A Citizen's 2% Solution

How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget

Archive for April, 2011

Our Current Tax Debate is Intellectually Dishonest

I believe we cannot and will not make progress on tax reform as long as our leadership allows the conversation to be framed by the intellectually dishonest claim that “nearly 50% of Americans pay no taxes”. 

Whether it is self-delusion, or willful distortion, the only way that allegation is true is if you close your eyes, hold your nose and pretend employment taxes aren’t taxes.  Instead of using smoke, mirrors and semantic nonsense to hide the fact the rich pay lower marginal tax rates than the working middle class, we need to confront that reality head-on.  If we would, I believe we could find a more equitable alternative. 

If the investment class paid tax rates comparable to what the working class now pays – we would have a balanced budget today.[1]  Make that your new perspective, and suddenly the challenge changes.  It is no longer, “How do we hide (or justify) the fact the rich are paying less?”  Or, “How do we raise taxes without affecting the investment classes and thereby slowing growth?”  It becomes, “Is there a different tax structure we could use which would allow us to normalize tax rates between labor and investments without resulting in recession or slow growth?” 

I believe there is such an alternative structure, one that taxes accumulated wealth with a nominal constant assessment – effectively taxing its earnings potential at a rate consistent with existing earned income tax rates.  It removes the subsidies paid for non-productive or lower return investments and rewards the most efficient and profitable allocations of capital – thus, hopefully, stimulating more rapid growth.  My proposal may not be the best solution, but at least it addresses the challenge.  But so long as our major reform efforts are guided by insiders who seek to hide the inequities that now exist – don’t expect them to either embrace my proposal or discover a better solution. 

I’m not surprised that our political class is unresponsive to my attempts to stimulate a new perspective on this critical challenge.  We do not reward politicians who change their mind.  We have made politics a competitive team sport.   Once the participants pick a side they put their future in jeopardy every time they diverge from the approved party line or daily talking points. 

But where are the media and academic thought leaders who should be actively seeking out potential new lines of reasoning and alternative solutions to our widely acknowledged fiscal challenges? 

Effective fiscal reform cannot be achieved by focusing on just the expense side of the equation.  We must demand Congress address the revenue side of our tax policies, not just because we need to generate more revenue, but more importantly because our current policies are deeply inequitable and riddled with misguided incentives.    

I would welcome any reply, observations or rebuttal you might care to offer, either publicly as a comment to this post, or privately through the nearby contact form. 

Douglas Hopkins

Author – A Citizen’s 2% Solution:  How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget. ISBN 978-0-9828328-0-6 

[1] House Speaker John Boehner and Wisconsin Congressman Paul Ryan are half right.  We do have a very serious spending problem.  But denying the fact we have a revenue problem, regarding the magnitude of legitimate needs, the inequitable distribution of the burden, and the misguided incentives imbedded in current policy, is dangerously irresponsible. 

Want Job Growth? – Reinvigorate Capitalism

As I observe America’s current dysfunctional policy and budget debates I scratch my head in bewilderment, franticly searching the braincells and bookshelves where I store lessons and concepts about the theory of capitalism in fruitless search for justification of current tax and monetary policies.  I find no such justification.  When was capitalism redefined to become a system that provides favored treatment to the privileged few? 

I’m sure some will say it was always thus.  But that certainly isn’t what I remember being taught in school.  As I remember it, the twin pillars upon which capitalism relies are 1) property rights which allow one the ability to accumulate and retain the fruit of one’s own labor, and 2) fair and open competition in pursuit of personal self-interest.   So how did we come to corrupt and undermine our central economic theory by imbedding undeserved and unnecessary preferences toward wealth in our tax code?    When and why did we decide that savings and investments are inadequately incented by self-interest and thus require and deserve government subsidy?   Why do Warren Buffett and his fellow billionaires pay tax rates only half as high as the working middle class? 

Justification certainly can’t be found in theories of Adam Smith, who advocated, “Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest in his own way, and to bring both his industry and capital into competition with those of any other man or order of men.”  I’m confident Mr. Smith wasn’t contemplating an unequal competition in which the wealthiest and most privileged among our society are subsidized with preferential tax rates.  So why have the laws which constitute our tax code diverged so sharply from the simple principles of justice and equity? 

True believers in capitalism, who understand the power that entrepreneurial vitality in pursuit of competitive self-interest has to stimulate economic growth, should recognize that preferential tax policies offered to an elite class of citizens are incompatible with the core premise of capitalism.  It constitutes cronyism; and cronyism is not just ethically wrong – it destroys the vitality and benefits of capitalism. 

