The Value-Added Tax: A New Tax System for the United States
Joseph George Caldwell, PhD
Originally published as
How to Stop the IRS…and Solve the Deficit Problem
November 16, 1987
Printed in the United States of America
This e-book edition November 8, 2000
Copyright © 1987, 2000 by Joseph George Caldwell. All rights reserved.
To the memories of George Orwell and Dr. E. Fritz Schumacher
To Mom and Dad, in Spartanburg
To Jay, Chris and Steve
Tables and Figures
The Value-Added Tax: A New Tax System for the United States proposes elimination of the personal and corporate income tax system in the United States. The central theme of the book is that the income tax system is not only a bad tax system from an economic viewpoint, but that it has severe political and sociological drawbacks as well. The book describes how the invasion of privacy and authoritarian tactics on which the current system is based have seriously damaged the relationship of the US citizen to his government.
The book describes the inadequacies of the current US tax system; its incredible complexity; its undesirable economic incentives which discourage saving, investment, and economic growth; the high administrative cost; the instability in government revenues caused by a narrow, volatile tax base; the incentive for wasting productivity in tax avoidance; the problem it causes in international trade; the invasion of privacy; and the tyranny of the IRS. The book shows how the Tax Reform Act of 1986 has not solved the fundamental problems of the income tax system, and explores why the US Government has perpetuated such a bad tax system for so long.
A major problem with the current US tax system is its inability to produce a sufficient level of revenue to cover desired government programs. The current system has resulted in massive government deficits and extreme wealth concentrations that threaten US and world economic collapse. The new tax system proposed in this book addresses these problems; it can help avoid economic collapse and reduce the severity of depressions.
The historical development and inadequacies of the US tax system are summarized. The archaic legislative process by which the current system was developed is described, and a modern approach to "tax engineering," based on the concepts of systems analysis and systems engineering, is presented. Alternative tax methods are identified, and the advantages and disadvantages of each method are discussed. A new tax system, based on the value-added tax, or "VAT," is proposed. The book shows how the VAT can raise the same or greater revenues as the current income tax system, but with far less economic, political, and sociological cost. The new system takes a humanistic approach to taxation: the tax system is viewed as a servant of the citizen, rather than his master. The VAT is a practical and feasible alternative to the income tax system.
Through the income tax system, the US Government has set up an elaborate and powerful police-state system for regimentation of the individual citizen. You are registered and monitored, and have lost not only your privacy but also most of your Bill of Rights personal liberties to the IRS. This book tells how you can help eliminate the income tax and stop the intrusion of the IRS into your life.
Joseph George Caldwell is the author of The Value-Added Tax: A New Tax System for the United States. A variety of experience has forged his views on taxes and privacy.
He has conducted, directed, and supervised a variety of economic studies, including studies in cost-benefit analysis, public finance, and tax policy analysis, in the US and foreign countries. He directed studies to develop alternative state allocation formulas for the vocational rehabilitation program and alternative matching formulas for the Medicaid and Aid to Families with Dependent Children (AFDC) programs. In Haiti, he supervised tax policy studies of agricultural commodities (coffee, cotton, sisal, mangoes, and meat); the goal of these studies was to develop tax policies that could improve the incomes of small farmers and increase the country's foreign exchange earnings. In the Philippines, he directed efforts to assess the social and economic impact of development projects, including the role of women as beneficiaries and facilitators of development.
A professional statistician, he has designed numerous national sample surveys, and is familiar with the constraints that the Privacy Act of 1974 and the Freedom of Information Act place on the use of information about individuals, both by the government and other organizations. He designed the statistical sampling systems for several state/federal programs. Having made heavy use of the computer since 1960, he is well aware of its power in storing, merging, and retrieving data on individuals.
He has supervised economic development projects in the Caribbean, Southeast Asia, and Africa. In his work as an international development consultant, he has had the opportunity to observe foreign governmental systems firsthand, and to consider both the restrictions that they place on the freedom of their citizens and the opportunities that those systems afford their citizens to effect political change.
As a university professor, he has had the time and resources to reflect on the problem and formulate a solution. Based on his experiences, the income tax / privacy situation in the US is an alarming one, and needs correction.
Dr. Caldwell holds a PhD degree in mathematical statistics from the University of North Carolina at Chapel Hill and a BS degree in mathematics from Carnegie Mellon University.
This is a book about freedom -- your freedom to be a private individual, unmonitored by government. That freedom has been lost in this country -- slowly but deliberately taken away -- ever since the advent of the personal income tax and the requirement to register for the Social Security Number, or SSN.
The only way to regain your freedom is to fight back now. You can stop the IRS by expressing the conviction that it is time to eliminate the personal income tax and the requirement to register for personal identification. This book tells why and how.
But wait! you may say. The government needs tax revenue to pay for everything that the citizens of a modern country demand: defense, roads, environmental protection, education, public safety, public health, and social services. That is true. Government revenue is needed, and this revenue is derived from taxes. What is objected to is the type of taxes used and the structure of the tax system.
The US tax system is a mess. The Tax Reform Act of 1986 has not addressed the fundamental inadequacy of the income tax system. The problem is not simply one of a complicated, burdensome, unfair income tax system. The US tax system cannot produce the level of revenue needed by a modern economy. It resulted in such massive deficits that the US domestic credit market could not cover them; as of 1985, the US is now a debtor nation, owing vastly more to foreign nations than they owe to us. Furthermore, the US tax system has failed to prevent extreme concentrations of wealth. The massive US debt and extreme concentrations of wealth contribute to an unstable situation that threatens US and worldwide economic collapse.
It is clear that leaving the selection of the tax system to politicians and economists has produced a disaster. Not only has an incredibly complicated tax system resulted, with the tax base defined by thousands of IRS regulations, but the system cannot raise the needed revenue. It is time for us to demand a simple, fair system that has good economic and sociological features.
This new tax system does not have to be complicated; taxes can be as simple as sales taxes and yet be very effective from an economic viewpoint. The tax base and rates do not have to be defined by thousands of IRS regulations. Having a complex tax system may serve to produce income for the tax lawyer, tax accountant, and tax preparer. But it does not serve you, the US citizen, well.
A complicated tax system is an economist's delight. A thousand PhD dissertations can address the intellectually stimulating tasks of defining income, measuring the "equity" associated with particular taxes, or predicting the economic impact of various tax changes. The federal government employs legions of economists concerned with the study of tax impact. Much of this effort is wasted on a tax system that is needlessly complicated. The evolution of the current tax structure, with its profound faults, demonstrates that tax policy is too important to leave to politicians and economists. The tax system that has evolved is a monstrosity. It is going to be up to us -- the US citizenry -- to correct this situation. And the way to begin is to advocate elimination of the income tax.
The idea of eliminating the income tax is not new. Until now, however, the idea has surfaced primarily through scholarly treatises on tax policy, or through news accounts of "crackpots" who refuse to pay on the basis of their claim that the income tax is unconstitutional. The objective of this book is to describe, in plain language, why the personal income tax is a bad tax and should be eliminated. It shows you how this tax is very costly to administer, is invasive of the privacy of individuals, encourages the waste of billions of dollars in tax avoidance efforts, and places the US at a disadvantage in international trade. You'll also learn why the personal income tax is impossible to justify on the basis of equity, or "ability to pay," and has undesirable economic side effects, including the discouragement of saving, investment, and production.
Throughout this book the term "personal income tax" is used rather than "individual income tax." Since the tax is levied on your family as much as on you as an individual, the term "personal income tax" is more descriptive of its true nature.
The corporation income tax creates as many problems as the personal income tax. This book tells you why it, too, should be eliminated. Actually, the term "corporation income tax" is a misnomer; the tax is not a tax on income; instead it taxes business profit. For this reason, in this book it is generally referred to as the "business profit tax."
In a free-enterprise economy, the last thing the government should tax is profit. The business profit tax discourages you from earning a profit while it encourages you to distort your business decisions and accounting to minimize your gains. Like the personal income tax, the business profit tax encourages the waste of productivity in tax avoidance efforts. Effort is also wasted in the attempt to estimate profit.
The business profit tax has the additional disadvantage of volatility (extreme fluctuations from year to year). This volatility makes government budget planning difficult and contributes to an increasing national deficit. When you have finished this book, you will not only have a full understanding of this weakness of the business profit tax; you will also be prepared to advocate an alternative that can improve the health of the national economy.
You may ask, if the income tax system is so bad, why does the US Government cling to it so tenaciously? As later chapters will show, the government's commitment to maintaining the income tax is based on the fact that the system provides a justification for intruding on the privacy of the entire population of the US.
In a situation such as a national health threat, large-scale invasion of personal privacy by the government may be warranted. In the case of the income tax, however, the government has set up an arbitrary system of rates and regulations that is totally unnecessary from an economic or other general-welfare viewpoint. The IRS then rigorously monitors all citizens to enforce compliance with these rules. The reason behind this monitoring and its dependence on the use of the SSN as a universal unique identifier are explained in detail in this book.
If the income tax is so bad, why has it lasted so long? There are several reasons. First, tax literature is arcane. The discussions about the inadequacies and costs of the income tax are found in academic journals and economic textbooks that are not widely read. Academic economists have criticized the income tax for years, but no one is reading their books. The US public is, in general, simply unaware of this literature, although it spans decades. Furthermore, the analyses of economists center on the assessment of the worth of a tax from the point of view of economic criteria. Except for the concept of ability to pay, their writings on alternative tax systems have essentially ignored sociological considerations such as regimentation, loss of personal rights, invasion of privacy, and the establishment of what amounts to a national police force for tax enforcement.
Second, the US Government has waged a propaganda campaign of massive proportions, touting the income tax as a beneficial, voluntary tax. It has steadfastly refused to give serious consideration to more humane forms of taxation, leading to the erroneous belief on the part of the public that an income tax is an absolutely necessary component of the country's tax system. The public now confuses the government's need for tax revenue with the need for an income tax. The former is necessary, the latter is not.
Through the income tax system, the US Government has set up an elaborate police-state system of regimentation of individual citizens. You are registered and monitored, and have lost not only your privacy but most of your Bill of Rights individual liberties to the IRS. This book tells how you can help eliminate the income tax and stop the intrusion of the IRS into your life. It describes a practical alternative to the police-state income tax system.
This book is not concerned with the issue of how much
money the government needs to conduct its operations. It addresses only the manner in which it
collects that money, and the identification of a system that can collect
sufficient revenue to avoid deficits.
There are many types of taxes: individual income taxes, sales taxes, corporate income taxes, payroll taxes, excise taxes, import taxes, property taxes, inheritance and estate taxes, and many more. Some of these taxes are more intrusive than others; that is, they require the government to obtain more information about you.
The personal income tax and property tax are especially intrusive taxes. They require the government to know who you are, how much you earn, how you spend it, who your family members are, what you possess. Other taxes, such as sales taxes, are nonintrusive -- they can be collected while protecting your privacy or even maintaining your anonymity. The value-added tax, or VAT, popular in Europe and around the world, is a prime example of a fair, efficient, nonintrusive tax. Details regarding the success of this "good" tax are presented in Chapter 15.
The worldwide growth of the VAT has been astounding. Since 1954, 39 countries have adopted VAT-based tax systems. It is a superior tax system that deserves consideration in this country. This book aims to overcome the problems that have prevented its acceptance in the US for so long, by taking the case for the VAT to the American people. The target audience for this book is the US public. It brings the issues out in the open and explains them in detail. It describes the drawbacks of the income tax in plain language, exposes the excesses of the enforcement system that is necessary to implement it, and shows how the VAT can avoid these problems.
Given the fact that the VAT is a tried-and-true tax, the basic proposals of this book are simple. First, eliminate the personal income tax and the business profit tax, replacing both with a VAT. Second, eliminate the requirement for individuals to possess a unique identifier, such as the SSN, and prohibit the government at every level from maintaining general systems of records on individuals.
These basic proposals have been derived from an analysis of a wide range of possible tax systems, using the principles of systems engineering. This scientific approach is a vast improvement over the archaic, unsystematic, hit-or-miss legislative procedures that have produced the hodge-podge of our current income tax system.
If these simple systems-engineering-based proposals are adopted, the government can collect exactly the same amount of tax revenue that it currently collects (or more), but without the need for maintaining files on individuals. IRS tracking of individuals is, at the very least, a severe intrusion into the private affairs of US citizens, and, in the long run, is a serious threat to liberty. Furthermore, it is not necessary.
This book is not against taxes -- it maintains that everyone should pay his fair share. The current system, however, is not fair. It is very costly to administer, has extremely high compliance costs, is extremely intrusive of privacy, and creates undesirable economic incentives. It is time for this system to change. This book shows how you as a private citizen can finally stop the IRS.
The day of reckoning has arrived. American citizens must choose, now, between continuing on a course that subjects them to constant monitoring, forced exposure, and control by a central government and dooms them to a future of oppressive regimentation, versus striking out on a bold, new, humanistic course -- based on a concern for the private dignity of the citizen and oriented toward the development and fulfillment of US citizens as unique individuals.
By now you must realize that this book is not simply a primer on tax policy analysis; it advocates the implementation of a particular tax system, which, although derived from the results of scientific analysis and systems engineering, is essentially a value judgment. The preferences that I express may not be your preferences. Because of the critical importance of tax policy to our society, I strongly encourage you to use this book to become aware of the basic concepts of tax policy. You can then use these concepts to form and express your own preferences regarding the choice of a new tax system.
