Other than them being obligatory, I don’t look at the taxes I pay any differently than I look at the price I pay for discretionary goods and services:
- Am I getting my money’s worth?
- Is the price I am paying a fair one?
Our current tax system has all but two of these properties, and I have a suggestion.
Be forewarned, this is going to be a lengthy post, and now is a good time to bail. Otherwise, you might want to grab a glass of your favorite beverage before you settle in to carry on.
I’ve not been able to find any document expressly stating the overall objectives by which our current tax system is designed and by which it is maintained. Renowned for its size, its architectural curiosities, and its lack of any master building plan, our current tax system is the Winchester Mystery House of government systems.
However, based on my own observational research and personal experience, I have discerned three objectives:
- To pay for the cost of our government.
- To provide financial incentives and disincentives to encourage and discourage different economic and social behaviors.
- To pay off, or pre-pay, special interest parties for their special support.
The first two objectives make sense to me, but I think our current system of taxation is poorly architected to implement them. In fact, our current system seems to be architected to optimize for the third objective, which is one that should not just be abandoned, but for which the system should be engineered to prevent.
With that, let me present my shot at tax reform. I’ll begin by citing some other concerns that I have with our current system. Then I will offer my alternative solution.
The solution I propose has two distinct tiers, one tier for each of the first two objectives above. One tier of tax programs to pay for the cost of our government. A second tier of tax programs to encourage and discourage economic behaviors.
Please understand that I don’t pretend to have every issue identified, every kink worked out, or every detail defined. Rather, my intent is to describe and explain enough to communicate the spirit and substance of the concept. I am also aware that I am taking a big risk because I will be exposing my ignorance of the subtleties and nuances of various schools of economic theory. But I decided that I can’t care about that—I can and do care about being ignorant, but I can’t care about hoping to satisfy all of the various economic religions and their disciples. I decided that the thing that is most important to me is that what I will propose makes sense to me, and that if my reforms were implemented, people would be able to honestly say of the new tax system, “I think I am getting my money’s worth, and I think the price I am paying is a fair one.”
The list of problems with our current system of taxation is long and illustrious. Two of the top issues that I have with it are that it’s wasteful and it’s divisive. But at the top of my issue list is that it’s confusing and incoherent.
The care and feeding of our current tax system requires hugely wasteful amounts of our society’s intellectual, cultural, and financial capital. It is financially wasteful in terms of the costs required to operate, administer, police and enforce it. Further, because it is a system that produces results that are neither repeatable nor predictable, it is wasteful in terms of tax revenue leakage, where taxes paid < taxes due. (Yes, I understand that there are individuals who do not take full advantage of all of the exemptions, deductions, and other incentives available to them. However, I suspect that pales in comparison to the individuals and companies that take every liberty conceivable when calculating their tax liability, with the worst of those being those who choose not to pay at all).
Beyond the financial waste, it is also intellectually and culturally wasteful. Consider the number of incredibly smart and talented legal, financial, and other professionals required to operate, administer, police and enforce this system. How much better would we be if the intellectual and cultural energy of these tax professionals could be applied to solving real problems facing our society? What if we could redirect this talent to solve more pedestrian problems; for example: education problems; poverty problems; globalization trade and commerce problems; crime and punishment problems; physical infrastructure problems; cyber-security problems; alcohol, drugs and other chemical abuse problems.
Every dollar and every hour spent in the care and feeding of any system of taxation is a dollar and an hour that can’t be spent on real, higher order pursuits. We should aspire to keeping that number of dollars and hours we spend on our tax system as near zero as possible.
It Is Divisive
Our current system of taxation is divisive in many ways. Here’s one that I find particularly dysfunctional.
Our government provides a framework of services, systems and safeguards to protect life, property and liberty, and to provide each individual with an equal opportunity to pursue their happiness to the furthest extent their knowledge, talent and skills will take them without interfering with the life, property, liberty or pursuit of happiness of another.
Our society has decided that those who have enjoyed more success under this framework should pay a greater share to operate and maintain that framework as well as to enhance it so it evolves commensurate with the evolution of our society. The idea is that one’s share in the costs needed to support this framework should be commensurate with the benefit they have realized under it. I support this, but under our current tax system breeds at least two problems.
