Responsible citizenship is best served when everyone pays some direct tax. In an economy productive enough to provide a high standard of living for all households (which should be the long-range goal of economic decision makers), the cost of government would be minimal. Since government benefits should be equally accessible to each member of society, strict, that is, commutative justice would demand an equal per capita charge on all individuals, without regard to their income levels. This, however, is impractical at this stage of our economic and social development.
A more realistic and just tax today would be a single or proportionate rate imposed on all directly earned and so-called "unearned" incomes above a poverty-level income for all taxpayers. A single tax rate would be administratively more efficient than a progressive or graduated tax. Ideally, a single rate tax on individuals would cover all government expenditures each year, including welfare, defense, interest on the federal debt, social security obligations, unemployment and all other current spending not covered by user fees. This arrangement could also cover the cost of health insurance premiums under universal minimum health care coverage, including health vouchers for the poor.
A more fair tax system would allow for the gradual or immediate elimination of regressive payroll taxes on workers and companies, making the economy more competitive. A tax system based on justice instead of a desire of politicians to engage in social engineering would also help make government vastly more transparent and thus accountable to the electorate. If tied to a vigorous national growth and expanded ownership strategy, we can easily imagine future candidates for public office actually competing for votes on the basis of who could offer the best government services at the lowest flat rate. Each year's single direct tax rate could be adjusted up or down to provide sufficient revenues to avoid budget deficits and pay off government debt over time.
Under a progressive or graduated tax, on the other hand, political irresponsibility and waste is more easily tolerated. Many voters believe that the cost of increased government spending can be shifted to a tiny fraction of high-income individuals or fat cat corporations. When combined with or replaced by State borrowing or even government control of the commercial banking system and the central bank, thereby permitting the State to monetize its deficits at will, the citizens find it very easy to overlook the dangers of "printing press money" and ignore the inevitable sizable budget deficits until the bill comes due and the financial and economic system dissolves into chaos. A single rate tax would help raise the levels of economic sophistication of the taxpayers, and provide for direct accountability and increased transparency of government activities.
Another shortcoming of a progressive or graduated tax is that tax evasion and the search for tax loopholes by wealthy taxpayers increase as tax rates increase. Adding fuel to the inflationary fires, when workers are forced into higher tax brackets — the notorious "bracket creep" caused by inflation — pressures for additional pay increases put more pressure on the seemingly inevitable and endless inflationary spiral.
More so than under other tax arrangements (except where the State has managed to find a way to finance its activities without recourse to taxation), revenues generated by a progressive or graduated tax system tend to be misallocated. As politicians become worried about the effects of adverse economic and financial conditions on the electorate — resulting from misdirected attempts to control the economy through misguided monetary and fiscal policy — economic decisions are increasingly made, not on their economic merit, but on political considerations that only by a very distant stretch of the imagination are consistent with sound tax policy, and which are frequently contrary to the national interest. As a result, high tax brackets stifle growth and incentives to innovate and increase production, making all of society the poorer and less competitive.
Should the US Adopt a Single Rate Tax?
First, we are in favor of everyone paying the same tax rate on income above what is necessary to meet common domestic needs adequately. That being said, however, it would be a disaster simply to impose a flat rate tax over the abominable tax structure that today afflicts the United States and virtually every other country on the face of the earth.
Most discussions of a flat rate tax take as a given that only the progressive portion of the income tax would be changed to a single rate. The heavily regressive Social Security and Medicare tax would remain in place. This would be a gross injustice by means of which the poor would continue to be taxed on the very first dollar they earn for redistribution among themselves. At the same time, individuals whose income is derived from non-wage sources would not only escape the Social Security tax, but, as they do now, often pay a lower income tax on dividends and capital gains.
True, dividends and capital gains are taxed at the corporate level, being charges against corporate income, and this is unjust. Two injustices do not, however, cancel each other out; two wrongs do not make a right. A serious and fundamental reform is in order, but first we have to examine the justification for taxing non-wage income (dividends and capital gains) at more favorable rates than wage income.
The reason for taxing non-wage income at favorable rates is to encourage reinvestment of income derived from ownership. This is believed to be the source of job creation, which is the principal means by which most people gain their income. Without favorable treatment of such investment income, so the theory goes, there would be little or no new investment, no job creation, and thus most people would have no jobs and thus have no source of income.
