by Philip L. Hinson.
In an unpublished article that I wrote last year, I advanced the notion that, in a time of rapidly increasing global competitiveness, the United States had the most uncompetitive tax system on the planet. That ranking is not just the worst among the larger advanced nations (China, Brazil, India, the UK, Russia, Japan, etc.), it also includes much smaller and relatively unsophisticated nations such as Belize, Ecuador, Chad, Cambodia, and Bangladesh. My basis for that conclusion consisted of four uncompetitive features of our current tax system, which no other nation in the world matches in terms of sheer economic destruction:
1. The US has the highest corporate income tax rate in the world.
a. The United States has thus far ignored the worldwide trend over the past several decades of reducing corporate income tax rates.
b. Japan lowered its rate on April 1, 2012, leaving the US with the dubious distinction of having the highest corporate tax rate in the world.
2. US corporate taxation is based on worldwide income, unlike many jurisdictions which levy their income tax only on domestically derived income.
3. The US has no border adjustment mechanism.
a. This means that the US has no ability to relieve exported goods of their tax burden and very little ability (with the enactment of NAFTA, GATT, etc.) to tax incoming imports.
b. The US is the only one of 34 OECD nations lacking such a feature.
c. Partially as a result, the US has by far the largest trade deficit in the world.
4. The US has the most complex income tax system in the world with enormous and growing compliance costs as a result, estimated in 2011 by Dr. Arthur Laffer at $431 billion per year.
Senators Marco Rubio and Mike Lee have issued a white paper that attempts to address some (but not all) of these uncompetitive features. Their tax reform proposal is one which attempts to duplicate the economic benefits of a consumption tax by modifying the income tax base to resemble that of a true consumption tax. They would also simplify the income tax structure by reducing the number of rates to two (15% and 35%) and by eliminating many of the “loopholes” and special interest provisions that riddle our current income tax system. We have recently seen this approach by the Heritage Foundation, which rolled out its “New” flat tax proposal a couple of months ago. The Heritage proposal is more of a true flat tax proposal in that it does feature a single income tax rate, and it, like the Rubio/Lee proposal, attempts to mimic a consumption tax’s economic benefits by modifying the traditional income tax base.
Let’s examine the Rubio/Lee proposal in terms of these four uncompetitive features.
1. Highest corporate income tax rate in the world – The Rubio/Lee proposal reduces the top corporate income tax rate to 25%. Although that is certainly not as competitive as reducing it to zero, it is clearly an improvement over our current situation.
Advantage – FairTax
2. World-wide taxation – The Rubio/Lee proposal (like the FairTax) would move our tax system to a territorial basis, meaning that U. S. corporations would no longer be taxed on incomes derived from foreign markets.
Advantage – Tie
3. No border adjustment mechanism – Since the WTO has ruled that neither form of direct tax (income and payroll) that the US uses (and would continue to use under the Rubio/Lee proposal) can be “border-adjusted,” the Rubio/Lee proposal offers no improvement here. In other words, we would remain the only one of 34 OECD nations with no border adjustment mechanism in our tax system. This is a huge problem.
Advantage – FairTax
4. Complexity/Compliance costs – The Rubio/Lee proposal offers benefits in this area due to its simplification of the current system. Dr. Laffer, as referenced above, has estimated that 90% of the then-current $431 billion per year could be saved with the FairTax, while 50% could be saved with a flat tax. It would seem likely that the Rubio/Lee plan would fall closer to the flat tax estimate than the FairTax estimate.
Advantage – FairTax
So for those keeping score, of the four uncompetitive features of the current system, the FairTax offers greater improvement in three of those, with a tie in one. Not a single one of these uncompetitive features in the Rubio/Lee proposal offers greater improvement than the FairTax. Perhaps the largest impediment to global competitiveness of our current system –lack of border adjustability –would be perpetuated with implementation of the Rubio/Lee proposal.
However, we all know that economic benefits, while extremely important in tax reform, are not the whole story.
