We Can End Federal Taxation as We Know It

By Barry Elias | Friday, 18 Dec 2015 06:56 AM

The way we tax is obsolete.

More than a century has passed since the inception of the federal income tax. It’s safe to say, this system has completely broken down. The complex, voluminous tax code — included in the 70,000-plus 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.

We need tax reform that will increase investment, productivity, employment, income, purchasing power, and economic growth, while keeping inflation and tax compliance costs low. I believe my tax plan will achieve all of these objectives.

The purpose of the federal tax is to collect enough revenues to pay for the government’s annual expenditures. We spent nearly $3.7 trillion in this fiscal year 2015, but only collected about $3.2 trillion, leaving a shortfall of nearly $500 billion, which must be borrowed, and we pay interest on this debt.

Furthermore, we forgo tax revenue due to deductions, exclusions and other preferential tax treatments. Last year alone, that amounted to roughly $1.2 trillion. New types of transactions have spawned an underground economy that is valued at close to $2 trillion per annum, which goes completely unreported. Included in this figure are transactions that occur on eBay and Airbnb; Bitcoin trading; illegal drug trafficking and distribution; domestic assistance; babysitter services; and lemonade stand revenue: The list is endless.

Due to the underground economy, the U. S. Treasury loses nearly $400 billion of tax revenue every year. In addition, social security taxes are only collected on the first $118,500 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 – one that looms large as a nuisance on our calendars in the months leading up to April 15 – has a hidden cost totaling hundreds of billions of dollars each year. This expense includes tax preparation professionals, financial advisers, estate planners, attorneys, lobbyists, Internal Revenue

Service agents, and the time spent by all parties involved. Nearly 6 billion hours are invested in this activity each year.

Tax compliance actually impedes economic growth. We can use the savings and 6 billion hours of time more productively to grow the economy. Our focus should shift towards making value-added goods and services at more competitive prices, rather than complying with an ineffective and inefficient tax code. The environment has also been harmed as we destroy forests to accommodate the massive printing of forms, manuals and instruction booklets.

Lost revenue and the cost to comply with the current federal tax system probably exceed $2 trillion. This is an extraordinary problem that yearns for a substantial solution.

Huge issues 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.

My solution to the current tax conundrum is streamlined and elegant. Instead of taxing monetary inflows, such as income, I propose assessing what is done with the money: it is either saved or spent, and we can derive revenue from both to balance our annual budget.

This plan will minimize tax rates and administrative costs, while maximizing the tax base and transparency. It will also increase investment, productivity, employment, income, purchasing power, and economic growth over the long term for the general population, while keeping a lid on inflation.

My proposal will eliminate all current forms of federal taxation. These taxes include the following: income, social security, Medicare, disability, interest, dividends, capital gains, gifts, inheritances, and corporate profits.

They would be replaced by a tax on savings and consumption. Savings will be assessed at a lower rate than consumption, since a dollar saved generates significantly more jobs and income for society than a dollar spent.

The savings that are assessed would include only liquid financial assets, such as stocks, bonds and cash. These products typically involve the trading of existing assets or the restructuring or retirement of existing debt, instead of the creation of new assets. Too often, financial assets are a method for transferring wealth rather than creating value.

Hence, these savings need to be subject to tax, albeit at a much lower rate than that for consumption.

Excluded from these savings would be direct capital investment, since this activity generates strong employment and income gains. Physical land and buildings would also be excluded due to strong productivity potential, and a low level of liquidity, which might cause extreme market volatility in the event of strong selling pressure to meet tax obligations.

This proposal would balance the federal budget at current spending levels, preserving key social programs like social security, Medicare, disability, Medicaid, food stamps, other welfare programs, and the earned income tax credit, while maintaining a strong defense and homeland security apparatus.

Savings in the form of equities, bonds and cash for individuals, corporations and tax-exempt organizations total nearly $189 trillion, according to the Federal Reserve.

