Theories and Models of Taxation

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This is an overview of some practices in taxation, and a proposal for a very simple and very practical scheme to replace all of them. I do not expect my readers to be conversant in anything but practical life experience and common sense.

Bird’s Eye View

Mafia model – the property tax
Marxist model – the progressive income tax
Mixed economy model – exemptions, deductions, social engineering
The Monopoly model – randomly selected victim pays randomly selected amount
Flat tax – no tax brackets
Fair tax – sales tax with pre-bates
Consumption tax and POS collections

The Mafia Model

The best illustration of this model of taxation is the property tax. Regardless of income or other economic condition reflecting ability to pay, and based more or less on market value or some convoluted estimate of it, it’s “pay up or else…” Or else they take your house. How is this any different from the Mafia’s protection racket?

I submit the proposition that your primary residence should NEVER be taxed. You should never run the risk of being taxed out of your HOME, whether due to unemployment, disability, retirement or anything else. The house you live in is NOT an investment, it is an EXPENSE — mortgage, insurance, repairs, maintenance, updates and upgrades are COSTS, not investments. The only time your home will look like an investment is if and when you sell it, and, as you have to live somewhere as long as you are alive, even the capital gain you might realize on that investment is offset by the cost of something else you buy as your next home.

So the only place where you could make a case for property being subject to the property tax is an income property. But even then, you have to consider a number of factors.

Is rental property an investment? Tenants rent their home, but it’s still their HOME. Well, if the “rich” homeowners are to pay no property tax on their home, the “poor” renters should not either. It’s only “fair.” But again, the property is realized as an investment only if and when it’s sold, not while it’s being managed. Any “income” generated by the property first and foremost goes to management; and management of the property, whether by a resident mom-and-pop owner or by a property management firm, is, again, only an expense, just another cost of doing business.

Similarly, commercial property is “home” to the business that’s leasing it. Again, that lease is a cost, not an investment. The business already pays all sorts of taxes based on gross receipts (thank you, Nevada “Republicans”), payroll, net receipts, profits and other measures of income, and they also pay all sorts of fixed or prorated fees. At the very least, a state such as Nevada, with its tenuous business climate even in the best of times, should not place additional burdens on a business, especially not on a small family operation, by imposing a higher lease cost due to the property tax on the leased property.

A corollary to this proposition that while indeed rents, like prices, are whatever people are willing to pay in a free market, rents should be no higher than maintenance costs, and would be so if there were no artificial restrictions on supply. (Demand of course is generally rising if only due to the increase in population.) Specifically, the rent should not cover the mortgage payments. It’s a question of fairness. You had to pay for your home. It is not fair that renters should buy the property for the owner. Let him buy it with his own money. Under presently accepted practice, a rental property is a great scam. For the amount of a small down-payment that is the owner’s initial investment, he gets his tenants to cover his mortgage payments, and when he sells out he keeps the full value of the property, without sharing the proceeds with his tenants. He’ll share it with his partners, but not with the tenants who made the mortgage payments for him.

A friend of ours who teaches economics in college pointed out that the property tax has historically been justified on the basis of supporting our local schools and other government services which are beneficial to the community as a whole, and therefore beneficial to the specific taxpayer (which the economists call “externalities”). As a retired geezer with grown children and as a father who had to pay for private education for my children because their special needs were not severe enough for the public schools to help them, and as one who’s been involved in the fight over Common Core and the poor state of public education, I am inclined to severely dispute the value of public education to the community or to myself when the result is that entering college freshmen are reading and writing at a level no higher than the seventh grade, and the first thing colleges have to do is put them through remedial courses to make them “college and career ready” — that is, we have to pay for the same educational services TWICE.

The Marxist Model

You know the infamous quote, the “self-evidently true” lie that seduces all the intellectually lazy college kids, graduates and professors — “from each according to his ability, to each according to his need.”

