Tuesday, June 4, 2013

Fair Tax or Flat Tax?

American public discourse, particularly on the Internet, includes a reliable population that is perpetually honked off, offended, and eager to unleash the awesome power of ALL CAPS against any idea, no matter how commonsensical.

But for all the hullabaloo around the IRS of late, with some claiming complaints against the agency are overwrought, and others going so far as to question the motives, intelligence and parentage of those of us who have called for its abolition, there has not emerged any kind of reasoned argument in favor of keeping the tax authority just the way it is.

What has come to the fore, however, is a healthy competition between two credible, if not complementary, alternatives to America’s current tax system. That is, should we move to a Fair Tax or a Flat Tax?

Simply put, would a consumption tax on goods and services (Fair Tax), or a single, small rate of tax on income (Flat Tax) be a better way to fund our government? The short answer is that either would be preferable to the Byzantine, corrupt tax system America has now.

Folks are fond of saying you can’t replace something with nothing. This is, of course, complete rhubarb, and if the US government could learn to replace something with nothing, it would go a long way toward solving its monumental debt and deficit problems. But in this case, we do need to pay for our public sector somehow, and since it would defeat the purpose to replace something with two things, it behooves us to consider which of these worthy ideas would work best.

First, the Fair Tax: There is legislative support for this approach, as the Fair Tax Act of 2013 works its way through Congress, sponsored by Rep. Rob Woodall of Georgia as H.R.25 in the House, and by Sen. Saxby Chambliss, also of Georgia, as S.122 in the Senate.

The gist of the plan is to phase out the IRS over three years, replacing income taxes with a sales tax on new goods and services, excluding necessities, of 23 percent. This figure is reached by combining the 15% income tax bracket with 7.65% employee payroll taxes, both of which would be eliminated. As to that last, fairtax.org stresses that their plan eliminates the payroll tax, and this is not an insignificant feature.

Many workers, particularly those with lower earnings, feel the bite of payroll taxes when they collect their paychecks, even if they do not end up with a federal income tax liability for the year. If we mean what we say about simplifying the tax code, then whatever system and rates we settle on ought to be straightforward and clear, and should account for whatever effect, if any, payroll and Social Security taxes will have on take-home wages.

A Flat Tax of, say, 10 percent should mean exactly that – not 10 percent, plus additional levies for retirees, unemployment, etc., that are not normally part of the income tax conversation.

If that can be accomplished, there is much to be said for the simplicity and transparency of a Flat Tax. Sen. Ted Cruz of Texas and The Heritage Foundation are among those calling for this approach. Americans spend billions of hours and hundreds of billions of dollars trying to comply with the country’s impossibly complex tax code. The opportunity cost to the productive economy is extraordinary.

Something that is often lost in discussions of income tax is that these rates also apply to small businesses, which create two-thirds of the new jobs in America, and almost all of which file at individual rates. If a Flat Tax can eliminate the expensive and time-consuming task of tax preparation, not only for individuals but for job-creators as well, that would be a boon to America’s beleaguered employment market.

As to revenues, economists of all stripes have looked through this glass onion, trying to make that dove-tail joint, and you will find very intelligent people convinced that a Fair Tax or a Flat Tax cannot replace the revenue raised by the current system; conversely, you will find wicked smart proponents of these ideas who say we cannot afford not to adopt them. Whom to believe?

Concepts like dynamic scoring – meaning, tax policy alters behavior, which should be considered in estimating revenues – are sensible. But, since not everyone acknowledges these factors, let us cleave to the concept of reasonableness. Would either plan get us in the ballpark of where we need to be?

Certainly, they can, and if the political climate that enables either of these policies to be enacted also facilitates spending cuts, more’s the better. The last two presidents, aided by
Congresses led by both parties, have each added a trillion dollars (and counting) to the federal budget over the past dozen years.

Despite this sharp increase in spending, recent silly-bears surrounding the sequester remind us that many insist the current level of government expenditure, no matter how high, is a sacred, serene, steady state, such that even one penny cut might mean Joe Biden has to peel his own grapes.

As a Republic, we can take that risk. So, if a Fair Tax or Flat Tax can get us close enough to the revenue we need, even if it requires pruning the Tsarist lifestyles of our so-called public servants, so be it.

Mission creep will also be an issue, with either a Fair Tax or a Flat Tax. Lest we forget, when the income tax started in 1913, the top marginal rate was a whopping 7 percent, applicable only to a relative few people. Politicians, present and future, will be eager to expand and increase the scope of the new system, and taxpayers must remain vigilant.

Questions linger, such as whether a Fair Tax would inhibit productivity, or spawn underground markets, and just what “necessities” would be excluded? Likewise, what would become of charitable or mortgage interest deductions under a Flat Tax? Each of these merits debate, but they are soluble. Considering our current system has the IRS shelling out $50 million for its agents to learn line dancing at sleep-away camp, even imperfect replacements represent serious improvement.

Further to that, while we remember that this discussion was brought about by scandals at the IRS, including hassling of groups seeking tax-exempt status, along with audits and harassment of people who donated to political candidates or raised their voices in the public square, the issue should not be consumed by politics or prosecutions.

Odious as Douglas Shulman, Steven Miller and Lois Lerner may be, they and the rest of the IRS squadron of winged monkeys that descended on Congress recently are beside the point. When you create an unaccountable, bloated bureaucracy, these are the sort of people who show up to run it. They and their ilk are not unique to history, nor are they helpful in solving the problem.

So again, which should we choose, a Fair Tax or a Flat Tax? The answer is: whichever one can gain traction.
The primary question of whether to abolish the IRS having been answered in the affirmative by both sides, disagreement between Fair Tax and Flat Tax proponents is akin to the quarrels of the Yooks and the Zooks in Dr. Seuss’ Butter Battle Book(to whatever extent Seuss intended the tome as a moral relativist metaphor for the Cold War, it was misbegotten – but it actually works here). In that tale, both sides enjoy toast, but are at loggerheads as to whether it should be buttered on the top or the bottom. The applicable lesson here is, having agreed on the big issue, residual differences can be worked out over breakfast.

And so they should be, with the American people as arbiter (though if everyone’s coming to the breakfast, making a reservation seems sage). Politics being the art of the possible, if there is an appetite in the land for a Fair Tax, and political leadership able to make it happen, Flat Tax folks should sign on, perhaps keeping personal lists of I-told-you-so’s, in case the system falters. Likewise, if the Flat Tax finds a market and effective champions, Fair Taxers should offer support.

Whichever option prevails, let us seize this opportunity to reform America’s tax system and change the country for the better.

Theo Caldwell, host of TV’s Global Command Centre, has been a member of the New York Stock Exchange, the Chicago Board Options Exchange, the American Stock Exchange, and the Kansas City Board of Trade. He can be reached at at theo@theocaldwell.com