The Restoration of Property, Part X: Reform the Tax System

Any way you look at it, the tax system in the United States is an abomination. Based on the tenets of the British Currency School, the tax system assumes as a given that existing accumulations of savings are essential to finance new capital formation and private sector economic growth. The tax system has been distorted, first, to encourage more savings and thus more investment by the rich, and, second, to encourage the non-rich to spend more than they make. The present federal tax system represents a virtually insurmountable barrier to widespread participation in capital ownership, democratic corporate governance, and the broad distribution of capital incomes from advancing technologies.

Both changes virtually guarantee that new money will 1) be created in ways that concentrate ownership of the means of production, and 2) spur demand artificially by encouraging consumers to spend far beyond their incomes. In the latter case, the home mortgage crisis is only the inevitable result of inducing the consumer to spend far more than he or she can ever hope to earn, although the consumer credit "industry" has the potential to maintain the current economic crisis or create a new, more severe one of its own.

To correct a situation that can only be described as inherently unjust and forestall a series of disasters even worse than the present one, we need to conform the tax system and the entire system of government finance and fiscal policy to support a restoration of property. Coincident with this is the need to restructure the tax system so that it becomes possible for people to live within their means without the necessity of constant borrowing to generate artificially induced demand. Creating a vicious circle, "stimulating" consumer demand by increased consumer lending in turn justifies artificial job creation to produce marginally marketable goods and services — which requires increased consumer debt in order to clear those same goods and services at what can only be described as subsidized prices.

As a first step, we advocate eliminating the "payroll tax" and merging the Social Security and Medicare taxes into general tax revenues. This does not mean the elimination of Social Security and Medicare. All promises must be kept, and kept per the original understanding and value of the promise. This is the basis of sound government as well as sound money. Ending the payroll tax, however, would put an end to the nation's most regressive tax by increasing the standard exemption plus an essential minimum number of deductions, and only taxing income above that level — no exceptions. These exemptions plus deductions and deferrals would apply to all income from whatever source derived. The myriad of other tax deductions, credit and other "tax expenditures" would be eliminated, so that a family could fill its annual federal tax return on a postcard.

All promises that have been made must be kept — but the government needs to stop making new promises that it cannot keep, whether in the form of creating money to cover the increasing deficit, or refusal to reform the Social Security and Medicare system or other entitlements that account for two-thirds of the Federal budget in "normal" times. This "social safety net" will then be properly understood as a supplement to wage and investment income instead of a primary source of income for so many. Social Security and Medicare would gradually be phased out in their present form, replaced by increased wage and property income. For those below a very generous "poverty level," we would institute a "negative income tax" supplemented with vouchers for health insurance and education. Such a reform would also greatly reduce administrative costs for the federal, state, and local governments.

We also advocate replacing the current progressive and regressive tax rates (Social Security and Medicare taxes are possibly the most regressive taxes in history, levied on the first dollar of wage income whether the individual is making a million a year or is far below the poverty level) with a single rate tax on all personal income above the standard exemption plus deductions for health care and education, and a deferral for every citizen to begin to save and accumulate income-producing assets through tax-sheltered vehicles. With guaranteed democratic access to capital credit for financially feasible projects, every citizen, whether or not he or she currently owns any capital in any form, will be empowered to purchase newly issued or transferred shares, and repay the capital credit extended for the purchases out of the "future savings" made possible from the full distribution of profits on shares acquired by the newly economically enfranchised capital owners.

While no one at the time put the two concepts together, with the institution of the Federal Reserve System in 1913 (perhaps not coincidentally, the same year in which the income tax was established) it became possible for the first time in American history to have a coordinated and systematic program of creating interest-free "new money" in ways that would universalize access to capital ownership and break the dependency on existing accumulations of savings. The twelve banks of the Federal Reserve System, although "hijacked" during World War I to finance government deficits and never returned to their original purpose, were intended to serve as regional development banks with the capacity under existing law to extend credit via the "discount window" through member commercial banks for qualified industrial, commercial, and agricultural investment. (§ 13 of the Federal Reserve Act of 1913.)