I direct you to Ayn Rand and her writings on this and related topics to see why this nonsense is not only not fair, but downright evil. In the simplest of terms, there is a limit to one’s abilities, but one’s needs are infinite. Just look at how the welfare rolls and welfare benefits have exploded over the past decades, from helping the few who are temporarily destitute, to multiple generations living in public housing, receiving SSI, food stamps, AFDC, Medicaid, school breakfast / lunch /dinner, taxi vouchers, “earned income tax credit,” help with utilities, “0bamaphones,” etc. Add to that list the decades-long practice of building permits requiring a certain number of “affordable” units, and now the coming requirement to shoe-horn  “affordable” (low-income) housing into affluent neighborhoods; that is, a direct attack on your freedom of association (a First Amendment right), on individual choice (the driving force of the free market), and on paying for what you want for yourself and your family (the foundation of all civilization: personal responsibility). I’m sure I left out a lot. Nobody stops to think, if all your needs are fulfilled by government — that is, by application of the government’s enforcement powers to make the taxpayers pay for it — what’s to motivate you to fend for yourself? When do “entitlements” stop ratcheting up? Everybody forgets the famous line by Margaret Thatcher: “the problem with socialism is that eventually you run out of other people’s money.” Read “Atlas Shrugged” to see where that leads and why.

Nevertheless, this Marxist nonsense is the guiding light behind the progressive income tax. Obviously if you earn more, you pay more, even if the tax rate is the same for all income levels. But a “flat tax” is not good enough for the Marxists; it is not “fair” because the “poor” are still left with less money than the “rich.” Therefore the tax RATES have to go up as total income goes up (”progress” to higher rates). THAT, to the Marxists, is “fair.” In the 1950s the top rate was 90%, and there is at least one candidate for President today who proposes going back to that rate again. Never mind that the progressive income tax dis-incentivizes and punishes success, whether achieved by hard work, ingenuity, or just plain luck. It is just not “fair” that some should have more than others. In the 1950s and 1960s, high tax rates in Europe (106% in Sweden) led to the “brain drain” of engineers and college professors from England and the “talent drain” of actors and directors from Sweden, fleeing to America. (This is what triggered Ted Kennedy’s “reform” of immigration policy, hugely increasing the quotas from the Third World and reducing them to practically nothing from Europe.)

I submit the proposition that the government does not need to know or care about how much I make, or how much I have. That is my business, not theirs. At least that’s how it used to be when this country respected its Constitution.

The Mixed Economy Model

This is a variation on the progressive income tax model. Somewhere between the “evil” free market and the “fair” Marxist theory of economics is the “mixed economy” to “regulate” or “rein in” the “unbridled, Wild West, dog-eat-dog capitalism.” This is where we get the legal, if not the moral or philosophical, justification for government oversight and regulation of businesses, which we’ve seen over the past several decades degenerate into micromanagement and control of the private lives of every individual citizen. This is where we get the punitive taxes on products such as alcohol and tobacco (and now, legalized marijuana), the bottle / can / shopping bag “deposits” which you never get back, tax breaks for products such as solar and wind power generators and hybrid or electric cars, the legal requirement to buy products such as health insurance, and of course the Income Tax Code with its countless pages and incomprehensibly complicated exemptions and exceptions.

THIS is also the source of endless tinkering by politicians and lobbyists, because now you can have endless — and endlessly profitable — arrangements over and provisions for exceptions, exemptions, and other forms of favorable treatment in the tax code. And it ensures the full employment of entire armies of bookkeepers, accountants, tax lawyers, IRS agents, tax court judges and other paper pushers whose only contribution to the economy is to divert huge sums from productive use to nothing but compliance with the tax code. Well, if the tax code were simple and fair, all these people would have to find productive employment in the private sector, producing and selling something that people might actually, voluntarily, want to buy.

And this is where you get the feverish claims (and sometimes the fact) that the “rich” do not pay “their fair share,” because, with the deductions and other favorable tax treatment for certain government-approved expenditures, effectively they end up paying a smaller total tax, or a smaller percentage of their income paid as their tax, than a regular Joe with no income high enough to benefit from such deductions. Never mind that the “rich” still have to dispose of money to get the preferential tax treatment, or that maybe you as a private individual can or might want to decide on a better use of your money than the government, but appearances trump facts in this Marxist world of social engineering via the tax code.

