A Plan to Renew the Promise of American Life, Plank 5
Plank 5. Rely on duties and excises
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 value-added tax (VAT), a flat-rate income tax (‘flat tax’), or a national retail sales tax (‘FairTax’).
In the previous plank, we saw why it’s essential to abolish the federal income tax in all its forms, including the payroll tax. Now we turn to its replacement.
In place of income taxes, I propose our federal government rely exclusively on what the Constitution calls ‘indirect taxes,’ just as it did from 1789 to 1913, and specifically on duties and excises. That is, taxes on foreign imports and domestic manufactures. The former are usually collected at the border, the latter either at the point of manufacture or the point of sale.
As we saw in the last plank, direct taxes are levied on work-effort while indirect taxes are levied on goods. Direct taxes can be avoided by working less, or by working under the table (cheating). Indirect taxes, by contrast, can be avoided by being frugal, that is, by consuming less and saving more. Saving is the key to wealth and prosperity. Therefore, indirect taxes are to be preferred over direct taxes, if we want to have more wealth and prosperity.
- Before 1913, our central government was about a tenth of its current size.
- During the nineteenth century, we went from being a fourth-rate to a first-rate power.
- And we were in many ways the freest, the most prosperous, and the happiest people on earth.
During that entire time, our central government relied almost exclusively on indirect taxes. Why not go back to that successful formula?
To be clear, I am not saying duties and excises are wonderful. They are taxes, a necessary evil. But they are better than the alternatives. A wise government avoids direct taxes like the plague. /1
What are some examples of direct taxes? Head taxes, taxes on land, and income taxes. /2
Before the Progressive Era, the federal government was funded by four main revenue sources: duties, excises, user fees, and receipts from the sale of federally owned land. The advent of the income tax in 1913 and the payroll tax in 1935 brought about a flood of new money into the federal coffers, so much so that those original sources have been swamped, as a share of total receipts. Now, they bring in almost nothing, compared to income taxes. As a result, we don’t even remember today what it was like before income taxation.
We also forget the great virtue of indirect taxes: their built-in self-limitation. As Hamilton observes in Federalist 21, indirect taxes are built into the price of the goods upon which they are levied. Set the tax too high, and people stop buying that good. Revenue is thus naturally limited, and with it the size and burden of government. Indirect taxes are also more agreeable than direct, to the populace, because they require no interaction with the tax man, no IRS audits, no April 15th, no Form 1040, no endless hours pulling one’s hair out trying to comply with an insanely complicated tax system.
And there are other benefits. Absent income taxes, federal tax collectors have no excuse to collect a lot of personal information on us, nor to pry into our private lives, nor harass us for our ‘incorrect’ political or religious views.
Question: Could excises (taxes on specific goods) be used to promote social engineering?
Answer: Sure. But there is no particular need for them to do so. For the record, I oppose the levying of so-called ‘sin taxes’ on such alleged evils as alcohol, tobacco, gambling, and carbon emissions. My view is taxes should raise revenue and be kept as economically neutral as possible. But at the end of the day, it is Congress’s job to craft the tax code.
Question: Aren’t tariffs just a tool of protectionism (government favoring some industries over others)?
Answer: Not necessarily. Protectionism (meaning tariffs and other trade barriers designed to protect domestic producers from competition) is, generally speaking, a bad thing. That’s why I strongly favor free trade, provided it is defined as follows: ‘zero-percent tariffs with a metallic standard and fixed exchange rates.’ (Not all free traders would define it that way, but I think they should.) Low or non-existent tariffs without honest money does not equal free trade. Free trade deals without honest money are a mirage, because trading partners can just manipulate their currencies to create a form of non-tariff trade barrier. For me, the question of whether a nation should replace income taxes with moderate tariffs is not a difficult one. It’s a no-brainer—just about the best policy upgrade a nation could ever make.
Question: Won’t this just lead to more cronyism and corruption?
Answer: No, just the opposite. While a certain amount of cronyism and corruption is unavoidable—we’re talking about politicians, after all—the overall amount of cronyism and corruption will always be less under indirect taxes than under income taxes. In the old days, you could open up your local newspaper and see a schedule of all the current tariff rates. From that information, voters could have a pretty good idea about which special interests had the most effective lobbies in Washington. And they could factor that information into their voting choices. They had a heck of a lot more transparency than we do under the income tax. No system is perfect, but what I’m proposing will surely be much more tolerable, all things considered, compared with the nightmarish complexity and hidden subsidies and giveaways endemic to an income tax.
Question: Could receipts from duties and excises completely replace income-tax receipts?
