Adam Smith's 4 Tenets of Taxation--Violated by Current Federal Income Tax System
By Dr. John Bredfeldt Posted in Taxes — Comments (19) / Email this page » / Leave a comment »
Some have asked for specifics of how the current Federal Income Tax System violates Adam Smith's 4 tenets of taxation. The first tenet is that the taxes paid by each individual should be proportional to their income. The progressive nature of the income tax system makes it just that--progressive. People with higher incomes pay a higer tax rate per increment of income, and a higher tax rate against their total income than those with lower incomes. A proportional tax rate would have all people at all income levels pay the same tax rate. The second tenet is that the tax should be certain as to amount, time, and place to pay. Under the current income tax system, people have to guess their amount of tax, pay it during the year through a combination of withholding by their employer or filing of estimated taxes by the individual. I defy anyone to know exactly how much tax they owe to the Federal Government on the 31st of December each year, let alone any date prior. The only thing all American taxpayers know prior to filling in their 1040s is that the amount withheld and paid through estimated tax payments is wrong. Oftentimes people don't really know whether or not they have to pay taxes or will get a refund. Even after they submit their tax returns the issue is not settled because the Federal Government can take up to 7 years to conduct an audit and send the taxpayer a nasty surprise about previous taxes owed--along with the associated penalties and interest of course. The third tenet is that the tax should be paid at a time and place convenient to the taxpayer. How many people each year have to scramble to find the cash to pay Uncle Sam due to under-withholding. The under-withholding for the most part is not the fault of the taxpayer because the Federal Government has yet to provide taxpayers and/or employers a set of income tax withholding tables that account for two income-earning households. And of course, the IRS is always compassionate to the American taxpayer whenever they decide the taxpayer owes Aunt Sammette additional taxes via their letters of surprise outside the cycle of the tax season. Finally, the fourth tenet is that the tax should be collective inexpensively both to the taxpayer and the government. It is estimated that the taxpaying American public spends at least $500 billion each year to pay their taxes to the Federal Government. And let us not forget the large sums of money the Federal Government spends to keep the income tax records of each American taxpayer current as well as the general oversight expenses of the IRS each year. Any one of these tenet violations should disqualify the income tax system. All of them being grievously violated should have killed it a long time ago. To see how a national sales tax--dubbed the Fair Tax--would abort all these grievances against the current Federal Income Tax System, I suggest people read the Fair Tax Book written by Neal Boortz and Georgia Congressman John Linder, or request a copy of HR Bill 0025 or Senate Bill 0025. As to how can we can kill the current Income Tax System--An educated, informed, severely angry taxpaying electorate who would pick up the phone and call their Congressional Representatives and Senators, and also write some letters to those same people with the simple message of kill the income tax and bring on the national sales tax should do the trick. If it does not--reading the Federalist Papers in regards to the 2nd Amendment of the U. S. Constituion might help people understand.
I understand your comment, and believe it or not, I really have tried to be brief. However, the topics are both complex and deep. I don't think sound bites would provide enough information for credible discourse. But in the spirit of brevity I will make two comments.
Please purchase my recent book entitled, "Of Political Correctness, Leading to Economic Insanity--Both Needing God." If a sufficient number of folks purchase the book, I know the detailed messages are being spread to the general populace and I can resort to sound bites.
2nd comment: OK
I don't really have a problem with the idea of progressive taxation. Obviously you can't get much money from poor people, and if you tax the hell out of them you will just have to have a program to feed them.
My problem is not progressive taxation, it's OPRESSIVE taxation. When you pay a total in all taxes a rate much above one third of all you make then that is oppressive.
My own opinion is that that is right about where the Laffer curve begins to swing downwards.
"Nothing works like freedom, Nothing succeeds like liberty"
Kyle
Do you have a problem with regressive taxation? If so, fix the highly regressive Social Security tax first. Then we can talk theory of a proportional versus progressive tax system. Second, the Fair Tax as currently proposed is progressive in that prebates go to all people for their first $20,000 or so income a year. Finally, the problem with a progressive tax system is that the determination of when a tax becomes opressive is in the eyes of the beholders. In the history of the United States, the beholders have never been the American taxpayers. Rather they have always been the 535 members of Congress who wouldn't understand fair, opression, or reasonable taxation if it bit them in the behind.
Should be:
Tax policy exists ONLY for the purpose of assessing and collecting funds necessary for government to function in the broadest and most equitable manner. Tax policy does not exist to promote, or punish any perceived or preferred behavior.
It doesn't matter how the taxes are paid if the spending of them is screwed with.
Unfortunately as currently practised in the USA, current tax policy at all levels--but particularly the federal level is used precisely to punish certain people and reward others. Do you think the oil companies think an excess profits tax would not be punitive? Are the democrats explaining it and justifying it to the American public on any basis other than being punitive? I think not.