A friend of ours who is an economist and has recently been elected to a State office points out that the value-added tax (VAT) and the gross receipts tax (formerly offered as “margin tax,” then renamed “graduated business license fee” and “commerce tax” by the Nevada RINOs who have just imposed the largest tax hikes in the State’s history) are just other variants of the income tax:

The gross receipts tax is a levy on all the money a business takes in, period. No allowance for cost of goods and other business expenses.

The VAT claims to know the value added when you weld a car body to its frame, or when you attach the wheels, and levies a tax on that amount. Never mind that there is no market for the partially assembled carcass of a car (heh heh heh…) inching its way down an assembly line. Never mind that the only way to determine the value of anything is to see what people are willing to pay for it. The administrators of the VAT must be omniscient.

I submit the proposition that the government does not need to know or care about how much I make, how much I have, and how I spend it. That is my business, not theirs. Furthermore, …

Plain reading of the Constitution makes it clear that none of these schemes of Marxist “social justice” and social engineering are legal; but a body of law built up by court decisions, based mostly on the “due process” and the “interstate commerce” clauses in the US Constitution, makes any counter-argument moot and gives the government a free hand to do anything it wants — until the court goes back to reading, understanding, obeying and applying the Constitution again. In the meantime, people get seriously insulted and bent out of shape if someone like me points out that the “mixed economy” is nothing but
(1) Fascism: government control of enterprise that’s private in name only,
(2) “Creeping socialism:” this phrase has gone out of fashion since the 1950s, but reflects the trend of government taking over one industry after another by “regulation,”
(3) Socialism: government directly owning major enterprises, of which we have as examples Fannie Mae and Freddy Mac and other “government sponsored entities” (GSEs).

I think at the present time we are mostly in the “crony capitalist” or fascist stage. The EPA is engaged in a land grab using the excuse of regulating “wet lands” (there goes your property rights), and putting the coal industry out of business using the excuse of regulating CO2 (there goes science and cheap power). The federal and state governments are subsidizing “green” energy companies even though it is physically impossible that they will never produce enough energy to replace fossil and nuclear fuels. And the FCC is proposing to take over the internet and regulating content in the name of a revived “fairness doctrine” (there goes your First Amendment right of free speech). Plainly the government had no difficulty asserting that certain companies are “too big to fail” and therefore must be bailed out by direct subsidies or even taking an “equity position” in the enterprise (for example, General Motors). And of course we are now adjusting to the blatant takeover of the mortgage, college loan, and health insurance industries. Next up is the health care industry itself; already the price of health care is not set by the providers but by negotiation between insurers and the government — and that’s how you get those insanely inflated bills for the simplest of procedures. For example, the price of an MRI is now set at $4200. I saw a recent bill showing that. A British-born radio talk show host was explaining last week that he could get first class round trip tickets to Bermuda, stay in a first class hotel, get his MRI in a first class hospital there, pay cash — and still have over $2000 left when he got back. I can dig out a bill for an MRI just a few years ago to show that it was well under $1000 in high-tax, high-cost. THIS is what the government and specifically 0bamacare is doing to your health care.

The Monopoly (game) Model

OK, back to taxes. The same friend who is an economist and serves as a State official points out that no form of taxation is fully equitable; that is, fully reflects the value of the services that a taxpayer “buys” with the taxes he pays. Also, no tax is “efficient;” that is, helpful in maximizing economic growth. And finally, income taxes are the least equitable and efficient…

(Every profession has its peculiar jargon, but I have a different understanding of the terms equitable and efficient. In everyday language “equitable” does not concern itself with the “value” of government services, it concerns the tax burden being fair to all taxpayers. And “efficient” is not whether the tax helps or hurts the economy, but whether the cost of enforcement is big or small relative to the amount collected.)

