April 18, 2011

Time to Prove Sobriety Over Changes Needed to Federal Budget

Seeking Alpha
written by Karl Denninger
April 8, 2011

Let's start a real discussion on this issue. As said on CNBC this morning, our government continues to play "powder puff" instead of dealing with the issue:

We'll start with what we know to be facts and then attempt to develop a policy prescription:
  • The Federal Government has never in the history of the nation managed to collect more than 20% of GDP in taxes. This has been true in times of peace, war, Democrats, Republicans, deficit hawks and doves. It has been the case with a top marginal tax rate from 90% all the way down to today's rates. The reasons for this are complex, but the primary one is that people don't have to work, and there is a pain threshold beyond which they simply work and get paid less, or at least "paid less" in terms that can be taxed.
  • The Federal and State Governments cannot have in its budget, for a sustainable spending plan, items that increase in price faster than the productive output of the economy. That is, GDP growth from actual organic growth, not from debt. That in turn means that the Federal Budget cannot fund medical care as it is currently constituted in the United States. This doesn't mean we can't have social assistance for medical care in some form, but what we have right now for a medical system precludes government involvement. This is a fact and the medical industry either has to deal with it (meaning getting rid of the elements that cause this distortion) or get thrown out of the government spending bucket - in its entirety.
  • We cannot generate a nation of people who vote for a living. That is, if you receive benefits from the government and have income you must in some form pay for that government. You don't necessarily have to pay a lot, but you do have to pay. Everyone needs "skin in the game" so that their voting and political involvement, to whatever degree they are involved, reflects in some form and fashion of self-interest. Altruism is a great idea but never works in the real world.
  • Taxation must be a means of raising revenue and be entirely transparent, rather than a means of attempting to direct social policy. If you wish to direct social policy that's fine - do it with legislation. Attempting to use the tax code for this purpose is evil, especially when you hide those benefits and costs in federal law and administrative code books at the IRS that take up linear feet of space.
With these facts in place let's deal with taxes first, then spending.

There are two outcomes for taxation that will work. The first is The Fair Tax, otherwise known as HR-25. This has been filed in the last several Congressional sessions. The broad outline is:
  • It replaces all federal income taxes (including FICA, Medicare, Unemployment, personal and corporate Income tax and similar) with one consumption tax on the first retail sale of any new product or service. Transactions in used goods are exempt. The 16th Amendment is effectively repealed on an interim basis by de-funding the IRS and deleting the entire Internal Revenue Code (the authorizing law for all those other taxes) and a formal repeal of the 16th Amendment is part of the process. There are no exemptions of any sort from taxation in consumption of new products and services. The "tax inclusive" rate is set at 23% (tax "inclusive" is how federal income taxes are set now.)
  • A "prebate" is sent by Treasury to all households in the United States of US Citizens. This "prebate" contains the amount of tax that is due on poverty-level spending for that household size, in advance, on a monthly basis. This results in a household that lives at the poverty line paying no federal tax at all. Those who live at two times the Federal Poverty Line would pay an effective tax rate of 1/2 the Fair Tax rate (or about 11.5%), tapering off until at approximately 10x the Federal Poverty Line (roughly $108,000 for a single person and $223,000 for a family of four) you would be exposed to the full level of taxation (that is, 23% inclusive.) As an example a family of four that spends $44,700 a year would pay an effective tax rate of 11.5%.
If you wish to criticize or debate this option you have an obligation to read the proposed statute first. That's the only warning I'll give those who intend to comment on this thread.

The second option would be to shred the entire existing tax code and replace it as well, but with a simple bracketed flat tax. Shredding the existing code means getting rid of the fiction of FICA and Medicare taxes as "separate items"; they are in fact not, and are insanely regressive as currently constituted, as in point of fact the poor pay about 15% of their incomes in this tax from the first dollar.

An acceptable replacement would be something similar to this for single people (add 50% for a married couple filing jointly):
  • $0 - $10,000: 10% (much lower than is paid now via Social Security and Medicare)
  • 10,000 - $50,000: 15% (note this and beyond is a marginal rate)
  • $50,000 - $100,000: 25%
  • $100,000 - $250,000 : 35%
  • $250,000+: 45%
Before you howl that this is a "huge tax increase" please read the above. It is not a tax increase; it is in fact a flatting of the code. For those without tricky tax returns and deductions it is moderate tax decrease as FICA and Medicare, along with unemployment, are included in this tax. Some of these taxes are currently hidden from you, but they are in fact deducted from your pay either directly or by reduction in what your employer is willing to offer in wages.

Second, everyone must have skin in the game who earns an income. Creating a nation of people who can (and do) vote for a living will eventually, when that percentage reaches a plurality, destroy the nation. This is not conjecture, it is certainty. We're damn close to this point today, and we must avoid it.

All dividends, interest (including carried interest) and short-term capital gains are taxable at the same rate for individuals. There are no deductions of any sort and no credits, refundable or otherwise. EITC, mortgage interest and similar all go away. The 1040 tax form fits on one piece of paper.

Corporations are taxed at a flat 20% of net income. Any corporation doing business in the United States is taxed on their worldwide income subject to a set-aside for taxes paid in other jurisdictions up to but not beyond the U.S. rate. This instantly stops the "tax shifting" game that GE and others play. There are no deductions permitted for interest expense but dividends are deductible dollar-for-dollar against net income (since they will be taxed at the individual level.) We must stop the unfair competitive advantage that large multi-national corporations have against small, home-grown entrepreneurs in the current tax code. Small business is what creates jobs and they must have a level playing field to do so.

Again, the corporate 1120 tax form fits on one piece of paper.

Long-term capital gains (defined as investments held for more than one year) are taxed at 20% or your base bracket, whichever is lower. Very long-term capital gains held by individuals only (defined as held for more than five years) are taxed at 10% or your base bracket, whichever is lower.

This change in corporate tax policy would provide incentives for corporations to do what they're allegedly supposed to do - pay out their net income to the owners. Doing so is not a taxable event, but it is taxed when the owner gets the money. Retained earnings that are actually spent on development are business expenses and do not get taxed; this allows investment in R&D and similar without penalty.

Debt has no offset in the tax code, so there is no incentive to take debt. Interest is not deductible for anyone - not people or corporations. There is no reason for the government to provide an incentive for people take on additional leverage. If you wish to do it you should pay the entire cost of doing so without tax offset.

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