A Plan to Renew the Promise of American Life, Plank 5
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Plank 5. Rely on duties and excises
Specific Recommendations
5.1. In lieu of income taxation, fund the federal government exclusively with duties and excises, with a little help from user fees and land sales. Prefer this approach over such attractive but flawed proposals as a flat tax, value-added tax, or national retail sales tax.
Comments
In the previous plank, we saw why it’s essential to permanently eliminate federal income and payroll taxes. Now we turn to the replacement system. The best replacement is what we did from 1789 to 1914: duties and excises — taxes on imports and manufactures.
I define ‘duties’ as taxes on goods that cross the border as they enter the country and ‘excises’ as taxes on goods produced within the country. Excises can be collected at the point of manufacture or at the point of sale. Personally, I prefer the point of manufacture.
As we saw in the previous plank, production taxes are levied on people while consumption taxes are levied on goods.
Why prefer consumption taxes? Because they promote freedom and prosperity. If you tax something, you get less of it. If you tax productivity, you get less productivity, less wealth. If you tax consumption, you get less consumption and thus more saving and investment. Saving and investment are the seeds of future production. Taxing consumption encourages saving and investment and thus expands future prosperity.
To be clear, I’m not saying consumption taxes are good. I’m saying they’re better than the alternative — they’re the worst form of taxation, except for all the others.
Consumption taxes leave us comparatively free to choose how much tax we’ll pay. We can minimize our personal tax burden by saving.
Consumption taxes are also naturally self-limiting. They leave us free to vote with our dollars. If consumers feel a tax is too high on a particular good, they can consume less of it or switch to a substitute, or in a pinch they can resort to black markets. These behaviors give policymakers helpful feedback.
(I’m not endorsing black markets, just noting their useful function as a signaling device.)
And while a consumption tax is normally regressive, falling more heavily on people with limited means, forcing them to spend a larger share of their income on necessities, that is not a reason to tax production. It’s a reason to exempt necessities.
Reliance on consumption taxes is critical if we want to achieve lower taxes, balanced budgets, and sound money, and if we want to maximize the benefits of free enterprise (through light regulation).
That is the system we had more more than a century, and it worked well. Before 1914, our central government relied exclusively on consumption taxes. During that time, it averaged about a tenth of its current size, as a share of the economy, and yet the country rose from a third-rate to a first-rate power. And in many ways, we were the freest, most prosperous, and happiest people on earth.
Why not go back to that successful formula?
Questions
Aren’t duties just a tool of protectionism? Not necessarily. Protectionism (meaning tariffs and other trade barriers designed to protect domestic producers from competition) is, generally speaking, a bad thing. I favor free trade, so long as it is defined as ‘zero-percent tariffs with a metallic standard and fixed exchange rates.’ Not all who call themselves free traders would define it that way, but I think they should — if they really want free trade. Without honest money, low or non-existent tariffs do not, by themselves, constitute free trade. So long as your trading partner can just use currency manipulation as a non-tariff trade barrier, any ‘free trade’ deal you have with him is a joke — on you. Can tariffs be too high? Of course. But as we’ve seen, consumers help keep rates in check through their purchasing choices. Can a nation benefit by replacing income taxes with moderate tariffs? Yes. Indeed, it’s about the smartest policy upgrade a nation could make.
Won’t this just lead to more cronyism and corruption? No. While a certain amount of cronyism and corruption is unavoidable — we’re talking about politicians — the overall amount of it will be less under a system that taxes consumption only. Tariff rate schedules and lists of excise tax exemptions are public information, much more transparent and easily interpreted than an income-tax code. And with that information, any voter can get a pretty good idea about which special interests have the most effective lobbies in Washington — which politicians are bought and paid for by which interests. And he can then factor that information into his voting and buying decisions. No tax system can be perfect. But all things considered, duties and excises are preferable to any income tax. I hasten to add that tariffs should be set by Congress and not by the president. It’s risky to delegate any portion of the taxing power to one man, especially when that one man also controls the diplomatic corps and the military.
Couldn’t excises be used for social engineering? They could. But social engineering is a potential risk with most kinds of taxes. Policymakers get to decide what gets taxed and what doesn’t. ‘Sin taxes’ are taxes on things we currently don’t like for some reason. My own view is taxing ‘sin’ is a waste of time (remember those black markets) and can spawn crime (think Al Capone). The prudent policy is to use taxes simply to raise a revenue and to do it in a way that is as economically neutral as possible. Tax codes are written by human beings. Inevitably, the tax code will reflect the community’s moral sense. Some sins will get taxed. I think that’s an evil we just have to live with — although, to be sure, we should minimize it.
Wouldn’t it be smarter to adopt a flat tax? No. I say this with a heavy heart. Admittedly, a flat tax, meaning an income tax with a single, low rate for everyone, and which taxes all income once and only once, would be better than today’s graduated, loophole-ridden mess. The Hall-Rabushka flat tax proposal, which is really a consumption tax that takes the form of an income tax that’s so simple you can file your taxes on a postcard, is one of the best ideas ever put forward for replacing today’s system. But let’s be realistic. Even an ideal flat tax like Hall-Rabushka would still require tax collectors to know how much money you make, and how you make it. And unlike today’s mess, it would be criticized for being regressive, and thus subject to constant pressure to become yet another graduated income tax. Politicians can’t help themselves. It would take a strong, enforceable constitutional amendment to keep the flat tax flat. Congress in 1986 enacted an income tax reform that was in some ways similar to a flat tax. It lasted four years. And then there’s the practical political problem of persuading the nation to adopt it when the existing income tax effectively exempts nearly half the population. For those voters, a flat tax will be a tax hike. The reader may counter that ending income taxation is a tax cut for the rich. It would be a fair point if we disregarded the payroll tax, which is an income tax that does not exempt half the population. But it’s also true that imposing duties and excises is a tax hike on the rich. Like the rest of us, rich people consume, and they consume more in absolute terms than the rest of us. No, as a practical matter, there is really only one realistic way forward: we have to do the two things simultaneously: impose duties and excises, and at the same time reduce income taxes, and especially payroll taxes. We can do it in stages. If we keep the changes roughly comparable and synchronized, we will keep the overall burden the same or lighter for the vast majority of voters. This, in my humble opinion, is the way forward. ‘Take things by the smooth handle.’
