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 federal income and payroll taxes. Now we turn to their replacement.
I propose that our federal government rely exclusively on what the Constitution calls ‘indirect’ taxes, as it did from 1789 to 1913, and specifically on duties and excises, that is to say, taxes on foreign imports and domestic manufactures. Duties are usually collected at the border, excises either at the point of manufacture or the point of sale.
As we saw in the last plank, direct taxes are levied on people (production), while indirect taxes are levied on goods (consumption). Direct taxes can be avoided by working less, indirect taxes by being frugal. Saving is the key to wealth and prosperity. Therefore, we should prefer indirect taxes.
Indirect taxation is critical to a system of low taxes, balanced budgets, sound money, and free enterprise — the system we had in the nineteenth century, and one that worked very, very well. Before 1913, our central government was about a tenth of its current size, we had risen, over the the preceding century, from 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. /1
Question: What are some examples of direct taxes? Answer: 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 embedded in 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 to the taxpayer, 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. Personally, 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 the legislature’s job to craft our tax codes, and such drafting inevitably involves legislative horse-trading.
Question: Aren’t tariffs just a tool of protectionism? 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 who call themselves free traders would define it that way, but I think they should.) Without honest money, low or non-existent tariffs do not, by themselves, constitute free trade. And international trade deals in the absence of honest money turn ‘free trade’ into a mirage, because trading partners can just manipulate their currencies to create a form of non-tariff barrier. Can tariffs be too high? Yes. But there are feedback mechanisms that help keep them in check. Can a nation benefit by replacing income taxes with moderate tariffs? Yes! It’s just about the smartest policy upgrade a nation can 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 here — the overall amount of cronyism and corruption will always be less under indirect taxes. The schedule of current tariff rates is public information, much more transparent and easily interpreted than an income-tax code. With that information, any voter can glean a pretty good idea about which special interests have the most effective lobbies in Washington, and can then factor that information into his or her voting choices. No tax system can be perfect, but all things considered, what I’m proposing will be far more tolerable than any income tax.
Question: Could receipts from duties and excises completely replace income-tax receipts? Answer: At first, probably not. But that’s okay. There would be a rise in the deficit, but it would be temporary. The economy would definitely grow in size — nay, it would boom. (By way of background: Income and payroll tax receipts currently represent 80 percent of all federal receipts, with income taxes, both personal and corporate, generating about 40 percent, $1.3 trillion in 2013, and payroll taxes generating about the same amount.) A deficit hit is unavoidable, if only because, as a practical matter, to get the reform enacted 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, for sure, 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 at first about the prices of consumed goods going up due to the new duties and excises. We would have to explain to the public, both before and during the transition, that everyone is better off, thanks to overall lower taxes and more job creation and income growth. Very quickly, we would see lower prices and higher living standards for everyone. By switching to consumption taxes, gross domestic product will grow more rapidly, and the economy will become stronger. And assuming we also freeze peacetime spending, the federal deficit will quickly vanish. We will go from chronic deficits to routine surpluses. We can then curtail federal borrowing and begin paying down the national debt, which will in turn produce a reduction in real interest rates, which in turn will improve economic health. The government will shrink, the private sector will grow, and living standards will rise. A virtuous cycle will set in, leading to ever-greater prosperity and happiness for everyone. 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: They’re only hurting themselves. 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 want to 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 this: countries continuously wage subtle war on their trading partners, by imposing non-tariff barriers to trade. And one of the tools in the trade warrior’s toolkit is to manipulate the domestic currency to make exports less expensive to foreign consumers and imports more expensive to home consumers. It’s trade war via monetary policy. So again, free trade does not exist today, and in my opinion it has rarely if ever existed, and will not exist in the future, until we have sound, honest money and an international system of fixed exchange rates based on such money. Free trade is not possible without sound money, and sound money is essential to free trade. By the way, so-called ‘free trade’ deals, invariably thousands of pages in length and administered by international bureaucrats, are not really free trade. They have lots of loopholes in them for pet industries and labor unions. To be clear, I am not saying we 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’ve lost whatever enthusiasm I had for a flat tax. While it would certainly be better than today’s graduated, loophole-ridden mess, it would still be an income tax, with all the inherent downsides. And it would not remain flat. Politicians can’t help themselves. And then there’s the political problem: as a practical matter, a flat taix is 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 superficially appealing 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 national 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: Only with a precautionary constitutional amendment, which probably makes the idea impractical. The Neutral Tax is the boldest and 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.
Keep it simple. The Founders got it right: 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/ As we saw in the previous plank, 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.