03 February 2010

Tax Reform: The Way Forward For The Economy And The Federal Deficit

There are those who may argue that what is shown on television does not change behavior. But the accuracy of that statement is belied by the billions spent on television commercials. Of course television changes behavior. Ask any advertiser.

The same can be said for taxes. The presence (or absence, if such a thing can be imagined) of taxes changes behavior. Anyone who might argue otherwise should talk to a politician, who knows to use the tax code to influence, to reward friends, and to alter patterns of behavior.

With the Administration’s proposals regarding the increase in taxes for higher-income earners, another step is taken along the path of increasing the complexity of the tax system. Since the Tax Reform Act of 1986, the tax code has been complicated by its use by politicians to influence behavior and to effect social change. From Clinton ’s Tax Relief Act of 1997, to Bush’s tax credits and modifications in 2001 and 2003, the tax code has grown in complexity, and has moved further away from its basic and oft-sidelined purpose, to raise revenue for the federal government.

The tax system becomes increasingly burdensome, opaque, unfair, and inefficient. The United States now has one of the most complex and unbalanced tax systems in the world. With the exemptions, loopholes, and credits, the ability of the government to fairly raise revenue has been hampered, at a time when we are living beyond our means, and could use the revenue to slow the rate of our indebtedness to China.

Further, we are looking at a period when stimuluses, job programs, bailouts, and industrial takeovers are failing to revive the economy. Economists make the argument that even more spending is needed to keep the economy afloat while simultaneously the historically high public indebtedness and the large amounts of money pumped into the system by a panicked and desperate government, are causing our nation to teeter on the precipice of economic disaster.

The current situation is unacceptable, untenable, and unsustainable.

NY Times: Deficits May Alter U.S. Politics and Global Power

Unless miraculous growth, or miraculous political compromises, creates some unforeseen change over the next decade, there is virtually no room for new domestic initiatives for Mr. Obama or his successors. Beyond that lies the possibility that the United States could begin to suffer the same disease that has afflicted Japan over the past decade. As debt grew more rapidly than income, that country’s influence around the world eroded.

Or, as Mr. Obama’s chief economic adviser, Lawrence H. Summers, used to ask before he entered government a year ago, “How long can the world’s biggest borrower remain the world’s biggest power?”

Republicans stayed largely silent about the debt during the Bush years. Democrats have described it as a necessary evil during the economic crisis that defined Mr. Obama’s first year. Interest in a long-term solution seems limited. Or, as Isabel V. Sawhill of the Brookings Institution put it Monday on MSNBC, “The problem here is not honesty, but political will.”

The question is presented: what to do? How do we work our way out of the situation in which our profligate past is catching up to our profligate present?

The first thing we should do, both to provide a lift to the economy and to assist in the repair of our public finances, is tax reform.

Tax reform would provide a boost to the economy, by removing the draining cost of tax compliance. Tax reform would end the distortion of our economy. A reformed tax system would allow individual economic decisions to be based on financial needs, not to avoid adverse tax implications. The invisible hand of the marketplace would replace the controlling hand of cynical and corrupt Congressmen and bureaucrats. It would remove billions of dollars of unnecessary costs from our economic system, in effect pumping money into the economy in the most efficient manner possible.

Further, tax reform would allow for the fair raising of revenue at a time it is sorely needed, by broadening the tax base. More would pay their fair share. It is better that many would pay a little bit, raising billions, and giving more citizens a stake in the system.

Also, and this is very important, tax reform would increase the fairness of the tax system by ensuring that the wealthy pay their taxes. Politicians may currently raise the upper tier of rates, but how may of the wealthy actually pay those rates? The same politicians that talk about “soaking the rich” also make sure that when no one is looking, plenty of loopholes and exemptions are available for the same wealthy donor whom they were bashing in public. With tax reform, all could pay their taxes with the assured feeling that all were paying their fair share.

The preferred vehicle to effect this tax reform is the Flat Tax. The Flat Tax adheres to the principle of a consumption tax: people are taxed on what they take out of the economy, not on what they put in. Flat Tax proposals would eliminate provisions of the tax code that bestow preferential tax treatment on certain behaviors and activities. Getting rid of deductions, credits, exemptions, and other loopholes also helps solve the problem of complexity.

As much as the Flat Tax is the best way to reform the tax system, other ideas and tax reform proposals exist that would accomplish much of the same.

The situation must be righted before we are led to our financial ruin by feckless Democrats and Republicans. The current path were are on is clearly one of eventual disaster, default, and increasing poverty. Now is the time for reform. It is time to correct our course, to reinvigorate our economy, and to repair the public finances. It will take some sacrifice and political will, but is far from an impossible task.

If our current political parties and politicians are not up to the task, then they must be made to yield to those who will: candidates with the leadership and foresight to lead. Candidates who will truly embrace and enact the change this nation needs. But before that can happen, we must each change our attitudes and be ready to support the candidates who are brave enough to speak the truth about the problems facing our nation.

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