Monday, May 17, 2010

A More Just Tax, Part V: Guidelines for Tax Reform

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

Monetary policy refers to how the State regulates money and credit and how money is created, at least insofar as government can control the process — or thinks it can. Fiscal policy is how government taxes and spends. Both monetary and fiscal policy affect the size of the national debt and government deficits. That being the case, a few comments on the wisdom of debt and deficit spending are in order.

Government Debt and Government Deficits

Under the influence of Keynesian economics, the objective of many tax decisions since the early 20th century has been to curb inflation and unemployment. This is inherently contradictory under Keynesian economics, for according to Keynes there is presumed to be a tradeoff between inflation and employment. The alleged choice is between either inflation or unemployment. You cannot have full employment and no inflation — or so Keynes believed. Keynes did, however, redefine "inflation" to mean not any increase in the price level, but a price level after attaining full employment — a meaningless semantic distinction. (General Theory, op. cit., III.10.ii, V.21.v.)

Further, as we have seen, Keynes assumed the continuance of historic patterns of extreme maldistribution of capital ownership. According to Keynes, the goal of government monetary and fiscal policy is merely to fine-tune that malstructured economy through the bureaucratic manipulation of government tax, spending, interest, and money-creation machinery. Structural reforms to our corporate ownership patterns were not part of Keynes' approach to the problems of unemployment and inflation.

Roosevelt's New Deal and the use of Keynesian economics were used to justify the power-concentrating and fiscally irresponsible money creation and spending policies that have characterized federal economic strategy since the 1930s. As a result, both the federal government and the Federal Reserve have, as we have already noted, approached a state of almost complete functional overload. If that were not enough, the disconnect between private property and money creation, combined with deficit spending financed by the Federal Reserve has seriously undermined not only personal sovereignty and human dignity, but endangered the sovereignty of the United States. As Henry C. Adams explained in 1898, pointing out the perils inherent in domestic indebtedness,
As self-government was secured through a struggle for mastery over the public purse, so must it be maintained through the exercise by the people of complete control over public expenditure. Money is the vital principle of the body politic; the public treasury is the heart of the state; control over public supplies means control over public affairs. Any method of procedure, therefore, by which a public servant can veil the true meaning of his acts, or which allows the government to enter upon any great enterprise without bringing the fact fairly to the knowledge of the public, must work against the realization of the constitutional idea. This is exactly the state of affairs introduced by a free use of public credit. Under ordinary circumstances, popular attention can not be drawn to public acts, except they touch the pocket of the voters through an increase in taxes; and it follows that a government whose expenditures are met by resort to loans may, for a time, administer affairs independently of those who must finally settle the account. (Henry C. Adams, Public Debts, An Essay in the Science of Finance. New York: D. Appleton and Company, 1898, 22-23.)
If the problems caused by domestic indebtedness are bad, those resulting from international indebtedness are infinitely worse. Allowing foreign nations to gain a position of financial domination by accumulating a government's debt paper puts the nation itself in serious danger. As Adams explained,
The tendency of foreign borrowing is in the same direction as that of domestic borrowing. As the latter obstructs the efficiency of constitutional methods, so the former tends to destroy the full autonomy of weak states. The granting of foreign credit is a first step toward the establishment of an aggressive foreign policy, and, under certain conditions, leads inevitably to conquest and occupation. (Ibid., 25.)
These are serious problems. In the Capital Homesteading strategy, however, the structural void left by Keynes is met head-on. Capital Homesteading would attack inflation and unemployment at the roots, as well as implement immediate debt reduction programs to reestablish the "faith and credit" of the United States on the firmest possible basis. The main thrust of this approach is to super-stimulate expanded rates of private sector capital investment, financed so as to broaden the base of equity owners in society. This will not only secure income to most people sufficient to meet common domestic needs adequately, but will rebuild the tax base to the point where the national debt can be completely eliminated within a generation.

The credit financing of corporate expansion must meet rigid standards of feasibility and must be repaid as a self-liquidating investment. New money created by the extension of bank credit to finance financially feasible projects would flow directly into new productive capacity. In sharp contrast, government debt seldom, if ever, finances any production increases. Rather, it goes into nonproductive spending, war, and even into waste of human talent and natural resources. Government debt is therefore inherently inflationary. Even worse, when government spending is not matched with current tax revenues, the inflationary impact causes the economic and financial situation to deteriorate rapidly. Funds must either be borrowed (thus diverting those same funds from productive investment in the private sector) or simply issued as printing press money.