From this amount, the following liquid financial assets would be excluded from taxation:

• wages and salaries, or $7.9 trillion;
• $100,000 for a family of three, or $10 trillion;
• retirement funds, or $25.7 trillion;
• education IRAs and 529 plans, or $250 billion;
• direct investment for capital expenditures, or $3.6 trillion (20 percent of GDP);
• and tax-exempt organizations, or $4 trillion, for a total $50 trillion.

The net taxable amount after exclusions would approach $139 trillion. A savings tax rate of 2 percent on this figure would raise approximately $2.8 trillion.

Instead of reporting dividends, interest and capital gains, financial institutions would report an average daily balance of liquid financial assets on hand over the course of the year — to minimize or eliminate tax arbitrage opportunities — and send the tax directly to the federal government, another cost saver for the American people. I assume most people will not stash much cash under a mattress, since they would forgo a return on their money, and it’s not a safe methodology.

Americans consume about $12.4 trillion annually in goods and services, according to the Bureau of Economic Analysis. Taxing consumption at 10 percent would raise about $1.2 trillion. An annual tax refund of $3,000 would be provided to each family of three to offset the first $30,000 of essential consumption expenditures, costing $300 billion each year.

Therefore, the total revenue raised would be around $4 trillion: $2.8 trillion from savings and $1.2 trillion from consumption. These revenues would offset the current $3.7 trillion annual budget plus the $300 billion yearly consumption refund.

To generate these tax rates, we divide the tax revenue by the pre-tax amounts for both savings and consumption. That is, a 10 percent consumption tax on a $1 (pre-tax) retail item would generate 10 cents of tax revenue, resulting in a post-tax amount of $1.10 ($1 plus 10 cents).

The Fair Tax proposal, which was presented to Congress in the late 1990s, would divide the 10 cent tax revenue by the post-tax amount of $1.10, to arrive at a consumption tax rate of 9.1 percent. By using the post-tax amounts, as used in the Fair Tax model, the tax rates for my plan would be less than what I have stated: 1.96 percent for savings (instead 2 percent) and 9.1 percent for consumption (instead of 10 percent).

The fair tax proposal would subject consumption to a pre-tax rate of 30 percent (10 percent in my plan) and a post-tax rate of 23 percent (9.1 percent in my plan). The Fair Tax plan does not include a savings tax, but does eliminate all existing federal taxes.

In my view, the Fair Tax plan is far too regressive. It hits the poor and middle class hardest, since they consume a much greater percentage of their income and wealth, as compared with those in the upper economic strata.

I believe my plan is fairer in this regard, and will have mass appeal.

The poorest would no longer pay 15 percent for social security and Medicare as they do today; they would likely pay no other federal taxes; and they would still have access to Medicaid, food stamps, other welfare programs, and the earned income tax credit.

The wealthy would no longer pay any of the current federal taxes, including those on income, payroll, interest, dividends, capital gains, gifts, and inheritance. Expenditures on estate planning would be negligible, and wealth will be preserved, since the average annual return on investment will most likely exceed 2 percent.

The middle class would benefit from all of these proposals, including the participation in the earned income tax credit program and a reduction in tax compliance expenditures.

These benefits and savings can then be directed toward the consumption of essential goods and services, such as food, housing, clothing, healthcare, and education.

Corporations will experience tax-free profits and dividends; lower costs of production, including tax-free labor and capital; and severely reduced tax compliance expenditures. As a result, there would be downward pressure on the price of goods and services produced, which would increase purchasing power for the masses.

On the government side, the strategy would virtually balance the federal budget at current spending levels and make social security and Medicare more solvent.

This simple method would assess the most money at the lowest rate with the least cost and most visibility. This transparency would ensure that virtually all individuals would feel the impact of any tax rate increase immediately, resulting in a call for justification or reform. This check and balance would likely keep the rates low and stable over the long term.

Today, special interest tax benefits are visible to a very select few, resulting in higher tax rates and tax bases for others to offset the lost revenue to the government. This system would also allow us to focus more on the creation of value-added products and services instead of on minimizing the tax liability.