The American ideal of equal opportunity for all citizens is based upon the principles of liberty and personal responsibility.  Our tax code infringes upon both.  We impinge upon the liberties of the working middle class and constrict their opportunity for advancement by making them bear a disproportionately large portion of the burden of government.  We then exempt our investment class from responsibility for shouldering their fair portion of the cost of government – and in so doing, we inadvertently impose perverse financial incentives that act against our collective interests.  We are subverting the fundamental features of our government and social structure that have been the source of our strength for over two hundred years. 

Back to my primary point:  Why is job growth so slow?  I have a hypothesis.  I believe it is because our tax and monetary policies have made tax avoidance and valuation manipulation more profitable than productive enterprise. 

Specifically, America’s political leadership and financial gurus became so focused on wealth as the measure of prosperity, that they began showering privileges upon the financial services industry.  In hot pursuit of Alan Greenspan’s “wealth effect”, they created policies which stimulated asset valuation bubbles and destabilized the economy.  Yes, when people felt wealthier, they spent more, and stimulated a consumer driven economic boom.  Had the wealth that supported that boom been “real”, that would have been fine.  But to the extent it was the phantom effect of irrational, speculative valuations in dot-com’s and mortgage securities, it was unsustainable and destabilizing in its effect.  How have we responded to the resulting recession?  By trying to re-inflate the asset bubbles.  By propping up the financial institutions that caused the debacle and ignoring the structural imbalances and mis-incentives at the core of our problem.  By bailing out the at-risk investors on the backs of middle class taxpayers and future generations. 

Despite Lloyd Blankfein’s proud proclamation, “I am doing God’s work”, and the popular pretence that finance is the engine of economic energy, annual IPO proceeds into publicly traded firms are less than 1% of annual trading value.  The vast preponderance of transactions generated by the financial services industry is aimed at manipulating valuations and shuffling and re-shuffling ownership interests – not stimulating productive enterprise.  

Yet we let Wall Street guide Washington.  I think we need to restructure our tax and monetary policies with regard to returns on capital to refocus energies on creating more productive enterprises. 

Incentives matter.  And the incentives currently imbedded in our tax code are stimulating speculative, non-productive trading activities, driving jobs and investment overseas, and obstructing the fluid reallocation of capital to more productive uses.   High nominal corporate tax rates discourage domestic hiring and investment and encourage tax avoidance activities, including off-shore transfer of profitable operations.  Reduced tax rates on investment returns and deferral of taxes on “unearned income” subsidize low profit and loss operations, discourage capital reallocation and actively stimulate asset valuation bubbles.  We are crippling our economic engine. 

The budget debate in Washington is presently focused exclusively upon disbursements – driven by an angry populist energy that screams out at our political class demanding government reform its profligate spending.  It is understandable and appropriate.  It is commendable.  But it attacks only one side of the problem – and perhaps the less important side. 

Where is the rage against the inequitable assessment of our tax burden?  Where is the rage against the unintended consequences of subsidizing unproductive capital?  It has been diverted by intellectual dishonesty among our political and economic leadership.  Our federal government has crafted a remarkably Byzantine structure of incentives and preferences; taxing revenues differently based upon their varying source and magnitude, pretending employment taxes aren’t really a part of the general revenues, using exclusions, deductions, multiple rate schedules,  alternative minimum calculations, surcharges, phantom trust accounting, etc., etc. etc., ad infinitum, all apparently designed to provide politicians tools with which to fractionalize and bribe their constituents  and reward their campaign contributors.    It appears designed to ensure that no two citizens receive equal treatment.  It is crippling our economic engine. 

We lie to ourselves and pretend we have a progressive tax system but, inclusive of employment taxes, the working middle class bears a marginal tax burden twice as high as that imposed upon their more affluent neighbors.  Washington beware.  Some day the public will wake up to this fact and the resulting demands for change will be far louder and insistent than anything seen from the Tea Party so far.    

Effective fiscal reform cannot be achieved by focusing on just the expense side of the equation.  And economic vigor cannot be optimized unless we stop subsidizing unproductive behavior.  The preferential treatment offered to holders of great wealth not only deprives government of needed revenues, the unintended consequences of those structural preferences has been instrumental in destabilizing our economy. 

We need to reform and impose more equal treatment upon our revenue policies.  If we acknowledge and remove the preferential treatment toward holders of pre-existing wealth, and eliminate the subsidies and mis-incentives that currently distort investment decisions, we can normalize tax rates between labor and investments while simultaneously stimulating more productive investment in America.  We can once again unleash the full entrepreneurial energy of capitalism. 

Comments, replies and rebuttals are invited and will be welcomed. 

Douglas Hopkins

Author – A Citizen’s 2% Solution:  How to Repeal Investment Income Taxes, Avoid a Value-Added Tax, and Still Balance the Budget. ISBN 978-0-9828328-0-6

Related posts:

The Big Lie of Government: the Myth of Progressive Taxes

Re-thinking Investment Income Taxes