From a standpoint of economic justice, government deficits make no sense at all. They cause inflation and are therefore a pernicious form of hidden tax on the public, falling most heavily on the poorest members of society. A just tax system would work toward the elimination of future inflationary budget deficits and to curb further increases in the already bloated government debt. Better yet, a concerted effort should be made to begin to repay this debt.

Inheritance Policy

Under a national ownership strategy, inheritance policy should be restructured to discourage excessive concentrations of wealth and, in order to promote individual initiative and capital self-sufficiency, to encourage the broadest possible distribution of income-producing assets. Gift and estate taxes therefore should not be imposed on the donor or his estate. This would necessarily include assets accumulated within proposed Capital Homestead vehicles.

Rather, taxation should be based on the size of the recipients' total accumulations after receiving the gift or bequest. If the values of the recipients' asset accumulations remain below the floor of capital self-sufficiency described above, no tax would be imposed on the newly acquired assets. Above that floor, a reasonable generational asset transfer tax (or a flat rate tax on "excess" Capital Homestead accumulations) would be paid.

Avoidance of Generational Asset Transfer Taxes

Above the targeted homestead accumulation floor, a generational asset transfer tax or the single rate tax would be imposed on each new owner. This would discourage future excess concentrations of wealth and economic power when assets transfer from one generation to the next. This general asset transfer tax would replace the existing estate and gift tax systems. These typically tax the estate or the giver, thus imposing what amounts to a double tax. Taxing the heirs or the recipients of legacies and gifts as income, regardless of the source, is more just. It also has the potential to avoid the envy and acrimony that tend to split apart families when some individuals are favored over others.

The generational asset transfer tax or the single rate tax could be avoided by a simple expedient. It would only be necessary to distribute excess accumulations as broadly as possible, including family members, friends, and employees, as long as their personal accumulations remain below the floor. This would minimize the overall tax "hit." Minimizing taxes is a prime consideration in estate planning. Equalizing the tax burden would lead to more equal treatment of everyone. The alternative is to concentrate the wealth in a single individual or, worse, take control over the wealth away from natural persons by setting up foundations and trusts.

Integration of Personal and Corporate Income Taxes

The double tax penalty now imposed on corporate profits has been widely understood as an inherently unjust form of tax discrimination that should be eliminated. The only ones in general not holding this view are the envious, and State bureaucrats who rely on such measures to generate revenue from a seriously depleted tax base. Some reformers have proposed to mitigate this problem through a highly complicated and arbitrary compromise that both evades the underlying problem and makes matters worse. Instead of eliminating the double tax directly at the corporate level, they would permit a partial deduction for dividend payouts to the corporation and a redistribution-oriented partial tax credit for shareholders. Such a "solution" does nothing either to restore the rights of private property in corporate equity or promote widespread ownership of existing or new equity issuances. The only thing such tax "reform" would accomplish would be to make the top 1% who own the majority of directly owned outstanding corporate shares even richer.

Tax reform under Capital Homesteading would attack this problem directly with elegant simplicity. It would recognize that property and profits are inseparable. All corporate net earnings, whether distributed or retained by the corporation, should be treated as earned by its owners. All earnings should therefore be taxable at the personal level, on the same basis as any other direct income. Under this alternative, the corporation would be treated for tax purposes like a partnership. The corporation's business expenses (including depreciation and research and development) would be attributed and deductible at the enterprise level, and all capital incomes attributed individually according to each owner's proprietary stake in the business. This is similar to the treatment of Subchapter S corporations under today's tax laws. To encourage more equity financing of corporate growth, higher dividend payouts must be encouraged and alternative low-cost credit sources for financing must be made available to expanding and viable new enterprises.

Capital Gains Taxation

How to tax capital gains is a continuing source of much of the complexity and confusion that now plague our tax laws. How would a property-oriented Capital Homestead policy handle this problem?

