(Editor's note: The following commentary was originally published April 14, 2005.)
Perhaps one day a U.S. president will deliver a memorable speech beginning, "April 15th, a date which will live in infamy. …" She’ll denounce a tax code too complex to be predictable, too large to be comprehensible and too demanding to truly serve us, the people.
Granted, our tax code is not the equivalent of Pearl Harbor. But there is something infamous in the fact that our representatives have burdened us with such a system — and something infamous in the fact that we, the heirs of a revolution born of liberty, have let them.
In Michigan this year, April 15 is not just the date by which we must "voluntarily" submit our tax payments and tax forms to the government; it happens to be our "Tax Freedom Day" as well. Tax Freedom Day is calculated by the nonprofit Tax Foundation in Washington, D.C., and the date represents how long we would labor to pay our taxes to our national, state and local governments if we started working exclusively for them on Jan. 1. Only on Saturday of this weekend would Michiganians, on average, begin working for themselves.
Some will object to this calculation, arguing that the government provides services to us, so that we are always working "for ourselves." One might respond that we don't get to pay for only those government activities that we actually see as services, but even setting this aside, it's also true that government services cost a great deal compared to other needs that are at least as basic. One Tax Foundation analyst notes, "Despite all the tax cuts that the federal government has passed recently, Americans will still spend more on taxes than they spend on food, clothing and medical care combined." The Foundation's numbers are arresting:
In 2005, Americans will work 70 days to afford their federal taxes and 37 more days to afford state and local taxes. Other categories of spending measured in the (Tax Freedom Day) report include housing and household operation (65 days), health and medical care (52 days), food (31 days), transportation (31 days), recreation (22 days), clothing and accessories (13 days), saving (2 days) and all other (44 days).
Surely there's a better way. We at the Mackinac Center therefore asked our friends and policy staff to discuss the ideal tax code; we even "channeled" a former U.S. president in the cause. Their comments appear below.
Adam Smith’s Principles of a Proper Tax System
by Jack McHugh, legislative analyst, Mackinac Center for Public Policy
(This piece was originally published on April 21, 2004.)
Adam Smith was the first person to describe all the elements that establish a modern free-market system. Smith, an 18th century Scottish philosopher, published his landmark "An Inquiry into the Nature and Causes of the Wealth of Nations" in 1776, the same year that the Declaration of Independence was signed.
In a chapter entitled "Of the Sources of the General or Public Revenue of the Society," Smith outlines a number of principles that should guide any system of taxation. What follows is a brief description of several of these, placed in the context of our 21st century American system.
Every person should pay in proportion to the revenue that he or she enjoys as a result of the protection government provides. This means neither a "head tax" nor a graduated tax, but a flat tax.
Taxes should be predictable, not arbitrary. Each person should know with certainty exactly how much he or she will pay given a certain level of revenue. There should be no preferences, abatements, exceptions or biases for or against selected taxpayers, occupations or revenue sources.
Taxes should be convenient to pay.
The tax should not be expensive to administer.
The system should not create huge incentives to avoid paying, such as excessive rates or burdensome compliance costs.
The tax should not skew or destroy incentives to work and invest.
The tax system should not attempt "social engineering." The only proper role of a tax system is to raise revenue to run the government. It should not explicitly attempt to encourage or discourage certain types of behavior.
The tax system should not encourage political corruption by creating incentives for special interest to buy tax favors from legislatures.
The bottom line is we want a system that doesn’t try to pick winners and losers, and that promotes economic efficiency, innovation, productivity, and incentives to work and invest.
Escaping the Labyrinth
by Lawrence W. Reed, president, Mackinac Center for Public Policy
My ideal tax code would certainly not treat citizens like lumps of dough to be shaped by politicians on the social kneading board. That’s what we have now — a complex and costly labyrinth shot through with treats and prods, amounting to a mindless, deadweight loss to the economy. As long as a bloated federal government spends two or three times what it morally and constitutionally ought to, no tax system will make much sense.
But a good start on a better one looks like this: Slash spending; repeal the 16th Amendment that authorized the income tax; finance half of each year’s federal budget through a national sales tax; and let the individual states raise the other half in whatever ways they choose. Nothing would do more than this last measure to revive the proper state-national relationship and resuscitate the states as opponents of unbridled power in Washington, D.C.
The reason it’s so difficult to devise an ideal tax code is that our national government is simply too monstrously large. Cut it down to size, and it won’t make a whole lot of difference how it taxes us.
And, come to think of it, this would do wonders for protecting American liberty. Wasn’t that the main reason the federal government was established in the first place?