Perhaps tongue-in-cheek, perhaps as a tragicomic comment on the way the progressive income tax is administered under the current tax code, a proposal for a theoretically equitable, efficient and ideal form of taxation is inspired by  the long-time popular board game, Monopoly.  As Monopoly players know, you are hit with taxes in that game when you land on a tax square or draw a tax card. This proposal consists of randomly choosing a victim to pay a tax, and then randomly choosing the amount to pay. Kind of like in the TV game show, Wheel of Fortune, or Price Is Right. Our friend calls this the random incidence lump sum tax.

At this point please recall from the discussion of the mixed economy model that the purpose of “tax policy” is specifically and intentionally designed to alter economic behavior and to channel resources into activities that the government favors and approves. The Monopoly model of taxation would completely eliminate taxation as a tool of social engineering. You could not possibly do anything to adjust your economic behavior with any regard to your tax liability as a result of one behavior or another, because the hit is random. It is the most “efficient” (as the economists define “efficient”) because there is nothing you can do to plan for it (except save, and save, and save for that fateful day when your number comes up?)

Before discarding this model as comic silliness, please reflect for a moment on the fact that it is no different from current experience with the federal income tax. What are your chances that you’ll be audited? What are the chances that you’ll owe a huge amount, regardless of how much you’ve already paid? That’s not all that different from spinning a wheel to see if you’re it, and spinning another wheel to see how much you’ll pay…

The “Flat Tax”

The same rate of taxation on income for all income levels, the “flat tax,” still suffers from the same problem that all income taxes do. You still have to declare your income, and therefore a bureaucracy is still needed to be in place to process and verify the tax returns. That is, the government still monitors your personal business and still invades your privacy. Then, of course, there will the hue and cry about the “fairness” of taxing everybody at the same rate, rich and poor alike, and the “fairness of “no” deductions to which all sorts of constituencies are addicted.

The same friend of ours who teaches economics in college pointed out a technical difference between the terms “proportional” (the amount of the tax is a percentage of the income) and “progressive” (the percentage increases with income). People who have ever filed out a tax return are familiar with those concepts under the terms “flat” (the same rate for all income levels) and “tax brackets” (a higher rates for each higher increment of income). However, actually the “flat tax” is also “progressive” if it kicks in on incomes above a certain level; in other words, income up to a certain amount, is tax-free, but the tax rate applied above that level is the same for all amounts of income (that is, the rate is “flat”).

I submit that the issue was resolved politically a hundred years ago with the introduction of the progressive income tax. So, even if a “flat tax” were to be enacted into law, the political pressure will be strong for reintroducing all the exemptions, exceptions and deductions that had bloated the IRS code to the 80,000+ pages it is reputed to be at present. Ironically, the biggest push will come from business, in the form of all the arguments over what is a business expense and what is not, plus the more and more unrealistic “accounting rules” that have been choking business formation activity and innovation, and distorting business statistics, since, for example, the Sarbanes-Oxley Act of 2002 and the Frank-Dodd Act of 2010. As long as we insist on basing taxes on income, we will have accomplished nothing to free the people and the economy.

The “Fair Tax”

Although it is presented as a national sales tax, the “fair tax” as laid out in HR25 is just a variant on the current income tax, philosophically speaking. It obviously buys into the Marxist maxim (quoted above) which it implements by means of its “pre-bate” idea — whether the pre-bate is indexed or reverse-indexed to income level or not — because it assumes a baseline of income as “necessary” for basic “needs.” Again, the government decides whether your basic needs amount to living on cup-a-soup in a flop house or on steak in a McMansion. Sorry, that is up to me to decide, not some politician or government bureaucrat. But because of provisions like this in HR25, the need for the IRS and other government bureaucracies to administer the “fair” tax does not go away, and so we’ll still be stuck with unnecessary and wasteful overhead.

I submit the proposition that while the flat tax and the fair tax are preferable to the current income tax, they are just faint-hearted half-way measures (that is, compromises with the Marxists) that do not achieve their stated goals, certainly not the elimination or significant reduction in the size of the IRS and other bureaucracies needed to administer them.