Books on tax reform do not sell well. Books on the abuses of the IRS do not sell well. Then why another book on the IRS and the inadequacies of the US income tax system? Well, there's a big difference. This book offers a solution to the problem. It presents a feasible replacement for the income tax that eliminates the need for the IRS to enforce tax collection on individuals. You can spend a lifetime complaining about IRS abuses and how constitutionally guaranteed freedoms have been trampled on by the government. Unless an alternative method is found to collect the needed revenue, however, these offenses are going to continue. If you want to stop the IRS from interfering with your life, liberty and pursuit of happiness, and if you want to regain the freedoms that were promised US citizens by the Constitution, this book tells you how. But freedom is not free. Your help is needed to restore the Constitution and make America once more the land of the free.
The task of eliminating the income tax will not be easy. As has been done in the past, the government will attempt to summarily dismiss consideration of the proposal to eliminate the income tax with a variety of responses that dodge the issue: "impractical" … "not a serious alternative" … "the proposal to repeal the income tax is naive" … "taxes have to be complicated to be fair" … "all developed countries have income taxes." Faced with strong arguments for elimination, and having no strong arguments for continuation, the government will attempt to perpetuate the income tax system by "stonewalling": by refusal to discuss and consider its replacement, just as it has refused to hear constitutional arguments against the tax in its "Tax Court." This book rejects those emotional appeals for continuation of the current system and challenges you to consider factual arguments why the income tax system can and should be replaced.
Some may criticize this book, saying, "If you don't like the way it is in the US, then leave." Before continuing, let me emphasize one point. In spite of its imperfections, I consider the US to be the greatest country in the world. In my opinion, there is no other country that surpasses it, overall, in terms of personal freedom, economic opportunity, freedom of expression, encouragement for self-development, diversity of opinion, technical and marketing creativity, scenic splendor, abundance of natural resources, efficiency of agriculture, tolerance of nonconforming points of view, standard of living, freedom of mobility, geographic and climatic variation, cultural diversity, ambition, generosity, courage, compassion, and independence.
And, I want to keep it that way.
With the exception of war and the human population explosion and the potential for global environmental disaster that it has spawned, the current unwarranted intrusion of the US Government into the lives of its citizens is the greatest threat to our freedom and democratic system that currently exists. This book describes the nature of that threat and ways that you can act to reduce it. I urge you to actively use this information today to take back your freedom.
The US tax system has an interesting history. The current system is an amalgamation of tax methods from many times and places: the income tax from England, the inheritance tax from France, sales taxes from the Dutch and Spanish, and property taxes from China and medieval Europe. The initial direction of the US tax system was set by the drafters of the US Constitution. They were concerned, in proposing a federal government with considerable power, that its tax powers be restricted. A principal cause of the US Revolution was "taxation without representation." To ensure a strong link between taxes and representation under the new government, the framers of the Constitution specified that all collections from "direct" taxes be apportioned, or allocated, to the states in proportion to their populations.
A direct tax is a tax exacted directly from the person (or entity) on whom the ultimate burden of the tax is expected to fall. In other words, it is a tax for which the ultimate burden falls primarily on the taxpayer: it is not "shifted forward" to others. Examples of direct taxes are income taxes, property taxes, and capitation taxes (a capitation tax is a head tax, such as a poll tax). An "indirect tax" is one for which the ultimate burden is shifted to someone else. Examples of indirect taxes are general sales taxes, excise taxes, and tariffs. When these taxes are generally applied, they have the effect of raising the price of a product, so that the tax burden is passed along to the purchaser.
It is not always easy to determine whether a tax is a direct tax or an indirect tax. In many cases, the burden of a tax levied on one source is shared by several sources. Consider, for example, the case of a city sales tax in an area where there is no county sales tax. Because consumers have the option of shopping in the county, merchants in the city may not be able to shift the entire tax forward to consumers. City merchants will have to absorb some of the sales tax (by lowering their profits, wages, or cost of other inputs) to remain competitive. It may be troublesome for consumers to travel to the county, however, so that many do not bother. In this case, part of the sales tax will be borne by the merchant and part by consumers.
In addition, part of the burden may be borne by the workers if the merchant tries to absorb some of the tax by lowering wages. The extent to which the merchant can do this depends on how sensitive workers are to wages. If they are willing to relocate to the county, the merchant will not be able to suppress wages. If they are unwilling to relocate (or to change jobs to a nonretail firm that does not pay the sales tax), he will be able to.
In general, the determination of the "incidence" of a tax (that is, determination of where the burden of the tax falls) is difficult. It is not only difficult to characterize qualitatively how the burden is distributed, but in some cases economists are even in disagreement about on whom the primary burden probably falls.
Unfortunately, the US Constitution did not specify which taxes were considered direct or indirect, nor did it provide a definition; the Supreme Court has had to make this determination.
The Constitution established a strong central government, and the framers of the Constitution wanted to limit its taxing authority, both to ensure a strong correspondence between taxes and representation and to preserve the sovereignty of the states. Also, the framers were wealthy landowners, who wished to restrict the ability of a strong central government to tax land. The framers originally required that all federal taxes be apportioned in proportion to representation (population), but modified this in the final version to the requirement that all federal direct taxes had to be allocated proportional to representation.
At the time the US Constitution was framed, the principal federal taxes were expected to be taxes on commerce, imports, and consumption, such as tariffs and excise taxes. The framers did not require that these taxes -- which were indirect in nature -- had to be apportioned to the states in proportion to population.
For many years, the US Federal Government was able to support federal activities through various indirect taxes, primarily the tariff. To meet the extraordinary costs of the Civil War, however, the federal government imposed a temporary federal income tax (1862-71). The income tax was levied as a temporary war measure. It was objected to as a permanent measure for several reasons: after the war, it was no longer needed; it was inequitable; agreement could not be reached concerning a definition of income; and its administration was inefficient and intrusive.
The federal income tax was reinstituted in 1895, but was declared unconstitutional because it represented a direct tax that was not apportioned to the states.
In 1909, the corporation income tax was established. Represented as an excise tax on business, its imposition circumvented the constitutional difficulties relative to an income tax. It was imposed at a very low rate -- 1 percent.
In 1913, the Sixteenth Amendment to the US Constitution was ratified. This amendment permitted the federal government to levy and collect a federal income tax, without the requirement to allocate the collections to the states in proportion to population.
Income taxes were established as the result of a quarter-century effort to promote tax equity and reduce great concentrations of wealth. Federal tariffs were considered to impose an unfair burden on certain sectors (labor and agriculture), and income taxes were viewed as a means of redistributing income and wealth.
The personal income tax started out as a tax on a very limited portion of the income of high-income earners -- a tax of only 1-7 percent on a very small proportion (about 1 percent) of income earners. The personal exemptions ($3,000 for single persons, $4,000 for families) exempted most families from taxation. The 1 percent rate applied to income up to $20,000 -- a very large income in 1913. The 7 percent rate applied to people earning over $500,000 per year.
Until the 1930s, state and local governments depended primarily on the property tax for revenue. When property values fell during the Depression of the 1930s, tax revenue fell correspondingly. It was not possible to raise the needed state and local revenue from property taxes, and the state retail sales tax was established as a major new source for state and local revenue.
A massive increase in revenue was needed in order to cover the massive cost of World War II. In response to this need, the federal personal income tax was converted from a tax on relatively few high-income earners to a tax on the general population. Exemptions were reduced, and taxes were withheld from income as it was paid. Aware that few families could save the large sums now required to pay the income tax, the government passed the Current Tax Payment Act of 1943, which required employers to withhold the anticipated amount of the income tax from wages and salaries.
Since World War II, federal income tax levels have fluctuated around an average of 10 percent of total personal income. Many changes have occurred, however, in the nature of this tax. Since income tax brackets were not indexed to inflation, the phenomenon of "bracket creep" occurred -- moderate-income earners (skilled workers and professionals) were driven into high tax brackets. The total income tax (including federal, state, local, and payroll taxes) has risen for these taxpayers from 20 percent of total income in the 1950s to over 50 percent today.
Under a single-rate, or flat-rate tax, the tax burden remains constant over time, regardless of the rate of inflation. Under a graduated (multiple-rate) system having higher rates for higher incomes (that is, a progressive system), however, the tax burden increases if inflation occurs and would decrease if deflation occurred. Inflation occurs in virtually all economies, and the tax burden corresponding to a specified set of tax brackets hence increases as incomes grow due to inflation and individuals are forced into higher and higher brackets. This phenomenon is called bracket creep.
Bracket creep was an important vehicle by which the US Government implemented massive increases in the income tax rates for many taxpayers over the last half-century. From the viewpoint of the government, bracket creep is a highly desirable way of raising taxes because people do not notice that it is happening. It goes largely unnoticed because it happens slowly -- rates in nearby brackets are close in magnitude and the rate of inflation is relatively low.
Most inflation is due to government monetary policies. It occurs when the government prints new money at a faster rate than the economic growth of the economy. It does this when it wants to spend more than it receives in the form of tax revenue. Inflation can occur from factors beyond the government's control, such as when a foreign government increases the price of a commodity we want, such as oil or platinum. For the US economy, the effect of inflation from exogenous, or foreign, factors is generally small, compared to the effect of the government's spending more than it receives. Essentially, the US Government caused most of the US inflation and was principally responsible for the effects of bracket creep.
US taxpayers accepted bracket creep, generally without a whimper, even though its effects have been dramatic. They objected vociferously to the 10 percent tax surcharge imposed during the Vietnam War, but hardly complained over much greater tax increases because of bracket creep.
After more than 50 years of bracket creep, with much of the population now in high tax brackets, the problem has finally been addressed in the Tax Reform Act of 1986. Tax brackets will henceforth be adjusted each year for the effects of inflation, by shifting the brackets by the percentage change in the US Department of Labor's all-urban Consumer Price Index. Why did the government wait so long to implement this change? Now that the horse has escaped, the Congress has closed the barn door.
The revenue demands of the US Federal Government have been steadily growing, for example, from about 25 percent of gross national product (GNP) in 1955 to about one-third of GNP today. Currently (1981 data), the breakdown of US tax revenues is individual income (37.7 percent), corporate income (8.6 percent), payroll (26.5 percent), goods and services (17.6 percent), property (8.6 percent), and inheritance and gift (1 percent). Individual income and payroll taxes account for 64.2 percent of total revenue, and corporation income taxes another 8.6 percent. As the revenue requirements of the US Government have increased, the burden of income taxes has become very heavy (50 percent) on a large portion (20 percent) of income earners. The base of the business profit tax is narrow and sensitive to economic conditions. The business profit tax is highly volatile; the amount of revenue it produces fluctuates wildly from year to year.
One of the features of the tax system in the US (and, indeed, in most countries) is that the government imposes taxes on a very large number of sources. A practical benefit of having many tax sources is that the tax rates may be kept low; low tax rates lessen citizen objection to taxes; lessen the incentive to spend time in tax avoidance; and lessen the incentive to engage in tax evasion. Having many tax sources also enables the government to hide taxes and promote the impression that the total tax burden is not very high.
There is a large variety of ways in which the government may tax its citizens. The decision about how to allocate taxes among these possible sources is arbitrary. From the viewpoint of the government, it is preferable to tax many points in the economy to make it appear that the total tax burden is not great. That is why there are income taxes, payroll taxes, sales taxes, property taxes, luxury taxes, gasoline taxes, telephone bill taxes, natural gas bill taxes, electricity bill taxes, water and sewage bill taxes, cigarette taxes, alcohol taxes, motel room taxes, federal income taxes, state income taxes, local income taxes, Social Security taxes, unemployment compensation taxes, real estate taxes, personal property taxes, severance taxes, and automobile license taxes. One of the reasons why the government will resist abolition of the income tax is that it will then have one less tax source, and some other tax rate (for example, a business tax rate or a payroll tax rate) will have to be increased to obtain the same total revenue. The government may very well go along with adding another tax, such as a VAT, but it will likely fight the abolition of the personal income tax and the business profit tax. Most taxes, once established, last for a very long time. This is true even of temporary taxes, such as excise taxes levied in wartime.
The government generally prefers to hide taxes from the
consumer to make it appear that the tax "bite" is less than it really
is. That is, it prefers that the tax
component of the price of an item not be indicated to the consumer. Traditionally, US citizens prefer to see a
sales tax or an excise tax explicitly indicated as an "add-on" to the
pretax price. They do not mind, however,
having other taxes (for example, payroll tax, corporation income tax) hidden in
the price. A few years ago, a 10 percent
tax was imposed on airline tickets. The
government did not want consumers to be reminded of this tax, and it was
initially hidden in the ticket price. In
response to consumer objection, however, the tax is now explicitly shown.
A number of previously explicit excise taxes are now hidden. Gasoline taxes are no longer displayed on gasoline pumps, and cigarette and alcohol tax stamps are no longer displayed on these products.
Today, the US Government has large revenue requirements (one-third of the GNP), and the tax base is too narrow and too volatile to dependably provide the needed revenue at reasonable tax rates. Large federal deficits have occurred because of this narrowness of the current tax base and its instability from year to year. The narrowness of the tax base makes it necessary for rates to be unreasonably high; the volatility of the tax base causes revenue to fluctuate from year to year. Fluctuating revenues have contributed to deficits because during boom times the government does not use the surplus revenues to cover the deficits of lean times. Instead, it introduces additional spending programs or reduces taxes, causing budget deficit increases with each recession.
