Ron Baker, FounderVeraSage Institute

@ronaldbakerThe History

of Taxation: For Good and Evil

• “Taxes are what we pay for a civilized society”– Supreme Court justice

Oliver Wendell Holmes, 1927

– Inscribed above entrance to IRS, Washington D.C.

• “I want a refund”– Anonymous

“Prices and quantities only change as the result of human action. Where in the world can a new price come from if not a human

bidding or asking above or below the market price? Supply and demand curves give us a

rough picture of market behavior as an effect of human action, and certainly not the

cause of it. No one acts with the into balance.”

“The prosperity as well as the decline of nations has always had a tax factor, and

this we will see time and again throughout history.”

Civil War to 16th Amendment

• Prior to 1894, government revenue came from tariffs• IRS created by Act of Congress on July 1, 1862• First income tax (1862) four pages• A shrewd Illinois lawyer overpaid his tax in 1864 by

$1,250• Tax evasion: World’s oldest profession• History: Don’t tax you, don’t tax me, tax the guy behind

the tree

Alternatives to the Current Tax System

• Reform, not Revolution• History• Application/Mechanics• Effect on international trade• Transition issues• Rate needed to replace existing system• Advantages and disadvantages• Political prospects

VAT: Very [easy to raise] A [hidden] Tax

• Average tax burden in VAT countries = 41.4% vs. 32% in non-VAT countries

Australia 8%, 1973; 10% todayDenmark 10%, 1967; 25% todayBritain 10%, 1967, 20% todayItaly 12%, 22% today

• Rate increases averaged 71% in 12 OECD countries that adopted VAT before 1973

• Total taxes as share of GDP = 27.2% (1965 Pre-VAT)• Total taxes as share of GDP = 41.4% (1993 Post-VAT)

National Sales Tax

• CATO Institute––16% national sales tax• Administered by the fifty states, not the IRS• The CATO proposal includes the following:• A 16% tax goods & services, except housing

and securities;• Every American receive annual rebate first

$4,000 of purchases;• 2/3 supermajority in both houses to raise taxes

Advantages of Sales Tax

• Taxes the underground economy• Lowers administrative & compliance burden• More visible than a VAT• Difficult to evade, easy to avoid––just save, don’t

spend• Indirect tax (not direct)• Eliminates IRS and most audits (of personal T/Rs)

Advantages of Sales Tax (cont.)

• Perceived as being fair• Removes filing personal tax returns

(majority of T/Rs)• Taxes the elderly more (who’ve been

receiving massive subsidies from Social Security and Medicare)

Disadvantages

• A 19% rate needed, not 16%• Exempt business/government/exports, 32% rate• Have to tax all services––few states do; exempt

services, 65% rate• Exclude food, 6% increase; exclude medical care,

11% increase; on top of average state rate• Incredible evasion temptation above 10%

Disadvantages (cont.)

• 5 states would have to adopt a sales tax• Admin burden mandate––increase rate 1%• Tenth Amendment issues• 43 states piggy back on IRS tax laws and may still

require T/Rs• Self employed still file returns• States continue audits of both tax returns• Cascading

Disadvantages (cont.)

• Requires tax registration number• Transition to a sales tax (boom/bust cycle)• Social Security benefits recalculated, as based

partly on income• Regressive tax• Who tracks the credit to the poor, requiring a 7%

increase• Intergenerational effect/eliminates consumer

surplus

Individual Consumption Tax

• Except India and Sri Lanka, tax authorities around the world have had no experience with an individual consumption tax

• In April, 1995 the individual consumption tax proposed by Senators Nunn and Domenici, The Unlimited Saving Allowance (USA) Tax

Individual Consumption Tax

Application

A typical calculation of the individual consumptiontax would be as follows:

Income $100Plus:

New loan for Auto $15Reduction in Mortgage Principal ($10)Net New Debt $5

Less:

Beginning of year bank balance $40End of year bank balance ($50)Increase in savings ($10)

Equals Consumption Tax Base $95

The Nunn-Domenici USA Tax

• Eliminates individual and corporate tax• Retains estate, gift and payroll tax• Progressive rate structure to 40%• Favorable treatment for housing, charity,

and state and local income taxes• Two part tax: Individual Tax; Business Tax

Advantages of USA Tax

• Increases savings––Salutary Substitution Effect

• Discourages consumption (Luxury Fever, Robert Frank)

• Shifts burden from young generation to elderly

Disadvantages of USA Tax

• Ridiculously complex• No country has experience with it• Central planning mentality• Why is consumption bad?

– Purpose of work is to consume– Savings not an end to itself, but a way to

finance future consumption– Should we work harder and die wealthy? Or die

happy?

The Flat Tax

• Robert Hall and Alvin Rabushka, The Flat Tax, Second Edition

• Application– Fringe benefits are currently not taxed at all– Dividends and capital gains are taxed twice– Interest income, supposed to be taxed once,

escapes tax (interest deductions exceed income in the aggregate)

Two Components to Hall/Rabushka Flat Tax

Individual Tax Business Tax

Advantages of the Flat Tax

• Lowers compliance burden (up to 94%)• Air tight––taxes all income once, closest to

source• Eliminates tax arbitrage• Levels playing field––eliminates

differentials in worth of deductions• Interest rates would drop (by 25%, Federal

Reserve Board)

Advantages of the Flat Tax (cont.)

• Effectively taxes government––labor intensive• Difficult for Congress to increase––supermajority• Doesn’t require repeal of 16th Amendment• Removes rewards/punishments––neutral towards

behavior• Marginal rate = effective rate = no penalty for

earning more

Disadvantages of the Flat Tax

• Doesn’t tax underground economy• Alleged windfall to the rich• Inherited wealth (coupon clippers) not pay fair

share• EIC is repealed, hurt the poor• Loss of mortgage deduction = real estate crash• Loss of charitable deduction will halt charity

Disadvantages of the Flat Tax (cont.)

