Tax Talk

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Steve Forbes was on the radio again last week, pushing his ‘Flat Tax ' proposal, which had the benefit of sparking debate on reforming the IRS and Income Tax, but had the distinct weakness of tossing out an old half-considered plan in the guise of a complete product. What Mr. Forbes fails to realize now is precisely what he has failed to see before; the Flat Tax, at least he describes it, is a non-starter.

I certainly agree that the Internal Revenue Service needs a refit, and the entire Tax Code must be replaced with something that most people will agree is acceptable. Not fair, not perfect, not some impractical nirvana where nothing is ever bad for anyone, but at least an acceptable system where the average taxpayer has reason to believe he is being treated with a modicum of respect and a general attempt at objective balance has at least been made. But there are a number of ways to get there, and part of the matter begins with accepting that with hundreds of millions of taxpayers, there is a minimum level of complexity which must exist. That complexity has three legs on which any plan stands; organization, income, and audit.

Without going overboard into the somnorific qualities of tax codes, there are three basic contenders for tax reform; a Flat Tax, like the 17% rate proposed by Forces, a tax on Consumption, like the proposed National Sales Tax, and a reformed Progressive-Rate Income Tax. All have their advantages and disadvantages. And all are based on the need to develop a functional system which pays for the government without crating a general resentment of itself. This is why the most principal quality of a tax code is proper organization. You will need a means to collect revenue, a means to report it and file the necessary paperwork, and you need a means to enforce your code. The present organization suffers, because the system of collecting revenue is punitive towards the average wage-earner, while it allows corporations and the wealthy to believe they can play with the works. Not many do, but the impression is enough to cause a great deal of trouble. The Flat Tax and the Progressive-Rate Tax both suffer from this condition, while the Consumption Tax is better-suited to acquire the revenue smoothly and with an appearance of balance.

The second leg is Income. The United States 2006 Federal Budget is an estimated $2.6 Trillion , against an expected $2.2 Trillion in revenue, representing an outlay of 19.9% of the GDP. Obviously that’s a lot of pork, but for here it is important to note that it explains the effective average paid of $17,368 per taxpayer. And yes, that’s just for your federal taxes. Whatever system you use, it has to produce approximately $334 a week in federal tax revenue from each and every taxpayer. This is the problem for the Consumption Tax; you’d have to calculate accurately just how much to charge, and whether or not to exempt staples besides the existing basics. And the bottom line, is that unless and until the Federal Government gets really serious about taking a chainsaw to spending, there’s not really going to be such a thing as a serious tax cut; a large chunk of the voting public is not going to like whatever system is chosen, and the Congress will take a hit from the unhappy voters, but in a way that by definition cannot be predicted. Just in case you were wondering why so many Congressmen are happy to say the Tax Code needs reform, but most refuse to go into specifics about what plan they support.

Next, no matter what sort of plan is implemented, taxpayers will need audits. For one thing, there are people who will try to cheat no matter how fair a system is, and also, there will be many people who will not like the new system, whatever is chosen. Also, despite the complex nature of modern life, there are an amazing number of people able to miss basic facts of life, and doing your taxes properly is generally considered an aberration, and will be viewed with prejudice no matter how simple a method of reporting is designed. The notion of ‘doing your taxes on a postcard’, or not having to file at all, is as naïve as the initial claim that an Income Tax would never claim more than four or five percent of a taxpayer’s income. Obviously, any system which allows for deductions means paperwork and mistakes and cheating to some degree, but so does a system which bases revenue on the merchants turning in the money – a merchant can increase his profit margin by cheating on what he pays to the government, so the Consumption Tax would also need a close eye. And as for the Fair Tax? Without deductions, it would come down to people honestly reporting income. It would drive a new resentment of class, because the lower-middle class lives pretty much on paychecks, while the lowest classes and professional classes are able to work “off the books”; the poorest because their employer wants to avoid government checks on his conditions, the professional because he can arrange such terms. This cannot be anything but a problem in convincing the average taxpayer to accept radical change.

Also, there needs to be considered the most likely effect of each system. For example, I used to be a referee in high school sports, which was difficult, took long hours and was expensive. The only thing which made it workable, was that I could file Schedule C on the officiating fees I received, balancing the money I got against the costs of my equipment and my travel to clinics, scrimmages, and games. If a tax system which allowed deductions was to be replaced with something else, the sports official would either be penalized for his income without a chance to claim his necessary expenses, or else buying the materials needed to do the job would increase in cost through the Consumption tax. In either case, no official would be willing to work at the same rates as before; the change in tax conditions would require a few increase. Or, to put it another way, no matter what system is put into place, some of the workforce will suffer under it and demand compensation, while those who gain from the new system will demand to keep their gains as a right. Any new system will necessarily be inflationary and also damage consumer confidence in the short term. In many ways, reforming the Tax Code will be a bit like adopting several teenagers into your family; expensive, noisy, full of surprises and things that wreck your plans.

After all this, I am not saying that a Consumption Tax or a Flat Tax cannot work, simply that their proponents have not thought things through even half so far as they need, and until that happens, the only changes we may expect will be timid, incremental, and politically rewarding for their sponsor.