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October 27, 2011

The Challenge of Creating an Economically Sound, Simpler, and More Just Tax Code (Part 1 of 3)

by Stephen Littau

If there is one positive thing Herman Cain has contributed to the national debate it would be this renewed discussion about tax reform. While I am skeptical of some of the specifics of his 9-9-9 plan, if nothing else, Cain has forced the other candidates to come out with proposals of their own. Gov. Rick Perry in a seemingly desperate move to remain relevant proposed an alternative 20% flat tax – a single rate that’s less than the sum of all of Cain’s 9’s.

Before I was aware of and became a supporter of the Fair Tax (a 23% consumption tax that would replace the income tax, payroll tax and all other federal taxes; Gary Johnson and Herman Cain* both support the Fair Tax) I was a supporter of the Flat Tax as proposed by Steve Forbes in his 2000 presidential bid. If we must be subject to an income tax, it seems only fair that everyone pay the same tax rate. None of these proposed plans are perfect but at least everyone is subject to the same rates.

But apparently my definition of “fair” differs quite a bit from those who think a “progressive” tax (i.e. the more you make, the more the government will take) is fair. Take this article from Politico for example:

Taxing the poor has become a badge of honor among conservatives. When Occupy Wall Street protesters launched their cry of “We are the 99 percent,” the right-wing blogosphere responded, “We are the 53 percent,” meaning the 53 percent of American households that they say pay federal income taxes.

Conservatives have become fixated on the notion that largely because of the Earned Income Tax Credit — passed under Ronald Reagan and expanded under Bill Clinton — almost half of all Americans pay no income taxes.

Perry launched his presidential campaign expressing dismay at the “injustice that nearly half of all Americans don’t even pay any income tax.” And he was not alone. Every major candidate — Rep. Michele Bachmann (R-Minn.), Mitt Romney and Cain — has suggested that too many of the working poor aren’t paying income taxes, a position The Wall Street Journal describes as “GOP doctrine.”

[…]

The argument is disingenuous. Working poor people do pay taxes. They pay a larger portion of their incomes in payroll taxes and sales taxes than the wealthy. And they pay property taxes indirectly in their rental costs. Poor workers pay about one-eighth of their incomes in taxes, on average.

For the sake of argument, I will assume that the author’s assertion is correct that the working poor pay a greater share of their incomes than the wealthy counting both direct and indirect taxes. Indeed there are all sorts of hidden taxes that are embedded in every good or service we all buy.

Regulations on business (which the author of this article undoubtedly supports) that contributes to the overall cost of employing a worker** are potential earnings the worker might otherwise be paid.

All the more reason why businesses should not be subject to federal taxes that will be passed on to customers and/or employees.

The class warfare blather continues:

This is reflected in the initial popularity of Cain’s 9-9-9 plan. It was only when Cain rose in the polls that policy groups and the press analyzed his plan — discovering that it would lower after-tax incomes of the working poor (incomes under $30,000) by 16 percent to 20 percent, while increasing the incomes of wealthier households (incomes above 200,000) by 5 percent to 22 percent. Roughly 95 percent of those earning more than a million would average an annual tax cut of $487,300.

Perry’s flat tax has similar defects. Flat taxes, by definition, raise taxes on middle-income and working people — the very people who have been hit the hardest over the past decades. This doesn’t require higher math to understand.

This article was written before the details of Gov. Perry’s plan were released. If the author had waited for the details, s/he would have learned that Gov. Perry’s 20% tax doesn’t apply to the $30,000 and lower s/he mentioned above.A family of four would pay no taxes on the first $50,000 of income; too progressive and less “fair” for my liking but should somewhat satisfy those who believe that low income individuals should escape paying income taxes…at least in theory.

Also, Social Security taxes are eliminated in the Perry plan. One less burden for the working poor.

The Perry plan does have its problems (especially because the 20% plan is optional which means the existing system would remain) but this won’t be the part that will draw too much criticism from the Left. I doubt that the details of the Perry plan has done anything to pacify those who think the top tax rate should be north of 40% because there is a fundamental disagreement about the notion of fairness and different understandings of basic economic principles between progressives and fiscal conservatives.

The author of the cited article laments that 95% of those who earn over $1 million annually would get an average tax break of $487,300 with the 9-9-9 plan. What does s/he think the average $1 million annual do with this extra cash, bury it in the back yard or hide it under a mattress?

Maybe Mr. Moneybags decides to buy a new Beverly Hills mansion, a yacht, a private jet or a Rolls Royce or two.

Alternatively, maybe Mr. Moneybags decides to start his own business or gets his own McDonalds franchise, invest in an existing business, or makes some other investment.

What difference does it make, really? In any of these scenarios, there is an increase in economic activity. Mansions must be first designed by an architectural firm (not to mention other trades such as structural, geotechnical, and electrical engineers etc.) then built by crews of construction workers. Similar economic activity would result from the purchase of the yacht, jet, or Rolls Royce. Starting or investing in a business obviously also means more economic activity.

Now multiply this economic activity by the number of individuals who would get to keep this additional $487,300. How much might this grow the economy?

And by economic activity, I’m referring to something virtually everyone in this country wants to see more of: J-O-B-S.

Part 2

*Rather than using Cain’s 9-9-9 plan as a bridge to the Fair Tax (which cannot be implemented until the 16th Amendment is repealed), I think the better approach would be to go “Flat” then “Fair.”

**Example: Payroll taxes. The amount that you see on your pay stub is only your half of the tax; your employer picks up the other half.

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3 Comments

  1. Supporters of the “Fair” Tax would do themselves a huge favor to start being truthful about it.

    First of all, the rate is 30%, not 23%.

    Secondly, the “prebate” is not a rebate, as it is not tied to payment of the tax — it’s just a monthly federal welfare check to every man, woman and child in the US.

    A tax plan that can’t be sold without telling whoppers about its two major features is a lemon.

    Comment by Thomas L. Knapp — October 30, 2011 @ 8:28 am
  2. [...] Thomas L. Knapp: Supporters of the “Fair” Tax would do themselves a huge favor to start being truthful… [...]

    Pingback by The Liberty Papers »Blog Archive » The Challenge of Creating an Economically Sound, Simpler, and More Just Tax Code (Part 2 of 3) — November 2, 2011 @ 1:52 pm
  3. [...] Thomas L. Knapp: Supporters of the “Fair” Tax would do themselves a huge favor to start being truthful… [...]

    Pingback by The Liberty Papers »Blog Archive » The Challenge of Creating an Economically Sound, Simpler, and More Just Tax Code (Part 3 of 3) — November 2, 2011 @ 2:04 pm

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