue. In addition, Social Security taxes are only collected on the first $117,000 of earned income. The professional athlete earning $10 million, for example, pays no Social Security tax on nearly 99% of his pay.

To make matters worse, complying with the current arcane system (that looms as a nuisance on our calendars in the months leading up to April 15) has a hidden cost approaching $1 trillion annually. This includes tax preparation; advisers, attorneys and lobbyists; IRS agents; plus the time spent by all parties involved.  Nearly 6 billion hours are invested in this activity each year.

There’s also a negative environmental impact from cutting down forests to print forms, instruction manuals, etc. Tax compliance actually impedes economic growth. We can use those 6 billion hours more productively to grow the economy. Our focus should shift towards making value-added goods and services at more competitive prices.

To summarize, lost revenue and the cost to comply with the current federal tax system probably exceed $2.5 trillion. This is a big problem!

Big problems have been tackled at other times in our history. At the dawn of the 20th century, when the NY Central Railroad was forced to convert  from steam locomotive to electric trains, the $70 million cost nearly matched their $80 million of annual revenues. Nevertheless, management figured out a way to lay new tracks underground, while the railroad continued to operate. Incidentally, this investment created a huge, unexpected economic boom. As it turned out, Park Avenue was built over the tracks, permitting air rights to be leased to developers.

Herculean problems call for out-of-the-box measures. Our solution to the current tax conundrum is streamlined and elegant.  Instead of focusing on income, we propose capturing two flows:  money saved and money spent.

Revenues can be generated from both.  We believe that savings should be assessed at a lower rate than consumption, since a dollar saved generates more jobs and income for society than a dollar spent.

Savings in the form of cash deposits, bonds and equities total nearly $67 trillion (and that doesn’t include the $2 trillion underground economy).  Instead of reporting dividends, interest and capital gains, financial institutions would report an average of the total financial assets on hand over the course of the year. We assume that most people will not stash their cash under their mattress, as they would forgo a return on their money (and because it’s not safe).

Americans consume $11.8 trillion annually in goods and services, as reported by the Bureau of Economic Analysis.  We believe the consumption of essential products and services – such as food, housing, healthcare and education – should be assessed at a lower rate than luxury items (e.g. the purchase of a loaf of bread would be assessed at a lower rate than a yacht).

Here’s one example of how our method might work. We would assess $11.8 trillion in consumption at an average rate of 13.5 percent (less for essentials; more for luxury items), generating $1.6 trillion. We’d also assess $69 trillion of savings at 2.75 percent, generating $1.9 trillion. Together, $3.5 trillion would balance the federal budget.

Our plan eliminates all federal taxes: income, social security, Medicare, capital gains, dividends, interest, inheritance, and corporate profits. Existing social programs will remain in place, including social security, Medicare, and welfare.

We believe our plan will have mass appeal.

The poorest will no longer pay 15 percent for social security and Medicare. Instead they’ll pay 2.75 percent on their savings and a small percentage on essential purchases.

The wealthy would no longer pay any of the above mentioned federal taxes. Expenditures on estate planning would be negligible. Wealth will be preserved, since the average annual return on investment will most likely exceed 2.75 percent.

The middle class would benefit from all of these proposals, including a shift from household spending on tax compliance to household spending on essentials.

Corporations will experience tax-free profits and lower costs of production, including tax-free labor and capital and severely reduced tax compliance expenditures.  As a result, there will be downward pressure on the price of goods and services offered to the masses.

On the government side, our strategy would virtually balance the budget and make Social Security more solvent.

Our simple method of assessment offers relatively low and stable rates.  This would allow us to focus on creating value-added products instead of  minimizing tax liability.

This environment will likely promote greater investment and net capital inflows, manifesting in greater employment, productivity, and economic growth. Liberals and conservatives alike believe my tax proposal is fair, effective and elegant in its simplicity.

The time has come to end federal taxation as we know it. _______________________________________________________

My wife Billie Elias provided valuable assistance with this piece.

An updated article of mine on this topic can be found here.