Cruel and Unusual Punishment
by David L. Littmann, senior economist, Mackinac Center for Public Policy
Benjamin Franklin had it exactly correct: Any government that taxed its people as much as 10 percent of their time to be in its service would be thought a cruel and uncaring government. We now have a national government that is roughly three times that dangerous, and it’s getting more so by the hour.
The path to an ideal tax system begins with significant spending cuts. Federal spending should never grow more quickly than real private-sector income — in other words, the tax base.
"Silent Cal" on Tax Species
Calvin Coolidge, 30th president of the United States
Inaugural address, March 4, 1925
The collection of any taxes which are not absolutely required, which do not beyond reasonable doubt contribute to the public welfare, is only a species of legalized larceny.
The wise and correct course to follow in taxation is not to destroy those who have already secured success, but to create conditions under which every one will have a better chance to be successful.
Break the Code
by Michael D. LaFaive, director of fiscal policy, Mackinac Center for Public Policy
"You can have a Lord, you can have a King, but the man to fear is the tax collector."
— Sumerian clay tablet, circa 4,000 B.C.
Taxes have shaped and destroyed civilizations for thousands of years. A smart tax policy can fund the most basic needs of a society while facilitating economic expansions that become legendary. A bad tax policy can crush or so distort people’s behavior that it strips their incentive to take risks, create life-improving products or simply maintain their homes and families.
Given the lessons of 6,000 years of tax history, I recommend the following changes to America’s federal income tax system. These changes are by no means original with me.
The ideal tax code would be low, flat and fair:
Low, to provide revenues for a minimalist federal government that limited its efforts to the defense of people and property and to addressing areas of society where no clear title to property exists.
Flat, to ensure simplicity and guard against unnecessary federal intrusion. The U.S. Income Tax Code has been described as "scaffolding for plunder" because of its ability to extract large sums of money from those who have earned it. In addition, the code is an excuse for the federal government to foist itself into the personal lives of everyday Americans through the audit process. Internal Revenue Service authority has even been used to punish political or personal enemies. A flat, low system would guard against such misuse by limiting the possibilities for infractions.
Fair, taxing all incomes or consumption at the same rate, instead of punishing people for either being successful or for being ignorant of the federal tax law’s many credits, exemptions and loopholes. The current income tax system maintains a series of rates for people in different income tax categories, moving up as one’s income rises. Such graduated rates discourage effort by punishing people who earn more by being productive.
In contrast, everyone is harmed by a tax code that rewards taxpayers who can afford to hire the best tax accountants and lawyers to take advantage of credits and exemptions that others don’t know about or don’t have access to. The harm is even greater when the taxes are too high and punish productivity to begin with.
Unfortunately, this describes our current system.
For the Flat Tax
by Bruce Bartlett, senior fellow with the National Center for Policy Analysis
President Bush has appointed a tax reform commission that will report to him next year on options for fundamental tax reform. A flat-rate income tax along the lines of the Hall-Rabushka plan is the best one ever devised.
Robert Hall and Alvin Rabushka are, respectively, an economist and a political scientist with Stanford University’s Hoover Institution. They first formulated their flat tax plan 25 years ago, showing how every business, family and individual could file their tax return on a post card.
The key to their system is sweeping away every deduction, exclusion, credit and exemption in the tax code with the exception of a large personal exemption of at least $5,000 per person. Businesses would not be able to deduct anything except cash wages to employees and purchases of materials or equipment from other businesses. Both businesses and individuals would pay the same single tax rate.
While simple conceptually, this plan would require elimination of deductions for state and local taxes, mortgage interest and charitable contributions. Businesses would also lose the deduction for interest and would no longer be able to exclude payments for employee fringe benefits, such as health insurance, from their taxable income.
On the plus side, interest income would no longer be taxable either for businesses or individuals; neither would dividends, rent or capital gains. Hall and Rabushka concluded that a 19 percent rate on both businesses and individuals would equal existing corporate and individual income taxes. On balance, they estimated that most individuals would pay less than they do now.
The size of the personal exemption and the rate can be negotiated. Congress could enact a higher rate and a higher exemption so that more people would pay no income taxes at all. What is not negotiable is the issue of a single rate on businesses and individuals. Take that away and the whole system collapses.
The flat tax is still a good place to start in thinking about how best to reform the income tax system.
Thomas A. Shull is senior editor at the Mackinac Center for Public Policy, a research and educational institute headquartered in Midland, Mich. Permission to reprint in whole or in part is hereby granted, provided that the author and the Center are properly cited.