Toward A Better Tax Structure

When I began this series of posts, I had no definite opinions.  Now I do.  Some conclusions surprised me, some changes would be very contentious, one looks promising but requires more research, and one may be good in theory but not in real life.

Our current system is explored in the first few posts and summarized in The Purpose and Performance of Our Tax System.  Our current system:

  • Fails by a wide margin to fully fund government spending
  • Creates a wealth distribution that 90% considers highly unfair
  • Costs far too much to operate (30% overhead on income tax)
  • Allows illegal evasion on almost 20% of taxable income
  • Is so complex nobody fully understands it
  • Creates seriously false beliefs about tax and spending

False beliefs?  Three in four Americans believe almost half of all government spending is wasted but oppose any cuts to programs that account for 60% of spending.  Unfair results?  Nine in ten Americans believe the wealthiest fifth has three fifths of the total wealth and wants them to have a third but in fact they have over four fifths and it’s growing fast at the expense of every other group.

Taxes, Wealth and Fairness notes that a fair distribution of  wealth means a relatively equal opportunity to become wealthy.  Who We Tax shows that while wealth is now extremely and increasingly unequal, the percentage of tax paid relative to income is similar for all income groups.  What We Do Not Tax shows that tax deductions equaling almost a third of Federal spending disproportionately benefit those with the highest incomes.  Business Tax shows how corporate income taxes have fallen as a share of GDP and corporate profits are transferred overseas where they are not subject to US taxes.

The last background post, Qualities of an Excellent Tax System, summarizes what public opinion surveys say we want, a system that:

  • Fully funds all authorized government activities,
  • Leads toward the distribution of wealth we democratically choose,
  • Has a low collection cost and minimizes illegal evasion,
  • Does not disadvantage US business in the global economy, and
  • Makes it easy to understand the impact of proposed tax and spending changes

What changes must be made to get what we want?  What We Tax, summarizes the existing structure.  The Federal government collects half of all tax revenue, chiefly from individual income tax (8.8% of GDP) and corporate income tax (2.2% of GDP).  The States collect 29%, chiefly from sales tax (2.1% of GDP) and individual income tax (1.9% of GDP).  Local taxes make up 19% of the total, mainly property tax (2.4% of GDP).  Later posts explore the pros and cons of that structure and of different taxes.

Estate Tax and Fairness highlights an extraordinary failure of logic – inheritance tax is felt to be the most unfair tax of all by a society that wants equal opportunities for all to become wealthy.  It also notes that estate taxes provide the least disincentive for economic activity.

The top estate tax rate was 77% at the end of WW2 (“equality of sacrifice”).  The UK ended domination by its hereditary aristocracy the same way (“equality of opportunity”).  Our huge public debt from wars in Iraq and Afghanistan, tax cuts on high incomes, and the Great Recession calls for equality of sacrifice now.  Our great inequality of wealth calls for equality of opportunity now.

Personal Income Tax and Fairness shows the higher top rates necessary to get the wealth distribution 92% of Americans want will not harm economic growth.  Research indicates we should raise the top rate closer to a revenue-maximizing 66.1% from today’s 39.6%.   Income is increasingly from capital gains taxed at lower rates than “ordinary” income.  93% of that $161B tax break goes to the top 20% of earners and two-thirds to the top 1%.  Half of all capital gains are not taxed because one who inherits property pays gains tax only on the difference between what it was worth when inherited and when sold.

The six Walmart heirs dramatically illustrate the result of the combination of low marginal tax rates on both inheritances and incomes.  They have more wealth, $90B, than the bottom 42% of Americans and it’s up from $73B in 2007, the same as the bottom 30%.   Meanwhile, the average American’s wealth declined from $126K to $77K and 13 million Americans have negative net worth.

Consumption Taxes and Fairness explores issues with this tax and with the central/local tax structure.  The wealthiest residents in most States pay the lowest rates because of consumption taxes.  The poorest 20% pay 6 times as high a percentage of income as the richest in the ten most regressive states.  The average state’s consumption tax structure is equivalent to an income tax with a 7.1% rate for the poor, 4.7% for the middle class, and 0.9% for the wealthiest taxpayers.