A large federal deficit is undesirable for several reasons. It causes inflation, cruelly eroding the lifetime savings of older citizens. Government borrowing to cover the deficit uses up available credit and forces interest rates up, possibly to very high levels. Lack of private-sector credit at reasonable rates stifles business development. If uncorrected, the large federal deficit can ultimately lead to economic collapse, both here in the US and abroad.
While the US has been struggling with its income-tax-based system, the rest of the world has moved on to tax systems that are better suited to modern economies and the international economic community of nations. Following World War II, many of the world's nations have agreed to a set of international trading rules, or code of commercial conduct, called the General Agreement on Tariffs and Trade, or GATT. The purpose of the GATT is to promote world peace and development by promoting international trade. Countries that agree to follow GATT rules are called contracting parties; as of December 1986, there were 92 contracting parties, including all developed Western nations, numerous developing nations, and several Eastern-bloc countries. The members of GATT account for 85 percent of international trade today. A brief history of the GATT is presented in the 1987 Economic Report of the President.
The GATT specifies permitted tariffs; it defines the ways in which a country can subsidize its exports and impose border taxes on imports. Generally, the GATT prohibits quantitative restrictions on international trade and outlaws export subsidies for nonagricultural products. Under the GATT, a nation may exempt its exports from indirect business taxes that it has imposed on them, and may impose a border tax equal to that amount on its imports from other countries. These procedures are called border tax adjustments.
The rationale for this approach stems from the view that a generally imposed indirect tax raises the price of an item approximately by the amount of the tax. While a government may impose indirect taxes on its domestic products in ways that cause few problems, there is a drawback, however, in attempting to levy indirect taxes on citizens of other countries. Other exporting countries may not tax their exports, placing them at a significant competitive advantage. By similar reasoning, the border tax is imposed on imports to ensure that untaxed foreign goods are not given an unfair competitive advantage relative to domestic goods, which have to pay indirect taxes. As an indirect business tax, the VAT qualifies for this type of preferential treatment.
Since many of the world's nations have switched to the VAT, the US is now "out of harmony" with many of its international trading partners. They subsidize their exports and impose border taxes on imports at the VAT rate, which averages about 20 percent worldwide, but the US cannot do the same with its income tax. The income tax is a direct tax, which does not qualify for GATT preferential treatment. It is not possible to estimate the extent to which the income tax raises the price of an item intended for export, so there is no reasonable basis for establishing a border tax adjustment. Even in the face of the rapid spread of the VAT to nations around the world, the US Government steadfastly has refused to consider a VAT. By clinging to its income-tax-based system, it thwarts efforts aimed at international tax harmonization. The prices of our products may be affected by the income tax; no adjustment is made for this effect. Our products do not compete in the world marketplace on the same basis as products from VAT-using countries.
In retrospect, whatever their reasons may have been, the framers of the US Constitution made a good choice in prohibiting the federal government from imposing an income tax. While the original concept of the income tax may have been to tax only a few high-income earners, the tax base has been expanded to include most of the population as the revenue requirements of the government have grown. Had the income tax not been established, the growth in federal tax revenue would have been in constitutionally approved indirect taxes, such as the sales tax or the VAT.
Use of the personal income tax as a mass tax has violated the privacy of virtually all US citizens, for no good purpose. This lost privacy could be recovered if the Sixteenth Amendment were repealed, and if the federal government were to return to the use of indirect taxes. Of course, since the states have followed the example of the federal government in imposing state personal income taxes, they too would have to be denied the use of the personal income tax, to restore individual privacy.
When it was first established, the serious drawbacks of the income tax were not anticipated. Simply defined and imposed at low rates on a small proportion of the population, the tax did not result in serious social or economic problems. In introducing the income tax, however, the creators of the Sixteenth Amendment had no idea of the Pandora's box they were opening. As the rates were raised, the drawbacks became evident. At low rates, a voluntary collection system worked; at high rates, a strong national police force -- the IRS -- was needed to enforce collection. By its very nature, the income tax reduces the incentive for the individual to work and to save. At low rates, these incentives are negligible; at high rates, they cause noticeable changes in behavior. At low rates, there is little incentive for tax avoidance and evasion; at high rates, the incentive is strong and many taxpayers succumb. Applied to a small proportion of the population, the income tax invades the privacy of only a few; as a mass tax, it invades privacy on a grand scale.
The income tax creates disincentives for firms to save, to invest, to be productive and efficient; the income tax subsidizes debt financing over equity financing, increasing the risk of business failure; the income tax penalizes efficient, profit-making firms; the income tax favors incorporated businesses over other business organizational forms. At low rates, none of these problems is noticeably manifest; at high rates, the income tax seriously distorts the economy.
Before World War II, the US Government's requirement for revenue was modest, the income tax was quite able to produce adequate revenue at low tax rates, and none of the above problems surfaced to a noticeable degree. When, during World War II, the rates were raised to high levels and expanded to the whole population, all of these problems surfaced. Furthermore, in recent years the income tax, with a narrow tax base, has been totally unable to produce sufficient revenue to cover the national budget. The result has been massive federal budget deficits, averaging about $200 billion per year, or about 5 percent of GNP. The gross federal debt is now $2.4 trillion, or about half of the nation's GNP of $4.4 trillion.
The massive deficits have turned the US into a debtor nation. The US Government's insatiable demand for credit to cover the deficits is sucking credit markets dry and choking private investment. The tax system is bankrupt, and the results threaten the collapse of the economy. The country needs a new tax system that is not based on the income tax.
As income tax rates were increased in a futile attempt to raise sufficient revenue, the tax code became more and more complicated. The inequities and social and economic deficiencies of the income tax surfaced. In an attempt to remedy these problems, new rules and regulations were adopted. A massive, complicated system of tax deductions, or tax shelters, evolved. These changes created incentives for still more changes, resulting in a tax code so complex that no one any longer knows the definition of taxable income. In thousands of cases, it is now necessary for the IRS Tax Court to make arbitrary rulings on what is taxable and what is not.
At high rates, the government can no longer collect the income tax on a voluntary basis. To escape the heavy burden of high income tax rates, many citizens now operate in an "underground economy," conducting their affairs in private cash or barter transactions to avoid a tax widely perceived as oppressive and unfair. Desperate to close the "tax gap," the government has created a massive bureaucracy -- the IRS -- with police-state powers outside the Constitution. The Supreme Court, alarmed that limiting these police-state powers might cripple the government's ability to raise revenue, exempted the IRS from complying with the personal-freedom guarantees of the Bill of Rights and endorsed the operation of the IRS outside of the Constitution.
The US Process for Developing Tax Systems is Archaic, Primitive, and Inadequate
Since World War II, Congress has passed over 20 major tax bills, including three tax reforms. Despite the concern of Congress, meaningful reform has not been achieved. The Congress is simply incapable of establishing a satisfactory system. One of the reasons for this inability is that the system used by Congress to develop a tax system is archaic, primitive, and unworkable. Instead of passing a law that represents a general statement of congressional intent and that charges the Treasury Department with working out the details, Congress itself defines every detail of tax law. By its very nature, the legislative process responds to pressures from numerous pressure groups. The resulting tax law is complicated, inconsistent, and illogical.
After the US introduced the income tax as a major revenue source, much of the rest of the world followed. In contrast to the US situation, however, most industrialized nations have now adopted a business tax -- the VAT -- as the main source of tax revenue. This type of tax can solve the US' current tax and deficit problem. Although the VAT was first implemented in the US (in 1953 in Michigan), since then the US steadfastly has refused to consider it as a tax at the national level. This refusal flies in the face of the experience of many of the world's nations, who have switched to the VAT. Since 1954 when France became the first nation to adopt the VAT, a total of 39 nations have adopted it. Because of its demonstrated superiority as a tax for modern economies, the spread of the VAT has been nothing short of phenomenal.
If Congress itself had to build the interstate highway system, we would not have one, or at least not a very well designed one. If Congress itself had to build the moon rocket, we would never have landed men on the moon. If Congress had to fight World War II by itself, we would never have won. Unlike every other area of governmental concern, in which Congress passes general legislation and charges an executive department with responsibility for getting the job done, Congress takes upon itself the job of completely defining the tax system. The result is a disaster that threatens to destroy the US economy and with it the world economy.
The country is in desperate need of meaningful and fundamental tax reform. This book presents a solution to the tax problem.
This chapter summarizes the problems associated with the personal income tax. These problems may be classified into three general areas. First, there are sociopolitical problems, such as the perceived fairness of the tax or the resentment that a heavy tax burden may cause. Second are problems associated with the economic impact of the tax. A good tax system should promote economic growth, stability, efficient use of economic resources, and high employment. Third, there are problems associated with the government's need for an adequate and stable source of revenue; the tax system should be a stable source of revenue of sufficient magnitude to cover the national budget. The current tax system fails miserably in all three areas of concern.
Within the three general problem areas -- sociopolitical
impact, economic impact, and revenue-raising ability -- the problems associated
with the income tax are further divided into nine specific categories. The next nine chapters describe and discuss
each of these.
In summary, the nine problem categories are as follows.
Implementation of the income tax requires that the government know the financial affairs of 100 million income-earning citizens, as well as 15 million income-producing business establishments. This feature of the income tax is in contrast to some other types of taxes, such as sales taxes, in which the taxpayer may remain anonymous. The government has imposed the requirement that each taxpayer use his SSN as a taxpayer identification number. The widespread use of this identifier, which was originally prohibited from use as a general identification number, as a key to a large number of data files has resulted in a serious erosion of privacy. Through the use of a "Writ of Entry," by which the IRS may enter a home and seize property without a court order, the government is in violation of the Fourth Amendment guarantee against unreasonable search and seizure.
Though originally intended as a tax on the rich, the personal income tax was transformed into a mass tax by the massive revenue requirements of World War II. The enforcement of this tax has resulted in the creation of an American national police force -- the IRS -- that operates outside constitutional law. It uses a variety of police-state tactics that violate constitutional rights of individuals, including search without a warrant, confiscation of property without due process or a court order, trial without a jury, presumption of guilt, threats, intimidation, defamation, the use of informers, entrapment, spying, monitoring, and harassment. It uses these tactics to intimidate taxpayers; to destroy their reputations, careers, and estates; and to silence their opposition.
The original Constitution outlawed the income tax. The Sixteenth Amendment authorized it. In the years since its enactment, the
Sixteenth Amendment has, in essence, resulted in the nullification of the
First, Fourth, Fifth, Sixth, Seventh, Eighth, Ninth, Tenth, and Thirteenth
Amendments. The passage of the income
tax amendment has virtually stripped the US citizen of his right to privacy,
his right to be let alone.
Under the tax code, the burden of proof rests on the citizen -- you are assumed guilty until you prove your innocence. The IRS can force you to produce documents without a court case being in process. You are tried in a special tribunal, without due process, outside the Judicial Branch, in patent violation of Article I, Section 8, Paragraph 9 of the Constitution, which requires all lower courts to be under the Supreme Court in the Judicial Branch. The IRS may seize your property and subject you to electronic surveillance without a court order.
Since knowledgeable taxpayers can often make the system
work to their advantage, the complexity of the tax system has led to a strong
feeling on the part of many citizens that the system is unfair.
The income tax system allows for confiscatory taxation of the lifetime savings of older citizens. Under tax reform, older Americans who sell their homes are socked with tax bills that can exceed 100 percent of the increase in real value of their homes since purchase, because the government taxes capital gains whether they are real or due to inflation.
Because of its substantial unfairness and unnecessarily high tax rates, the income tax system has spawned a large underground economy, which conducts cash or barter transactions to avoid tax payment. The Congress has implemented an unfair tax and allowed the Executive Branch's IRS to employ draconian measures to enforce it. Perceived as unfair, many US citizens no longer pay their income taxes voluntarily, as they once did.
The income tax system includes very strong, yet unnecessary, incentives to evade taxes. Under tax reform, the corporate (federal) income tax rate is up to 39 percent. Payroll taxes on the employer are up to 7.15 percent. State corporate-income-tax rates may be 10 percent. The personal federal-income-tax rate is up to 33 percent; state and local income tax rates may be another 10 percent; the employee's payroll tax rate may be up to 7.15 percent. The combined effect of all of these taxes is an effective rate of up to 76 percent on the businessman's earnings. Because of these very high rates, an incredible incentive exists for businessmen to make personal purchases (such as automobiles) through his firm to avoid this confiscatory level of taxation. These high levels of taxes are completely unnecessary; the needed tax revenue may be raised with alternative taxes at much lower rates. No good purpose is served by setting up a system with incredible incentives to evade taxes.
The income tax is defined in thousands of complicated tax code rules and regulations. No one knows the code's intent, which must often be arbitrarily determined through the Tax Court. The tax law is so complex that 40 percent of all taxpayers find it necessary to hire tax preparers.
A major problem with the income tax is that economists cannot agree on a definition of income. In fact, some leading theoretical economists state unequivocally that it is impossible to develop a satisfactory definition of income. The government's definition of income is continually changing, as the rules for defining income become more and more complex.
By using a progressive income tax system, many inequities, illogical constructs, and economic inefficiencies are introduced. In an attempt to remedy these problems, additional rules and regulations are passed. After seven decades of this process, the income tax system is now so complicated that no one fully understands it.
Both the personal income tax and the business profit tax have serious economic deficiencies. Although these deficiencies have been recognized for a long time, the US population has been unsuccessful in prodding Congress to enact meaningful tax reform. Even under the Tax Reform Act of 1986, many serious economic problems continue.