Why not adopt a national retail sales tax? A national retail sales tax is a popular idea. Perhaps the most appealing variant of it is marketed as ‘The FairTax.’ The idea is to replace all federal taxes with a single, national sales tax collected at the cash register. This idea is at first very tempting, but on closer examination, it turns out to be flawed, for at least three reasons. (1) It would not remain transparent. Why? Because it would morph into a value-added tax (VAT). Supporters tout it as highly transparent: the amount you pay is printed right there on your receipt. But that’s not the end of the story. Cash-register taxes are easy to evade, which leads inevitably to a game of tax enforcement whack-a-mole. This happened in Europe. Retail sales taxes there evolved into VATs, which are collected not just at the cash register but also at every other stage of the economic process. That, of course, makes the tax complicated and confusing, and thus non-transparent, and thus non-self-limiting, or at least much less self-limiting, than duties and excises, which, as we’ve seen, have the virtue of being straightforward. Now, if you force me to choose between an income tax and a VAT, I’ll take a VAT. But look around. Wherever there’s a VAT, it exists on top of income taxes, not in place of them. A VAT plus income taxes is the worst of all worlds. (2) Despite FairTax supporters’ rhetoric about ‘abolishing the IRS,’ the plan actually necessitates the retention of a quite nosey government agency in order to pay every citizen something called a ‘prebate.’ The prebate is included to make the system less regressive — to offset the burden of taxing essentials like food, clothing, and shelter. Since rich people don’t need such protection, the prebate would inevitably be targeted to the poor and thus adjusted for income. Which means everyone would need to report their income — just like an income tax. (3) The federal government already collects duties and excises. They work. They’ve proved their worth. Why get fancy?
What about a gross receipts tax on the states? This is a bold idea, and at first glance an appealing one. But I think it’s unwise. I’ve seen it marketed under the label, ‘the NeutralTax.’ The idea is to replace all existing federal taxes with a single, gross receipts tax on state governments. Uncle Sam would tax the states rather than individuals. The states would in turn tax their residents in whatever way they think best. In a sense, it would devolve federal tax policy to the states. This, of course, would require a constitutional amendment. Now, presumably, in practice it would generate an equilibrium and an optimal one. The tax rate would be set at the point that produces a maximum of revenue for the feds with a minimum of burden on the people. I’m assuming every state would in time come to adopt for itself a relatively efficient tax system to pay the feds with. The scheme would certainly be very simple to administer — for the feds. And it would also depoliticize tax policy — for the feds. But the trouble is it would also give Congress a weapon with which to manipulate the states. And to put it starkly, if you want to live under a consolidated, highly centralized government like France or Russia, this approach seems like a pretty good way to get there. A gross receipts tax on the states could kill federalism. Under the Constitution, state governments may not tax the federal government (McCulloch v. Maryland, 1819). And the reverse also holds, for the most part (New York v. United States, 1946). The basic rule is sovereigns may not tax other sovereigns. That is a good rule, and a logical one. But under the NeutralTax, the feds would not only be able to tax the states, they could influence their behavior in ways not so readily available to them now. They could use the threat of rate hikes, or the lure of rate cuts, to secure changes in local policy — sticks and carrots. At least with federal spending programs (grants-in-aid), a state is free in theory to decline the money. But here, there would be such no freedom to say no. The tax must be paid. And Uncle Sam, alone, sets the rate. Uncle Sam is the sovereign, the states are tributaries. It resembles a protection racket. No, thanks.
Why not rely instead on head taxes? Because head taxes are not consumption taxes. And because they are an abomination.
Why not rely instead on property taxes? Because property taxes — taxes on the assessed value of homes, cars, and the like — are not consumption taxes. And even if they are, not everyone owns property. And because local governments traditionally rely on property taxes. A federal property tax on top of local property taxes would be burdensome. A federal property tax in lieu of local property taxes would weaken local self-government. As taxes go, property taxes are relatively easy to administer and transparent. You can get a pretty good idea, from looking at your property tax bill, of whether you’re getting a good value for money, in terms of government services. And if the answer is no, you can vote with your ballot, or your feet. A federal property tax would prevent you from being able to vote with your feet. (The ideal property tax, in my view, applies one low rate to the property with no exceptions for favored groups or caps on the assessed value. Keep the tax simple, the base broad, and the rate low. A good rule for all taxes.)
To sum up, in my ideal system, localities would continue to rely primarily on property taxes, states would continue to rely primarily on sales taxes (but not VATs), and Congress would go back to relying primarily on duties and excises. And income taxation would be abolished in all its forms.
Constitutional Amendments
This plank does not require any constitutional amendments.
Benefits
Contributes to robust economic growth.
Permanently shrinks the central government, thanks to the self-limiting nature of duties and excises.
Reduces tax-driven social engineering and wealth redistribution.
Revised 6 May 2016
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