An across-the-board flat tax is more burdensome on the less fortunate (i.e., it’s regressive). While we want everyone to carry their share of the load, we aspire toward fairness, not oppression. So, we mitigate this problem by defining tax brackets based on income, with each bracket having its own tax rate, and with the brackets’ tax rate increasing as the brackets’ income increases.
Theoretically, this should solve the problem, but we need to factor in all of exemptions and deductions available to taxpayers. Unfortunately, the less fortunate are not in a position to take advantage of but a select few of these exemptions and deductions, while the wealthy are able to take much fuller advantage of them. So, we set the base tax rate for the lower income brackets low, and we set the base tax rates for the higher income brackets very high—so high, in my opinion, that without deductions and exemptions they would discourage people from pursuing financial success.
However, we need and want some critical mass of people to aspire to financial success, whether selfishly motivated by greed, or less-selfishly motivated to simply achieve and contribute, because business serves a social purpose. That purpose is to improve the quality of life and economic well-being of our society. Business does this through the creation of products and services, which creates the jobs which creates the wealth necessary to be able to afford to consume those products and services and to fund the research and development of even more goods and services to advance the quality of life and economic well-being of our society even more. The fact is that the there is no program that the government or any other entity could invent that will solve more social ills than are solved by a person having a fairly paying job.
The financially successful are rationally motivated to go after every exemption and deduction. Which they do, and with gusto—the savings potential is so great that it is financially attractive to incur the costs of hiring tax professionals to assist them in the effort. And it doesn’t stop there. Being highly motivated, being achievers accustomed to getting things done, and being well financed and equipped, they mount lobbying efforts to build even more exemptions and deductions into our tax code, ones rationally designed to favor their self-interests. The ability and capacity to mount lobbying initiatives that promote one’s self-interests is yet another advantage not available to the less fortunate and less powerful on the other end of the wealth spectrum.
Even in those upper brackets, the exemptions and deductions are such a confusing mish-mash that there is no objective way to tell if one’s final tax obligation is something that a reasonable person would generally regard as “fair.” So, folks simply go for the lowest possible tax they think can plausibly defend, some even throw the “plausible defense” precaution to the wind and take their chances of being audited, and then there are those who are able to achieve a tax obligation of zero.
To summarize, our current tax system is divisive because the less fortunate are left with little recourse when their rates become oppressive, while the wealthy have the ways and means to mine the deepest possible deductions and exemptions, to legally negotiate more favorable outcomes when a dispute regarding the confusing and incoherent tax code arises, and to fund and mount the kind of lobbying campaigns needed to add, change, or delete tax regulations to their financial advantage. It is mathematically possible and legally permissible for well off individuals and organizations—individuals and organizations that have enjoyed great success under the framework of services, safeguards, and protections that our government provides—to pay less tax than those who are dramatically less well off, with some well-off individuals and organizations legally able to achieve a zero-tax burden.
It degrades from there.
We need a way to resolve oppressive rates at the high end, and/or encourage or discourage economic or cultural behavior by some means other than lobbying the butcher to put their thumb on the scale.
It’s Confusing & Incoherent
At the top of my list of concerns, simply because it is so exasperating, is the fact that our current system is so contrived, convoluted, and confusing it brings even otherwise intelligent people to their knees. Take any two people who make our tax system their profession, provide them with exactly the same inputs, and they will produce different outputs. Achieving such random variability in any system is no meager feat. Unfortunately, it’s not one you want in a system that commands people to part with hard earned money.
I have a mantra: “Purpose before process, and process before technology. And the way you go from process to technology is in three steps, done in this order: simplify, standardize, then systematize.” I begin in that spirit.
I also begin with a blank slate. We will not solve our tax system’s problems by tinkering with it. Nor is the answer in further automating the current system—automating crap is stupid. Our system of taxation needs to be blown up and redesigned from the axels up.