As income taxes (as opposed to consumption taxes), the personal income tax and the business profit tax encourage consumption and discourage saving because they tax the return on investment from saving. The economic incentives caused by income taxes result in serious distortions of the economy. Income taxes distort the choice of business financing (by favoring debt financing over equity financing), business organization (penalizing corporations relative to other business forms), production technology (favoring the use of capital over labor), and consumption decisions (favoring tax-deductible purchases over others).
To administer the income tax, the IRS maintains a bureaucracy of 85,000 employees and expends an annual budget of $3 billion. The IRS administrative cost is, however, just the tip of the iceberg. In addition, the full administrative cost includes the labor expended by firms impressed into service by the IRS to collect the personal income tax for the IRS, since it has proved infeasible for the government to tax individuals directly. The administrative cost of executing the personal income tax is just too great.
As great as it is, however, the administrative cost of the income tax is dwarfed by the compliance cost; that is, the cost incurred by firms and individuals to determine their tax liability. Individuals expend their own time and hire paid preparers for two reasons. First, the tax code is so complicated that errors are likely. Second, the tax code is so complicated that there is a good chance that the taxpayer may inadvertently overpay his taxes by considerable amounts, if he does not hire a tax expert. This cost is called the cost of tax avoidance. The cost of tax compliance -- forms preparation and tax-avoidance activities -- has been estimated to be on the order of $35 billion.
The personal income tax base is relatively small -- only 39 percent of GNP is subject to tax. For this reason, if the government relies mainly on the personal income tax as the major revenue source, very high rates are required to produce the revenue needed by the country (which is about 31 percent of GNP). These high rates cause citizen anger, resentment, and frustration; contribute to tax evasion and the growth of the underground economy; lead to escalation and excesses of IRS enforcement activities (as the government grows more desperate for cash); and substantiate the perception that the government is oppressive.
The corporate income tax base is very small -- about 7 percent of GNP -- and what is more, it fluctuates considerably from year to year, as economic conditions fluctuate in the business cycle. Consequently, the corporate tax revenues fluctuate from year to year. Not only does this make planning for continuing government programs difficult, but also, as mentioned in Chapter 2, it contributes to growing budget deficits.
Since income tax rates are already far too high, the government is reluctant to raise them higher, and the deficit continues to grow to astronomical levels. As of 1985, the US became a debtor nation, so that it, one of the wealthiest nations in the world, is absorbing capital (savings) that is desperately needed by poorer countries to further their own economic development.
The current US income tax system cannot raise the level of revenue needed for a modern economy. The income tax base is too narrow. The result has been massive government deficits, on the order of $200 billion per year. The US government can no longer cover these massive deficits through the domestic credit market, and it now owes a massive debt to foreign governments.
The current system has not succeeded in preventing extreme concentrations of wealth. One percent of the US population now owns over one third of the nation's wealth. This situation is undesirable from the point of view of stability. Extreme concentrations of wealth generate envy and social discontent; they represent private concentrations of power that may threaten the security of the nonwealthy; they are also believed to contribute to the severity of economic recessions.
The federal tax system imposes a heavy burden on US citizens and affects the lives of us all. Billions of dollars are wasted in unnecessary administrative and compliance costs. Billions more are lost in tax avoidance efforts in response to unnecessary incentives, and in tax evasion motivated by a complicated, burdensome system. The privacy of all citizens is unnecessarily intruded upon. Citizens are outraged by the complexity of a system that discourages work, saving, and investment. The business profit tax also acts as a disincentive to save, invest, and be efficient. The inadequacy and instability of revenue have contributed to deficits, inflation, high interest rates, and low economic growth. The stakes are extremely high, and yet the process used to develop the tax system is old-fashioned, unsystematic, inferior to available alternatives, and inadequate.
How did the Tax Reform Act of 1986 help solve the preceding problems? Hardly at all; in fact, some problems were made worse. The Tax Reform Act was an effort to expand the income tax base so that adequate revenue could be raised at low tax rates. The Act is a failure, on two counts. First, the tax rates are not low. Second, even with the current high rates, the tax revenue is inadequate to cover the national budget. Since the US overall tax level (as a percentage of GNP) is one of the lowest in the industrialized world, this is a clear indication that the structure of the tax system is simply inadequate. The US pioneered the income tax system at a time when the country's revenue needs were low. The income tax system is simply inadequate to support a modern economy with high revenue needs. The US should pioneer the elimination of this malicious, inhumane, and inadequate form of taxation.
The major thrust of tax reform was to remove tax preferences, or tax shelters. The goal was to achieve a tax system in which people with similar incomes would pay similar tax; that is, to achieve "horizontal equity" with respect to income. The motivation for this thrust was that the rich and tax-wise could take advantage of these shelters, whereas others could not. The ability of some to shelter most or all of their income led many to perceive that the system was unfair.
While the Tax Reform Act of 1986 may have in large measure accomplished its goal, that goal was totally inadequate. A review of the problems identified in this chapter shows that virtually all of the problems will continue to exist when tax reform is fully implemented. The system is still a costly, complicated, privacy-intrusive one, with many undesirable economic, social, and political drawbacks. It needs to be scrapped, and a new system should be developed that is responsive to today's revenue needs and does not alienate the US public.
A major shortcoming of the Tax Reform Act is that, while it can raise the level of revenue generated by the system before tax reform, it cannot produce sufficient revenue to cover the national deficit without income tax rates of intolerable levels.
Under tax reform, the government has abolished many tax shelters for individuals. Unfortunately, many of the investments that, under the previous law, represented tax shelters for individuals will still represent tax shelters for businesses, so that the economic inefficiencies may continue. Business and personal-finance decisions should rest on sound economic principles and the efficient allocation of resources. What is needed is an economically neutral tax that does not interfere with rational economic decisions. The current income tax system is not such a system.
The problems of the previous income tax system (that existed before the Tax Reform Act of 1986) are essentially unresolved under tax reform. The burden and complexity of the system is reduced for some low-income earners, but they are actually increased for many taxpayers. Many US citizens will probably still find it necessary to retain tax advisors and tax preparers. The cost of collection will remain essentially unchanged. The unnecessary invasion of privacy will continue. The incentive for businessmen to purchase items through their businesses will be, in fact, significantly increased because of the elimination of many tax deductions for items that may reasonably be characterized as business related.
Unfortunately, the Tax Reform Act failed to address the many ills of the income tax system. The new tax reform laws retain many of the same fundamental problems as the old tax law. First, the income tax rate is progressive (that is, a higher income is taxed at a higher rate), so that the government still needs to keep track of each person's total income. Second, there are still deductions, so that if a person is to pay no more than his fair share, the government needs to keep track of other personal information, such as the number of dependent children, how much is saved for retirement, and how much is spent on one's home mortgage. In short, the tax will still be an income tax, and the government will still require that individuals be registered and monitored.
The government has meddled significantly with the economic market forces in its incredibly complicated collection of deductions, exemptions, and credits. US tax law is a fantastic and complicated collection of rules which accomplishes little but a redistribution of income to tax lawyers, tax accountants, and tax preparers. For many years, these rules so favored the wealthy that the US tax system was characterized as a massive welfare system for the wealthy. While the recent tax reform simplifies some of these rules for individuals, it still allows to remain in place a mechanism -- the personal income tax -- that is intrusive and inefficient. Moreover, the tax law for businesses will remain complicated and complex, perpetuating the loss of productivity by businesses in tax planning, analysis, and avoidance.
The tax system under tax reform is not a good system. It is still an income tax system, and a seriously burdensome one at that. Moreover, the business income tax is poorly coordinated with the personal income tax, resulting in substantial inequities and undesirable economic incentives. The US income tax system causes economic waste and seriously violates the privacy of individuals.
In The Price Waterhouse Guide to the New Tax Law, former IRS Commissioner Roscoe L. Egger, Jr., discusses the Tax Reform Act of 1986. He states that the objective of simplification has not been met and, in fact, that simplification of the income tax is virtually impossible. He states that all taxpayers -- individuals, corporations, and others -- now face complicated new rules; that this is an inevitable and necessary transition from how it used to be to how it should be.
It does not have to be this way. The US tax system does not have to be complicated. The government simply has refused to consider simple, fair, efficient alternatives.
Many governments desire to maintain a high degree of control over their citizens. This desire appears to be a normal result of the evolutionary process of governments. Given this desire, there is hence from the government viewpoint a very substantial political advantage in the income tax. The government has convinced people that an income tax is necessary, to support public expenditures. Taxes are necessary; an income tax is not. The government will not readily give up the income tax, however, because it justifies their monitoring of individuals. Without the income tax, there is little justification for monitoring of individuals other than the desire to control them, and our government would be reluctant to admit this as a goal.
The government will fight the abolition of the income tax, not because it fears a loss of revenue, but because it fears the loss of control of individuals through registration (through your tax identification number, the SSN), and knowledge of your personal and financial affairs. The government can collect the desired level of tax revenue in other, less costly, more economically efficient, more equitable, less intrusive ways. It has not chosen to do so and will not choose to do so, however, in order to justify its continued monitoring of individuals.
The high degree of individual monitoring that US citizens experience is not present in many less-developed countries, since the governments of such countries do not have the resources available to monitor every individual. The estimated $35 billion cost of implementing the personal income tax works out to a cost of $150 for every man, woman, and child in this country. That amount exceeds the total per-capita income tax for many countries.
A US citizen who travels abroad is often struck by the fact that the citizens of many foreign countries often have considerably greater individual freedom than individuals in the US. The citizen may have less political freedom in many countries, but, as long as he doesn't threaten the government's security, he is often far less "hassled" by the government than is the citizen of the US. Thirty-five billion dollars can buy a lot of hassling!
Many US citizens are fed up with the intrusive activities of government, especially at the federal level. They perceive that the Orwellian era of "Big Brother" has in fact arrived. The major factor underlying the monitoring and control of individuals is the income tax, whose implementation requires identification of individuals. The monitor of Orwell's 1984 turned out not to be a video monitor -- it is the personal income tax.
This chapter discusses the loss of privacy that has occurred, and is growing more severe, because of the availability of the Social Security Number (SSN) as a near-universal, near-unique identifier. It describes the ways in which the SSN is used to facilitate compilation, storage, and retrieval of personal information about you, and to assist monitoring of you.
To many people, the issue of privacy is a "nonissue." They do not feel uncomfortable with the current situation vis-à-vis privacy, they have not previously been slandered by a false credit report, and they do not perceive the loss of privacy as a loss of or potential threat to freedom.
To me, privacy is an important personal asset. I value it and want to maintain it. Some degree of privacy, such as the desire to wear clothing, is valued by almost everyone. If privacy does not mean much to you, the arguments presented in this chapter in favor of protection of privacy and curtailing the use of the SSN will seem irrelevant. These arguments are presented in this book because the loss of personal privacy is a major social cost of the personal income tax. As the discussion of this chapter will show, your loss of privacy is not associated simply with the government's knowledge of your income. Rather, the availability of a unique, universal, permanent identifier -- the SSN -- has enabled a comprehensive and organized assault on the privacy of US citizens.
Harvard law professor Arthur Miller, author of the book, The Assault on Privacy, was quoted recently (Time, July 6, 1987, p. 33) as stating that the threat to individual privacy in this country arises from entities that are not governmental: hospitals, corporations, each other. That position is open to debate. Both governmental and nongovernmental threats are very severe, as this chapter will show.
The US Government now monitors all financial transactions of over a few thousand dollars (bank deposits and withdrawals, interest payments, stock purchases and sales) under the guise of ensuring that everyone pays his fair share of the income tax. Through the Sixteenth Amendment and the income tax, the US Government has been able to accomplish what it would otherwise never have been permitted to do. The US public has been duped into believing that only the income tax can provide the revenue needed by the government; in this belief, it has grudgingly submitted to monitoring of its financial affairs. The income tax is not necessary; government monitoring of the financial affairs of individuals is not necessary; individual taxpayer identification numbers are not necessary. This chapter explains the many ways in which the availability of a personal tax identification number, the SSN, has led to the loss of personal privacy in the US -- in your personal dealings, not just in your dealings with the government.
Is There a Legal Right to Privacy?
In his book, Civil Liberties and American Democracy, John Brigham discusses the legal aspects of privacy. In certain areas, such as marital privacy, a right to privacy has existed in common law since long before the Bill of Rights. Although a general right to privacy was not explicitly stated in the Constitution, it has, in the twentieth century, been institutionalized by the opinions of the Supreme Court. The legal origin of a constitutional right to privacy begins with Judge and Professor Thomas Cooley, who, in 1888, articulated a "right to be let alone." In 1890, Samuel Warren and Louis Brandeis published a law review article in which they advocated a right to privacy based on Judge Cooley's concept. This article has been cited in numerous Supreme Court decisions. In 1965, a constitutional right to privacy was formally and conclusively recognized by the Supreme Court, in the case of Griswold v. Connecticut. The right to privacy is considered to derive from the First, Third, Fourth, Fifth, and Ninth Amendments.
Brigham notes that apart from constitutional law, the right to privacy has been implicit in American ideology, tradition, and common law. By 1960, a right to privacy was recognized by 31 states.
In summary, under US law, a right to privacy exists, both in common law and constitutional law.
