Thursday, May 13, 2010

A More Just Tax, Part IV: The Case for Tax Reform

By Norman G. Kurland, Dawn K. Brohawn, and Michael D. Greaney

Clearly the tax system in the United States is badly in need of reform. Unfortunately, a demand for "tax reform" does not evoke a very high comfort level in either citizens or legislators. Most demands for tax "reform" are actually wishful thinking that taxes can either be abolished completely, or put off on somebody else. The former is unrealistic. The latter is unjust. Both are politically dangerous. Throughout history tyrants, demagogues, and self-appointed saviors — actual and wannabe — have gained power on the strength of a promise to abolish taxes forever. This inevitably ended with the imposition of heavier taxes than the ones presumably being abolished.

It was, for example, due to the promises made by Henry VIII Tudor that he would abolish taxes that the people, by and large, acquiesced in the confiscation of the property of the Catholic Church. Known as "the Patrimony of the Poor," the wealth of the monasteries and other religious establishments provided the social safety net for Medieval Europe, funding welfare, health care, and education. Church and State counterbalanced each other, preventing either one from gaining too much power. Henry VIII, however, decided to separate from Rome and declare himself head of the Church in order to grant himself a divorce. He thereby combined Church and State in a single monolithic entity, and took the opportunity to seize the wealth of the Catholic Church, especially the land, the chief productive asset of the time. As the Protestant historian and political commentator William Cobbett described the situation,
Great promises had been held out that the King, when in possession of these estates, would never more want taxes from the people; and it is possible that he thought that he should be able to do without taxes; but he soon found that he was not destined to keep the plunder to himself, and that, in short, he must make a sudden stop, if not actually undo all that he had done, unless he divided the spoil with others, who instantly poured in upon him for their share, and they so beset him that he had not a moment's peace. . . . Before four years had passed over his head he found himself as poor as if he had never confiscated a single convent. (William Cobbett, A History of the Protestant Reformation in England and Ireland, 1827, §§ 169-170.)
In other words, Henry VIII found that he either had to pay off political favors, or go back to the way things were before. No one, whatever his or her ability, drive, or vision, ever got into power without assistance. Whatever the fragile nature of many political promises, there are some that had better be kept — ironically the ones that probably shouldn't be kept. Despite the allure of the idea of "no more taxes," it is also clear that there are some promises that shouldn't even be made in the first place. Not only is it a promise impossible to keep, it eliminates the principal means by which the electorate holds the government accountable. As Cobbett commented,
You may twist the word freedom as long as you please, but at last it comes to quiet enjoyment of your own property, or it comes to nothing. Why do men want any of those things that are called political rights and privileges? Why do they, for instance, want to vote at elections for members of parliament? Oh! because they shall then have an influence over the conduct of those members. And of what use is that? Oh! then they will prevent the members from doing wrong. What wrong? Why, imposing taxes that ought not to be paid. That is all; that is the use, and the only use, of any right or privilege that men in general can have. (Ibid., § 456.)
The problem, of course, is that everybody hates taxes. Most people are willing to lend an ear to anything that promises to reduce or, better, eliminate taxes. Thus, just as Henry VIII managed to use people's hatred of taxation to good effect — possibly even with the best of intentions — the Congress of the United States gradually seized control of the Federal Reserve System, potentially the most powerful tool ever invented to ensure that every American could have the opportunity to become an owner of capital. This turned what could have been a significant force for freedom and democracy, and turned it into something to support the growing intrusion of the State into every level of people's lives.

Functional Overload

When business corporations, voluntary associations, or any other specialized social inventions become socially dysfunctional and create, rather than solve, problems for society, government is the instrument through which we overcome the problem, directly or through a restructuring of our institutions and laws. It is not in the nature of government to leave social vacuums unfilled.

Today however, as a result of the maldistribution of ownership and income, we have reached a point where government itself is suffering from an acute case of functional overload. Public redistribution and efforts to control the economy have placed responsibilities on government that go far beyond its originally conceived and more normal functions of enforcing contracts, protecting property, suppressing violence, and otherwise maintaining a just and peaceful society.

The mere shifting of centralized governmental activities to state and local levels totally ignores the underlying defects within our economic system. These defects have engendered and exacerbated the growing wealth, income and power gap. Reorganization of the federal bureaucracy is a similarly futile palliative.

Capital Homesteading offers a solution, not an excuse for perpetuating or ignoring structural flaws in our major economic institutions. Behind Capital Homesteading is a philosophy of taxation. The serious reader will find the justification and tax philosophy behind these Capital Homesteading reforms described in detail in the article, "Beyond ESOP: Steps Toward Tax Justice," by Norman G. Kurland, published in the April and July 1976 issues of Tax Executive and updated in Chapter 8 of Curing World Poverty: The New Role of Property, John H. Miller, ed., Social Justice Review, St. Louis, 1994.

The Federal Reserve and Freedom

While no one at the time put the two concepts together, with the institution of the Federal Reserve System in 1913, 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 wealth. Ironically in light of the animosity directed at both the Federal Reserve and the Internal Revenue Service, this was the same year in which the income tax was established — and the same populist and anti-monopoly arguments used to establish the Federal Reserve were also used to support the income tax.