Answer: No, not at first. But that’s okay. There would be a rise in the deficit at first. But the economy would definitely grow—nay, it would boom. (By way of background: Income taxes, personal and corporate, generated about 40 percent of federal receipts in 2013, or $1.3 trillion. The payroll tax generated about the same amount. Together, these sources constituted about 80 percent of federal receipts.) A deficit hit is unavoidable, if only because, as a practical matter, to get the reform passed we would need to give most taxpayers a net tax cut. (‘Revenue neutral’ tax reform is almost impossible to enact because by definition it entails raising taxes on some people in order to give tax cuts to other people.) The rise in deficits would look bad. But it would be worth it. It would be an investment. Admittedly, while everyone’s income and payroll tax burdens would vanish, there would still be grumbling about the prices of consumed goods going up due to the duties and excises. We would have to explain to the public, both before and during the transition, that we are all better off, thanks to overall lower taxes and more job creation and income growth. Very quickly, we will see lower prices and higher living standards for everyone. By switching to consumption taxes, economic growth will take off and, assuming we also freeze peacetime spending, the federal deficit will quickly vanish. We will go from chronic deficits to routine surpluses. We will then curtail federal borrowing and begin paying down the national debt, which will produce a reduction in real interest rates, which will in turn send positive waves throughout the economy. The government will shrink. The private sector will grow. Living standards will rise. And assuming we maintain our discipline, a virtuous cycle will set in, leading to ever-greater prosperity and happiness for everyone. That strikes me as well worth the price of a temporarily higher deficit!
Question: How would this reform affect trade, including free trade agreements like NAFTA?
Answer: The reform shouldn’t affect our existing trade agreements, which generally permit trade measures intended to attain non-economic objectives, such as raising a revenue. We collect tariffs on something like 12,000 items at the same time we adhere to NAFTA and other international trade agreements. If we raise our tariffs, and our trading partners retaliate by raising theirs, my response is: So what. They’re only shooting themselves in the foot. True free trade is when I unilaterally eliminate my tariffs, regardless of what you do, so I can reap the benefits of you flooding my markets with cheap stuff. You wanna let Americans buy your cheap stuff? Great! So-called fair trade is when I lower my tariffs only to the extent that you show me the same courtesy (reciprocity). In an ideal world, everyone would practice free trade. In the real world, everyone practices ‘fair trade,’ or claims to. In reality, no one does even that. Reciprocity is honored only in the breach. What really goes on is countries wage subtle war on their trading partners by imposing non-tariff barriers to trade. And one of the tricks in their toolkit is to manipulate their domestic currency to make our exports more expensive to their home consumers than their own, home-produced goods. It’s trade war via monetary policy. Free trade does not exist today, and in my opinion will never exist until we have sound, honest money, meaning an international system of fixed exchange rates based on gold. Free trade is not possible without sound money, and sound money promotes free trade. By the way, so-called ‘free trade’ deals, which are invariably thousands of pages long and administered by international bureaucrats, are not really free trade. They have lots of loopholes in them for pet industries like agriculture and key manufacturing interests. To be clear, I am not saying should scrap our existing trade agreements (although it’s a good idea to review them constantly, to make sure they serve our interests). What I am saying is we should not cede our sovereignty by letting ‘free trade’ deals get in the way of needed tax reforms. If we can lower or even eliminate duties, great. But we have to fund our federal government somehow, and duties (and excises) are the ‘least worst’ way to do it.
Question: Should we adopt the Flat Tax?
Answer: In my opinion, no. I have lost whatever enthusiasm I had for a flat tax. While it would certainly be better than today’s graduated, loophole-ridden income tax, it would still be an income tax, with all the inherent downsides. And it would not remain flat. Politicians can’t help themselves. And as a practical matter, it’s probably a nonstarter, because it would raise taxes on about half the U.S. population (the half who currently don’t pay income taxes). That’s almost certainly why, in the twenty years since it was first proposed, this idea has never been voted on, in either house of Congress.
Question: Should we adopt the FairTax?
Answer: I don’t think so. I am cool to the idea of creating a federal retail sales tax collected at the cash register, whether or not it would replace all income taxes (including the payroll tax), for three reasons: 1) Although supporters of the idea tout the FairTax as a highly transparent way to fund our government, it would almost certainly morph into a highly non-transparent one. This happened all over Europe, where national retail sales taxes quickly morphed into value added taxes or VATs, which are collected not just at the cash register but also at every other stage of the economic process. VATs are not self-limiting, in the way that duties and excises tend to be. They generate a ton of revenue for vote-buying politicians, without transparency. And they tend to exist on top of, rather than in lieu of, income taxes. 2) Despite FairTax supporters’ rhetoric about ‘abolishing the IRS,’ their plan actually necessitates the retention of the IRS by another name. The FairTax plan includes a monthly cash payment to every citizen called a ‘prebate’: it’s intended to, in effect, offset the burden of the sales tax on such essentials as food, clothing, and shelter. (Under their plan, the national sales tax rate would be in the vicinity of 25 to 30 percent, a reflection of how big our government has become as a share of our economy. Hence the desire to exempt essential items from the tax via the roundabout method of a prebate.) The amount of the prebate for each household is determined based on income and household size. Thus everyone has to report to Washington their income and household size, just as with today’s income tax. 3) There’s no need for a new tax. The federal government already collects duties and excises. Just expand those. Keep it simple.