The SSN Was Originally Simply a Retirement Account Number, Not a Universal Citizen Identification Number
The SSN is used to expedite the collection of personal income taxes. Each person is assigned a unique account number to facilitate keeping track of his tax contributions. (The SSN is actually not unique. A number of people have the same numbers, but most individuals have numbers that differ from everyone else's.) Originally, the purpose of the SSN was to keep track of each individual's Social Security account. An employee pays into the Social Security Trust Fund during his productive years, and he is (or his survivors are) paid out of this fund when he is no longer able to work (retired, disabled, or deceased). Because the amount of the payment depends on his earnings history, it is necessary to maintain a record of that history.
A strong central government can be a very effective force in accomplishing activities that are of national or regional concern or scope, such as national defense, regional environmental protection, and public health. It can also be effective in preventing or reducing major concentrations of power, such as very large businesses or unions or extremely wealthy families, which threaten the security and freedom of the individual. The US Government has accepted this role in breaking up very large businesses, but it has been unwilling to break up very large unions.
The government can, however, accomplish all of these beneficial activities without intruding in the privacy of each and every American family. Philosophically, the Jeffersonian concept of democracy is that the welfare of the citizen is best protected by minimal interference of government in private affairs. From this viewpoint, the personal income tax is one of the worst taxes ever devised; it causes the unnecessary intrusion of the government into the affairs of all individuals, when the same (or a greater) level of tax revenue could be collected as nonintrusive business taxes.
Originally, the SSN was intended as nothing more than an account number for a person's Social Security retirement account. It was adopted as an individual's taxpayer identification number (TIN), after passage of the Current Tax Payment Act of 1943. Today, it has become a universal citizen identification number. As this chapter will show, the existence and use of a government-sponsored citizen identification number has resulted in the significant loss of privacy of the individual and in control of information about his personal affairs. It is the linchpin of a comprehensive information system that stores and distributes personal information. Both the US Government and the private sector use the SSN to monitor individuals to a degree that would be very different without government sponsorship. Because many decisions affecting the individual are made by government and private organizations based on information that is assembled using the SSN, the SSN identification system has led to a significant loss of control by the individual of his own status and affairs. This chapter explains the many changes that have occurred in the individual's privacy, independence, and autonomy, because of the government-sponsored implementation of the SSN as a general citizen ID number.
The US Government's Commitment to Protect Privacy Is Waning
When the US Government first attempted to introduce the SSN, there was a loud outcry against the introduction of a numerical identifier for US citizens. A friend of mine told me that she remembered the reaction and the government's promise that it would never be used as a general identifier - every Social Security card was to bear the legend, "NOT FOR IDENTIFICATION." Evidently, that promise was a lie, or has been forgotten. The government has, in fact, deleted that legend from recently issued Social Security cards. The Privacy Act of 1974 ostensibly restricted the use of the SSN as a general identifier, but its use in that regard is now widespread and growing.
The Computer Age Has Created a Demand for a Unique, Universal, Permanent Identifier
The reason for the increasing use of the SSN as an identifier is that it enables very easy storage and retrieval of personal data and the matching and merging of data stored in different data files. Whenever an organization wishes to store information about you, it needs to identify you in some way. Previously, a person's name, address, and age or date of birth (DOB) were widely used to uniquely identify him. This information uniquely identifies the individual because it is virtually certain that no two people have exactly the same name, address, and date of birth. A person's name alone is not a useful identifier because many people have the same name.
A problem associated with the name/address/DOB identifier is that a person's name has many different forms, and he may change his name and address often during his lifetime. In other words, although the name/address/DOB may identify a unique person, there may be many different versions of this identifier (that is, it is not uniquely determined, or "single valued"), and it is not permanent. For example, there are usually many different versions of a person's name (such as, Francis Allen Smith, F. A. Smith, Frank Smith, F. Allen Smith III, and so on); a person could own two homes and therefore have two addresses; or move, and have a new address; and a person may change his name (such as, when a woman marries and adopts her husband's surname).
The fact that the name/address/DOB is not a single-valued or permanent identifier causes problems in storing and retrieving information. For example, a credit-reporting service might end up with five different records on the same individual, each under a different version of his name or under a different address. Or, a woman may have changed her name last year, and the identifier used in the service's file would be obsolete. Or, information about another person having the same name may be entered into your file. Unfortunately, this happened to a friend of mine -- disparaging information about someone else was inadvertently entered into a credit-reporting service file maintained on him. This information was released by the credit-reporting service to a bank, his credit reputation was damaged, and he was denied a loan.
The SSN Is an Ideal Universal Identifier
These problems are avoided if your SSN is used as the identifier. First, it is nearly unique: very few individuals have the same SSNs. Second, it is virtually permanent. Once assigned to an individual, it is almost never changed. If a credit-reporting service identifies individuals by SSN, data entered into its files can be easily maintained in a single record. If a creditor specifies your SSN, the credit-reporting service can retrieve your complete record quickly and easily. It can retrieve information that was originally stored when you had a different name or address.
Furthermore, whenever the credit-reporting firm obtains new information about you, it can readily enter it into your record, once it knows your SSN. If the firm obtains a new set of data, for example, notices of bankruptcies, it can quickly merge this information into its computer data files in a matter of seconds or minutes, when the information is identified by SSN.
Information maintained by two different organizations can easily be combined, if both organizations use the same identifier. The process of combining information contained in different data files requires the "matching" of records that correspond to the same individual in the two files. Once two matching records are found, the information contained in those two records is combined, that is, the files are "merged."
For example, suppose that your state motor vehicle department sells information about all of the automobile owners in its state to a direct-mail marketing company, and that the company wishes to merge that information with information already available in its data files. It is an easy job to merge files that are identified, or "indexed," by the SSN. The record match and subsequent merge can be done very quickly and at very low cost, automatically, by a computer program.
Use of the SSN as an Identifier Is Growing
The US Government makes heavy use of the SSN for matching. For example, it matches income tax records to assistance payment (welfare, Medicaid) records, child-support payment records to income tax and employment records, student-loan repayment records to income tax and employment records, and so on, in an attempt to monitor the activities and status of its citizens. State governments routinely enforce liens against citizens by tracking them down through their SSNs and garnishing their wages.
There is a growing use of the SSN as a universal identifier: an identification number that is used by many organizations to identify people. This use is growing in spite of the fact that every Social Security card (except those issued recently) contains the legend, "NOT FOR IDENTIFICATION," and the federal government has restricted the use of the SSN as an identifier. According to the Privacy Act of 1974, for example, no federal grantee (an organization receiving a federal grant, such as a university research grant or funds for social services) is permitted to set up a system of records based on the SSN.
Despite the fact that the federal government recognizes the loss of privacy that is inherent in the availability of a universal identifier, it itself is one of the greatest offenders of the spirit of the Privacy Act of 1974. The Privacy Act generally prohibits use of information for purposes other than that for which it was collected, without the consent of the individual. A recent report by the government's Office of Technology Assessment notes that computer matching of records has become common in the government, without the consent or awareness of the individual. Recently, a former student of mine told me the number of times he had been asked for his SSN as identification in the past few weeks: the telephone company, the University registrar, the University financial aid office, the Border Patrol at the Nogales border crossing, and the bank.
The term "Social Security Number" is a misnomer. Originally, the number was intended to serve as a sort of account number to enable government determination of the size of the retirement, disability, or survivors' payment to or on behalf of an individual whose employer had participated in the Social Security program. Now, its primary use is to identify individuals, enabling easy income monitoring by the government.
The Information Business Is Big Business
As the US transforms from an industrial economy to an "information" economy, both the demand for and supply of information on individuals has skyrocketed. Governments at all levels (federal, state, and local) maintain files on individuals: tax records, property records, automobile registrations, Social Security records, assistance program records. Credit-reporting services and medical-reporting services maintain extensive, up-to-date information about your personal and family credit history, health, and medical background. Mail order firms maintain personal and financial information about a large portion of the population. Department stores, credit card companies, credit unions, and banks maintain files on their customers. Physicians and hospitals maintain records on their clients. Companies maintain records on their employees.
A large segment of the economy is involved in information processing, a large portion of which is concerned with the storage and retrieval of data on you.
The Use of Deceptive Information-Extraction Procedures Is Common
Information on individuals can now be stored and retrieved with tremendous ease, and big profits can be made in the large and growing market for personal information. Because of the profits available to the personal-information-trafficking market, firms in the business of maintaining files on individuals are generally very aggressive in trying to learn your SSN. They have devised schemes for obtaining your SSN by "high pressure" tactics and obtain much personal information by means of deceptive practices.
For example, suppose that you are submitting an application or claim to a medical insurance company. The insurance company will no doubt ask you to sign a "standard information release" form, permitting them to obtain a variety of information about your past from various medical-information services. Information about your past is kept in data files that are indexed by your SSN. What many people do not realize, however, is that the "fine print" in the release agreement doesn't simply allow doctors and others to release information to the insurance company -- it usually also permits the insurance company to release the information you are submitting to it on the form to any credit-reporting services it pleases!
Here, for example, is an example of the release statement you are asked to sign for one large US company:
You are authorized to provide (company name) any benefit plan administrators, consumer reporting agencies, attorneys and independent claim administrators acting on (company)'s behalf, with information concerning medical care, advice, treatment of supplies provided the Patient, and any employment-related information regarding the Patient.
Here's another example:
I authorize any physician or other medical professional, hospital or other medical care institution, insurer, medical or hospital service or prepaid health plan, employer or group policyholder, contract holder or benefit plan administrator to disclose to (company name) or any benefit plan administrator, consumer reporting agency, or attorney acting on (company)'s behalf, any medical information and any employment-related information regarding the patient.
These releases authorize the company to release your personal information (and that of your spouse and dependents) to consumer-reporting agencies! This includes release of personal information that has nothing to do with your medical problem (such as employment information) to credit-reporting services or any attorneys that your insurance company or self-insured employer may retain. These conditions are outrageous infringements on personal privacy, coerced under threat of denial of health-care-insurance benefits.
In plain language, medical insurers and paying agents of self-insured employers "trick" you into giving permission to release personal, private, and confidential information to data services, when you are led to believe that you are permitting just the opposite. For this reason, these data services are able to keep their files up-to-date, with no reimbursement to you for the release, future use, and sale of your private information. Most medical insurance companies will require you to sign a release authorization every time you make a claim, will request your SSN to be entered on the form, and will release your SSN to the medical-data services. Of course, you are not required to provide your SSN, but the insurance company will threaten that if you do not cooperate fully with their request for information and fill out the form completely, they may have grounds for denying payment of your claim. In fact, a friend of mine, who recently refused to reveal his SSN, received the following notice from his medical insurance company: "No future charges can be considered without (employee's) Social Security Number."
Coordination of Benefits -- a Very Effective Tool for Privacy Intrusion
Some of the most aggressive and intrusive of today's privacy intruders are health-care companies and "self-insured" corporations. Self-insured corporations are very large corporations, with annual sales in the billions of dollars, which have so many employees that they can safely play the role of the insurance company. With a large number of employees, it is possible to accurately predict what the total employee medical cost will be and to charge premiums or set aside fringe benefit amounts that are virtually certain to cover that cost. There is essentially no chance that the firm will be "wiped out" by an unexpectedly large number of catastrophic cases. Generally, self-insured corporations hire large insurance companies to act as claims administrators, or paying agents, for their employee's claims.
Perhaps the most obnoxious weapon in the privacy-invasion arsenal of health insurers and large self-insured corporations is "coordination of benefits." Under a coordination-of-benefits provision, if you and your spouse are both employed and have separate medical insurance plans, the two plans "coordinate" their insurance payments to you so that the total insurance payment does not exceed the total medical cost, that is, you can't collect from both companies for the same medical expense. The companies praise this device, noting how it can reduce medical insurance costs. While this is true, it is a deceptive practice. In order for coordination of benefits to work, there is a severe cost that you must pay in terms of your privacy.
Consider what your employer will force you to do under coordination of benefits. Suppose that you submit a claim for your dependent. Reasonably, on your health-claim form, you should be expected to identify yourself as an employee of the company and to provide particulars about the health-care expense (dependent's name, health-care provider, nature of the problem, and treatment cost). Under coordination of benefits, however, the insurance company or your employer will demand that you provide your spouse's and dependent's names, addresses, birth dates, marital statuses, student status (of dependent), names of employers, whether your dependent has received any insurance payment from any other source (such as automobile accident insurance), or whether your dependent is covered by any other insurance (such as your ex-spouse's current employee group medical plan). What business is it of your employer if you have a spouse, or, if you do, whether she is employed, or who her employer is, or what her name and age are, or where she lives, or if you are legally married to her, or whether you have an ex-spouse, or who she is, or who her employer is? Absolutely none! The demand for this information is a presumptuous, arrogant intrusion into your personal life. If the claim is for your dependent, it is not even any business of your employer whether you are married at all.
Fine, you may say, that's none of their business, so you won't tell them. What happens? They will refuse to honor your claim. Even if you are not married and there is no other insurance at all, if you refuse to disclose this personal information to the insurance company or to your employer, you will be denied insurance coverage. In today's society, medical cost for some illnesses can run up to a million dollars or more. It is not practical or prudent to be without insurance coverage. Medical insurance coverage is costly. If you refuse coordination of benefits, you may have to spend thousands of dollars a year in premiums to obtain individual coverage outside of your company. Few people will resist this pressure to release their personal information.