Or more precisely, I think many people misunderstand the precise nature of taxation in a fiat money system that has no sources of external discipline, like ours. Since money has no actual reality, the total amount of it is flexible.
When the US Treasury receives tax payments throughout the year, it actually disburses them back into the economy almost immediately. Although the government "spends" what appears to be about $3 trillion over the course of a year, the total amount of deposits it maintains in the commercial banking system at any point in time is rarely any more than about $50 billion. (Interestingly, the total amount of bank reserves, which are the Fed-funds deposits and vault cash that form the basis of the entire monetary system, amount to no more than $40 billion or so.)
Taxation is actually a modality for reducing the overall money supply. (A budget surplus, which greatly frightened Alan Greenspan when we briefly ran one in 1999, is a tool for producing deflation.)
The money supply always finds its balance in the push-pull between the Treasury's fiscal policy and the Federal Reserve's monetary policy.
That's why, even though there is a host of apparent flaws with the income tax as it exists today, it's not generating the kind of real pain that will result in reform.
Heavy taxation is evil because it empowers the government to direct the productive power of the economy in ways the people would not themselves choose. But this too is a question of balance. At roughly 21% of GDP, US Federal spending is much less than it is in Europe. This means that the government can probably grow a hell of a lot more before anyone squawks enough to make a difference.
Bottom line: the Fair Tax, and every other kind of tax reform I've heard of, is a total non-starter. Whether we tax income or consumption is utterly immaterial in terms of how taxation actually operates in the economy.
"Whether we tax income or consumption is utterly immaterial in terms of how taxation actually operates in the economy"
Are you saying that it is the aggregate amount of taxation that matters? In other words, are you saying that the specifics of how taxes are calculated on an individual by individual basis are irrelevant?
Any framework that disregards the impact of marginal changes in taxes charged to tax payors is missing the boat. Moreover, how could a consumption-based framework not enhance the desirability of basing corporations in the US and the desirability of producing products in the US for export elsewhere.
The beauty of the Fair Tax in my view is that it addressed the downsides of a global economy without attacking capitalism
I have to admit that I disagree with nearly all your statements, although this discussion probably deserves its own thread.
Remember that the government controls the economy by the fact that it defines the unit of account. They maintain this control by the fact that taxes must by law be paid to the government in its own money.
Give that a moment's thought. The fact that all of us must pay our taxes in dollars is the only reason that dollars have value. This is the reason that (from the government's perspective) it's essential for every American to pay some tax, and it's also why the payroll tax will never go away even if the income tax becomes much more progressive under a Democratic administration.
It doesn't matter whether you tax income or consumption because at the low end of the economic scale, they're indistinguishable. At the high end, you're not going to improve the quality of savings with a consumption tax, because savings are just deferred consumption. They'll eventually get taxed anyway.
And you don't accomplish anything by making more money available for investments via a consumption tax, unless you also make investing a more attractive activity in itself. That's a very important problem, and it can be solved by improving the regulatory environment for business activity in the US in ways that are politically not likely happen.
I agree that savings are just deferred compensation, but you seem to be saying the ability the control the timing of taxation is irrelevant. You also seem to be saying that taxation is less important that regulatory constraints to make investments attractive.
You should post separately on this--I would look forward to it.
...affect behavior, and then I took it out of my draft reply. Yes, they certainly do but in general, people at the high end of the income scale have the flexibility to respond to the distortion of incentives in rational ways.
The government's primary job with respect to managing the economy is to ensure prosperity, which basically means enough creation of goods and services every year in such a configuration that every citizen has what she needs in reasonable measure. Free markets create the incentives that result in basic productivity, and the government has to avoid destroying them as it does the other things it tries to do. That's the balancing act.
(You might reply that this shouldn't be the government's job and in fact it wasn't until the middle of the New Deal. Absolutely right, but I can't think of a way to unscramble that egg.)
I'm not sure if Fair Tax doctrine holds that benefits will ensue from reducing progressivity (since consumption taxes are inherently regressive). If that is what Fair Taxers believe, then I'd point out that marginal income rates will have to go a lot higher, and in fact become confiscatory, before they start really curtailing economic activity in ways that reduce the aggregate productivity of the economy.
And, as we saw before Reagan's tax reform, you really can't achieve an extreme amount of progressivity regardless of the marginal rate, for two reasons: people will begin to cheat, and people will begin to corrupt their Congressmen to get special breaks.
I deal with plenty of wealthy people, and they rarely if ever complain that their taxes are too high. This is what I mean by the balance between fiscal and monetary policy. If the Treasury collects too much in taxes, the Fed almost automatically creates more money.