By excluding labor and capital from taxation, employment, investment and productivity will rise, generating greater income, stronger purchasing power, and more robust and sustainable economic growth, while keeping inflation in check.

Low tax rates will likely increase net capital inflows from overseas, including some of the more than $22 trillion of U.S. financial assets that reside abroad, as well as new foreign assets. If these net inflows materialize, tax rates can be lowered while maintaining a balanced federal budget. Moreover, reductions in government spending would allow rates to fall further.

My tax proposal is seen as fair, effective and elegant in its simplicity by a large swath of the political spectrum, including liberals and conservatives. The time has come to end federal taxation as we know it.

My wife, Billie Elias, contributed significantly to this article.

Barry Elias is an economic policy analyst. To read more from him, CLICK HERE NOW.

© 2015 Newsmax Finance. All rights reserved.

Cruz Champions Sound Money

By Barry Elias | Thursday, 03 Dec 2015 11:05 PM

The primary function of the Federal Reserve should be to stabilize the U.S. Dollar.

This view has been voiced recently by former Federal Reserve Chairman Paul Volcker and 2016 republican presidential candidate Senator Ted Cruz from Texas.

By stabilizing the dollar, real income for the masses will once again increase tremendously, thereby reversing a 40-year trend of income stagnation for the bottom 90 percent (the striving majority), according to Put Growth First, an organization that advocates for pro-growth monetary stability and supply side tax reform, and has provided advice to the several 2016 republican presidential candidates, including Senator Ted Cruz of Texas.

(Disclosure: I am an economic advisor to Put Growth First.)

Annual inflation-adjusted GDP growth from 1790 to 1971 averaged nearly 4 percent.

However, since 1971 – the advent of the floating paper dollar backed only by empty political promises, but no real intrinsic value – yearly growth slid to 2.8 percent, and since 2000, it fell further to 1.7 percent per annum.

Moreover, the future prospects are dismal: the Congressional Budget Office and Social Security Trustees now project real economic growth of slightly more than 2 percent.

From 1948 through 1971, the bottom 90 percent experienced a cumulative rise in real income of 85 percent according to the 2012 World Income Database.

Why was this happening?

During this time, the value of the dollar was stable and the Fed did not employ a single labor market variable on its dashboard of indicators. It was up to business to invest so productivity kept pace with wage growth.

A stable dollar permitted more stable material costs for businesses and less demand for expensive financial hedging.

This allowed capital to flow toward more productive investments that generated employment and income for the many – instead of exotic financial products that tend to rely on arbitrage and speculation that extract equity rather than enhance wealth.

The result was faster economic growth. And, despite strong income growth for the striving majority, business profits relative to GDP remained strong and steady.

The situation changed drastically in 1971 when the U.S. dollar lost its intrinsic value anchor and began floating. Since then, real income for the bottom 90 percent (the striving majority) stagnated while that for the top 10 percent grew an additional 140 percent.

Lost economic activity due to the lower growth rate since 1971 totals $104 trillion: $75 trillion since 2000 and nearly $9.2 trillion in 2013 alone. The total inflation-adjusted cost of all U.S. military wars is $7.7 trillion, according to the Congressional Research Service and Stephen Daggett, a specialist in Defense Policy and Budgets. In other words, stagnation has caused more destruction than all wars combined.

Had the 1948-1971 trend for real income of the striving majority continued, the bottom 90 percent would be earning 2½ times more than they do now. If income for the striving majority was 2½ times greater today, how many of our current problems would still be problems?

What happened?

Since the dollar was no longer stable, the Fed surreptitiously began targeting wage growth as an indicator of inflation that needed to be curtailed.

This is because inflation was redefined to mean an increase in a price index rather than a decline in the value of the dollar. To keep the index from going up, they have raised interest rates every time we’ve had decent wage growth in the last 30 years. This squelched the growth along with wages and employment opportunities, causing volatile business cycles and stagnation.

This theory was promoted in the 1970’s, which suggested there was a tradeoff between unemployment and money wage inflation as depicted in the Phillips Curve.