What follows is my shot at defining a system of taxation that answers the two questions: Am I getting my money’s worth, and is the price I am paying a fair one? And does so in a way that minimizes variability in process, while also minimizing the amount, kind and caliber of intellectual, cultural, and financial resources required to care for the system’s operation, maintenance and enhancement.
Although my recommendation is written from the perspective of the federal system of taxation, I believe it scales and could be applied at the state or other levels of government.
Purpose & Objectives
The purpose and objectives of the proposed system of taxation are:
- Pay for the cost of our government.
- Provide the ways and means to create, revise and retire tax mechanisms that provide financial incentives and disincentives to encourage and discourage specified economic and social behaviors.
- Optimize for fairness, clarity, coherence and integrity throughout.
- Achieve and maintain process simplicity, process standardization, and process integrity such that process results are predictable and repeatable.
In order to achieve the stated objectives a two-tier tax system is to be designed. The goal of the first tier is to pay for the cost of government. The goal of the second tier is to provide an environment where tax mechanisms to provide financial incentives and disincentives intended to encourage and discourage specified economic and social behaviors, can be created, revised and retired.
Each of these tiers is described more fully in the sections that follow.
Tier 1: Paying for the Cost of Government
The purpose of this tax tier is to pay for the cost of government. I am not so ignorant nor naïve not to recognize that the portfolio of services, systems and safeguards that our government is a source of constant debate. This proposal does not eliminate that debate and takes no sides in it. This proposal simply recommends a way for paying for whatever government services, systems and safeguards our elected officials and august bodies finally decide to provide.
Everyone is expected to pay taxes in this tier—all legal entities: all individuals, all for-profit and all not-for profit organizations including churches and charities. Because there is no individual or entity that won’t be served by, or benefit from, government services, systems and safeguards, all individuals and entities are expected to share in the costs necessary to operate, maintain and enhance those services, systems and safeguards.
Whether you are an individual, a company, a charity, a church, or any other kind of entity, if you expect the police to show up if you’ve been robbed, if you expect the fire department to show up if you have a fire, if you expect EMS to show up if you are injured, if you expect authorities to safeguard your intellectual property, if you expect the courts to hear your civil case, if you expect social wrong-doers to be punished, if you expect the military to protect you, if you expect all scales to be properly calibrated, if you expect all food handling facilities to be safe, if you expect all buildings to be safe, if you expect streets and sidewalks and streetlights and you expect them to be kept in good working order 7x24x365, if you expect schools and teachers, if you expect safe drinking water, and so on, then you get to help pay for that stuff.
Two, and only two, tax mechanisms are provided: an income tax, and a VAT-like sales tax.
Each legal entity pays an income tax based on the income that legal entity earns. For people, all income above the defined poverty level is subject to tax. There is no distinction between single and married, and there are no joint returns for married people. For all other legal entities, all income is subject to tax. It doesn’t matter how that income comes to you (e.g., as wages or as what we currently call capital gains). Nor does it matter what your expenses might be; the income tax is based on gross revenue, not on some adjusted gross, and not on net earnings.
With one exception, there are no exemptions or deduction. The only exception is for entities earning less than established poverty level for their entity type. A poverty level already exists for individuals. The equivalent needs to be similarly established for all other legal entities. The reason for providing a “poverty level” for legal entities other than individuals is the same as the reason for providing a poverty level for individuals: to give those struggling to survive a fighting. Both “poverty levels” are based on gross income level. As stated previously, this tax tier does not care what your expenses might be, it doesn’t care what some adjusted gross income or what your net income might be. Nor does this tax tier care how you earned that income (e.g., regular wages or capital gains).
Beyond that, there are no exemptions or deductions—NONE. Remember, the purpose of this tax tier is to pay the cost of government. This tax tier is not to be used to encourage or discourage economic or social behavior, such as buying a house or having children. Providing mechanisms to create financial incentives and disincentives to encourage and discourage specified economic and social behaviors is the purpose of the other tax tier.
Because an across-the-board flat tax is regressive (i.e., more burdensome to the poor and the less wealthy), there are multiple flat tax rates based on multiple income brackets, with the tax rate escalating as income escalates. There is one lane of tax brackets for individuals, and there is a second lane of tax brackets for all other legal entities.