The attraction of consumption taxes is they are hard to evade and cheap to collect.  The problem is they disproportionately impact those with a low income.  That can be mitigated, however, by higher tax rates on high incomes, a subsidy for those who work for low pay, exempting food and other necessities, and providing essential services such as healthcare at no or low cost.  Consumption taxes must be part of our system since personal consumption historically represents 70% of our GDP.

Property Tax and Fairness explores another aspect of the local/central issue.  Property tax is the chief source of revenue to support local education, police and fire protection, and infrastructure.  A protest against high Local property taxes in California resulted in higher State income taxes and a shift in power from Localities to the State.

This post also looks at how tax structures impact economic growth.   An analysis of 21 OECD countries over the last 35 years concludes:  “Property taxes … seem to be the most growth-friendly, followed by consumption taxes and then by personal income taxes.  Corporate income taxes appear to have the most negative effect on GDP per capita.  …  These findings suggest that a revenue-neutral growth-oriented tax reform would be to shift part of the revenue base towards recurrent property and consumption taxes and away from income taxes, especially corporate taxes.”

To get the desired wealth distribution, it may be better to collect property taxes at the Federal level and redistribute them on a per capita basis to the Local level.

Corporate Income Tax and Fairness notes they are costly to collect, easy to evade, and fraught with competitive issues.  Two thirds of US businesses reporting profits of $1 million or more are not incorporated, which means tax on their income is paid by their owners.  Treasury Department economists reckon four fifths of the profits of corporations is also paid by owners.  When we say corporations should pay more, what we probably mean is we want business owners to pay more.

A related issue is corporations pay very different rates of tax because they have flexibility in where they locate production and where they realize profits.   They can borrow in one country and take the interest deduction there, locate production facilities and employ workers in another country, and realize profits in a third country.  $1.7T of profits is estimated to be offshore where US taxes are not incurred.

Because 80% of corporate income tax is ultimately paid by business owners, is costly to collect and easy to evade, it looks better to eliminate it while raising the tax rate on high personal incomes.  Tax on all business profits would then be paid by business owners.

To end the harm to our economy caused by the offshore tax break, it looks better to combine business profits shown in all jurisdictions, deduct income taxes paid in other jurisdictions and tax the balance at US rates (ala State and Local tax deduction for Federal income tax).

Social Security Tax and Fairness notes that Social Security spending is matched by dedicated payroll deductions that are fundamentally different from other taxes because they are payments for our individual pensions and insurance.  We need payments to be mandatory because we don’t save enough voluntarily or have enough disability insurance.

Keeping Social Security financially sound is a separate issue from balancing overall government revenue and spending.  Social security can be kept sound by increasing the payroll tax ceiling to the same percentage level it was not long ago and modestly raising the tax rate as we’ve done before.

We are easily misled about the health of Social Security because its revenues and spending are rarely presented together.  That is a problem with all government activities that leads to our mistaken beliefs about overall tax and spending and makes it easy to mislead us about necessary changes.

Conclusion:  When I began these posts, I had no definite opinions.  Some changes that I now see to be positive are not unexpected but I was surprised to find no basis for lower tax rates on capital gains.  That and other changes could be made but eliminating all tax deductions, which would make the system fairer and cut collection costs would be very difficult (as the Japanese say).  I will in future posts return to tax preferences and explore whether we really should want government, for example, to be encouraging home ownership.

Another change, eliminating corporate income tax, looks positive but to come to a definite conclusion I must research international tax treaties and think through how the accounting would work.  Centrally collected property tax and VAT for redistribution to State and Local governments also looks positive but to come to a conclusion about that I must explore issues of governance.  What about the associated increase in Federal government power?

So, here are conclusions I’m confident about (definite) and those needing more research (probable).