Financing Capital Formation
The problem is that this belief is entirely false, even extraordinarily damaging to the process of capital formation and the general health of the economy. As Dr. Harold Moulton explained in his classic, The Formation of Capital (Washington, DC: The Brookings Institution, 1935), it is much better to finance capital formation by extending bank credit rather than relying on existing accumulations of wealth. Most accumulated wealth is already invested, being in the form of corporate net assets. These assets are not used directly to finance capital formation in any event, but serve as collateral to increase the holdings of the currently wealthy through the use of what Louis Brandeis called "other people's money." The wealthy should not be reinvesting their income by retaining earnings, but spending it, thereby increasing effective demand and spurring economic growth.
Using existing accumulations of savings — essentially non-consumed income — to finance capital formation puts the cart before the horse. Moulton discovered that when consumption increases, investment in new capital follows (The Formation of Capital, op. cit., 49-74). When consumption decreases, however, investments tend to fail — what Moulton called "the economic dilemma" (ibid., 26-48). Thus saving, which in the Keynesian approach to finance relies on cutting current consumption, causes the very capital being financed to be non-viable, and the economy is forced into a never-ending cycle of "boom and bust," which policymakers attempt to ameliorate by manipulating money and credit and the tax system.
Proper use of the commercial banking system and the central bank (e.g., the Federal Reserve System) can supply sufficient financial capital to the economy without first having to save. There is saving going on, of course — Keynes and the classical economists are absolutely correct that savings must equal investment, and vice versa. They were wrong, however, in asserting (completely without proof) that the savings had to take place before investment: "saving, which is the excess of income over consumption" (General Theory, II.6.ii). Although Keynes ridiculed the idea (ibid., II.7.v), saving can take place after investment.
This is a process called "future" savings, which relies on the capacity of the very thing being financed to generate sufficient income to pay for itself, a concept accountants and finance professionals call "financial feasibility." We have used the term "forced savings" to describe this in the past. Forced savings, however, has a different meaning in Keynesian, Monetarist, and Austrian schools of economics, something Moulton called "involuntary savings." All three schools assume as a given that saving consists exclusively of reductions in consumption. For clarity's sake we will try and use future, rather than forced savings to describe the process.
Using bank credit removes the need for the rich to save their income instead of spending it. As Adam Smith observed in his "invisible hand" argument, the rich confer greater benefits on society by spending than they do by saving through the increase in effective demand. Removing the need for the savings of the rich from the economy thus removes the justification for giving favorable tax treatment to the rich in order to encourage them to save, e.g., a lower tax rate on dividends and capital gains. That being the case, a properly structured single tax rate would be of great benefit to society — after some major reforms:
Since the justification for the labyrinthine tax structure in the United States is to effect capital formation through savings and redistribution when wage income proves inadequate, all capital formation should be financed with bank credit. To raise income levels without tampering with a market-determined wage rate, ownership of all new capital should be spread out by giving everyone democratic access to bank credit with which to purchase sound, financially feasible capital, usually in the form of corporate equity. Thus, the U.S. currency would change from being backed by government debt, to being backed by the hard assets of the economy. This would be better than gold or the traditional silver, because precious metals by themselves do not produce anything.
So that the capital can pay for itself (and repay the bank loan used to purchase the capital), dividends should be tax deductible at the corporate level, and (to increase the tax base) taxed as ordinary income at the personal level. Without the need to retain earnings to finance capital, in fact, it would be counterproductive to retain earnings instead of paying them out. The corporate tax should, therefore, be raised very high to encourage payout of tax-deductible dividends and inflation-indexed capital gains.
All personal tax deductions except for health care and education should be eliminated, as well as all individual tax credits. To make up for this, the personal exemption should be raised to a realistic level, sufficient to cover reasonable living expenses. Currently, a realistic amount for an exemption plus deductions for education and health care for a non-dependent adult appears to be approximately $30,000, and for a dependent, $20,000. Anyone below this amount could be paid a version of Milton Friedman's "negative income tax" to bring them up to an adequate and secure income, and all entitlements — two-thirds of the $3 trillion federal budget before the current economic crisis — eliminated.
