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The Public Policy
Tax Equity for Real
You can’t get a fairer tax system by raising taxes.
President Obama has repeatedly called for a fairer tax system. Last month he told a crowd, “Keep in mind, a quarter of all millionaires pay lower tax rates than millions of middle class households. You’ve heard me say it: Warren Buffett pays a lower tax rate than his secretary.” This is, of course, a political stunt rather than a serious proposal, but we should learn from it. If you really want to tax all income at the same tax rate independently of how it is earned — whether via dividends from a company you invest in or wages from your employer — the last thing you should do is hike the tax rate on capital gains.
Here’s why. Let’s start from a simple, unarguable premise: A business doesn’t pay taxes any more than your front door does. People pay taxes. Taxes on corporate profits are actually paid by customers through higher prices, workers through lower wages, and stockholders through lower dividends.
Now suppose you hold company stock. That stock is a claim on the company’s future dividends, when it distributes future profits. Inventing new products or capturing new markets opens up new possibilities to make profits. That should increase the value of your shares.
Unfortunately the tax system takes a bite out of those returns in at least three ways: 1) a share of the profits, 2) another share when what is left is paid out in dividends, and 3) a final share when the prospect of those dividends leads to an increase in the share price. That increase in the share price is smaller than it would have been without the taxes on profits and dividends, but it still produces a capital gain and yet another tax bill.
Growing business profits lie at the heart of the free market’s mechanism for economic growth. They provide the vital reward for innovation and the investment needed to bring it to market. Yet we tax that vital process repeatedly and then wonder why the economy doesn’t produce more new jobs and higher wages. Lazily, we often blame “corporate greed” instead, and look to tax it more as punishment. But yet more damage could be done.
Policy makers could easily compound the existing error by setting the capital gains tax alone at the same rate applied to labor income. It was fortunate that the Buffett Rule failed. However, that doesn’t necessarily mean the basic idea of tax equity is bad in itself.
If you really want to ensure everyone pays the same rate, then you need to ensure that they are paying the same tax as well. To do that we need to get rid of taxes on corporate profits and capital gains and instead apply a single tax when money is distributed — however it is distributed. That is easier said than done, but across the Atlantic, the TaxPayers’ Alliance and the Institute of Directors in London have set out a plan to achieve it as part of their 2020 Tax Commission project.
Their Single Income Tax would merge all the different taxes into a single, comprehensive, and equitable tax on capital income that ensures no one pays more or less than their fair share. They also consider ways to achieve the same with labor income. The reforms would produce a far simpler tax code — no more worrying about depreciation schedules or anything of the sort. They would also be a huge boost to competitiveness. And the same principles apply to America.
Importantly, the Commission came to one crucial conclusion when looking at how to achieve a fairer and simpler tax system: You can’t do it while raising taxes. The lesson of major tax reforms from Kennedy to Thatcher and Reagan is that they can be successful and last, but only when they cut the rates paid by ordinary people.
That won’t satisfy politicians who want to plug huge deficits caused by excessive and wasteful spending with ever higher taxes. But it is the right objective for those who want to foster innovation and growth, and who don’t see leaving more money in the pockets of the taxpayers who earned it as a bad thing.
About the Author
Iain Murray heads the Center for Economic Freedom at the Competitive Enterprise Institute and is the author of Stealing You Blind: How Government Fatcats Are Getting Rich Off of You.
Letter to the Editor View all comments (22) | Leave a comment
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Gary B| 5.30.12 @ 10:04AM
If we could possibly remove the political motivations behind our tax code, this might work. When you have a ruling elite intent on pushing class warfare, it'll be impossible. I'm afraid a post card tax form is not in our future.
John Navratil| 5.30.12 @ 10:15AM
"If you really want to tax all income at the same tax rate independently of how it is earned..."
This article uses a lot of words to state what must be obvious from the premise. If you tax anything but income, you are not effectively taxing income at the same rate unless everyone engages in all taxable actions at the same rate.
That said, any attempt to tax capital income at its distribution assume control at the point of distribution. Capital is mobile.
PolishKnight| 5.30.12 @ 11:10AM
"Let's start from a simple, unarguable premise: A business doesn't pay taxes any more than your front door does. People pay taxes. Taxes on corporate profits are actually paid by customers through higher prices, workers through lower wages, and stockholders through lower dividends."
Generally, when someone starts out with an "unarguable premise", it's easily argued against.
Taxes upon corporate profits don't automatically raise prices for customers anymore than they necessarily raise tax revenue. As GE has demonstrated, they can simply define away profits via "losses" or business expenses. Many businesses are "non-profit" in the sense that although they show no actual bottom line profit, they continue to function quite well and simply invest their "profits" into development and growth. If you think about it, the best corporations are effectively non-profit. Stockholders can get their money back tax free simply by cashing in stock that has grown in value...
If we equate corporations with people, most of us are also non-profits in that we ultimately spend our money over our lifetimes on expenses such as children and retirement.