Another major difference between these two proposals concerns the area of permanence. We now have a 102-year uninterrupted history with an income tax, which started as a very simple tax that affected an extremely small proportion of Americans. Americans have witnessed a dizzying proliferation of amendments to the system, mostly in the name of simplicity and fairness. An enormous multi-billion dollar per year industry has grown up in our nation’s capital, centered on K Street. That industry is based on the exchange of tax preferences for campaign cash.
Former U. S. Senator Mike Gravel (D/AK) related the story of a meeting he had with the then chairman of the Senate Finance Committee when, as a freshman senator in the 1970s, he was selected to be on that committee. He told Chairman Russell Long that he had a great idea – why not eliminate the income tax altogether and replace it with a sales tax? He said that Senator Long looked at him for a minute and then explained: “But Mike, you don’t understand. The income tax is how we reward our friends and punish our enemies.” That conversation took place a long time ago and preceded many other attempts to convince our elected leaders to put the national interest above their own self-interest, mostly to little avail. However, it still stands alone for sheer candor and brutal honesty.
These uses of the tax system to wield political power are not without their economic consequences. Economists tell us that tax systems which have the broadest base and the flattest rates produce the least economic distortion and spur the strongest economic growth. Also, let’s remember that when Congress passes a special exemption for some special interest that has made a generous campaign donation, it does not cut expenditures in other areas to offset that lost revenue. That means that the rest of us have to make up the difference or the deficit is increased.
This begs the question to Senators Rubio and Lee: How are you going to prevent Congress and K Street from doing exactly what they have been doing to an income tax for the past 102 years? How can you assure us that the simplifications that you enact will stay that way and will not be viewed by the influence peddling industry as a job security measure? To put this concern in its proper perspective,note that the tax system measured 26,000 pages in 1986 and has grown to well over 70,000 pages today, according to Commerce Clearing House. In the last decade alone, there have been more than 4,400 changes to the Code – more than one per day.
As we have seen recently, in spite of many attempts to “reform” the IRS, it remains largely impervious to such attempts. For those who believe that the Obama administration has pioneered the “weaponizing” of this agency, I would recommend a book entitled Power to Destroy by John A. Andrew III. That book chronicles in great detail the use of the IRSfor purely partisan political purposes during the John F. Kennedy, Lyndon B. Johnson and Richard Nixon administrations. The author went to great lengths to search official records and present a factual and unbiased picture of those abuses. That was a long time ago, but the essential nature of the agency is unchanged, as evidenced by recent revelations.
Any tax reform proposal which includes an income tax perpetuates the IRS, including the Rubio/Lee proposal. The notion that the IRS can be “defanged” or converted into an agency that is strictly concerned with tax law enforcement is contradicted by its long and sordid history.
The claim that the FairTax offers no benefits in this area because there would still have to be an agency to collect taxes is highly deceptive and misleading. The FairTax would be collected mainly by the states, with a small sales tax administration authority within the Treasury Department. This authority would have no direct contact with individual taxpayers, just as currently the states have no direct contact with those who pay their sales taxes. There is a crucial distinction to be made between direct taxes (such as income taxes) and indirect taxes (such as sales taxes). This distinction may not be significant to Senators Rubio and Lee, but it is one that both the Founders (many years ago) and the WTO (currently) find to be crucial. In fact, that distinction was so important to the Founders that it is the only distinction made in the US Constitution with respect to taxes.
We are not persuaded by assurances that the essential nature of the IRS will be transformed by the Rubio/Lee proposal. We believe that history demonstrates that any income tax will inevitably devolve into a tool for abuse of our Constitutional freedoms and liberties and that politicians of both political parties will be unable to resist the temptation to use the collection arm for partisan political purposes. The timeline may vary, but the overall trend is unmistakable.
Those of us who advocate for the FairTax welcome the myriad of alternative tax reform ideas that come from a variety of sources. These alternatives give us a basis for comparison and an opportunity to explain the singular benefits of the FairTax proposal. The FairTax would move us from having the least competitive tax system on the planet during the globalization century (the 21st) to the tax system that other nations would have to copy in order to compete with. The Rubio/Lee proposal, which is clearly better than our current system, might move us out of last place, but it clearly would not provide the enormous boost that the FairTax would.