The shift away from the Federal Reserve System's stated purpose in providing a flexible and stable asset-backed currency by discounting private-sector productive loans to finance growth of agriculture, industry, and commerce, to a debt-backed currency to cover non-productive federal deficits, was made official in the 1930s with the formation of the "Open Market Committee," headquartered at the Federal Reserve bank in New York City. Ironically, one of the chief reasons for the formation of the Federal Reserve System was to break the monopoly on money and credit held by Wall Street. (U.S. Congressional House Committee on Banking and Currency, Report of the Committee Appointed Pursuant to House Resolutions 429 and 504 to Investigate the Concentration of Control of Money and Credit. Washington, DC: U.S. Government Printing Office, 1913.)

With the institutionalization of open market operations via the Open Market Committee centered in New York City used to fund government deficits, the "money power" in the United States became even more concentrated than before the Panic of 1907 that resulted in the investigations that led to the formation of the Federal Reserve System. Far from being key installations in a program to spread out economic power, the eleven Federal Reserve Banks outside New York have become relegated largely to research roles, and implementing policies dictated by the Federal Reserve Board of Governors in Washington, DC, and the Open Market Committee in New York.

In theory, calculating a single tax rate is simplicity itself. The calculations that follow are necessarily vague. The numbers should be taken only as illustrations of the concept, and certainly not as specific recommendations! Arriving at "good" figures will require at the minimum months of intensive effort by experts trained in the field of tax and fiscal policy, not a few hours research carried out with the goal of testing the general plausibility of the concept. Thus, these figures should, at most, be taken as a general, even vague hypothesis that must be subjected to a great deal of further testing and gathering of data. We're after the concept, not strict accuracy in the numbers. The numbers that follow should be construed as assumptions, not established facts.

The Gross Domestic Product (GDP) is divided into the anticipated government expenditures for the year after subtracting aggregate exemptions from the GDP. (Government expenditures must be retained in this calculation, because while expenditures should come out of tax revenues, they represent income for whoever sells a good or service to the State.) The amount of GDP representing government expenditures can be expressed as a percentage. To calculate this percentage, we first subtract the estimated aggregate of all income below the exemption. Anything above that amount is subject to taxation.

If the proposed tax reforms were adopted today, we estimate that the single federal tax rate for incomes above the aggregate exemptions, deductions, and deferrals would be around 35-40%. (If we haven't stressed this point enough, we will state it again: these are assumptions. They may be good assumptions or bad assumptions, but we're after the concept, not mathematical accuracy.) Adding up all the exemptions and deductions for a "typical" family of four would mean that any such family group earning less than $100,000 would not be taxed.

Briefly (for the rationale and the calculations even for these general assumptions would take up more text than this entire blog series), we assume that each non-dependent taxpayer should have a basic standard deduction of $10,000. We picked this amount because it is approximately the poverty level from 2005 for a single individual. Each dependent should have a basic standard deduction of $5,000.

To this we add $7,000, consisting of $6,000 for an average per capita health insurance premium and a $1,000 deductible for a non-dependent, and $1,000 premium plus $1,000 deductible for dependents (direct medical expenses for minor children are typically substantially less than for non-dependents, especially when most of them are aggregated under those of the parents). Education works out to $3,000 per capita, while we add another $10,000 to allow tax-free accumulation of capital assets up to $1 million.

To ensure that taxpayers receive the full benefit of the increased exemption and limited deductions and deferrals, all vouchers received for education or health care are included in calculating income as well as an expenditure, and any unused portion of a deduction or deferral would be carried forward or back without a time limit or sunset date. (For example, a taxpayer could "amortize" an educational expenditure of, say, $60,000 in a single year over twenty years, using the full $3,000 deduction every year and carrying over the unused amount of the deduction. Setting money aside for future educational expenditures would be counted toward the deduction in the year in which the money was saved.)

The total exemption plus deductions for a non-dependent taxpayer would thus typically be an average of $30,000, and for a dependent taxpayer would be $20,000. A "typical" family of four of two non-dependents and two dependents would thus pay no taxes until aggregate income exceeded $100,000.