So what’s a fair, equitable and efficient form of taxation?

I am asserting the proposition that the only constitutional, moral, fair, equitable and efficient form of taxation is a consumption tax — presently already known and practiced as the retail sales tax. (“Equitable” and “efficient” as the commonly understood meaning of these terms, not the economist’s jargon.) The end consumer pays it at the time of purchase. Collection is automatic, there are no forms to fill out, no penalties for filling them out incorrectly, no penalties for late payment or non-payment, etc. The consumer pays it only when he is buying something; that is, only when he can afford to buy something. Otherwise, no purchase, no tax. And the customer is the only judge of his ability to pay, not some bureaucrat enforcing some infernal tax “schedule.” Most states and localities already have the infrastructure in place; very few face new implementation costs if a national retail sales tax replaces the federal income tax.

Under a retail sales tax, the issue of “fairness” is resolved automatically, two different ways:
(1) Basic necessities such as food can be legislated to be tax free. That solves the problem of the “poor” paying an unfair amount of taxes as a proportion of their income, of the “unfairness” of taxing necessities.
(2) The “rich” and others with rich tastes and therefore a penchant for consuming expensive goods automatically pay more taxes. Whether they pay the same, more, or less in taxes as a proportion of their income depends on their tastes and incomes, and can also be legislated on the basis of “basic necessities” vs. “luxury goods.”

Yes, of course that’s a bone tossed to the Marxists, and therefore yes, of course the politicians, lobbyists and special interests will still have a lot to squabble over. That’s as old as our republic, it’s as old as the history of government, and it will never go away. What is “food”? Is it fair that champagne and caviar are taxed at the same rate as pretzels and beer? What about clothes — tee shirts, or Armani suits? In most places in the US a car is not a luxury. Is it fair to tax a Civic at the same rate as a Carrera? The answer could be simple or as complicated as will satisfy the merchants of class envy and class hatred. I’m sure each State will have its own ideas about that.

HOWEVER, the undeniable fact remains that none of that makes any difference at the time of sale, at the point-of-sale terminals that have long replaced the old cash registers. The computers running the POS terminals already automatically apply the tax, whatever it is, however the politicians chose to define it. If and when this system is universal, the merchants, consumers and the general economy will benefit enormously from the almost total lack of overhead for processing the collections. Programming the computers will be trivial, because the entire scheme reduces to something that computers handle with the greatest of ease: a look-up table with just five columns (item, federal, state, local, final sale / resale). The same computers can also automatically and immediately route the tax payment to the right target agency — federal, state and local; all you need is their account and routing numbers, as is currently done in processing checks or wire transfers. There will be no need for audits and other collection efforts against merchants who fail to remit the right amounts to each one, because their POS terminals handle the remittances automatically. There will be literally nothing for the merchant to do, not in the name of tax compliance. The merchant can concentrate on running the business and satisfying the customers, not the taxman.

Under a scheme like this, government ceases to look at businesses, the “rich” and the taxpayers the same way as predators look at prey. Everybody — private enterprise and the government — is invested in making the economy purr. Everybody wins. And as a result, heaven forbid, tax RATES might actually go down as collections exceed expenditures — assuming of course that politicians can resist the urge to find more cronies and scams to spend on.

Yes, it DID too happen before and it can happen again. See, for example, the story of the depression of 1920 and how the country recovered from it in only 18 months, with the Roaring Twenties as the result: Self-Correction | The Weekly Standard, and The Forgotten Depression: 1921: The Crash That Cured Itself: James Grant: 9781451686456: Amazon.com: Books. Contrast that with Hoover’s and FDR’s Great Depression (1929-1945), Ford’s and Carter’s depression (1975-1981), and now Bush’s and 0bama’s depression since 2008. Enough to make you sick of RINOs, Democrats and other Marxists and Keynesians yet?