First, it would restructure the tax laws to encourage investment and discourage speculation. At least for non-wealthy individuals it would add disincentives to gambling in high-risk securities and the commodities market. Tax laws would be designed to facilitate the acquisition, accumulation and retention by today's capital-deficient Americans of long-term investments, held mainly for their potential of yielding high, steady, and relatively secure second incomes to supplement their paychecks and retirement checks in the future.

As under present law, to the extent capital gains income results from short-term purchases and sales of commodities and securities, realized capital gains should be treated like any other kind of direct personal income. Such capital gains are no different than the purchase and sale of any other goods for a profit, or gambling gains, for that matter.

Capital gains from long-term holdings deserve different treatment, however, under a national strategy to broaden the base of capital ownership. As recommended above, to the extent that investments are accumulated within a tax-qualified vehicle, the gains should be permitted to increase tax-free or tax-deferred, until the individual affected reaches a targeted floor of capital self-sufficiency. Above that level capital gains would be subject to normal taxation after indexing for inflation.

If all of the proposals recommended here were adopted, the capital gains problem would gradually disappear. Much of the appreciation in the values of corporate common stock can be traced to the retention by management of earnings under the fallacious assumption that earnings must be retained to meet new capital requirements. As dividend payouts increase (encouraged by tax-deductibility of dividends at the corporate level) and as new sources of equity financing become readily available through the discount mechanism of the Federal Reserve System, the value of individual shares would tend to stabilize over time. Share values would tend to be based on current and projected dividend yields per share instead of speculative pressures emanating from the secondary market. In consequence, tax revenue from long-term capital gains would fade to insignificance.

This is because to some extent, long-term capital gains result not from the increased productive value of the underling assets, but from a gradual debasement of the American currency. Inflation-inducing government economic policies can be blamed for these artificial increases in profits and capital values. Except where prices increase from natural shortages, government should assume total responsibility for inflationary increases in the value of investments. Therefore capital gains taxation should always be inflation-indexed to see if any gains in value actually exist.

State and Local Tax Systems

Today, a heavy portion of local revenues comes from the taxation of property. Taxing property discourages investment and improvement of industry and residential property in their areas. Sales taxes also increase price levels, encourage tax evasion by local merchants, discourage trade, and generally can cause one area to become less attractive than another. Since high production, high incomes, and a higher quality of life rest on the quality of the structures, industrial equipment and facilities, and technology available to the residents of an area, it should be obvious that taxes on local property are counterproductive. Property taxes should, therefore, be gradually supplanted with a universal system of state and local taxation based upon the direct incomes of its residents from whatever sources.

Thus federal tax policy should create additional incentives for state and local taxing authorities to shift gradually from property and other taxes, to direct single rate income taxes at the individual level, for the reasons outlined above. To simplify tax collections, state and local rates could be set at a percentage of the federal taxable incomes of residents of the area. Another advantage of this approach is that all areas of the country would become tax-neutral for investment purposes. This would increase the nation's overall efficiency in the allocation of our labor and other resources.

Tax Simplification

Although corporate income tax returns would still be important for disclosure purposes and for corporations unwilling to pay out their earnings fully to their stockholders, most of the tax revenues would flow from the expanded personal tax base. The personal income tax return and the tax system itself would, as a result, be enormously simplified and easier to understand. A simple one-page personal income tax return the size of a postcard with a limited number of supporting schedules in case of audit would be well received by the American taxpayer.

Most personal deductions and tax credits could be eliminated under a single rate tax system. This would restore the neutrality of the tax system over people's consumption choices. Personal exemptions, however, could be raised above the poverty level, so that only the lowest income families would pay no taxes, including payroll taxes. By filling in a simple annual income tax return, however, a low-income family could qualify for a negative or reverse income tax (or refund) as once proposed by the conservative economist Milton Friedman.

Doubtless there are many more issues that need to be addressed in reforming the tax code. What we've listed here, while in one sense only the tip of the iceberg, addresses the major areas that need reform. There is a multitude of sub-areas and technical issues that may need to be addressed. The main principle to keep in mind, of course, is that a tax system is supposed to have a single purpose: to raise money so that the State can carry out its legitimate business. Using the tax code to do anything else, however worthy or necessary it might seem at the time, undermines both the purpose and the justification for taxation in the first place, and virtually guarantees that neither the legitimate purpose of taxation, nor what has been loaded on to the system will be carried out efficiently, justly, or in some cases at all.

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