Question: Should we adopt the Neutral Tax?
Answer: The Neutral Tax is the most radical tax reform idea I’ve seen. The idea is to replace all existing federal taxes with a gross receipts tax on state governments. The states would remain free to impose whatever kind of taxes they want. In a sense, this amounts to devolving federal tax policy to the states. It would be the simplest of all systems to administer and would depoliticize tax policy at the federal level. If we could guarantee that the Neutral Tax would not work to the detriment of federalism, I would support it. But that would almost certainly require a carefully written constitutional amendment, which makes it less attractive than simply altering the existing system by ordinary legislation. And I do have concerns. For example, we should conservatively assume that the feds would keep trying to raise the tax rate, while the states would generally tend to resist such impositions by reducing their total receipts, in order to maintain what they regard as an optimal tax level for their own citizens. Ideally, this tug of war would produce an equilibrium. If matters ended there, I’d be happy. But I fear the feds might find ways to overwhelm the states and micromanage state tax policy and in the process degrade state sovereignty. That would be counterproductive. The Supreme Court has said that federalism implicitly denies to the states any power to tax the federal government, because, in Chief Justice John Marshall’s famous phrase, ‘the power to tax is the power to destroy.’ For a long time, it was also assumed that the reverse is true: that the federal government may not directly tax state governments—which would make sense, in a federal system like ours. Sovereigns should not be able to tax other sovereigns, right? But since New York v. United States (1946) the assumption that the states are immune to federal taxation has become questionable. That case would seem to suggest that, as far as the Supreme Court is concerned, the principle of sovereign tax immunity works mostly in one direction, to the benefit of the feds. If that (in my opinion, erroneous) interpretation sticks, it represents a two-edged sword. It makes it plausible to enact a gross receipts tax on state governments (the Neutral Tax). But it also means the states could, in effect, be destroyed by federal impositions.
Conclusion. Let’s keep it simple. The best policy remains that of our Founders: Congress should rely solely on duties and excises, with a little help from user fees and land sales.
1/ What are ‘direct’ taxes? The precise definition is a bit controversial. but broadly speaking direct taxes are charges for living or earning a living in a community. They include capitations or head taxes and taxes on property and businesses. Indirect taxes, by contrast, are basically levies on consumption. They include duties, imposts, excises, and sales taxes. Scholars debate whether income taxes are direct or indirect for constitutional purposes. The Supreme Court, as we’ve seen, has been on both sides of that question. I think you can argue it either way. And of course. the Sixteenth Amendment renders it moot: they are specifically excluded from the definition of ‘direct taxes’ for constitutional purposes. The more important question to me is whether a given tax falls mainly on production or consumption—on people or things. The answer is federal income taxes fall mainly on people. Therefore, they burden liberty and prosperity and should be abolished. For more information on the original meaning of these terms in the Constitution, see this scholarly article.
2/ To prevent the federal government from trying to redistribute wealth, the Constitution imposes a brake on the use of such taxes, by requiring those taxes to be apportioned according to population (meaning ‘one man, one buck,’ regardless of other considerations). This makes direct taxes practically difficult to levy. By contrast, the Constitution leaves Congress free to impose indirect taxes, such as duties, imposts, excises, and sales taxes, with the one proviso that they must be ‘uniform throughout the United States.’ Traditionally, the federal government has avoided levying sales and property taxes, which have long been mainstays for local governments. That’s a good thing, in my view. In my ideal world, I would take this division of labor a step further. I’d have the feds rely exclusively on duties and excises, and state and local governments primarily on land value taxes. A land value tax or LVT may be thought of as a property tax that ignores any buildings and other improvements. You just levy a percentage assessment on the value of the land itself, without regard to anything people have done to it. The assessment will, naturally, tend to be higher in a prosperous area where land is valuable, than in a backwater where it’s not. An LVT is regarded by economists as the ‘perfect’ or ‘least bad’ tax, because it does not deter production, distort markets, or otherwise create deadweight loss. It is inherently progressive. Environmentalists like it, because it tends to reverse urban sprawl and expand green belts. Antipoverty activists like it because it promotes infill of vacant urban lots and thus creates jobs where people need them. The tax has long had advocates across the political spectrum. The nineteenth-century American economist Henry George was so enamored of it, he sparked a popular movement to make it the ‘single tax,’ the lone tax in place of all others. While I don’t think we need to go that far, I would certainly like to see this particular tax used in lieu of traditional property taxes.
This plank does not require any constitutional amendments.
Will contribute to robust economic growth.
Will permanently shrink the central government, thanks to the self-limiting nature of duties and excises.
Will reduce tax-driven social engineering and wealth redistribution.
Revised: May 6, 2016.
Published: June 21, 2013.
Author: Dean Clancy.