The number of tax brackets and the flat tax rate associated with each bracket is an open question that should be easily answered via financial modeling. The only mandated construct is that the first tax bracket in the individual lane range from zero to whatever the defined individual poverty level is at the time, and the tax rate for this tax bracket—people in poverty—shall be zero. Similarly, the first tax bracket in the lane for legal entities other than individuals should range from zero to whatever the equivalent to the individual poverty level would be, and the tax rate for this tax bracket—legal entities other than individuals also struggling for survival—shall be zero.
To recap the important points about the income tax in this tier, with the exception of the impoverished, every legal entity pays this Tier 1 tax. It doesn’t matter what kind of legal entity they might be. It doesn’t matter if you are an individual or a corporation, a church or some other kind of non-profit. It also doesn’t matter whether you earn your income through a salary, bonus, hourly wage, and/or gratuities, through capital gains, through sales revenue, through charitable contributions, through interest earnings, through gifts or an inheritance, or through any other means. In this tax tier, there are no exemptions.
Value Added Tax (VAT)
Regarding the VAT, it doesn’t matter how one, be they an individual or another legal entity, chooses to spend their money or for what purpose. Everything is subject to VAT. However, like the income tax, and for the same reasons, it is desirable to vary the VAT rate depending on the item being purchased. For example, the VAT rate on essential staple items (e.g., food, clothing, medical services and products, etc.) is to be lower than the VAT rate on luxury items.
Like the income tax, the various VAT tax rates are an open question that should be easily answered via financial modeling. Consideration should be given to making the VAT rate zero on food that is not pre-prepared, on clothing, and on medical services, equipment, OTC and prescription drugs.
No Other Taxes
One may reasonably ask, “What about all of the other taxes we currently have, targeted taxes like the gasoline tax, or excise fees, or subsidies and exemptions?” There are none; not in this tier. Remember, the purpose of this tax tier is to cover the cost of government—that’s it. Taxes intended to encourage or discourage economic and/or social behaviors are the purview of Tier 2, and would have to comply with its constructs.
I also don’t buy into the notion of targeted taxes. For example, having a gasoline tax in order to fund road maintenance based on the thinking that those who use the roads should pay for the roads. The fact is, everyone, whether they personally use the roads or not, benefits from them. That said, if additional funding were needed for roads, it would be permissible to raise the VAT on gasoline, diesel fuel, automobiles, trucks, tires, brakes, and other products associated with road use.
(I have a different approach that I prefer for ensuring that infrastructure maintenance is properly funded
Simplicity and Standardization.
It is important to keep Tier 1 simple, clear, uncluttered, and standardized in order to maintain fairness among all legal entities, and across the entire wealth spectrum.
If you’re an American citizen, I don’t care where you live or from whom you earn your income; your income will be taxed. If you’re not an American citizen, but are living in the US, you will be taxed. If you are another kind of legal entity, such as a business, charity or church, your US operations will be taxed.
No matter who you are, purchases that you make in the US will be taxed; purchases that you make and keep outside the US will not. However, purchases you make outside the US, but bring into the US, will be subject to the VAT (i.e., the VAT acts like a tariff).
This simplification and standardization dramatically reduces the number of taxpayers confused by the tax code. All that the taxpayer will need is honesty, and the intellectual competence equivalent to a high school education.
In addition, the government resources required for administering the application and collection of this tax code will be dramatically reduced—they won’t be eliminated because there will always be dishonest people. Further, there will also be a dramatic reduction in society’s need for private tax professionals (e.g., tax accountants, tax attorneys, etc.). Whether through raw market forces, or government influenced market forces, a lot of financial, intellectual and cultural capital will become available to address higher order societal needs.
Tier 1 Tax Rates
As stated earlier, calculating respective tax rates should be a relatively easy financial question to model. That said, while I haven’t done the analysis, I would like to think that we could fund the cost of our government for <10% of the GDP. If we can’t, then I would argue that something else is the matter.