Sadly, as we've seen with Carly Fiorina, higher CEO salaries and corporate profits don't automatically translate into higher worker wages.
Harry the Horrible| 5.30.12 @ 1:39PM
Stop taxing productivity. Tax consumption instead.
Repeal the 16th Amendment, end income tax and implement the Fair Tax.
TrueBlue | 5.30.12 @ 2:16PM
Tax all income at 10%, allow up to 25% of income to be written off for children and/or charity donations. Code simplified. Pass that as one Amendment.
Next, pass an Amendment that forces the government to not spend more than it took in in taxes for the PREVIOUS year (not expected receipts for the upcoming year). The only workaround for this being spending on Defense following a declaration of war by Congress. Lot of cuts required to accomplish this one, but if the citizens have to operate on a budget, the government should be forced to do the same. The only loans the federal government should be taking out should be to ensure the safety of this country (thus the above Defense requirement).
TrueBlue | 5.30.12 @ 2:18PM
Sadly not really realistic in the short-term, but as a long-term goal it'd be silly not to consider it. The excuse that we can't do XYZ because it'd take X number of years is getting really tiring. If we had drilled or taken advantage of resources we've had available for 30 years we wouldn't still be hearing the excuse that it'll take 10 years to see the effect of doing XYZ.
Al Adab| 5.30.12 @ 3:02PM
Frankly gentlemen, The progressive income tax violates the 14th amendment n equal protection clause by treating one persons property (their income) differently than anothers based solely on volume and source. If we wish to continue to tax income, every person and every dollar should be treated the same.
Fiscal| 5.30.12 @ 3:11PM
We have a progressive income tax because payroll taxes are regressive. Since Medicare and Social Security are no longer insurance plans since there is no reserve for claims and thus they should be funded out of the general fund. That would make a flat tax fair. Income from capital gains is no longer tied to business growth as it was decades ago, and therefore there should be no special rate. Today, business has more capital than it has ever had and it is not investing it in new initiatives. Growth is now a function of demand, not capital. Furthermore, in the financial community, income from their daily work is now taxed as capital gains rates when it should be taxed as income.
Al Adab| 5.30.12 @ 3:39PM
Tail wagging the dog. Tax policy has created an economy and business climate built around the tax code. The end result of a command and centrally planned economy and a tax code which punishes success. Bad idea and result. Time to rid ourselves of such and watch the markets grow.
Fiscal| 5.30.12 @ 3:51PM
Tax policy is based on political donations -- we both know that. It is NOT based on any type of planned economy. To believe the tax code today punishes success is a nice talking point, but is not true. Wealthy people today are taxed at the capital gains rates and business lobbyists have long reduced their effective business tax rates through subsidies, government contracts, tax credits, and tariffs. The effective business tax rate is now about 25% -- not much different than the tax rates in other developed countries. Most people don't understand the difference between marginal rates and effective rates which is why they are fooled by politicians and columnists who don't understand themselves.
John Navratil| 5.30.12 @ 4:48PM
Fiscal,
What do those who are net receivers of government largesse donate? Their vote! The tax policy is based on accreting power to the politicians. The people who pay the taxes will always be the worker and the wealth creator. The "poor" can be supported as this was never a major source of revenue to the fed - the votes are comparatively more valuable.
When anyone sells their assets they pay capital gains tax on any gains. Of course, if they never invested they wouldn't pay that tax. They do start by putting up their own capital and there is no tax rebate for losses (I didn't say losses don't offset gains). Would the system be improved if there were no investors?
We are on our way to finding out what happens when there are no workers and no investors. And tax policy is very much to blame.
Fiscal| 5.30.12 @ 5:41PM
You are equating tax policy with capital investment. This is not the last century. Investment funds today don't put a lot of capital at risk because of diversification and hedging. In addition, they have first information which lets them get out of an investment before the rest of us. The textbooks of the last decade don't understand this fundamental change brought on by new investment vehicles like derivatives.
The largest net receivers of government largesse are seniors who get much more from the government than they put in. This amount is much larger than welfare. But as I said before, I'm a supporter of a flat tax so I don't have that issue.
John Navratil| 5.30.12 @ 5:16PM
Al Adab,
This may be the first time I've disagreed with a post of yours, but your 14th Amendment argument doesn't hold water. The tax rates, progressive or no, apply equally. If you make so much money you will pay so much tax, no matter who you are. An unequal argument would be if you and your neighbor, making the same money, were taxed at different rates.
Of course, I agree with your broader point that the tax system is broken and is a disincentive to economic growth.
Al Adab| 5.30.12 @ 6:58PM
John,
Glad I checked back this evening. The tax code as progressive certainly treats the dollars differently depending on volume and source. To me that treats the earners differently on the same basis. If one income is investment, stocks, rents etc., and the other wages are they not treated differently even if the dollar amount is the same? Anyway I always appreciate your comments and insights.