However, empirical evidence has contradicted this model over several decades and it has become more apparent that inflation is a function of the supply and velocity of money relative to the total quantity of goods and services provided in the general economy.

Also, the Fed was given a dual mandate by Congress in the late 1970s, to minimize and stabilize unemployment in addition to inflation. Unfortunately, the Fed lacks proper tools to deal with unemployment, since it involves fiscal policy to a large degree.

In essence, the Fed was acting in a reactionary manner, since inflation and unemployment are lagging indicators, have subjective measurements and are constantly revised.

Moreover, the policy intervention has lag built into it; by the time it became operational, the underlying conditions that were being addressed may have changed. Therefore, too often we were treating the wrong problem with the wrong solution at the wrong time, causing severe business cycle volatility.

During Senate testimony, Janet Yellen (now Federal Reserve Chairwoman) said, “A key lesson of the 1970s is the critical importance of maintaining well-anchored inflation expectations so that a wage-price spiral like we saw back then does not break out again.”

There have been numerous times that Yellen has referenced strong labor market conditions as a potential source of inflation, which the Fed needs to keep in check – primarily via increased interest rates.

However, the goal of the Fed should be to maintain the stability of the dollar as a unit of measure, and not guided by fiscal parameters, such as wage levels, that the Federal Reserve Bank has little control over.

Partially backing credit and currency formation with the production of real assets, such as gold, silver and virtual currencies using market-driven pricing, would couple money supply growth with the productive use of resources, including land, labor, and capital, and lead to more productive investment of that credit. In addition, business borrowing will be predicated on well-developed ideas that have greater likelihood of being executed effectively.

As a result, the increase in money supply will be absorbed by money demand in a more timely and complete manner, thereby maintaining a stable and predictable value of the U.S. Dollar – a requisite frame of reference, since all economic activity is based on its value.

Real time, market based prices of commodities, foreign currencies and future investment opportunities (bond yields) provide better signals for altering the money supply. The market would set interest rates and determine the money supply, which would require much less monetary intervention by the Federal Reserve.

In fact, it is advantageous for wages to rise so long as they are met with commensurate gains in productivity.

This will ensure cost-effective unit production and strong purchasing power, where unit wage increases tend to be small, stable and roughly equivalent to unit commodity price increases over similar time frames.

Predicating credit creation on the production of real assets will help ensure strong productivity gains in the future, thereby creating an environment ripe for employment, economic growth, moderate and stable inflation, and strong and stable purchasing power.

Direct domestic investment has been weak over the past few decades as a result of this misguided monetary policy. This is the worst economic recovery precisely because this is the worst recovery in business investment.

A volatile dollar inhibits business investment. Business investment acts as the fuel for the train engine that drives economic growth. Consumption is the caboose that follows: it does not push the train. One only consumes what has already been produced.

Currently, Put Growth First is actively working with members of Congress, including the House Freedom Caucus led by Rep. Jim Jordan, R-Ohio, and will soon launch a Growth Task Force with input from caucus members such as Rep. David Schweikert, R – Arizona.

Put Growth First has also been involved in helping to advance House of Representatives bill 1176 in the previous 113th Congress, sponsored by Rep. Kevin Brady, R.-Texas, that would establish a Centennial Monetary Commission to examine United States monetary policy, evaluate alternative monetary regimes, and recommend a course of monetary policy going forward. It was reintroduced to the House of Representatives on June 25, 2015, as H.R. 2912: Centennial Monetary Commission Act of 2015.

Senator Cruz is right to promote a stable U.S. Dollar, which is backed by real assets that are produced with an efficient use of limited resources.

It will increase business investment, productivity, income and purchasing power over the long term for the masses.

It is important to couple this sound monetary policy with a pro-growth tax reform plan to ensure optimal results.  I will elaborate on my tax proposal in the following column.

© 2015 Newsmax Finance. All rights reserved.

Why Economists Fail

By Barry Elias | Friday, 23 Oct 2015 07:24 AM

I attended a presentation this past week at Cooper Union College in Manhattan by an economist promoting his new book.