Tier 2: Encouraging/Discouraging Economic and/or Social Behavior
It is in Tier 2 where additional taxes can be defined with the objective of encouraging/discouraging a specified economic or social behavior.
There is only one ground rule for Tier 2 Tax proposals. No proposal can have an adverse affect on the Tier 1 Tax total. A Tier 2 tax proposal may be to adjust the income tax and VAT rates to encourage more spending or more saving, but it must be revenue neutral to Tier 1. In other words, if the rates for Tier 1 taxes are calibrated to generate $X in tax revenue, no Tier 2 proposal may result in a Tier 1 tax revenue total < $X. Under-funding the cost of government in Tier 1 and relying on Tier 2 tax revenue to cover the shortfall is not an option. The cost of government must be covered by Tier 1 tax revenue.
The creation of each Tier 2 tax, and the revision of each existing Tier 2 tax, is done via the Tier 2 Tax Proposal Process. The retirement of a Tier 2 tax will be done automatically if it fails to achieve the benefits in the time frame on which it was approved. The retirement of a Tier 2 tax that is achieving the benefits in the time frame on which it was approved can be done via the Tier 2 Tax Proposal Process.
If a “Christmas Tree” style bill is passed, then it must come complete with a proposal for each Tier 2 tax creation, change or retirement “ornament” included in it.
Tier 2 Tax Proposal Process
Every Tier 2 Tax proposal must specify the following (bear with me, this is going to get a little wonky):
- Purpose & Objectives: The purpose and objective(s) of the proposed tax must be expressed in terms of the behavior to be changed. That is, if this tax proposal is successful, what social or economic behavior will there be more of? What social or economic behavior will there be less of? For example:
The purpose of this proposal is to improve our national security by improving the health of our populace and reducing the cost of healthcare, by addressing the country’s diabetes epidemic. It’s objective is to reduce the consumption of foods with a high glycemic load.
- Process: Describe the mechanics by which this tax would be implemented and operated. For example:
- Glycemic Load (GL) shall be calculated as:
(Glycemic Index * carbohydrate content)/100
Glycemic Index of a standard apple = 40
Carbohydrate content of a standard apple = 15
Glycemic Load of a standard apple = (40 * 15)/100 = 6
- The GL of a food shall be added to that food’s nutrition label.
- The VAT for foods with a GL > 10, shall be increased by 2%.
- The VAT for foods with a GL > 20, shall be increased by 25%.
- Proof of Concept: Each proposal must be pilot-tested via a “proof-of-concept,” or PoC, in order to demonstrate its effectiveness in achieving the proposed purpose and objectives in real life. This is an orderly way to move from a theoretical context to pragmatic issues, so a final decision can be made based on information, rather than speculation.
Remembering that the goal of taxes in this tier is to change some economic or social behavior, and that the behavior this particular proposal is intended to change has been specified in the “Purpose & Objectives” section, this section should state the PoC’s:
- Goal: Restate the behavior sought to be modified.
- Scope: Specify the scope of the geography and/or demographic group in which the PoC will be conducted. For example, rather than conduct a PoC on a national scale, it may be preferable to limit the PoC to a particular state, region, series of zip codes, etc.
- Specify the things that will be measured to see if the desired behavior modification is occurring.
- Specify how these things will be measured.
- Specify when these things will be measured.
- Duration: Specify how long the PoC will last.
- Results: Specify the range of results that will indicate the PoC’s success or failure in achieving its stated purpose and objectives.
- Behavior to be modified: Reduce US consumption of foods with a high GL.
- This PoC will be conducted nationwide.
- Sales of foods where GL ≤ 10; to be measured quarterly via VAT transaction processing data.
- Sales of foods where 10 < GL < 20; to be measured quarterly via VAT transaction processing data.
- Sales of foods where 20 ≤ GL; to be measured quarterly via VAT transaction processing data.
- National obesity rate; per the existing measurement process.
- National diabetes rates; per the existing measurement process.
- Duration: The duration of this PoC shall be for 3-years beginning with the implementation of the process as stated in the prior section.
- This tax shall be judged to be a successful if there is a drop in the PoC population’s obesity rate ≥ X%, and/or a drop in the PoC population’s diabetes rates ≥ Y%, during the PoC period.