Definite – to more fully fund government activities, make the opportunity to become wealthy more equal, lower tax collection cost, minimize illegal evasion, make it easier to understand the impact of proposed tax and spending changes, and not harm our economy we need:

  • Higher tax rates on inheritances
  • Higher tax rates on high personal incomes
  • The same tax rates for all kinds of income
  • Higher payroll tax ceiling and payroll tax rate
  • Revenue and spending reported together for every major government program

Probable – to more fully fund government activities, minimize tax avoidance, and not disadvantage US businesses in the global economy we should:

  • Eliminate corporate income tax and account for all business profits the same way globally
  • Eliminate all tax exemptions
  • Collect property tax at the Federal level (instead of some or all by Localities) and redistribute it per-capita to Localities
  • Collect VAT at the Federal level (instead of some or all State Sales Tax) and redistribute it per capita to the States

Because only some changes are definite, I can not yet propose exact rates, what percentage of revenue should be raised by each tax, or what percentage should be collected at each level of government.  I will explore international tax treaties and governance to decide about the “probables” then propose an overall structure but first, a more urgent question.

Presumably, it’s the same 92% of Americans who want less inequality as the 93% who lost an additional 4% of their savings in the past three years while the wealthiest 7% grew 28% even more wealthy.  No surprise they want less inequality but would that in fact be better for society?  I used to want cigarettes; it’s better I no longer do.  I still want red wine; that is in moderation OK and it may even be positive.  Is the more moderate inequality our majority wants more like cigarettes or red wine?

2 comments on “Toward A Better Tax Structure

  1. Martin, I agree with your “definite” proposals but have some issues with your “probable” suggestions.


    I can see where this might make sense if it were coupled with increasing tax revenues from real people as you outlined in your “definite” proposals, but I still think businesses should be required to take steps to eliminate environmental damage (e.g. proper disposal of waste, “scrubbers” on chimney stacks, etc.) and should be held responsible for mitigating environmental damage they caused. Consumers should have to pay the “true cost” of producing a product, and if that means unregulated overseas competitors will have an unfair advantage, tariffs might help to level the playing field in the U.S. market.


    There were 363 “tax expenditures/exemptions” AKA “loopholes” in 2012. Most probably could be eliminated, but this would involve repercussions to people and companies who made long-term decisions based on these exemptions.

    Would you eliminate IRAs and 401Ks and the like? Would you abrogate the tax free advantage for all those who have been putting money into IRAs and 401Ks for years and decades? Would you grandfather in existing accounts, but eliminate opening new accounts? How would this affect retirement plans for the middle class?

    Would you eliminate the municipal bond tax advantage which would require states and towns to pay more for borrowing money?

    Would you eliminate income averaging for farmers who often have wide swings in income from year to year?

    Would you tax all social security benefits?

    Would you tax capital gains when you sell your house even though you will be moving into a new house that has gone up just as much in value?

    Would eliminating depreciation rules stifle business expansion if a company had to write off the entire building of a manufacturing plant in the same year the expansion took place when the plant had not yet started producing goods/profits?


    Does “redistributing per-capita” mean urban localities would get most of the money for their schools and fire and police departments, and rural localities would get little or nothing?

  2. I do agree with the majority in this case, however my intent is not to advocate but to articulate what the majority wants and figure out the implications. The majority wants a more equal opportunity to become wealthy. What does that imply for our tax system?

    The “definite” changes do seem to follow inevitably from what the majority wants. I’m hoping to hear if there are any flaws in my logic about the “definites”.

    You make an important point about “external” costs, John. It feels like a big topic that I need to research separately. When is regulation the better approach, i.e., making business bear the costs, and when are taxes better, e.g., carbon tax?

    I agree, too, that “eliminate all tax exemptions” needs more thought. One aspect is the transition, mitigating the impact on long range plans that depend on them (e.g., IRAs). I figured I’d get to that only if/when I become convinced the tax expenditures would be better eliminated. Another aspect is details of the collection mechanism (e.g., income averaging). But the central issue is, when should the tax system be used to encourage behaviors? That’s the one I’ll try to address first because it’s by far the most difficult.

    I will do more research about “redistributing per capita” if it looks like a good idea at all. What I’m concerned about first is having more money flow through the central government. More money = more power and more opportunity for corruption. The central question in this case is about governance. It feels like governance will be the topic for my next series of posts.

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