I was rather aghast to hear him say: “No one” predicted the global economic crisis and experts did not foresee how slow the recovery would be.

Following the collapse of Bear Stearns on March 17, 2008, I divested most of my family’s investment portfolio from the market when the Dow Jones Industrial Average hovered near 12,000. By September of that year, the Dow reached its nadir – around 6,500.

At that time, I expected the unemployment rate to double from 5 percent to 10 percent, which it did. I also suggested the global recovery may take a decade or two to return to robust growth, since the crisis was the result of financial mismanagement that spanned several decades.

Further, on May 6, 2010, the day of the infamous “Flash Crash,” my article entitled “Why I Divested From the Dow” was published: About six hours later, the Dow had plummeted about 1,000 points.

The Cambridge-educated economist that I alluded to earlier is Adair Turner, the chairman of the Institute for New Economic Thinking; a member of the United Kingdom’s Financial Policy Committee: and the former chairman of the Financial Services Authority (FSA) until its abolition at the end of March 2013.

The FSA was an independent regulatory body for the financial services industry in the United Kingdom (U.K.) between 2001 and 2013. It was appointed by the Treasury and funded entirely by fees charged to financial firms.

Due to the apparent regulatory failure of banks during the financial crisis, the U.K. government abolished and replaced the “failed” FSA on April 1, 2013 with two new agencies: the Financial Conduct Authority (FCA) and the Prudential Regulation Authority of the Bank of England, in an effort to strengthen England’s financial system with a more forward-looking perspective.

While the FSA under Turner’s leadership presided over the near-total collapse of several major financial institutions, including the merger of Lloyds Bank with ailing HBOS in September 2008, Turner claimed in February 2009, as well as today, that other global regulatory authorities also failed to predict the economic collapse. He did not apologize for the actions of the FSA, and believes the intellectual failure was the result of a focus on processes and procedures, in lieu of the larger economic landscape.

Economists ought to take note of that admission and view the world with greater breadth and depth, especially before proposing public policy prescriptions that may have implications for many decades to come.

In his new book, Turner argues most credit formation is not necessary for economic development. He suggests excess credit drives real estate booms and wealth inequality, which then lead to financial crises and depression. Turner believes banks need to increase capital and reduce real estate lending, and debt needs to be taxed as a form of “economic pollution.” I wholeheartedly agree with the premise and prescriptions presented.

Income inequality is self-reinforcing, since wealthier households consume a smaller percentage of their income, and savings tend to be invested in short-term, speculative, and arbitraged financial assets. This dynamic undermines employment and economic growth for the masses as compared with direct investment. Favorable tax rates on investment income, especially for hedge fund managers, perpetuates this viscous cycle.

Since 1970, financial firms expanded credit among themselves and households seeking real estate, because it involved a simple and secure business model: real estate collateral valuations were more predictable as compared with the assessment of an entrepreneurial endeavor. This methodology permitted the excessive refinancing of existing assets, and less on the creation of new ones.

Financial firm credit skyrocketed from 10 percent of GDP in 1970 to 125 percent in 2008, while that for household credit rose from 40 percent to about 90 percent, which included toxic subprime mortgages. (During the same period, federal government debt as a share of GDP increased from 35 percent to 60 percent, and that for non-financial corporate debt rose slightly, from 35 percent to 40 percent.)

The financial firms essentially transferred wealth among themselves and others instead of creating new wealth. This led to less optimal employment and income growth for the masses, since direct investment in business endeavors was on the wane. Instead, financial products that were derived from preexisting assets exploded, and wealth and income inequality grew.

The net worth of the financial sector was negative from 1996 through 2007, reaching a nadir of negative $1.46 trillion in April 2007. Quantitative easing by the Federal Reserve following the financial crisis put the financial industry in positive territory, but it turned negative at the end of 2013, and by of June of 2015 it stood at negative $809 billion.

Why was the financial industry protected so well?

Some suggest a significant number of economists with keen academic and think-credentials regularly accept funding from corporations to provide “objective” analyses that actually promote corporate objectives and defy evidence and logic.