We now come to the question of calculating the single tax rate to be applied on aggregate family incomes in excess of $100,000. Again, we have to caution the reader that these figures are not intended to represent reality accurately, but to present the concept.

Dividing the "pre-recession" federal budget of approximately $3 trillion by taxable GDP of $4.25 trillion (total GDP less the aggregate of exemptions, deductions, and deferrals) gives us a single tax rate of 70.59% for any taxpayer earning more than $30,000. Since this figure is a rough "guesstimate" in any event, we will round it down to 70% for ease in calculation. This looks bad, but let's look more carefully at these numbers. Realizing that self-employed individuals making below $30,000 per year at the present time can pay an effective federal tax rate of almost 40% makes the figure slightly more palatable, but not much. Are these rather stark figures, however, significantly worse than current tax rates applied to income reduced, as at present, by a token exemption and deductions insufficient to shelter enough income to provide for common domestic needs adequately?

We can expect that individuals in the upper brackets will protest that the bulk of their income derives from dividends and capital gains. Due to the erroneous belief that existing accumulations of savings are essential to finance capital formation, such "capital income" is usually taxed at a more favorable rate than wage income. This is to encourage reinvestment of corporate profits in order to finance economic growth and provide wage system jobs — which can then be taxed instead of dividends and capital gains. Is that, however, the most efficient and cost-effective means of financing more universal participation in economic growth and capital formation?

Not according to Dr. Harold Moulton in The Formation of Capital. As we have already noted previously in this blog series, by cutting consumption (which is what, effectively, reinvestment is), economic growth is slowed dramatically. In extreme cases, where money is created for non-productive uses and reinvested in speculation or gambling (as was the case in 1929 and again with the home mortgage crisis), the resulting "readjustment" in the economy can be devastating in its effects.

Even without reductions in the federal budget the effective tax rate on incomes of less than $150,000 under our proposed single rate reform would be under 15% — substantially less than now. Still — an effective rate of more than 60% on incomes of $1,000,000 or more is pretty high. It is much higher than the approximately 15% rate for dividends and capital gains currently paid, especially considering that wage income above $1 million is relatively rare. Most people with incomes at that level receive it in the form of dividends and capital gains — on which they receive favorable tax treatment.

Consider this, however. Given the actual "double taxation" of dividends and the effective double taxation of capital gains (presumably a reflection of the value of retained earnings, which represent undistributed corporate income on which taxes have been paid), is the favorable tax treatment for dividends and capital gains all that "favorable"? Looking at how dividends and capital gains are currently taxed for a single individual gives a somewhat different picture. Assuming a 15% tax on dividends and capital gains, and a 35% tax on corporate profits, we get an effective "single rate tax" for "non-wage" income in the form of dividends and capital gains of 50%.

Thus, people who receive "favorable" treatment of capital gains and dividends have already paid 35% in taxes before receiving a dime. When personal taxes of 15% are added in, the recipient of dividends and capital gains under the current system pays an effective rate commensurate with individuals earning $300,000 of wage income under a reformed single rate tax with high exemptions but no reductions in the federal budget. These figures do not materially change when we factor in the current level of personal exemptions and the standard deduction — many rentiers (small investors) do not qualify for itemization if they've been financially prudent. The figures, however, increase if we factor in a corporate tax rate greater than the 35% minimum we used in the calculation. The "favorable" tax treatment under the current double- and triple-taxation is not quite as "favorable" as many people suppose.

We have to remember, however that income from capital will at first supplement, and eventually replace virtually all transfer payments, Social Security, Medicare, and other entitlements once existing promises have been kept, and that the personal exemption plus deductions and a negative income tax (or vouchers) will take care of education and health care. Private charity will be able to handle much of what remains in hard cases, so that government welfare and entitlements will diminish to the absolute minimum necessary to maintain an emergency "social safety net."