One personal tax deferral must be permitted, up to, say, $1 million worth of income-generating assets that can be accumulated tax-free. Financed with bank credit extended democratically, with individual accounts professionally managed, this would allow the United States (and any other country adopting similar measures) to become a true "nation of owners." Taking the increased exemptions into account, the current level of government expenditure, and forbidding the socialist measure of the federal government borrowing any more money (the current national debt is, according to the "national debt clock" as of May 2010 just under $13 trillion), a single rate tax would be in the neighborhood of 48-50%.
While this might sound shocking, people earning under the median income would pay no taxes of any kind. Nor would there be a tradeoff for those over the median until a non-dependent's personal income hit around $100,000. At that point, given the current tax structure, a self-employed individual with no dependents would pay approximately the same tax as under a $30,000 exemption and a 50% single rate tax on all income above $30,000. A "typical" family of mother, father, and two children would pay nothing until aggregate family income exceeded $100,000.
What the Single Tax Rate is Not
The single rate tax proposal presented here bears a superficial resemblance to the program recommended by Henry George, noted author of Progress and Poverty (1879). While George's thinking did, in fact, influence the analysis and provide some profound insights, George's proposal contains some serious flaws that preclude wholesale adoption of his program.
First we must clearly understand that "property" is not the thing owned, but the natural right to be an owner. This right to property is inherent (inalienable or absolute) in every human being. What is necessarily limited for the common good is the exercise of property, that is, the bundle of rights that define how an owner may exercise his or her ownership — the rights of property — but the exercise of private property must never be defined or limited in any way that effectively abolishes the underlying right of a private person to be an owner in the first place, individually or in free association with others.
"Property," as Kelso noted, "in everyday life, is the right of control." (Louis Kelso, "Karl Marx: The Almost Capitalist," American Bar Association Journal, March 1957.) If, therefore, someone or something controls or enjoys the "fruits of ownership" of an asset (i.e., right of use, disposal, the income generated therefrom, and so on), then — regardless who has nominal or formal title to that asset — "ownership" is vested in whoever exercises control over the asset and enjoys the fruits thereof. If the entity enjoying the fruits of ownership is a private individual or association, then the institution of private property is secured. If the entity enjoying the fruits of ownership is the State or some entity that represents the collective and is thus the State in all but name, private property is abolished to that extent; what was private property becomes common property.
The bottom line in this discussion is how Henry George and Karl Marx viewed private property. Marx was very clear. As he stated in The Communist Manifesto (1848), "The theory of the Communists may be summed up in the single sentence: Abolition of private property." Karl Marx and Friedrich Engels, The Communist Manifesto. London: Penguin Books, 1967, 96.) Marx applied this basic precept to land as number one on his list of measures to destroy (make "despotic inroads" on) the rights of property: "Abolition of property in land and application of all rents of land to public purposes." (Ibid., 104.)
This is identical to Henry George's proposal:
What I, therefore, propose, as the simple yet sovereign remedy, which will raise wages, increase the earnings of capital, extirpate pauperism, abolish poverty, give remunerative employment to whoever wishes it, afford free scope to human powers, lessen crime, elevate morals, and taste, and intelligence, purify government and carry civilization to yet nobler heights, is — to appropriate rent by taxation.Thus, the only difference between Marx and George is that Marx advocated abolition of private property in the means of production, whatever form it took, where George advocated abolition of private property only in land. Marx is thus the "compleat" socialist, where George is, in theory, "only" an agrarian socialist. The danger in advocating abolition of private property in one form of productive asset, of course, is that it creates a precedent for the abolition of private property in all forms of productive assets. As Locke commented, "What property have I in that which another may by right take, when he pleases to himself?" (Locke, loc. cit.)
In this way the State may become the universal landlord without calling herself so, and without assuming a single new function. In form, the ownership of land would remain just as now. No owner of land need be dispossessed, and no restriction need be placed upon the amount of land any one could hold. For, rent being taken by the State in taxes, land, no matter in whose name it stood, or in what parcels it was held, would be really common property, and every member of the community would participate in the advantages of its ownership. (Henry George, Progress and Poverty. New York: The Robert Schalkenbach Foundation, 1935, 405-406.)