Let’s keep the economists honest and forward-looking, shall we?

© 2015 Newsmax Finance. All rights reserved.

Hillary Clinton’s Tax Reform Proposal Falls Short

Hillary Clinton is promoting a tax reform plan that will not achieve her objectives.

Clinton would like to increase long term business investment, since it would stimulate innovation, productivity and economic growth for the masses. A laudable goal, indeed; however, the remedy she prescribes will not cure this patient.

Clinton correctly states that corporate stock repurchases and dividend payments have benefited the corporate boardrooms, C-suite executives and shareholder class at the expense of the working class, since it lowered the level of retained earnings for investment in labor, plant and equipment for many years.

Stock repurchases and dividend payments have equaled, on average, 85 percent of earnings since 1998, excluding two years of recession in 2001 and 2008. In 2014, this figure was about $914 billion, or roughly 95 percent of earnings, with about $565 billion in buybacks and $349 billion in dividends, according to Bloomberg and S&P Dow Jones Indices.

Since March 2009, repurchases total nearly $2 trillion, a prime catalyst for the 191 percent increase in the S&P 500 Index in 5½ years, while stocks with the most repurchases saw a 300 percent return, according to Forbes. During the past two years, sales growth rose 2.6 percent each quarter for these firms, while per-share-earnings more than doubled to a whopping 6.1 percent, according to Bloomberg.

The share of cash flow allocated to buybacks rose to more than 30 percent, nearly double what it was in 2002, while the share for capital spending declined, from more than 50 percent to roughly 40 percent during the same time period, according to Barclays. Low levels of investment have resulted in the highest average age of fixed assets since 1956, reaching 22 years in 2013, according to the U.S. Commerce Department.

Carl Icahn believes the major proponents of quarterly-capitalism are the corporate board members and the chief executive officers, who promote the stock to enhance the value of their equity option plans.

Clinton proposes an increase in the capital gains rate on the wealthiest 0.5 percent to solve the problem.

She envisions doubling the rate to 40 percent for the first two years, and scaling it back gradually to 20 percent over the next four. Currently, the top 40 percent rate applies to assets held less than a year and reverts to 20 percent afterward. These figures exclude the 3.8 percent healthcare surcharge on net investment income.

Recently, BlackRock CEO Larry Fink proposed something similar: a 40 percent rate that applies to the first 3 years, then gradually falls to zero over the next seven.

In an interview several years ago, Larry Fink, whose firm manages $4.7 trillion, suggested he let the country down, since the financial industry became much too large over the previous three decades and the return on capital relative to labor was excessive. Bill Gross, the former founder of Pacific Investment Management Company and a current portfolio manager at Janus Capital, has expressed a similar view and expects these yields to plummet 50 percent.

The problem with Clinton’s proposal is four-fold:

* Approximately two-thirds of stock trading is conducted on behalf of tax-exempt organizations, such as pension funds and 401(k) plans, which are completely immune from any tax implications and already trade with a long-term view.

* Her proposal does not encourage 99.5 percent of the population to engage in a long-term investment perspective.

* Modifying the capital gains rate will not incentivize the corporate board and C-suite executives to focus on the long-term instead of seeking short-term profits to promote the stock price of their firm.

* Financial trading is based primarily on short-term arbitrage opportunities and speculation that do not promote long-term direct investment in labor and capital.

The key to increasing long-term capital investment is to make it more attractive for businesses to do so.

My tax proposal would achieve this objective by permitting an income tax deduction for all capital expenditures in the year they are made. Currently, these expenses are deducted over the entire life of an asset, which can range between two and fifty years.

In addition, my tax plan will replace all federal taxes with a low tax rate on consumption and savings that would balance the budget at current spending levels; save scores of billions of dollars each year in tax compliance expenditures; increase investment, employment and income; and maintain strong purchasing power.

Clinton’s capital gains scheme will not achieve these objectives.

© 2015 Newsmax Finance. All rights reserved.