Assuming that the average income below the new individual "poverty level" of $30,000 (the amount of the personal exemption plus deductions and savings deferrals) is exactly half of the new poverty level gives us $15,000. This means that $15,000 would be needed on the average for each person in poverty to bring him or her up to the poverty level. According to the Census Bureau, 37 million Americans live in poverty, which we will round up to 40 million.

Obviously, increasing the "poverty level" to $30,000 would, in and of itself, vastly increase the number of Americans living in "poverty." This is offset by the fact that the Federal Reserve Board estimated total consumer debt as of September 30, 2007 at $2.482 trillion, or approximately $8,000 per capita. Adding in mortgage debt (characterized by former Federal Reserve Chairman Alan Greenspan as a "bubble") of $3.001 trillion gives an additional $10,000 of per capita debt, much of which exceeds the value of the homes on which the mortgages were made.

In effect, each American family of four has a debt burden of $72,000. We are forced to conclude that families are spending far beyond their actual incomes, and are already effectively, if not officially, living in poverty (we called this "the Micawber Effect" in an earlier posting, from the character in Charles Dickens's David Copperfield). The needs of these individuals and families must be met out of non-existent savings or by various forms of State welfare or redistribution.

Taking only the "non-revolving" consumer debt figure of $1.5 trillion supplied by the Federal Reserve for September of 2007 (ibid.) ("non-revolving" meaning debt that must be paid in the current period, and is not renewable, or "revolving"), gives a per capita amount by which each individual lives beyond his or her means each year of $5,000 ($20,000 for a family of four). Subtracting $5,000 from the basic exemption of $10,000 plus the health care deduction of $7,000 gives $12,000.

A significant amount of this "increased" income (actually taxes that are not paid until income from all sources exceeds $30,000) will result from folding Social Security and Medicare taxes — currently at around 15% — into the general, single tax rate. This would mean an effective increase in consumable income of $4,500 on wage incomes of $30,000. This is, ironically, almost exactly equal to the reported per capita annual borrowing for consumer goods and services. (The possibly unwelcome conclusion resulting from this analysis is that the Social Security and Medicare taxes are in some measure causing the very conditions they are intended to ameliorate, as Alexis de Tocqueville predicted in his Memoir on Pauperism in 1835.)

Multiplying our new "half poverty" level of $15,000 by 40 million persons gives us an "add back" to the Federal budget of $600 billion in negative income taxes. We round this down to $500 billion due to the fact that we originally rounded up the number of people in poverty. We also did not take into account that there are probably no individuals receiving absolutely no income, and, as the economy gears up for full production, far fewer people will receive the negative income tax, and those in decreasing amounts as personal income rises with the creation of jobs in a fast-growth economy combined with increased capital income.

Adding $500 billion back into the reductions of $2 trillion leaves us with a rough estimate of the federal budget under a program of expanded capital ownership of $1.5 trillion — less than half the current anticipated budget. Using these new figures to calculate the single tax rate under Capital Homesteading gives us $1.5 trillion divided by taxable GDP of $4.25 trillion, or 35.29%, which we round to 35% for ease in calculation.

If it were possible to eliminate all welfare and other entitlements that make up two-thirds of the pre-recession federal budget (an unrealistic expectation, of course), we would have a tax rate calculated by dividing $4.25 trillion by $1 trillion, or 23.53%, or (rounded) a tax rate of 24% on incomes over $30,000, much less than today, but still high. Still, being able to reach the hitherto "unreachable star" of full employment by including full employment of capital combined with widespread ownership thereof and a focus on full production, should eliminate poverty as a permanent condition of life for an estimated 13% of Americans. Something along the lines of a negative income tax could be implemented to succor the truly unfortunate until they can get back on their feet, instead of trapping people into an unbreakable cycle of poverty.

This version of the single rate tax represents a revolutionary restructuring of the Welfare State based on class warfare and redistribution, to a welfare state based on the economic empowerment through capital ownership of every citizen as a fundamental right of citizenship and self-governance. This, of course, would make the State more dependent on the citizens, rather than having the citizens increasingly dependent on an absolutist government.

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