Wednesday, May 19, 2010

A More Just Tax, Part VII: Looking at the Numbers

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

We come, finally, to the number-crunching part of our analysis. These final postings should be regarded as something of an appendix to the main argument. They will be useful for readers who want to examine the rationale behind the numbers we used in developing the argument, but can be omitted without affecting the flow or sense of the presentation.

We also have to issue a caveat here. These figures were prepared using publicly available data, not projections from a properly prepared econometric model. A solid econometric model for binary economics still remains to be done. Thus, the data used are purely historical, not a combination of historical and projected figures. As such, they were already outdated before the previous single rate tax concept paper was written. These figures, therefore, should be used only to gain a general idea of the amounts, and test the logic of the proposal.

At such time as Congress seriously considers adopting Capital Homesteading, the federal government has researchers much more qualified than we are to put together numbers to justify the program, as well as much greater resources to apply to the task. We are after the general concept, and only need to test the common sense of the tax proposal.

Targeting an Increased Exemption

The basic problem with the standard exemption today is that, although intended to exempt an amount from taxation sufficient to meet common domestic needs adequately, it is, obviously, grossly insufficient. The standard exemption for a single non-dependent individual in 2007 was $5,350 . . . a sick joke when we consider that the official poverty level was just under $10,000 for that same individual. This was at a time when the median income in the United States was $52,000 per household. The amounts are not substantially different for 2010. The slack is taken up by various deductions, transfer payments, and entitlements, the great bulk of which are taken from the "working poor" in the form of regressive Social Security and Medicare taxes, and from everyone else through the magic of deficit spending and a national debt approaching $15 trillion.

For that reason, we will calculate a new standard exemption based on what an individual needs, as opposed to attempting to manipulate or play political games with an unrealistic poverty level. Our calculation will thus work "backwards" from the amount needed to balance the federal budget at current levels of expenditure. The government should have to justify what it takes in taxes. Citizens should not have to justify keeping what they earn. Rather than try and see how little can be allowed people, then, we will proceed on the assumption that income belongs to those who earn it, and see what is the least amount that can be taxed to balance the budget and eliminate the current and projected deficits in the shortest possible time.

Admittedly, this is a new tax philosophy, or, rather, a return to the tax philosophy on which the United States was founded, that of John Locke. As we have already seen, Locke's position was that taxes are a grant from the people to the government to allow the servant of the people to do its job. Over the past two centuries or so, however, the tax philosophy of this country has evolved into that of the totalitarian apologist Thomas Hobbes: that taxation is an exercise of private property on the part of a divine right sovereign in the wealth of his subjects. Everything ultimately belongs to the State in the person of the ruler, and it is only through his generosity that they are permitted to keep anything at all.

Taking the Lockean approach to taxation is a much more rational and sound approach than that of Hobbes. Rather than trying to wring as much as possible out of the people, the proper orientation is to determine how little is needed for the State to fill its proper role — and ask the people to levy the tax on themselves through the Congress.

Actually, going from what people evidently need gets us close to the same amounts, but leaves little for expenditures above the minimum, such as extraordinary educational or medical expenses — and does not, in any event, have a built-in respect for individual rights to and of private property. The extended discussion following the bare presentation here of the basic calculation explains this at length. We take the view that the State should justify taxing the people; the people should not have to justify keeping some of their money.

After working with data provided by various government agencies, we came up with a total exemption for non-dependent individuals of $30,000 per year, and $20,000 per year for a dependent. These amounts are based on data as of 2007, but were intended to be generous when first calculated, and the situation with respect to living expenses hasn't changed too much in the interim. In any event the figures are being used primarily to see how the concept might work, and should not be taken as absolute — although any politician who wants to tax any part of the first $100,000 for a family of four should have a better case than most do now.

These exemption amounts were achieved by "plugging" the amounts into a spreadsheet that calculated the minimum amount necessary to balance the federal budget. This amount was compared to what a bureaucrat believed people need, until a reasonable figure was reached. The process was relatively straightforward, but we should give some justification why we believe the amounts are reasonable. This is particularly important given the needs of individuals and the demands of a State that has for far too long mortgaged the future of the country and placed an unendurable burden on unborn generations.