Coercion and Harassment Await Those Who Resist Submission of Their SSNs
If you refuse to provide your SSN on the form, you will probably be informed that it is required; that processing of your claim will be deliberately delayed; and that your claim may even be returned. Your claim may even be rejected. Since the numerical value of your SSN is not germane to the medical basis or eligibility basis for your claim, however, there is no reasonable basis for the requirement to submit it; you are justified in refusing to provide it on the grounds of unwarranted invasion of privacy. Remember, when it initiated the SSN identification system, the Social Security Administration explicitly specified that SSNs were "NOT FOR IDENTIFICATION."
The fact that knowledge of your SSN makes it easier for the insurance company to investigate you or enables them to augment a data service's dossier on you with up-to-date information, does not override your right to privacy. Most people are intimidated by the insurance company's demand, however, and are led to believe that their claim will be justifiably denied if they do not cooperate with this request. At the very least, the insurance company will delay payment of the claim, while it harasses the insured individual for his SSN. In the case of my friend who recently refused to submit his SSN, the claim was for hospital expenses. After waiting several months for payment, the hospital finally forwarded the bill to a collection agency. While the insurance company will no doubt eventually have to yield on the issue of demanding the SSN, it will cause, through its delays, a considerable amount of inconvenience before doing so. For large bills, payment delays may entail collection fees, attorneys' fees, and even the ruin of your credit rating. Few people can afford to resist this pressure.
Most people either do not realize that the insurance company may compromise the privacy of their medical information, or they do not perceive that the indiscriminant access to their SSN compromises their privacy, or they are unwilling to resist the insurance company (or pressure from their employer) on the matter; they simply capitulate. Moreover, some companies hold the privacy of their employees in such low regard that they will release their employees' SSNs to medical insurance companies or paying agents, without even asking the employees' permissions.
Credit-checking companies operate in much the same way. You can be reasonably certain that there are a number of credit-reporting services that contain information about your past in their files and regularly sell your personal information to a variety of curious organizations or individuals. In addition to insurance companies and credit-checking companies, a variety of other companies, such as direct-mail marketing companies, retain information on you in their databases. Your state government may well contribute to these bases by selling information about your automobile, plus other personal information, to various organizations.
The Growing Use of Computers Increases the Demand for a Permanent, Unique, Universal Identifier
Thirty years ago, most organizations maintained information on individuals in "manual" data files. Because the records were reviewed often by human beings, it was a relatively easy matter to maintain them using the name/address/DOB identifier. Furthermore, since it was prohibitively expensive to merge data files from different organizations by manual means, there was little demand for a universal identifier.
The situation has changed radically since the 1950s, when the digital computer first "went commercial." Today, most personal information is stored in digital computers, in computer databases. To better understand the important role of the SSN in assisting the operation of these databases, it is helpful to know a little about how the data are stored in computer data files.
The information that is stored about you in these various databases is almost always stored in a "record" that is contained in a computer database "file." A "record" is simply the collection of information about an individual. A "file" is a set of records, for example, all of the individuals in a state. A "data base" is a collection of files. In order to access data in these files, it is necessary to have a "key" or "identifier" or "index" on each record. The identifier could be your name, but, as discussed earlier, there are several problems with this.
The dependence of computer merging on the availability of a reliable, universal identifier is increasing dramatically. Previously, most computer data processing was done by programmers, who could develop and modify the "match/merge" computer programs. If no reliable identifier existed, similar records could be printed out and matched manually. In the past several years, however, there has been a move to the use of "data base management systems (DBMSs)," which can be used by nonprogrammers.
Modern DBMSs Need Keys Such as the SSN
The most powerful of these packages are called relational data base management systems (RDBMSs). These systems include an easy-to-use "query language" capability, which enables the data base user to retrieve information without programming. The query language is a "fourth generation" language, which enables the user to extract information simply by specifying what information he wants. It is no longer necessary to develop a computer program that specifies the procedures for extracting the information and presenting it in the form of a report; that is, the new languages are "nonprocedural." A variety of RDBMSs has been developed and can be purchased for use on both large ("mainframe") and small ("mini" and "micro") computers.
In order to use an RDBM, however, it is necessary to specify a key, or unique identifier, for each record in the data files of the database. The RDBMs cannot perform its data manipulations and retrievals without it. The days in which a programmer could "work around" imperfectly identified records are fast disappearing. The new DBMSs demand reliable keys, and many of the personnel using these new systems do not have the programming skills to process data without them. The sociological impact of this technological development is that the federal government, state governments, local governments, credit-checking firms, insurance firms, direct-mail firms, and any other organizations interested in maintaining files on individuals have a substantially increased vested interest in having available a universal identifier, such as the SSN. Their new data base systems will, quite simply, not work without one.
Concern Over the Loss of Privacy in the US Is Mounting
The availability of data files containing information about you -- both true and false -- is increasing dramatically. Many "horror" stories have been reported about people who have tried to correct false credit files. Several books have been written on the subject of invasion of privacy by data base services (for example, Professor Arthur R. Miller's book, The Assault on Privacy). The greatest single facilitator of the merging of data files is the availability of a unique, universal identifier. The SSN is a nearly unique identifier that has been assigned to almost all adults (that is, it is nearly universal, with respect to the adult population). Furthermore, it doesn't change, even if a person changes his name; it is permanent (for all practical purposes).
The Pressure on You to Release Your SSN Is Intense
By requiring each working adult to have an SSN, the federal government has created a universal, unique, permanent identifier that is used very much by private organizations to intrude on the privacy of individuals. It may be argued, however, that no one has to release his SSN to anyone, except perhaps (as required by law or regulation) to his employer for use in collection of payroll taxes and to the IRS when filing his personal income tax. From a practical viewpoint, unfortunately, that is definitely not the situation. For example, if you apply for a driver's license in Virginia, you are required to release your SSN to the state, or you will not be issued a driver's license. The Privacy Act of 1974 allows this, under a "grandfather" clause. Obviously, in today's mobile society, one cannot afford to be without a driver's license, so from a practical viewpoint it is not feasible to refuse.
Submit to Release of Your SSN or Face Disfranchisement
A few years ago a friend of mine moved to Tucson, Arizona, and promptly proceeded to register to vote. He was asked for his SSN (and some other personal information), and he respectfully refused. He was told that the SSN was required in order to identify him. He agreed to reveal his full name, address, and date of birth. Because it was extremely unlikely that more than one person had all three of these characteristics identical to his, he contended that that information was quite sufficient to identify him for voting purposes. He also indicated that his Social Security card bore the legend, "NOT FOR IDENTIFICATION." He was then told that his voter registration would be refused. He had been disfranchised and has not been allowed to participate since that date in any election -- federal, state or local.
Submit to Release of Your Tax Return -- or Lose Your Passport
The US Government is embarked on a full-scale assault on your privacy. The new tax law requires that any US citizen applying for a passport or any resident alien applying for a "green card" must file an IRS information return with the passport application. Fine, some may say -- if you've nothing to hide, there's no problem. That may be, except for the fact that the IRS can ruin your reputation without due process. The security of the individual from government control is enhanced if information is "compartmentalized"; that is, different agencies do not share personal information. This practice controls the dispersion of personal information, avoids the proliferation of copies of individual records, and reduces the damage to individuals in the event that erroneous information is transmitted. This practice is used by the Department of Defense to reduce the risk of compromise of classified information.
The US Government is clearly bent on total exposure of its citizens. In the long run, that policy will work to the detriment of free individuals.
Release Your SSN to the Government -- or Go Without a Job
Scientific consultants often work with highly classified data and require special security clearances, such as a "top secret" clearance, a "Q" clearance, or an "SI/TK" clearance. A few years ago, a friend of mine became engaged in nondefense consulting, and his clearance "lapsed," or became inactive. Recently, when he reapplied for clearance, he was informed that he had to submit his SSN to the Defense Industrial Security Clearance Office. He refused. He was then told that if he did not release the SSN, he would be denied the clearance -- he would lose his job. He has a wife and children to support. He is not independently wealthy and needed the work if he wished to remain in Tucson, where the opportunities for highly technical work are limited. He was in no position to refuse and was therefore forced to submit the SSN.
Release Your SSN to Your Bank -- or Go Without a Bank Account
If you apply to a bank to open an account -- of any kind, not just an interest-bearing account -- you will be asked for your SSN. The Treasury Department sponsored a law that requires a taxpayer's identification number on every account. With respect to interest-bearing accounts, the rationale for this requirement is that it enables the bank to report interest income to the IRS. For noninterest-bearing accounts, identification of assets by taxpayer ID number facilitates IRS attachment of your assets in the event that they claim, correctly or incorrectly, that you owe the money.
You have, of course, the privilege of refusing to release
the SSN to the bank, but if you do, your request for an account will be
denied. Once again, in a modern economy
it is very inconvenient not to have a checking account, just as it is not to
have a driver's license.
Since you must supply the SSN even for a noninterest-bearing (checking) account, the requirement in this case has nothing to do with taxation of income. It is simply an attempt on the part of the government to identify and catalog your property to facilitate monitoring and possible confiscation.
In some cases, it is feasible to deny a request for an SSN. For example, if someone insists on it as identification to cash a check for you and you refuse, he will probably refuse to cash your check. That is certainly his privilege: he wants to know as much as he can about you before taking a chance, is free to ask you for whatever personal information he pleases, and can refuse to cash your check for whatever reason he pleases. This presents no serious problem, however, since you can probably readily find another source, such as a bank, to cash the check for you, without requiring your SSN.
As mentioned earlier, your employer's medical insurance company or claims paying agent will no doubt ask you to reveal your SSN on your medical expense reimbursement claims. You may refuse, in which case they will complain, but will probably not persist in refusing to pay your claim, since it would no doubt be viewed by the court as an inadmissible basis for denying the claim.
Protect Your Privacy at Your Peril
Recently, a friend of mine applied to a large mortgage company for a mortgage loan to purchase a home for his family. The mortgage company asked him for information on his earnings, assets, and liabilities. In addition, they asked for permission to make a credit check through a national credit-reporting company. As part of this request, they also asked for permission to release his SSN and all of the private financial data he had just provided to the credit-reporting firm. He refused, indicating that while he had no objection to the mortgage company's obtaining and reviewing a report from the credit-reporting firm, he saw no need for them to release his current private financial information to the credit-reporting firm. He stated that he had no objection to release of his name, address, and age to the credit-reporting firm, since these items uniquely identify him in the credit-reporting firm's files.
The mortgage company terminated his mortgage application, indicating that the conditions he imposed were too restrictive. It stated that it was able to receive a credit report using his name, address, and age, but would not request one unless he would permit release of all of his current financial data to the credit-reporting firm. Having been defamed by a credit-reporting service in the past, my friend replied that he had no intention of ever releasing any information to any credit-reporting service.
The situation was clear -- either allow release of his private information to credit-reporting companies or he would never receive a mortgage loan. A conspiracy between the mortgage company and the credit-reporting service? Who knows? The fact remains that today, unless you submit to release of your private information to credit-reporting services, you may never be able to purchase another home on credit. Submission of all of your financial or other personal data to the mortgage company is evidently no longer accepted as a basis for the mortgage company's review of your qualification for a mortgage loan. You must agree to provide the credit-reporting services with up-to-date personal data for them to sell to others without compensation to you, or the mortgage company will deny your loan.
Modern Computer Technology Can Link Together Distributed Data
With modern data base technology, it has become an easy matter to combine data on an individual from many sources. In technical terms, the data structure is called a distributed database. Previously, when data on individuals were maintained manually by a large number of independent and "unlinked" organizations, it was not feasible to assemble, maintain, and distribute reasonably complete and current dossiers on a large segment of the population. That is now done as a matter of course. Moreover, from a practical viewpoint, the individual is coerced by financial, insurance, and governmental organizations to provide -- without reimbursement -- both the universal identifier needed to operate these systems and the up-to-date private information needed to fill the files.
Use of the SSN Identifier Is Increasing Dramatically
The government will not let go of the SSN without a fight. The SSN is used by a wide variety of agencies to monitor and control the activities of individuals. The most widely recognized use of the SSN is, of course, to track income. Employers, banks, and investment firms are all required to report information about your earnings to the IRS, using the SSN for identification. The Office of Child Support Enforcement uses the SSN to track parents who make child support payments. The Office of Education uses the SSN to track college graduates who made education loans. The Department of Defense uses the SSN to identify soldiers and individuals having access to classified information.
Many states use the SSN to monitor and track motor vehicle drivers. A friend of mine told me that she was stopped for speeding in Ohio recently and was requested to provide her SSN to the patrol officer in order for him to run a "check" on her identity. To an increasing extent, police cars are being equipped with computer terminals that link the car directly to local, state, and national computer systems. Unless positive steps are taken soon, the day will arrive when a police officer may routinely demand a person's SSN for entry into such systems for a search of his records. It would not be surprising if, someday, laws are passed that require an individual to release his SSN on demand, or his driver's license will be revoked. Such a procedure is already used in some states in the case of sobriety tests. If a person refuses the test, he is arrested on the spot, and his driver's license is revoked. The issuance of the driver's license is viewed as "presumptive" permission to administer the test.
In spite of the restrictions placed on the use of the SSN by the Privacy Act of 1974, the use and abuse of the SSN as an identifier is growing. Some colleges and universities use the SSN to identify students. This use appears to be illegal, since the Privacy Act prohibits any federal grantee from setting up a system of records based on the SSN, and most colleges and universities receive federal grant funds that benefit students.
