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Thursday, November 3, 2005

By Ralf Seiffe

OPINION - For the third time in 30 years, a blue ribbon tax commission has submitted its report.  Like its predecessors in 1976 and again in 1996, this estimable commission determined that the current federal tax system is an abomination worthy of root and branch eradication.  The commission found that the current tax system “distorts the economic decisions of families and businesses” and that the system is “unstable and unpredictable”.  They also decided the complexity of the tax code means that taxpayers “cannot easily understand their own tax obligations” and that its “volatility is harmful to the economy”.  

Whew!  

Despite these findings, the commission recommended merely simplifying, not eliminating, the features of the current system that cause these shortcomings.  They prescribe, “The Simplified Income Tax Plan” or, “The Growth and Investment Tax Plan”, recommendations that preserve the current system rather than profoundly change it.  Both plans are income taxes that maintain the twin hallmarks of progressivity and deductions or credits that have characterized our system since the 16^th Amendment was ratified.  The rates, which now range from 10-35%, rise to 15-33%.   Tax efficiency advocates must have been disappointed to learn that corporations will still be taxed at 30-31.5% while the individuals who own them will receive large exclusions for dividends paid.   

The two proposals are not so much a reform but a devaluation of the current system.  The huge tax code Congress uses to protect itself would be rendered smaller by this proposal but the skeleton would remain. Those bones will encourage legislators who believe tax cuts are “expenses” for the government to continue to use the tax code as a primary social engineering tool.  Should either of these two proposals become law, they will begin to tinker with the “new” IRS Code before the ink dries.  

Those interested in tax reform initially hoped the commission would have presented taxpayers with a genuine choice of taxation theories, including a consumption tax.  Indeed, the commission reported that it looked at studies of consumption taxes and found “virtually all such studies suggest that the long run level of national income would be higher.”  The Treasury’s own studies of consumption taxes predict that adopting that method would increase economic activity by as much as 6%. “The principal advantage of a Progressive Consumption Tax relative to the Growth and Investment Tax Plan would be its more favorable treatment of savings and investment, and its greater transparency and simplicity.” the commission tells us on page 183 of the report.

In the end, neither of these two plans proposed will achieve the commission’s goals over the long term for the very same reasons the commission tells us the current system doesn’t work---it is an income-based system.  People who earn income work hard to avoid paying taxes.  It is an economic certainty that taxpayers will spend their money to avoid paying the government----even if they only net a dollar.  The size of the tax accounting, financial planning and insurance businesses are testament to that fact and no income based tax system can ever escape this understandable taxpayer behavior.  

Worse, by urging an income-based system, the commission has foreclosed tax policies that could have improved American living standards well into the 21^st century.  In addition, by preserving progressivity, the commission extends America ’s 100 year old Class War into a second century.  

The real opportunity cost of this third failure to drastically reform our tax system is that we’ll probably have to wait another decade to fix the problems the commission so properly identified.  During the time we do nothing, China , Russia , India and others will press their advantages.  Delay in adopting a competitive tax system will put us at a significant disadvantage to these and other countries who have discovered a truly transparent tax system, especially ones with low rates, is an important, capital attracting asset.  Without keeping our own capital and attracting others’, creating the jobs and the income we’ll need to maintain our nation’s living standards will be harder.  

Even Iraq has a flat tax---put there by the American viceroy, soon after Saddam’s statue toppled.  

The commission recognized the disaster our system has become.  The meetings I attended showed the commissioners interested in alternatives and their final report seems to recognize the advantages of a consumption tax. Their report reveals advantages that demand a serious look and a recommendation.   A report containing one or two income-based proposals and a consumption tax proposed in contrast would have made for an interesting debate and forced politicians to make a public choice.  

So, one wonders, why did the commission wind up making such timid proposals?  

It’s my sense that the political class realizes an income tax, with its intrusive and coercive authority, is the best way to maintain their prerogatives.  Regardless of general academic agreement that a consumption tax would improve our living standards, they prefer an income tax, even if it diminishes Americans’ futures.   The president knows this, having participated in the various tax debates during his presidency.  An act of pure leadership would be for him to mark the commission’s report “Incomplete” and send the commissioners back to the drawing board.

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Ralf Seiffe advises business start-ups and product launches from Chicago, Illinois and is a political analyst and columnist for the Illinois Leader.