Tax reform is by far the best strategy for getting the economy moving again. Tax compliance takes 3 million man/years, or 2% of our active workforce. Cutting compliance time in half would add 1% to national productivity. In addition, management and investors waste way too much valuable time considering tax implications, tax avoidance strategies, or active lobbying, rather than focusing on core business strategies. On the safety-net side, the current system encourages people not to work to their full potential.
Priorities: A flat tax rate; eliminating wealth taxes, including capital gains, estate, and gift taxes; territorial taxation; first year expensing; and integrating safety-net programs to improve the quality of support and eliminate disincentives. The existing system needs total overhaul, but we must recognize legacy constraints and commitments, such as Social Security, Medicare, and medical support for the chronically ill or disabled. To achieve bipartisan support, the new tax/safety-net program should be revenue neutral and spending neutral, but should provide a migration path to long term sustainability. While spending will be held neutral, dramatic cuts in overhead will reduce the size of the government bureaucracy, allowing support to flow directly to citizens with minimal bureaucratic diversion. The new system should be: simple, efficient, transparent, and fair.
Flat tax rate for individuals – The simplest tax to collect is a true flat tax on all employee salaries. Gross salary times the flat tax rate equals accurate tax withholding. This would dramatically simplify the payroll process for businesses. And, there would be no need for annual tax filing by the employee, thereby reducing the size and intrusiveness of the IRS. The employer will report gross salaries and taxes paid. Collection will no longer involve the individual, but rather businesses broadly defined. [Individuals that generate “business” income will need to file annual tax returns.]
On its own, a flat tax is politically unacceptable, because the effective tax rates are not progressive. Provision must be made to make effective tax rates at least progressive enough for legislative passage. The tax rate should be high enough for neutral revenue collections, but significantly lower than today’s highest marginal rates. [Note that states may require additional reporting. As part of tax simplification, employee FICA would be eliminated. Automatic payroll deduction for individual retirement accounts should be the default option.]
Flat tax for businesses – Here there are a variety of options, however, the tax rate for businesses should be the same as that for individuals, to avoid business owners gaming the system to get the most favorable rate in the way they compensate themselves. The simplest option would be a tax on sales, with deductions allowed only for expenses where the flat tax rate has previously been applied including gross salaries; domestic components, inventory, capital items, services [directly supporting development of the product or service] and product transportation. [Note that deductions would not include healthcare or pensions or business perks, which will simplify the taxation process and broaden the tax base, lowering the flat rate. Businesses will be free to provide perks, but they will not be tax deductible. Increases in taxable gross salary could replace lost benefits and reduced corporate payroll expenses, including employer FICA. Individuals will become responsible for healthcare and retirement, which will no longer be disrupted by changing employers.]
Eliminate wealth taxes – Investment stimulates growth and jobs. By eliminating taxes on investment, more opportunities will exceed hurdle rate returns. Wealth taxes constitute double taxation, since investments have already been taxed once. [It is far more efficient to collect taxes at a single source, rather than have no corporate tax and collect from thousands of investors whose stock may be buried in mutual or pension funds.] International investment should flood into the US, as the US becomes the “tax shelter” for the world. Full reliance on a “consumption tax” rather than wealth taxes will promote investment, leading to higher long term growth rates.
There are however certain “investments” that should be re-categorized as “business activities” and taxed at the business flat rate. These would include derivatives, short sales, short-term trading, collectibles, and other “investments” that do not contribute to economic growth. Banks, Insurance companies, and hedge fund managers are in the business of making markets and providing advice and will be taxed accordingly.
Territorial taxation – Business taxes on overseas sales must be eliminated to encourage exports and to reverse corporate inversions. We want the US to be the most attractive place in the world for corporate headquarters and investment. Any product or service sold within the US will be taxed at a flat rate, regardless of whether produced domestically or imported. The elimination of corporate taxes on exports will be more than compensated by taxes on imports, since the US is a net importer. [Note that imports will not be directly taxed, however, they will be disallowed as an expense against domestic sales.]
First year expensing – Multi-year depreciation does not change the total amounts written off, only the timing. Expensing will allow expanding companies to grow faster by delaying the tax impact of taxes on profits. Paperwork will be drastically reduced, a serious consideration for start-ups. [With the disappearance of wealth taxes, dividends from companies with no profits must be disallowed or taxed at the flat rate for later deduction as a salary equivalent expense. In addition, GAAP should require a “Note”, providing “market value” of fully expensed assets, so investors may more accurately estimate book value.]
Integrating safety-net support – Safety-net programs have been added ad hoc since the 1930’s to deal with multiple issues related to poverty, disability, and old age. They include: welfare, unemployment, disability, Medicaid, Social Security, Medicare, ACA. Under the broad category of welfare are multiple federal agencies and programs dealing with housing and food issues which often overlap and conflict. In addition there are similar programs under state or charitable control. Potential welfare recipients need a PhD in benefits to navigate the maze of programs. Because of limited oversight, there is rampant fraud and waste. Since these programs are means-tested for income, recipients often lose benefits by earning too much money. It is imperative that safety-net support eliminate the nanny state nightmare and integrate with the tax code. These programs should not be to make poverty comfortable, but provide a smooth path out of poverty for those who are able.