The Move to SSNs for Children
Under the new tax reform legislation, all citizens over the age of four will be required to be issued SSNs, in order to be claimed as dependents. If you do not submit an SSN for each dependent over the age of four on your tax return, you will be fined. The rationale for this move is that it makes it easy for the IRS to check to see whether separate filers have claimed the same dependent. With no personal income tax, this rationale would evaporate. Although the government has a greater interest in having a universal identifier than it has in maintaining personal deductions, it is politically very difficult to argue that it needs a universal identifier to monitor and track its citizens. It is much more palatable to say that personal deductions are necessary in order for taxes to be "fair," and that the SSN is necessary to make certain that everyone claims no more deductions than he is entitled to. For this reason, the US Government will be extremely resistant to the idea of dropping the income tax, even though a lower-cost, higher-equity, less-intrusive alternative is available.
Individuals Have Suffered a Tremendous Loss of Privacy in the US
In summary, a substantial loss of privacy has occurred with the advent of the electronic digital computer and its use in monitoring you. Low-cost storage and retrieval of personal data is now possible, and the merging of files from different sources is greatly facilitated by the availability of a near-unique, near-universal, near-permanent identifier, such as the SSN. Unfortunately, these practices have contributed to a tremendous erosion of privacy in the US. Careless maintenance of these files has severely damaged the reputations of many people, and will harm many more. These practices would be substantially curtailed if no universal identifier were available.
It may be argued that the preceding loss of privacy would occur even if the SSN were not available. That is not at all clear. It is not obvious that it is hopeless for a person to retain a substantial measure of privacy in a modern world, even though the federal government is making achievement of that goal very difficult in the present-day US. In any event, should the US Government, with its purported concern for privacy of the individual, be in the position of facilitating privacy loss through its promotion of the SSN?
On May 6, 1987, New York Times columnist Anthony Lewis published an editorial entitled "American Journalism," decrying the Miami Herald's tracking of Senator Gary Hart for the purpose of exposing his personal life. In that editorial, Mr. Lewis stated, "Loss of regard for privacy has exacted a terrible price in American politics." Given that the citizens are, in effect, placing their lives and futures in the hands of the President, it may be understandable that they wish to conduct a detailed examination of his life, both public and private. For the private citizen who wishes simply to lead an unharassed existence, however, that exposure is unwarranted. The loss of privacy has exacted a terrible price in America, period. If someone asks you an impertinent question, you should be able to deny his access to that information simply by saying, "That's none of your business," without jeopardizing your right to a job, to health-care benefits, or to vote. With the massive trafficking in third-party sale of personal information, however, the private citizen has little control over the dissemination of information about him and his family and little chance of maintaining his privacy.
A major aspect and component of human dignity is privacy. Rampant disregard for personal privacy diminishes our dignity and depreciates the quality of life in the US.
Institutional Defamation of Character
Some people argue that if you have done nothing wrong, you should have no objection to allowing storage, sale and distribution of information about you by government agencies and private-information procurers/peddlers. That argument is specious from several points of view. First, it denies our cultural desire for privacy, the same desire that drives us to wear clothes and place window shades and interior doors in our houses. Second, because of the strong potential for misuse of credit data, it is unwise to allow third parties to maintain and distribute personal information about you. Third, information about your personal characteristics or past may be used as a basis for unwarranted discrimination against you. Fourth, many US citizens routinely break laws they consider unreasonable or immoral, or may refuse payment for an improperly rendered bill without wishing to go to court over the matter. It does not serve the best interests of our imperfect system of government and justice to support systems of records that permit the destruction of a person's credit rating or the documentation of his protest of certain laws. Fifth, our culture has a heritage of "forgive and forget"; there is no strong rationale for permanent documentation and distribution of your past. The preceding points are discussed in detail in the following paragraphs.
The Desire for Privacy
Most people desire and enjoy privacy. The extent to which they enjoy it varies, from the nudist who desires exposure to Howard Hughes, for whom privacy became a consuming obsession. Most people don't want everything about them known to the public, and many people don't want much about them known.
The Argument for Personal Control of Distribution of Personal Information
In addition to wanting to retain a measure of privacy, some people want to retain control over distribution of personal information about them. The concept of control is far more important than many people realize. In many instances, erroneous information is entered into credit-reporting-service data files. Many times, you do not know that false information about you is being distributed by the credit-reporting service. Correction of these files may be difficult; tracking down and correcting all of the false reports that have been distributed may not be possible. Furthermore, it may be impossible to undo the damage that has been done by a false report.
Because of errors made by credit-reporting firms, severe damage has been caused to people's reputations. It is extremely difficult to undo this damage. Most of us cannot afford the cost of a lawsuit to recover compensation for the damage to our reputations. Because of this situation, a strong argument can be made that all third-party information trafficking -- the general collecting, buying, and selling of personal information by firms such as credit-reporting services and medical-information-reporting services -- should be made illegal. The current system, under which we ostensibly have the right to deny these firms access to their personal data or are free to sue for damages if defamed, has simply failed. We are almost powerless to deny them access to our personal data and to deny them permission to sell that information.
"Revealing Well-Kept Secrets"
As an example of damage suffered because of loss of privacy, consider the case of the epileptic. Richard Pollack published an interesting article in the September 8, 1986, issue of the Arizona Daily Star. The article, "Revealing Well-Kept Secrets," discusses the dilemma of an epileptic who may be subjected to a drug-screening test. He, along with hundreds of thousands of others who have epilepsy, takes anticonvulsant drugs to control seizures. These drugs are detected in urine tests, such as those proposed recently for drug abuse detection.
One fear is that people who take legitimate drugs -- for epilepsy, hypertension, diabetes, or depression -- could be refused hiring, or even fired, if drug tests became mandatory conditions of employment. Even routine foods, such as poppy seeds on bread rolls, can cause positive drug test results. Suppose that such a positive result is entered into an information system and that the individual is later determined only to have eaten dinner rolls? Will he ever be able to make sure that his records have been corrected?
Another fear is that many people discriminate against epileptics, and Pollack does not consider that fair. He would prefer that people be able to keep their epilepsy or other health conditions to themselves, as protection from what they consider unwarranted prejudice. With the current rampant development of medical-information systems, recording personal information about millions and distributing this information around the world at the touch of a keyboard, the freedom to preserve one's privacy and protect oneself from unwarranted discrimination and prejudice is in serious jeopardy.
Forgive and Forget
We all make mistakes and have shortcomings. Until a few decades ago, most of these mistakes and shortcomings, except for major crimes, were not documented in data files. As we grew older, it was a delightful aspect of human existence that a person could, in essence, "wipe the slate clean" and start over again. That privilege is no longer allowed us.
Trafficking in personal information is big business. Our credit problems, employment problems, medical problems, marital problems, driving problems, psychiatric problems, and substance abuse problems are documented and maintained, usually in computer data bases, along with a variety of other personal information. Your personal information is distributed nationwide. If you've had some problems in the past, they're "cast in concrete" and are going to haunt you the rest of your life.
Human beings aren't perfect, and they don't respond well to documentation of their past and constant reminding of it. In our culture, a 40-year-old does not expect to be held perpetually accountable for the peccadilloes of his youth, and is not, unless they are extreme.
Many people have difficulties, weaknesses, shortcomings, personal characteristics, or experiences that they do not wish to share with the public. These may include a small income, a heart problem, epilepsy, occasional use of alcohol, consultation with a psychologist, a lost job, divorce, and marital problems. Having such facts reside in the memories of a friend, associate, or family member is one thing. Having such facts reside in the memory of a computer, owned and operated for someone else's profit, is quite another matter. The existence of such documentation constitutes, in effect, an institutional defamation of character. Because of the SSN, such information is easy to store, retrieve, merge, transfer, and sell.
Some may argue that a person should be held fully accountable for his current status and past actions. This point of view, however, fails to recognize that a person grows, matures, and changes. A 40-year-old is virtually a different person from the 20-year-old he once was. Furthermore, it is not a defense of defamation to prove the truth of the defamatory statements. The storage and release of information about an individual's past that defames his reputation or limits his ability to qualify for future benefits on the basis of the assertion that it is true is insufficient justification, and does not enhance the quality of life in our society.
"If You've Done Nothing Wrong, You've Nothing to Hide"
The growing use of the SSN to track individuals is a significant invasion of privacy. Some would argue that this practice is socially beneficial. Mothers forced to raise children without assistance from fathers endorse tracking fathers down and garnishing their wages. In April 1987, a bill (SB 1031) was introduced in the Arizona legislature to require that all child-support payments be automatically deducted from a parent's paycheck -- whether the parent is behind in the payments or not. This bill is in violation of a person's right to both privacy and due process.
In our society, use of the law to track down fathers and force them to support their children can be carried just so far. A very effective way of forcing fathers to support children is to outlaw divorce. Although this is the policy in some countries, few in the US would endorse this use of the law to force parental support.
The Move Toward a National Identification Number
One of the most controversial potential uses of the SSN is to track "illegal" aliens. While citizens of some Western European nations have acquiesced on the matter of work permits, national identity cards, and police "good conduct" documentation, such control is not consistent with our heritage of freedom of the individual.
Privacy of the Individual Represents Protection of Imperfect Human Beings From Imperfect Laws
Some would argue that all of these activities are legal. The term "legal" does not necessarily mean morally justified, or even generally desired by the citizenry. Many laws are enforced for years and then judged to be unconstitutional. The basis for "civil disobedience" is that the breaking of minor laws may be justified as a means to righting greater wrongs. The institution of detailed information systems that enable close government monitoring of individuals can stifle the ability of US citizens to force the government to be responsive to their needs. Privacy of the individual is an important protection against governmental tyranny.
The following examples are just a sample of the many laws that are unwanted or ignored by a large segment of the population, and are often inconsistently enforced.
Prohibition of alcohol was once the law of the land, even though a majority of citizens apparently did not want it. Blacks and women were denied the vote at one time. For many years, the national speed limit was 55 miles per hour, although a majority of the population routinely exceeded this limit. Gambling is legal in some states, illegal in some states, and legal if operated by the state (such as lotteries) in others. Private poker games in one's own house are illegal. Office football gambling "pools" are illegal. Bingo games operated by the local fire department fraternal organization are not.
Cigarette smoking is legal, although it has been designated as a leading public health hazard and secondary (involuntary or "passive") smoking has been identified as a cause of thousands of cancer deaths each year. Alcohol consumption is a legal form of recreational drug use, although it is widely recognized as very damaging and a severe and widespread drug abuse problem. Marijuana smoking is not legal.
"Sanctuary" movement church members believe that they should be permitted to save human beings from death, regardless of whether by accident of birth they happen to bear the label of citizens of a particular country. Many people opposed the Vietnam War. Alcohol consumption on the beach at Ocean City, Maryland, is illegal, but the law appears to be enforced against teenagers, and not against middle-aged individuals. Sexual relations between an unmarried 18-year-old male and a 17-year-old female is a crime in some states -- statutory rape. Oral sex is illegal in the US, although many engage in this practice. Many people are outraged at the rounding up and incarceration of Americans of Japanese descent and the subsequent loss of their income and properties during World War II.
Many laws (such as, exceeding the 55-miles-per-hour limit, private poker parties, drinking on the beach, adultery, sex between a 17-year-old and an 18-year-old) are routinely broken by a large number of US citizens, and many "law-abiding" US citizens do not intend for the offenders to be apprehended or punished. The law in these cases is evidently regarded merely as a statement of an "ideal" standard of conduct, for which most people are prepared to overlook nonoutrageous infractions by their fellow citizens. The penalties for such laws are often set very low. For example, when the national speed limit was 55 miles per hour everywhere, if a person was stopped by the Arizona police for driving 60 miles per hour, he was fined a small amount and cited for failure to conserve natural resources.
Most Citizens Don't View Changing the Law as Practicable; Privacy Is a Buffer Against Unreasonable Laws
In general, many generally law-abiding US citizens recognize that the law is an arbitrary collection of regulations, some of which are "right" and some of which are "wrong," depending on a person's set of moral values. Based on our own personal system of values, we decide which laws we will obey and which we will not. If a law is morally unjust, or unreasonably intrusive, and we feel strongly about it or believe that the affected domain is none of the government's business, we will not obey it. The US civil rights movement proceeded on the basis of violation of laws considered unjust.
In addition to the fact that many laws are viewed simply as standards of conduct, another factor underlying this point of view is that many people do not feel that they have much control over which laws are passed and which are not. They may be convinced that a law or government regulation is wrong, but feel helpless to change it. The bureaucracy has become so large and powerful that the ordinary citizen feels a strong sense of helplessness. People who have dealt with the IRS know the feeling -- essentially, you cannot deal with it. Its notices are threatening and intimidating, and its reputation for confiscation of personal property without due process is widely known. People who opposed the war in Vietnam saw 50,000 young citizens die, billions of dollars squandered, and a decade pass before the war was finally terminated by President Richard Nixon.
The effort to change the system, even when the change is generally supported by public opinion, may be Herculean, and could require a lifetime commitment. From a practical viewpoint, quietly ignoring stupid or immoral laws is a more reasonable approach. Our system of representative government vests power in the hands of a select few who are able to make the two-party system work for them. Most people do not possess the time, resources, and charisma required to change the law, or the desire to devote themselves to becoming lawmakers or political appointees. Most citizens have their own lives to live and do not have time to campaign for changes in laws.