What Would a Capital Homesteading Single Rate Tax Look Like?

While "the flat rate tax" has been a liberal bogeyman and a conservative darling, neither group has made a very good case why a single rate tax should not be adopted — or why it should. As we have already noted, both liberals and conservatives appear to assume as a matter of course that all other features of the tax code will remain in full force; that the only change would be in the rate structure itself, or limited to the category of "tax expenditures" the choices of which are determined by politicians, rather than allowing citizens to be free to choose how to spend their own earnings.

Maintaining the current tax system, however, would in and of itself be an injustice, for it would mean that people whose incomes are insufficient to meet ordinary living expenses would continue to pay taxes out of what they need to live on, while those with "surplus" incomes would merely be paying taxes to the extent the current system maintains current "tax loopholes" for current owners of capital, out of incomes beyond what they can physically consume.

Both liberals and conservatives can be satisfied with respect to their expressed concerns, however, by eliminating all payroll taxes and increasing the personal exemption to a realistic level sufficient to meet common domestic needs adequately. By setting the personal exemption at a realistic level sufficient to cover reasonable living expenses and adding only a deferral for savings for retirement, no one would be taxed on what is needed to cover basic subsistence and provide an adequate quality of life.

How anyone satisfies his or her subsistence is (within reason) a matter of personal choice — filet mignon is as legitimate a choice as hamburger if within the means of the consumer — but no poor or middle-income person should be taxed on income needed to meet basic subsistence, and certainly not to meet the basic subsistence needs of others, as is the case with our current pay-as-you-go Social Security and Medicare systems. See, e.g., Peter Gaskell, The Manufacturing Population of England (1833), which took as a basic premise that the poor themselves were the most to blame for being poor, and that by the exercise of a little thrift and breaking themselves of bad habits they could lift themselves out of poverty. See also William Cobbett, A History of the Protestant Reformation in England and Ireland (1827), which pointed out that the "Poor Laws" and various welfare systems relied on taxing the poor to support the poor. The Social Security system could thus be understood as the old English "Poor Law" system that caused so much misery under a new name.

What Would Be a Reasonable Single Tax Rate?

In theory, calculating a single tax rate is simplicity itself. The Gross Domestic Product (GDP) is divided into the anticipated government expenditures for the year after subtracting aggregate exemptions from the GDP. This percentage of all income above the exemption is payable as taxes. If the proposed tax reforms were adopted today, we estimate that the Federal Budget could be balanced under a single Federal tax rate of 50% on incomes from all sources, over and above exempted incomes for meeting basic living, health, education, and savings. A family of four earning less than $100,000, for example, would not be taxed a single cent. This would leave enough family earnings to take care of its own wellbeing independent of government "largesse."

Some people might complain that a tax rate of 50% on all income over $30,000 is unfair. What, however, does this mean, effectively, for those in the upper brackets? A single self-employed adult making $100,000 in labor income would pay $35,000 (($100,000 — $30,000)/2) in total federal taxes. Social Security and Medicare would be merged into the general tax rate. Further, any income attributable to dividends paid on shares in a Capital Homestead Account would be tax-deferred if used to make debt service payments on the acquisition loan.

Under the tax rates in effect in 2007, the same adult would pay $36,042.50, or approximately the same amount, assuming the standard deduction, exemption, and the regressive Social Security and Medicare tax — and no provision for retirement. Factoring in an IRA deduction for a taxpayer under the age of 50, the tax would fall to $34,642.50, but the taxpayer would have to come up with the $4,000 cash (2007 maximum contribution) out of consumption income to put into the IRA. This would effectively decrease disposable income by a net of $2,600, making the taxes plus deferral out of "surplus" cash total $38,642.50, or $3,642.50 more than under Capital Homesteading with a 50% singe tax rate. A single tax payer making $100,000 would clearly be better off under Capital Homesteading. He or she is much better able to meet common domestic needs adequately, even after paying taxes of $35,000, leaving $65,000 in disposable income, more than enough to cover estimated education ($3,000), health care ($7,000), and housing ($30,000), leaving $25,000 for everything else.

