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Tea parties and tax reform

January 10, 2011

Is there a principled small-government position on tax policy?

Martin Sullivan says the fight over the Ethanol and biofuel subsidies in the Bush-era tax extension bill last month previews a split in Republican ranks on tax policy:

In one side were the farm state legislators trying to keep corn prices high and the profits flowing from ethanol distilleries all over the Midwest. Their ringleader was Senate Finance Committee ranking minority member Chuck Grassley, R-Iowa, who was just reelected to his sixth term with 64.5 percent of the vote. He cosponsored legislation with Senate Budget Committee Chair Kent Conrad, D-N.D., to extend the credit, along with tariffs on imported ethanol, for five years.

But for the first time, there was serious opposition to the three-decade-old ethanol subsidy: The Tea Party Movement:

"If you're wondering which of America's leaders are serious about cutting wasteful government spending, you might start by examining who's behind the effort to extend tax breaks to America's corn ethanol industry," wrote Tea Party activist Tammy Henry on her blog. David Horowitz on, another right-leaning blog, blasted conservatives for allowing inclusion of ethanol subsidies in the tax bill: "If Republicans lack the will to strike out at the heart of the dependency and welfare state after a stunning electoral victory, then when will they assert themselves?" And similarly from Lurita Doan on the conservative website "Why allow pork, such as the ethanol subsidy, to besmirch GOP efforts to restore fiscal sanity?"

Mr. Sullivan notes that some folks identified with libertarianish outfits, like Cato's Michael Cannon and Americans for Tax Reform's Grover Norquist, are unabashed loophole lobbyists. That's a position I've always found puzzling. If you don't think the government is competent to control the economy by writing checks to favored industries, why would you think they should try to do the same thing with targeted tax breaks? Spending is spending, and running it through a tax return doesn't change it into something better.

Mr. Sullivan can't resist some of the conventional nonsense about the Tea Party movement:

... the Tea Party is more famous for passion than for logic...No doubt the reform-minded academic highbrows will be squeamish about allying themselves with the anti-intellectualism of the Tea Party.

Mr. Sullivan doesn't identify the towering intellectuals in Congress or elsewhere that the Tea Party is against. It's hard to see where reliance on intellectual rigor has been a big part of politics since maybe 1789. For what it's worth, the Tea Parties would claim a few intellectuals in their corner, like Hayek and, in their view, Jefferson, Locke and Adam Smith.

Still, Mr. Sullivan accurately notes the tension illustrated by the ethanol debate. It's broader than an intra-party squabble. It's a battle between outsiders and insiders. As he points out, "Targeting tax breaks to favored constituencies comes naturally to politicians." To many traditional Republicans, the battle for power is just a fight over who controls the goodie faucet. The Tea Party activists want the faucet shut off.

The TaxProf has more.

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Simple administrative change = Revolution in taxation.
Case for the Composite Business Levy.

By Richard Hombek

The taxes we know today can be traced back millenniums, as far back as the Egyptians who were taxed in the form of crop percentages as recorded on papyrus around 3000 BC. Since then several forms of taxation have evolved and continue to do so as the system become ever more complicated and consequently, ever more inefficient.

The same business or individual can be taxed several times, even on items that are already taxed (i.e. gasoline). We have income tax, sales tax, real estate tax, property transfer tax, health tax, Employment Insurance, the Pension Plans, capital gain tax, capital tax, excise tax not even including licensing fees and tolls that could easily fill a page. The number of taxes imposed on Citizens and the level of taxation will soon reach historical highs once the full impact of the budget deficit is taken into account. And yet, we’re still ‘in progress’ as the system continually grows more complicated.

Tax codes and regulations are thousands of pages long and businesses and citizens are expected to know these regulations. It seems an absurdity, considering even specialists have to consult one another when examining the fine print of the law and even then, full compliance with all of the regulations is not a guarantee.

Imagine for a moment, the vast amount of administration costs associated with the imposition, collection and enforcement of each tax, toll and fee. To help understand this better, let’s take a look at real estate tax. To simply put a value on every piece of real estate property in a very small jurisdiction like Ontario costs $180,000,000/year and the cost of collection comes on the top of it. Annual real estate taxes in Canada amount to approximately 3% of Gross Domestic Product. Real estate properties are gradually becoming more liabilities than assets.

By using a personal experience, I can illustrate this example better. Several years ago, I was offered a research position in Westchester County in New York State. I was very excited about this opportunity and after some consideration, decided uproot my family from Ontario for a few years. One sunny spring weekend, our real estate agent took my wife and I house hunting. After visiting a few properties, a large bungalow with a swimming pool attracted our attention. The price was an extremely tempting $130.000. We couldn’t believe our luck! However, if something feels too good to be true, it probably is. The real estate tax was $26,000 a year. What does that mean? It means that if I bought the property, I would essentially be paying the local government of Westchester County the price of my house in taxes every five years. The situation in other US jurisdictions and in many Canadian municipalities has not yet reached that extreme however, we are moving in that direction.