• Simplicity is the enemy of fairness• Not a perfect tax• An old tax is a good tax––flat tax never

been tried (broken odometer)• The Pinocchio Press Effect (Rabushka)

America:Who Really Pays the Taxes, Donald Barlett and James Steele

BushAGI $1,324,456Total Taxes $239,083Effective Rate 18.1%Royalties $889,176(Millie’s Book)Contributions $818,803% of Income 62%Net Income $505,653Effective Rate 47%

Portland Oregon$33,499$6,61819.8%-0-

N.A.N.AN.A.N.A.

Who Pays the Tax? 1996

Top % Taxes Income Avg Rate1% 32.3% $229,230 28.7%5% 50.8% $101,202 23.9%10% 62.4% $74,981 21.4%25% 81.3% $45,833 18.0%50% 95.7% $23,160 15.9%50% 4.3% $23,160 4.4%Bottom

Who Pays the Tax? 2012

Top % Taxes Income AGI Share1% 36.7% $434,682 21.86%5% 58.95% $175,817 36.84%10% 70.17% $125,195 47.87%25% 86.4% $73,354 69.25%50% 97.22% >$36,055 88.9%50% 2.78% <$36,055 11.1%Bottom

Progressive Taxation

Thought Experiment:Jack earns $10,000 @ 30% tax = $3,000

Jill earns $100,000 @ 5% tax = $5,000

They both draw equal amounts of water from the community well

Is this fair?

The Constitution of Liberty, Friedrich A. Hayek

• Chief source of irresponsibility of democratic action

• Arbitrary––no limit to top rate, can always go higher

• Violates equal pay for equal work• Horizontal equity––people under similar

circumstances bear equal burden• Vertical equity––ability to pay

The Constitution of Liberty, Friedrich A. Hayek

• Big business protection act• Devised by salaried men• Decreasing marginal utility––specious

argument (utility ≠ income)• Doesn’t redistribute income, but taxpayers

Milton Friedman on Tax Reform

Least bad tax: Henry George’s tax on undeveloped landNext least bad: Flat tax with exemptions (progressive)

Three reasons major tax reform won’t happen:1) Neither side trusts the other and both are right

(deductions creep back in; rates creep back up)2) Importance of appearance vs. reality (fairness)3) Congress would be out of business—nothing to sell

Charles Adams’ Nine Reforms

Tear down the spy systemEstablish a crime for tax extortion as well

as a civil action for damagesEstablish a civil action for damages for

tortuous tax admin including: malicious tax investigations, extortions, leaked info, and grand jury abuse

Charles Adams’ Nine Reforms (cont.)

Have all federal tax districts coincide with congressional districts and provide for the recall of district directors

Adjudicate tax disputes like any other debtDecriminalize the tax law––fraud is a crime, not

evasionMake congressional representatives and federal

judges immune from the IRS

Charles Adams’ Nine Reforms (cont.)

Make our federal tax system indirect as much as possible

National consumption tax, like a sales taxIndirect taxEliminates IRSOnly businesses under scrutinyExports more competitiveTaxes underground economy

A Modest Proposal

Compute the following ratio for each Congressman:

Spending Generating Votes = RatioRevenue Generating Votes

Your Total Tax Liability (per Form 1040) x Your Congressman’s Ratio

Giving money and power to government is like giving whiskey and car keys to

teenage boys–PJ O’Rourke

Thank You!

ron@verasage.comTwitter @ronaldbaker

VeraSage website/blogwww.verasage.com(707) 769-0965

www.voiceamerica.comFridays, 1pm PT/4pm ETwww.verasage.com/tsoe

In every economy, one major conflict:

• Between the past and the future• Joseph Schumpeter labeled it “creative

destruction”• Death of TV, newspapers, music, publishing• Mainstream press• Labor unions declining• School vouchers/home schooling

Thought Experiment

A failed haberdasherA Harvard sophomore dropoutA 6-month junior college dropoutCollege student with a C+ term paperGeneral Motors

Which one will the government invest in?

Two Effects From Changes in Marginal Tax Rates

• Income Effect––people have more money, so they work less (a target income theory)

• Substitution Effect––work pays more relative to leisure, so people work more

The Laffer Curve100

Tax Rate (Percent)

0Revenues

A

4 Ways to Spend Money

Yours

Someone else’s

You Someone else

Family car Gift

Expense account

Government

Individual Tax Levied On:

• Wages, salaries, pensions, workers comp, and FMV of stock options when received (not exercised); Social Security is tax free

• Interest, dividends, and capital gains are not subject to the individual tax

• Rental income, sole props, partnerships and corps required to file the Business Tax Form for each activity

Individual Tax Levied On (cont.):

• No deductions allowed, except for a personal allowance and dependency allowances

• No tax on gifts, inheritances or trust income––Subtitle B of the IRC is repealed

• Children under 14 with income added to parents––no “Kiddie Tax”

Business Tax is Levied On:

• Gross receipts and proceeds of business assets; less

• Compensation, capital equipment, inventory items, real estate, other business property, supplies, services, travel and entertainment, excise taxes (not property taxes) and any transition deductions allowed

• No deduction for employer’s share of FICA or for any fringe benefits

Business Tax is Levied On (cont.):

• NOLs carryforward indefinitely, adjusted with a Treasury Bill Index annually

• Hall/Rabushka allow owners to pay themselves from business (Armey-Shelby does not)

• Businesses would be able to purchase other companies and retain any NOLs

Transition Issues

• State income tax conformity• Fringe benefits• Mortgage deductions• Depreciation (unused basis = $597B in

1992)• NOLs and credits

The problem with Category II