What of those individuals who make $1 million or more? A single individual with no dependents would, under Capital Homesteading, pay $485,000 in taxes on an income of $1 million. This would leave $515,000 of disposable income. While some might complain that $515,000 is not sufficient for them to live in the style to which they have been accustomed, it is far more than an amount sufficient to meet common domestic needs adequately. An individual would have to spend nearly $1,500 per day to dispose of this amount.

What about individuals such as John Paulson of Paulson & Company, who made the widely publicized $3.7 billion in 2007 as the manager of a "hedge fund"? Mister Paulson would pay a little under $1.85 billion in taxes on an income of $3.7 billion. We say "a little under," because the calculator we are using does not have enough places to be able to compare amounts in the thousands with amounts in the billions. In any event, a $30,000 tax exemption is pretty much meaningless when income is more than $1 billion.

Consequently, Mr. Paulson would have to struggle by on a beggarly $1.85 billion and change annual disposable income. This would mean that he would have to spend more than $5 million every day of the week — more than $58 every second, $3,500 per minute, $211,000 per hour in the day, awake or asleep — just to get rid of it. And keep in mind that these are "after tax" amounts. As played for comic effect in the various film versions of Brewster's Millions, spending that much could be a feat more astounding than making the money in the first place. In view of figures such as these, it is difficult to have much sympathy for anyone who might complain.

A tax rate of 50% might seem high, but it must be set at that level or higher to meet all government outlays at the current level of expenditure without borrowing or adding in any other way to the outstanding federal debt. For more than a century the United States has been mortgaging its future and laying a burden on the backs of future generations. We have danced, and now it's time to pay the piper.

Paying Down the National Debt in Less Than 20 Years

There is, however, an advantage to such a high rate of taxation over and above a very high range exempt from all taxation of any kind. Once Capital Homesteading begins taking over the burden now borne by the federal government in the form of entitlements that make up two-thirds of the entire federal budget, the "surplus" tax revenue can be applied to debt reduction. The total outstanding debt of the United States government as of May 2010 is nearly $13 trillion. Other sources state that it is $13.8 trillion, or as "low" as $11 trillion. We will use $15 trillion in order to be as conservative as possible, and to allow for the projected deficits and the rapidly deteriorating tax base anticipated as a result of the current economic crisis.

Conceptually, once entitlements have been completely eliminated, the entire $2 trillion formerly allocated to entitlements can be applied to reducing the debt. It would not, however, be necessary to wait until entitlements were completely eliminated before debt reduction could begin. Assuming a straight-line regression, a total population of 300 million with Capital Homestead Accounts, a dollar-for-dollar replacement of half the current level of entitlements with Capital Homestead income above what is necessary for personal debt service, and total GDP remaining constant (all of which are extremely conservative assumptions), the federal debt would be completely paid off in under 20 years. The $74 trillion or so of the "off budget" Social Security and Medicare projected deficit would disappear, except for a minimal social safety net. Both programs would be phased out and replaced by Capital Homesteading Accounts generating capital incomes more than sufficient to meet retirement needs.

Given that the national debt would be completely eliminated within 20 years after the adoption of a Capital Homesteading program, the single rate tax could then be reduced. Of course, we are assuming that there would be no other reductions in the federal budget, which is unrealistic, and that only half the entitlements would be replaced. For example, as the debt is reduced, the amount of interest paid by the federal government on outstanding obligations not held by the Federal Reserve would decrease rapidly.

The amount formerly paid out as interest could also be used to retire debt, or fund the social safety net (Social Security and Medicare). Nor are we taking into account the potential "peace dividend" as the export of justice in the form of Capital Homesteading results in decreased military expenditures. Finally, there are other potential reductions in the federal budget as private citizens reassume functions that the federal government has taken over, such as financing privately owned infrastructure and education. We need hardly mention the benefits to be realized by the elimination of "pork barrel" spending as politicians strive to deliver lower taxes instead of inventing new government-funded projects to create jobs to benefit constituents and campaign contributors.

It is thus not inconceivable that, while eliminating entitlements would eventually cut approximately $2 trillion from the current federal budget, eliminating additional spending would cut the remaining figure by more than half. For the purposes of this analysis, however, we will assume only a dollar-for-dollar reduction in half the amount of current entitlements through Capital Homesteading.

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