- An increase in both the PoC population’s obesity and diabetes rates during the PoC period shall demonstrate this tax to be a failure.
- A decrease < X% in the PoC population’s obesity rate, or < Y% in the PoC population’s diabetes rates, will call for further analysis and perhaps a new PoC with modified parameters.
- A mixed result showing an increase in either the PoC population’s obesity or the PoC population’s diabetes rates, with a simultaneous increase in the other rate, will call for further analysis and perhaps a new PoC with modified parameters.
- Conclusions: Upon completion of the PoC, state the conclusions that can be drawn from the PoC.
- Recommendations: Upon completion of the PoC, state the recommendations to be made based on the conclusions drawn. It is envisioned that the recommendation would be one of these four possibilities:
- Move forward with the proposed tax as pilot tested in the PoC, and defining a regular schedule by which the tax will be reviewed to assess its on-going necessity and effectiveness. (See the description of the post-implementation described in the “Accountability” section below.)
- Move forward with the proposed tax with specified modifications, and defining a regular schedule by which the tax will be reviewed to assess its on-going necessity and effectiveness. (See the description of the post-implementation described in the “Accountability” section below.)
- Conduct another PoC with specified modifications.
- Withdraw the proposed tax.
The House committee that brings forward the Tier 2 tax proposal is also the body that will monitor its PoC.
If implemented, every Tier 2 tax proposal will go through regular post-implementation audits by an independent third party, such as the non-partisan Office of Management & Budget, (OMB), to ensure that it remains necessary and continues to be effective. These post-implementation audits will be conducted according the schedule specified in the approved proposal.
The House committee that brought the proposal forward is free to conduct their own audits of the proposal’s performance as they deem appropriate.
I think that does it—that is my recommendation for tax reform. Perhaps I should have thought this through a little more before posting it. I could have. I have been. But this should suffice for now. As mentioned earlier, I know that I leave a lot of details to be worked out. But, as I said, it wasn’t my goal to offer a complete, fully finished solution. Rather, my intent was simply to communicate enough rationale, structure and detail to communicate the spirit and substance of my recommendation. My goal is to provide something equivalent to the Virginia Resolves in regard to our system of taxation—a starting point for a conversation that is independent of party politics and is deaf, dumb and blind toward special interests.
I do not under-estimate that energy that would be required to overcome the inertia of the status quo, so let me close by offering one suggestion for how this might move from talk to action.
My earlier reference to the Virginia Resolves was not accidental. With a topic as politically and emotionally charged as our system of taxation, perhaps the best way to revise it would be for Congress to:
- Charter a team composed of members who are chosen not because of the constituencies or politics that they represent, but because of the expertise, character, and strength of leadership that they bring to the table.
- Commission that team to design a new tax system in the same manner that the Constitutional Convention of 1787 designed a new republic. And like that Constitutional Convention, I think this “Funding Our Republic Convention” should:
- Cloister themselves as they do their work, with all of their work done in closed-door session, and with all members operating under a gag order forbidding them from revealing anything about the Convention’s work while that work is in progress. This way, just as in the Constitutional Convention, members would be more open to persuasion, as there would be no loss of face should they decide to change their minds or position on any particular issue.
- Elect their own Convention Chair.
- Convene as a “Committee of the Whole”, to define the principles on which the new tax system should be based, and to commission and oversee two sub-committees:
- A “Committee of Detail” to take the principles defined by the Committee of the Whole” and devise the processes and mechanics necessary to put those principles into operation in the pragmatic conditions of real life.
- A “Committee of Style” to take the Committee of Detail’s work, once completed and approved by the Committee of the Whole, and restate it in terms and conditions that are understandable and relatable to the rest of the nation.
- Package the product of the “Funding Our Republic Convention’s” work and advance it in the form of a Constitutional Amendment.
My point is to not put it through the normal congressional sausage making process, where it would be at the mercy of the lobbying efforts and other campaign contribution financed influences of all of the special interests and other parties with a stake and a self-interest in maintaining the status quo.