America, for all the opportunity it offered for those without ownership of the means of production to become proprietors — notably with Abraham Lincoln's 1862 Homestead Act — had never managed to institute a truly sound and democratic financial system. The state banking system prior to the American Civil War was ineffectively regulated with no federal oversight.

The National Bank Act of 1864 (ch. 106, 13 Stat. 99) that superceded the National Bank Act of 1863 (ch. 58, 12 Stat. 665), while instituting a modicum of banking regulation and uniformity in the paper currency (to which the coinage act of 1873 (H.R. 2934) added metallic currency), was designed to meet the needs of an agricultural economy. The Act left the country with a banking system still inadequate to support a national program of expanded capital ownership to match the land-oriented Homestead Act. The National Bank Act was modeled on the British Bank Charter Act of 1844 (7 & 8 Vict. C. 32). Sir Robert Peel's Bank Charter Act was a triumph of the British Currency School that relied on a distorted understanding of money and credit. Neither act allowed for expansion and contraction of the money supply to match the present value of existing and future marketable goods and services in the economy, nor even acknowledged that an "elastic currency" is possible. Instead, in an effort to control the money supply, both acts mandated that banknotes were to be backed exclusively by government debt in a fixed amount.

The Federal Reserve System is a network of twelve interrelated regional central banks that, although "hijacked" during World War I to finance government deficits and never fully returned to its original purpose, were intended to serve as regional development banks. They had 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 United States' entry into World War I marked a transition from the Federal Reserve System's stated purpose. The Federal Reserve was formed primarily to provide a flexible and stable asset-backed currency without inflation or deflation. This was to be done by discounting private-sector productive loans to finance growth of agriculture, industry, and commerce, supplemented with limited open market operations in private sector securities. What the Federal Reserve ended up doing was providing a debt-backed currency to cover non-productive federal deficits. The shift was made official in the 1930s with the formation of the "Open Market Committee." The Committee is headquartered at the Federal Reserve Bank in New York City.

In a strange twist of history, 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.) 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.

Today, the money power of America is more concentrated than ever before. To make matters worse, the U.S. currency — M1 and M2 (the "money stock" or "monetary base") — has become backed by government debt paper and a huge amount of "toxic" private sector mortgage-backed securities held by the Federal Reserve. Government securities represent the ever-growing federal deficit since the American Civil War, while the mortgage-backed securities were purchased to further State bailouts that charge the taxpayer for failed speculation on Wall Street. As of mid-2010, the debt paper and questionable securities total approximately $2 trillion. With America's abandonment of the last vestige of the gold standard in the 1970s, there are virtually no real "assets" behind today's U.S. dollar ( the prime currency in the global marketplace ( other than unsustainable promises of politicians to pay for non-productive spending in the past out of future tax revenues wrested from a shrinking and increasingly impoverished tax base.

New Money in New Ways

Extending credit for private sector investment instead of to fund government deficits would break the dependency on "old money," that is, the reliance on existing accumulations of savings to finance capital formation. It has the potential to open up democratic access to capital credit (the chief means by which people acquire ownership of productive assets) — without taking anything away from current holders of wealth. By encouraging today's ownership elite to spend their income instead of reinvesting it (either in the form of retained earnings or purchase of shares out of unconsumed income), the currently wealthy will perform a valuable public service at the same time that they encourage balanced, sustainable and more justly distributed "green" economic growth through the functioning of Adam Smith's "invisible hand." (Adam Smith, "Of Restraints upon the Importation from Foreign Countries of Such Goods as can be Produced at Home," The Wealth of Nations. Book IV, Chapter II, §9; "Of the Effect of Utility upon the Sentiment of Approbation," The Theory of Moral Sentiments. Part IV, Chapter I, §10.)

Of course, if current owners insist on concentrating ownership by using retained earnings as collateral, and "surplus" income to finance growth instead of using capital credit obtained via expanded ownership mechanisms such as individual Capital Homestead Accounts, they are free to do so. Of course, they would do so in the full knowledge that any earnings not paid out as dividends would be taxed at the corporate level instead of being tax deductible as proposed under Capital Homesteading. This would increase financing costs, and leave only a limited amount of new share issuances available for purchase.

Any remaining "surplus" income would be available to purchase existing shares, but without being eligible for favorable treatment under the Capital Homestead Act once an individual's ceiling for overall tax-deferred capital accumulations has been reached. This could be set, perhaps, at $1 million per individual. Yes, it's a free country. Justice, however, trumps freedom, and is violated when freedom for some comes at the expense of freedom and equal opportunity for others.

Rates of Taxation

This brings us to the issue of setting the rate of taxation. A growing number of tax scholars have argued that the case for progressive or graduated rates of taxation is weak at best. (Walter Blum and Harry Kalven, The Uneasy Case for Progressive Income Taxation, University of Chicago, 1953.) If redistribution of income (in contrast to redistribution of future ownership opportunities) is a form of direct discrimination against property, a progressive income tax, number two on the list in The Communist Manifesto of measures to destroy private property, is inherently an unjust tax, assuming one accepts the Kelso-Adler, rather than the Marx-Engels, version of economic justice.