We can indeed achieve the desired result that no one will mind taxes if taxes are painless. The proponents of the “fair tax” produced calculations to show that with a sales tax of 23% (or 30%, depending on how you calculate it), which is enough to cover current federal expenditures (but who says federal spending must remain at current levels?), the elimination of income tax, the payroll taxes and all other embedded taxes and fees will result in NO increase in the total cost of goods to the customer at the point of sale. In other words, by eliminating the current regimen of taxes, the cost of goods will fall by the same amount as the sales tax that the “fair tax” people are proposing. I’d like to think that we can achieve tax rates falling to biblical lows (remember, 10%) and therefore prices FALLING — not because of deflation but because of lower costs — if we grow the economy, eliminate the compliance and enforcement costs, and rein in some of the other spending schemes that the political Left has foisted off on us in pursuit of their idea of a utopia.

My idea of a utopia is freedom; let people be free to pursue their own happiness. In true freedom, the costs of the legitimate functions of government as defined in the enumerated powers (US Constitution, Article 1, Section 8), plus humanitarian assistance to the few unlucky ones who need help from taxpayers, will not exceed that biblical 10%. It is only under this “mixed economy” and the Marxist theory of “social justice,” not freedom and the free market, that the share of the population that receives some form of government subsidy has grown to 47%. Yes, it will be a political challenge to convince at least 37% of the people that they’d be better off under freedom. But that too has been done before; for example, when welfare was changed to “workfare” and the welfare rolls dropped dramatically as people actually went back… to work!!! It can be done again, if we adopt a simple, fair, effortless and painless tax policy.

So now the only question is whether legislators who see themselves as statesmen, not as politicians, will understand and agree with my proposal and actually try to enact it, and if we can rally enough people to support the effort. Wasn’t there someone in the recent past who campaigned on the slogan, “Yes We Can”? Oh, yucch, there was, but he was the one who more than doubled the national debt and imposed more and more taxes, overt and covert taxes, and effectively very regressive taxes, in the name of “social justice” and “fundamental transformation.” As we did in 1980, let’s try something better in 2016.

PS

These ideas have been percolating in my brain for a very long time. The betrayal by the Nevada “Republicans” in the recently concluded 78th session of the Legislature, when they imposed the largest tax increase in the State’s history, has finally inspired me to get these ideas down on paper. By some coincidence, I started to write this about the time Ben Carson was appearing at the UNR and making his comments on taxes, among other things. He cited the biblical 10%, as a flat tax (Candidate Ben Carson calls for tax changes in Reno speech | KSL.com).

This was also about the time when Donald Trump announced his candidacy. While everybody is jumping on the bandwagon of ridiculing him mercilessly (they must think he is a real danger to the establishment to get so worked up about him), an internet story offered a summary of his major ideas for reforms; among them, taxes: http://www.breitbart.com/big-government/2015/06/17/the-man-with-a-plan-donald-trumps-5-part-strategy-to-make-america-great-again/:
1. Repeal the death tax
2. Lower the rate on capital gains and dividends
3. Set the corporate income tax to 0%
4. Impose a 20% tax on companies off-shoring jobs
5. Simplify the IRS code to 5 brackets, from 1% to 15%.

These and other ideas from his book Time to Get Tough: Making America #1 Again published in 2011 identify him as more of a pragmatist than a conservative. Clearly he is only tinkering with the current system, not changing or ditching it. He is in business to figure out how to get things done under existing conditions, but I suspect he doesn’t give much thought to HOW you decide what should and should not be done. Only philosophy or religion (”ideology”) can provide guidance; pragmatism offers no moral compass.

And just the other day Matt Kibbe from FreedomWorks has announced the formation of a new PAC on behalf of Rand Paul and the “fair tax.”

I see nothing in the comments by Ben Carson, Donald Trump, Rand Paul, Matt Kibbe and FreedomWorks that would prompt me to change my text. These ideas are my own and I’ve been thinking like this since long before these people appeared on the national scene.

I thank our friends the professor and the State official for their constructive comments on this draft, and I thank my wife and another friend the English teacher for some corrections.

For a downloadable, printable copy, get the PDF file theories & models of taxation.

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