The reason we face a fiscal crisis in regard to Social Security and Medicare isn't because there won't be enough money to pay for them. (The government can print an infinite amount of money if it chooses to.) It's because we may (or may not) reach a tipping point when Federal spending as a share of GDP goes well above its current 21% or so.
All of the Fair Tax proposals are revenue neutral. Therefore they do nothing to address the core of the problem.
First, revenue neutrality may make the national income tax (fair tax) similar in impact to the economy as with the federal income tax--so far as collections go. However, the cost of collection for the income tax is opressively high (to steal a concept from another respondent). This would not be so for the fair tax. And, the loss of taxes from the underground economy would diminish greatly because someone somwhere in the great stream of money exchanging hands would finally spend it on consumption. Finally, no tax charged to a business is economically neutral because it is ultimately paid by the purchaser of the good or service. Thus, business spends a lot of money to comply with the various federal taxes only to pass the entire bill to the American consumer.
I do agree with your point about the real reason for our Federal Government's fiscal crisis. I will deal with that at a later date. Remember, it is one of the 10 items on my list for the Republican Party to endorse for this year's Congressional elections.
I believe that the timing of paying taxes is very important--especially to the taxpayer. The quicker taxes are paid, the greater the certainty of tax payments to the taxpayer. In general most taxpayers would rather pay the tax immediately and forget about it. For the Federal Government I believe the national sales tax would help them achieve their fiscal Nirvana as well--a steady, predictable, uninterrupted stream of cash coming to the Federal Treasury virtually every day of the year. The current federal income tax skews payments by people to annual eventful confrontations for settlement with the federal government. The Treasury always has trouble predicting accurate tax collections each month but especially during February through May of each year.
To me it is a quite stark and simple matter. The $500 billion per year that business and households pay to comply and file income taxes could certainly be diverted to saving (and therefore investment). Additionally, the crazy things people and business do to avoid taxes are virtually all the antithesis of saving and investment. If everything else about the current federal income tax system would be neutral when compared with the national income tax, the impact of freeing $500 billion a year for people and business towards more productive ends would be tremendous. And when business and people made all production and consumption decisions on purely economic criteria, sans worrying about tax impacts or consequences, I, for one, believe the impact to the U. S economy and culture would be tremendously positive.
"Whether we tax income or consumption is utterly immaterial in terms of how taxation actually operates in the economy"
Are you saying that it is the aggregate amount of taxation that matters? In other words, are you saying that the specifics of how taxes are calculated on an individual by individual basis are irrelevant?
Any framework that disregards the impact of marginal changes in taxes charged to tax payors is missing the boat. Moreover, how could a consumption-based framework not enhance the desirability of basing corporations in the US and the desirability of producing products in the US for export elsewhere.
The beauty of the Fair Tax in my view is that it addressed the downsides of a global economy without attacking capitalism
Whether you realize it or not (and I'm not complimenting you today because I'm a suck-up) this statement is beautiful and it deserves a simple graphic explanation:
The money supply always finds its balance in the push-pull between the Treasury's fiscal policy and the Federal Reserve's monetary policy.
Why I find that statment so attractive today is a little bit of an interesting story concerning how the ink supply system works in one of my big inkjet printers. I had to do some maintenance today and when I removed the machine's covers to look inside, it reminded me of the simple and beautiful principles of gravity and basic fluid mechanics that the system is based on.
Let me explain briefly to make the analogy clearer:
The ink system on a Riso HC5500 inkjet printer consists of four big cartridges that each hold about a liter of expensive ink, mounted at the highest point in the machine. Given the technical complexity of the rest of the machine, you might think that the ink makes its way to the printheads through a complex system of computerized whimwams that defy the rules of what ink would normally do. Instead it is actually a very intuitive system based on gravity, air pressure, some reservoirs and a few very simple valves that open and close to allow ink to flow to different places. Sure, the valves are under computer control but all of the rest of the ink flow is the result of the natural process of liquids tending to seek their own level and atmospheric pressure pushing things around from one place to another. I was astonished the first time I opened the machine and saw how conceptutually simple it really was.
And yes, I'm oversimplifying it a bit here, and I know you are too, but it's still a beautiful statement. You should draw a picture.
...that one of my buddies (a Wall Street trader from way back) uses all the time.
It's like a balloon, or a sausage. Squeeze one end of it and the other end expands.
Squeeze both ends and you get either a big noise or a big mess.
All your comments may have merit in a benign collection arena. However, the current federal income tax collection process is anything but benign to the U. S. Economy and the American public. Spending a collective $500 billion a year to comply with the federal income tax system certainly prevents people being able to spend money on real items of output and prevents business from producing real items of output. The psychological impacts on the behavior of people and business merely to avoid income tax payments is also costly--but rarely if ever measured.
And please learn to use the "Enter" key.
____
CongressCritter™: Never have so few felt like they were owed so much by so many for so little.