A recent study from 2008 by Fraser Institute, estimated that the cost of compliance of tax regulations for businesses and individuals in Canada, as well as the administrative costs for the government, could reach over $30 billion per year. In the US this number is over $350 billion. The number does not include differed costs and unfunded liabilities such as pensions and benefits for the government and business employees. Also not included are the costs of lost business opportunities caused by a complicated taxation system.

The total amount of taxes collected by all levels of government in Canada is around 33% of Gross Domestic Product or in the range of $450 billion. Most people accept the fact that society needs certain levels of government and that we pay our taxes to support government activities. This should not mean however, total acceptance of wasteful and complicated methods of tax collection.

Many organizations and individuals are trying to improve the situation and offer solutions for the simplification or total overhaul of the taxation system (i.e. the Flat Tax, Fair Tax). Many of these suggestions however are politically dead at the start line because they change the current level of taxation, which would of course be opposed by all who would be subjected to increased tax obligations. For a while, I thought that any meaningful reform on the current taxation system was futile but I was wrong. What if I told you that a simple administrative change could eliminate all the taxes and complicated bureaucracy that goes along with it?

This administrative change is illustrated by using a simple mental exercise. Lets imagine that final price of the product or service to the consumer consists of the following major components:
- the cost of manpower to produce it (net pay plus all the payroll deductions)
- the cost of raw materials (net cost plus all the sales taxes)
- the cost of facilities ( rent or capital cost plus real estate taxes)
- the net income of the business
- the sales taxes.

The question is, what would happen if all net costs are separated from the taxes associated with them, then the remaining taxes are combined into one single charge?

The answer is: the creation of a new and sustainable taxation system. Let’s call this lumped together taxes and fees the “Business Levy” (BL). Created this way, the BL is not a new tax on business. It is simply a replacement as a single charge of all existing taxes already paid by the business or collected by the business on behalf of the government. This collection of all government revenues from a single source of gross business revenue will create a stable source of government revenue. So, how do we determine the BL to guarantee that the same level of government revenue collection? The solution is very simple. Let’s start with the definition of Gross Domestic Product (GDP). GDP is “the total market value of all final goods and services produced in a country in a given year, equal to total consumer, investment and government spending, plus the value of exports, minus the value of imports”. If we take the sum of government budgets at all levels: municipal, provincial and federal, and subtract from it any transfers between governments, divided by the GDP, we get an average rate of “Business Levy.”

For a country like Canada, with complex taxation jurisdictions, we have to slightly complicate the system by introducing a “Composite Business Levy” (CBL), which consists of a federal, provincial and municipal component. The level of CBL will be determined for each sector of the economy and in each jurisdiction to reflect the current level of taxation. This will be a one-time exercise at the introduction of the new system. By taking this approach, taxes collected in specific provinces will be allocated to the respective province. Each taxation jurisdiction will retain freedom of changing their part of the CBL.

This system, very simple in nature, is able to replace all the tax codes and regulations. As a consequence, business and personal financial decisions will be made based on the outcome of transactions without tax implications.

Since business payroll deductions are included in this system, employees will receive the net pay under the new system to avoid changing of the total money supply in the economy and avoid inflation. All programs and benefits provided by the government will be fully financed and the administrative savings will give the governments new resources for extra stability. Capital gain and interest income are not considered as business revenue under this system. The combination of that and net employment income will allow individuals not involved with business activities out of the tax regulations and obligations. Business real estate taxes are automatically part of the BL system. Residential property taxes are also included in the scheme and financed partially by administrative savings offered by the new system. A slight increase in BL (1-2%) could be transferred to consumers in the form of a price increase.

The positive consequences of this approach will touch every citizen and business. Specific outcomes for each sector of economic activities will be described in separate articles. Displaced employees involved in the current taxation system could be transferred to other government departments, which experienced manpower deficit or presented with generous transition packages.

This approach to the taxation system reform is a realistic, politically and economically attractive for many reasons:
- saves more than $30 billion in Canada and $350 billion in USA a year
- eliminates all tax regulations
- makes country with such taxation system, very attractive place to do business
- does not change the level of taxation of any party involved
- does not change the money supply in the economy
- reduces the cost of services and goods manufacturing
- keeps individuals not involved in any business out of taxation system
- stable source of revenue related to GDP.

The economic impact of this reform can significantly reduce the budget deficits on federal and state/provincial levels. The governments can focus on governing and not be preoccupied with the revenue generation.
The collection and distribution system of government revenues is fully automated. The governments will have real time economic statistics for each sector of economy and each jurisdiction.

The implementation of this reform is very simple at negligible cost. What will be required to be a reality?
On the government side: determination of the average Composite Business Levy for each sector of economy in each jurisdiction (one time exercise), voiding all tax regulations and dealing with displaced employees.
On the business side: opening the special bank account called “Business Gross Revenue Account”. Any business gross revenue must be deposited to this account. The only functions of this account will be: retaining the information on the source of the revenue and redirecting the money to Government General Revenue Account according to Composite Business Levy and to business operating account.

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