But what about the poor? No more effective aid can be provided the poor than allowing them to share in the new job and ownership opportunities within a healthy and growing private economy. The problem of those still too poor to share in the cost of government can be handled through tax exemptions or direct vouchers, or perhaps even the kind of negative income tax advocated by Nobel prize winner Milton Friedman.

Earned or Unearned Income

Under the Kelso-Adler theory of economic justice, the earnings from one's property in the means of production are morally indistinguishable from the earnings produced by one's skill or brainpower. Since they are both rewards directly related to their contributions to production, they should be taxed alike. Further, discrimination against property discourages investment and reduces society's overall productive capacity.

Karl Marx considered profits as income stolen from labor or the consumer. Tax laws that discriminate against property incomes reflect the same bias. The tax system, therefore, needs to recognize that capital is a producer of wealth in exactly the same way as labor, and the profits of capital are due to the owners of capital no less than the profits of labor are due to the owners of labor. Capital incomes, whether distributed or undistributed, are as legitimately earned by those who share property rights in that capital, as those who are paid for their skills and ingenuity.

The most serious problem with laws that discriminate against property incomes is that they hurt the poor more than they do the rich. Access to the full, undiluted stream of earnings from capital is a prerequisite for the financing on credit of broadened ownership opportunities. Broadened ownership of capital is also essential for more widespread distribution of profits as second incomes among today's non-owning citizens, including civil servants, many professionals, teachers, the military, and the unemployed, even the presumably unemployable.

The only form of income that can properly be classified as "unearned" is that which is truly gratuitous and wholly unrelated to the production of marketable goods and services. Examples of unearned income, which should be taxed at the same rate once poverty-level incomes are exceeded are: welfare payments, unemployment and Social Security benefits, food stamps, gifts and bequests, gambling gains, and other gains not immediately converted into tax-free or tax-deferred individual capital accumulations, as described below.

Individual Capital Accumulations

As discussed previously, building capital self-sufficiency into every American household will not take place overnight. Once we establish a specific minimal level or floor for individual asset accumulations as a ten or twenty-year goal, however, it allows everyone to focus on the importance of property and the need to remove all institutional barriers to the broader distribution of ownership opportunities as expeditiously as possible.

The floor of capital accumulations per household should represent the industrial equivalent of the 160 acres of frontier land that the federal government made available to its propertyless citizens under the Homestead Act of 1862. Tax laws should therefore be reformed to encourage the tax-free (or at least tax-deferred) accumulation of a "Capital Homestead" for all Americans over the course of their lives, consisting of a growing number of equity shares in the economy's expanding industrial and commercial frontier.

A tax-qualified CHA could be set up in the name of each individual, from birth, at a local bank to serve as his or her tax-deferred accumulator of capital. Shares acquired through ESOPs, CSOPs and CICs could be rolled over into one's CHA account tax-deferred, as well as income-producing property acquired through gifts and bequests. There is a well-established precedent. In 1984, Congress allowed for an analogous tax-deferred rollover of ESOP assets into an Individual Retirement Account or other qualified deferred compensation plan that a participant received in one lump sum. This was liberalized in 1992 to include incremental distributions rolled over into another qualified plan.

In any event, each individual's total acquisitions would continue to accumulate tax-deferred until the federally established capital self-sufficiency floor was reached. Thereafter, future accumulations would lose these tax privileges and become taxed at the proposed single rate, thus discouraging grossly excessive, monopolistic accumulations of capital in the future.

Upon death or when all or part of the assets are sold to increase consumption incomes, such tax-deferred assets would be taxed at the single rate then prevailing. Fairness in the distribution of future ownership opportunities would mainly be controlled through the traditional IRS tax-qualification controls over discriminatory allocations and, more importantly, through the Federal Reserve Board's control over credit extended by commercial bank lenders to ESOPs, CSOPs, CICs and CHAs to foster growth of the private sector economy.

Under H.R. 462, the proposed Accelerated Capital Formation Act introduced in 1975 by Ways and Means Committee member Rep. Bill Frenzel (R-MN), this tax-deferred floor was set at $500,000. Whatever the target amount, it should be set at a level that both fosters initiative and a desire for income independence for its owner, and it could be adjusted to rise with cost-of-living increases. To encourage the continued accumulation and retention of income-producing investments, and to discourage squandering, all tax-qualified accumulation trusts would be required to pay out all property incomes on a regular basis as second incomes to the owners, subject to direct personal income taxes.

The rationale behind permitting tax-free accumulations below excessively large wealth concentrations follows the principle that new capital formation and widespread capital accumulations should be encouraged, both for promoting economic democracy and for raising the standard of living for all citizens. Taxes on property slow down the capital creation and accumulation process. In contrast, a direct tax on the incomes from already accumulated capital assets is simpler to understand, less harmful to investment and the care of property, and easier for tax authorities to administer.

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