Fiscal| 5.30.12 @ 3:17PM
The argument in this article makes sense only if you won't think. Revenue now only funds 60% of our federal expenses. Even with a 40% spending cut, you still need to fund that 60%. If you get rid of business income tax, it just means the same amount is transferred to individuals. Actually, I'm in favor of eliminating the business income tax and replacing it with a consumption tax because that will favor the economy of a society based on consumption. It will make locating a company here less expensive and collect taxes on goods from China and other countries. It wouldn't be regressive if there was a phase in for one year that required companies to lower prices in an amount equal to their average tax rate for the past 5 years (so they can't game the system).
John Navratil| 5.30.12 @ 4:54PM
Fiscal,
The other way to look at this is that the government is simply too damned big and promised too damned much to too many people. Promises that lead to bankruptcy aren't promises, they are lies. I question the "need to fund that 60%".
Fiscal| 5.30.12 @ 5:45PM
We fundamentally agree on this issue. But I suggest you go through the budget and start cutting. Would you be willing to cut Social Security and Medicare payments by half to seniors? Would you be willing to cut the military budget in half? You cannot cut payment on our debt so you'll have to cut more elsewhere. All other budget items only total 18% of the budget including all other government departments, the IRS, the FDA, legislator salaries and budgets, highway maintenance, etc. In other words, if you are unwilling to cut payments to seniors, and want to give more to the military, you can only cut 5% or so and we still have 35% unfunded. So John, go through the budget and let me know what you want to cut. One of the major newspapers had an interactive budgeting app to play with.
John Navratil| 5.31.12 @ 9:24AM
Fiscal, (part 1 of 2)
My parents are in their eighties and have, no doubt, consumed more than they put in. They are also conscripted into a government program. Means testing would be a start for them.
As I said before, a promise you cannot keep is a lie. There is no choice not to cut entitlements. No one prefers to cut these, but they must be.
I'm ten years away from the Social Security which I've know for thirty years wouldn't be there. I proposed to my Congressman (Culberson) that we raise the retirement age each year by several months until the program insures no one. My letter went, typically, unanswered. Any proposal which doesn't involve the baby boomer is, definitionally, an additional tax on our children's productivity.
The only thing required by our Constitution is a military. How much is a political question. I favor a strong military as I think it is cheaper in the long run as a deterrent - others disagree which is why we have elections.
Entitlements must be cut and means tested to reduce them from their "nanny state" levels. There is no reason to retire at 65 when we are living routinely into our 80's. Not so in 1940.
John Navratil| 5.31.12 @ 9:25AM
Fiscal, (part 2 of 2)
Now, eliminate the two DoE's. We KNOW these are simply boondoggles. Everyone wants clean air and water, but the EPA has been co-opted by the enviros. If it isn't disbanded, the enabling legislation must be re-written to effect big items (no more wetlands in peoples back yards) and to wrest control of carbon from them.
Why do we need a Dept. of Transportation? Can we not transport goods without them? Axe it. Similarly, remove HUD, Labor and Agriculture - there's another entitlement program.
Kill these and the Office of Personnel Management and the GSA shrink.
Are the no programs in any of these departments which do no good? Even a blind hog finds an acorn every once in a while. I'm sure there are. Are they so good that we can't live without them. I think not. More often we get reports of fifty distinct jobs training programs which overlap and, sadly, do not result in employment.
Any of these changes put workers out of the public sector into the private sector. This is a good thing all around.
One thing is absolutely sure. If you can't cut this budget ALL the promises will become lies.
Fiscal| 5.30.12 @ 5:47PM
By the way, I would cut Medicare, Social Security, and military budgets and still can't get to 60%.
CJW| 5.30.12 @ 8:45PM
Eliminate the Dept of Energy, Dept of Education, and cut federal employment across the board at the other depts and agencies by at least 10%.
Eliminate the staff of the First Lady. Hillary expanded her staff to hundreds. Not necessary.
Have a national sales tax, with exemptions for food and clothing and basic appliances such as washer/dryer, stove, refrigerator, and you could fire most of IRS.
PolishKnight| 6.4.12 @ 2:21PM
Commenting on this late, but why not.
CJW, the IRS will always exist when it becomes necessary to enforce tax collection whether it's sales taxes or income taxes. I've read CPA's discuss the implications of such a change and they make compelling case against it: sales taxes can be just as, if not more, complicated than income taxes. When sales taxes become significant, then people will attempt to wiggle out of them. This can be done by arguing that goods and services are bought "wholesale" otherwise every transaction would effectively become a VAT. Just as the devil is in the details with income taxes, it's even moreso with sales taxes.
If someone is a home builder and needs to buy lumber, should they pay sales tax on the transaction? Should the lumbermill pay sales taxes to the lumberjacks? That's a relatively simple transaction but imagine how many sales taxes would be bundled up in, say, the manufacture of a car with thousands of parts from a variety of sources. Large companies with their own parts distribution would effectively pay not taxes while small businesses would be swamped. It's a perfect recipe for oligarchy crony capitalism! (Not that we're not getting into that now!)