The Road to Participatory Democracy Is Rocky
In his book Megatrends, John Naisbitt sees a trend away from representative democracy toward participatory democracy, through the increased use of initiatives and referenda. Although this trend may give citizens a stronger voice in the setting of laws, recent experience has revealed some serious drawbacks in this approach. While it may work in very small local areas, evidence is mounting that it is proving to be a very ineffective means of dealing with regional problems, compared to representative government.
For example, in spite of the fact that the transportation-planning department in Tucson, Arizona, has over the past several years produced many fine plans to speed the flow of traffic through the city, local residents have consistently voted all such plans down -- "no freeway in my neighborhood!" The participatory democracy system has failed to solve the transportation problem. Today, traffic flow in the city is paralyzed. The use of referenda to implement urban policy by the citizenry has failed miserably. Participatory democracy has prevented the implementation of proven solutions to the problem and nullified the attempt to plan and implement a high quality urban environment. If egregious examples of the failure of participatory democracy to solve regional problems continue to surface, the trend to participatory democracy will reverse, and a return to representative democracy and central control will occur. Given recent experience, the trend to participatory democracy probably will slow and reverse itself. In this case, the sense of hopelessness of individuals to affect their laws will continue.
In a society of imperfect laws, privacy of the individual serves as a buffer that prevents suffocating governmental control. This is especially true in a large nation, in which the infinitesimal size of an individual's vote effectively denies him a significant voice in government or control of his nation's character. As a practical matter, an individual must accept the culture into which he is born. As unique individuals, however, their personalities, characters, and interests may not coincide with society's norms. America's tolerance of individual differences and heritage of nurturing the independent, entrepreneurial spirit has been a major factor in its greatness. Privacy is a major safeguard of the right of an individual to express his individuality, to achieve his full potential as a unique human being, and to enjoy a rich, full life, unfettered by the shackles of uniformity, conformity, and control which our increasingly restrictive government forges, year by year.
Privacy is the nemesis of tyranny, the strength and
shield of the free man. A strong right
to privacy is a hallmark of freedom.
Preservation of a strong right to individual privacy is an effective
defense against the evolution of a police state.
With a silver tongue appealing to the duty of the US citizen to pay his rightful share of the tax burden under an income tax system devoted to equity and based on ability to pay, the beguiling IRS would strip the US citizen of his right to privacy, brand him with the SSN as a thrall of the state, and subject him to a lifetime of monitoring and control.
It Is Demeaning for Human Beings to Be Registered and Monitored
If a local government decides that dogs should be controlled, it usually requires that each dog be issued an identification number. The ID numbers are registered with the local government and cataloged. The dog is monitored throughout its lifetime: the status of the dog's registration, ownership, and rabies vaccination is repeatedly reviewed. Use of ID numbers to systematically identify all of the members of a group is the first step in an effective control program. For about a century-and-a-half -- until the beginning of the Social Security and personal income tax programs -- US citizens were not individually identified and registered.
Upon incarceration, convicted criminals are assigned numbers. In the concentration camps of Hitler's Germany, identification numbers were tattooed on inmates. In primitive societies, slaves were branded. We are not dogs. We are not criminals. We are not slaves. It is demeaning and degrading to be issued an identification number and registered by a government. Individual anonymity is a strong component of freedom from governmental tyranny. The concept of a government-issued ID number is not consistent with the US tradition of independence and a high degree of freedom for the individual.
Why the SSN Survives
One of the reasons why the US Government has gotten by with requiring the SSN for so long is cultural. As young people grew up in this country, they were told that they had to apply for an SSN before they could get a job. It was just one of the many things that you had to do in our culture. To some, receiving an SSN was one of the evidences of emerging into adult society. The fact that it, in effect, represents a "work permit" and increases the potential for infringement on a person's privacy and liberty is rarely discussed with the young person.
Another reason why the SSN has lasted as long as it has is that the considerable economic value of a universal identifier such as the SSN was not realized until recently, with the commercialization of the digital computer, the subsequent development of a large number of data bases containing personal information, and the ability to merge data files based on the same identifier at low cost. The demand for personal information has always been strong, but never before was it available so inexpensively and on so grand a scale. The government placed minimal restrictions on the sale of private information -- in fact, it was one of the greatest consumers of such information -- and the market for personal information grew to the multibillion-dollar industry and public sector component we have today.
The Shift to an Information Economy Has Increased Demand for Information System Identifiers
Another factor contributing to the use of the SSN is the gradual shift the US economy has undergone, from an industrial economy to an "information" economy. In today's US economy, many people's jobs are concerned with processing information about individuals. With the single exception of agriculture, the economic activities of a country are largely discretionary. Once the country's food demands are taken care of (and in this country they are taken care of by just 3 percent of the population) the remainder of the population can become engaged in any economic activities it (or its government) chooses: manufacturing cars, personal computers, video cassette recorders and antitank missiles; going to the moon; gambling in the commodity and stock markets; fighting "political" wars; building ski slopes; foreign travel.
This country has opted to invest a large portion of its discretionary productive capacity in data processing. Once the choice of economic activity is made, however, a degree of economic inertia sets in. People tend to want to continue doing the same type of work they have been doing, whether it is copper mining, shoe manufacturing -- or dealing in private information. The immediate elimination of the availability of a universal identifier would cause a temporary economic dislocation: the price of producing personal information would rise, and the demand would fall. Some people would be out of work, until the economy (or the government) decided what other type of productive (or nonproductive) work would be substituted for the decrease in the level of personal-information data processing.
Government Intrusion on Privacy May Be Warranted in Some Situations -- But the Income Tax Isn't One of Them
I am not arguing that all intrusion of privacy by a government is unwarranted. Some intrusions may very well be warranted, even necessary. Search warrants provide government a basis for search in the event that a crime is suspected. Other good examples occur in the area of public health. In order to protect the US population from decimation by AIDS, governmental identification and monitoring of infected individuals may turn out to be the only effective means of control of a serious threat to the well-being of the population.
In the case of the income tax, however, the government has set up an arbitrary system of rates and regulations that is totally unnecessary from an economic, health, or other general-welfare viewpoint, and monitors all citizens to enforce compliance with these rules. The income tax system is a contrived one that serves no purpose other than to rationalize government monitoring of individuals. Monitoring of individuals may be justified in public health issues such as in the case of smallpox, tuberculosis, or AIDS; it is not, in the case of the income tax.
The Potential for Abuse of the SSN Is Profound
To many people, the concern over the SSN may appear to be a "tempest in a teapot." They are culturally accustomed to the current low level of privacy, unconcerned with the sale of personal information, desensitized to the defamation of character that has been associated with personal-information reporting, and do not perceive that their personal freedom is in imminent danger -- at least not on account of the SSN. It is an axiom of human sociology, however, that governmental systems do not endure. All empires and nations rise and fall. The US will not exist forever as it exists today. Our system of government may change, either gradually or precipitously, or we may be conquered by a foreign power. When that change occurs, the availability of a universal identifier could facilitate the immediate and effective control of the population by a new power.
With our history of having never been conquered, this nation is not sensitive to this concern. Other nations are. For example, it is the law in Sweden that all adult men possess a rifle and a number of rounds of ammunition. While a rifle-armed citizen-army may be no match for a powerful external threat, that government nevertheless recognizes that, in the final analysis, national security depends on the willingness and ability of individuals to take a stand. Anonymity is a valuable resource in the fight against a governmental tyrant. The leaders of any revolutionary movement will be quick to confirm this fact. The US population has allowed the anonymity of the individual to slip through their hands. In the interest of the long-term survival of our heritage of freedom and independence, it is essential to regain this important asset.
Although the danger associated with the loss of anonymity may not be widely perceived, it is real. A government that knows who its citizens are, where they live, what they own, and where their incomes are derived from, is in a strong position to control its people -- for good or ill. Although the US Government to date has promoted the general welfare of its citizens, the situation may not always be so pleasant. The time to take steps to preserve and strengthen our liberty is now, while we still possess it.
One of the most objectionable aspects of the US tax
system is that you are considered guilty until you prove your innocence. If the government believes, rightly or
wrongly, that you owe a tax, it will take the money from you, and it is up to
you to prove that you do not owe it.
This concept is quite different from the fundamental premise of US law
that a person is considered innocent until proved guilty.
If the US Internal Revenue Service, the tax collection agency of the US Federal Government, believes that you owe a tax, it will send you a dunning notice, which includes the warning, "We have enclosed a copy of publication 586A, which provides information about our collection procedures and your rights in relation to them. Your attention is specifically directed to our Enforced Collection Policy . . . ." The publication goes on to state, "Enforced collection action includes the filing of a Notice of Federal Tax Lien, the serving of a Notice of Levy and/or the seizure and sale of your property (personal and/or business). Once a Notice of Federal Tax Lien is filed, it becomes a matter of public record and may adversely affect your business transactions or other financial interests."
Even though you respond with an explanation or hire a tax accountant to represent you, the notices may continue. The next one threatens that the IRS "must now consider filing a Notice of Federal Tax Lien and seizing your property, wages, or other assets to satisfy your unpaid tax. The amount due includes additional interest and penalties which will continue to increase until the balance is paid in full." All of this, before you have ever had a day in court. The process represents nothing less than conviction and confiscation without due process of law.
The important thing to realize -- which many people do not -- is that the IRS can take these actions whether or not it has been proved that you actually owe the tax: they can destroy your home and business before you have ever had a day in court!
US tax law is so complicated and so confusing that it is impossible for a layperson to know all of the correct tax procedures. Some tax rules defy logic. The IRS nevertheless employs the doctrine that ignorance of the law is no excuse, and may ruin you for a reasonable and honest mistake -- or totally because of its own error!
In tax matters, the burden of proof lies with the individual -- you are guilty until proved innocent. One hundred million Americans are placed in this terrible position because of the personal income tax. No other way has been found for implementing a high-rate personal income tax. Only with the elimination of the personal income tax will the US be able to claim, sincerely, that an individual is innocent until proved guilty. The cost of placing 100 million Americans in jeopardy would be a heavy burden for a worthy cause. To pay this price for a costly, inefficient, inequitable, and intrusive tax is folly. The personal income tax is a tax structure irreconcilable with the ideal of personal freedom and is unworthy of a role in our system.
Because of the concept in tax law that the burden of proof lies with the taxpayer, that is, he is guilty until he establishes his innocence, all US citizens are at risk of punishment at the discretion of the government. Although this ploy has not been used on a grand scale to date, the situation offers a tremendous potential for abuse. The federal government has set up an incredibly thorough information system for monitoring all US citizens and has established the legal machinery to arrest and jail US citizens at will. This system poses a potentially serious threat to freedom. It stands ready and waiting for the first truly tyrannical leader of the US as a means to enslave us.
Before the implementation of the personal income tax in 1913, the federal government relied on indirect business taxes, such as tariffs, to raise revenue. Upon implementation of the personal income tax, the government required citizens to file annual tax returns, revealing their income and other personal information. As mentioned, the tax originally applied to only a small proportion of the population. The massive revenue requirements of World War II converted this tax to a mass tax, including essentially the entire population.
Today, the income tax process is a massive intrusion on the privacy of the entire population. Each year, the citizen is required to provide a detailed accounting of the amount and sources of his income, how he spends it, his dependents, and a variety of other information, such as the names of his creditors, physicians, churches, and charities.
The IRS is the government agency that enforces the tax system. As discussed previously, it operates under the assumption that you are guilty until proved innocent and has broad powers to search and seize your property and to fine you. The IRS is an organization, 85,000 strong, that is engaged in the monitoring of the activities of US citizens. This type of organization has no place in a nation such as the US, with a heritage of independence and freedom of the individual.
The IRS is a bureaucracy committed to and involved in the investigation of the financial affairs of private individuals, and in their cross-examination. This bureaucracy is a cancer in the tissue of a strong citizen-government relationship. It wastes productive resources and instills anger, fear, resentment, and hatred in the citizens. The concept of independence and freedom of the individual from government tyranny is incompatible with the personal income tax system. Even if a dictator realized sufficient wealth from natural resources (oil, minerals, forests), wealthy landowners, or businesses, he would do well to implement an income tax, just for the firm control it enables over the citizens.
Given their cultural heritage, many US citizens do not want a "big brother" watching them, yet that is exactly what has evolved in this country, as a byproduct of the income tax. The legislators who implemented the personal income tax in this country evidently did not intend that it turn out this way. When started in 1913, less than one half of one percent of the population was required to file. Now, the vast majority of the population is taxed in this manner. The social movements of the late nineteenth and early twentieth centuries were oriented toward taxing the rich, not the development of a system to monitor all citizens.
If the personal income tax were eliminated, the government would have no reason to identify, monitor, investigate, and cross-examine millions of US citizens, as it now does in its tax enforcement program. Not only is the personal income tax unnecessary, but it is extremely costly in terms of the disgust it engenders in the citizen for the government. No other tax is discussed and vilified to the extent and degree that the income tax is. In general, US citizens do not reject the concept of paying taxes; they object very much, however, to being subjected to the unnecessary control and harassment associated with the personal income tax.
To summarize, a major problem with the income tax is that it is an intrusive tax, generally perceived as inequitable, and applied to the general population. Originally, it was conceived as a low-rate tax applied to a very small proportion of the population. Today, the government considers it necessary to verify the income of virtually everyone. Citizens are encouraged by offers of rewards from the government to inform on their friends suspected of tax evasion.
There is a total lack of trust on the part of the government. It requires employers to inform them of wages paid to individuals, and banks to notify of payments of interest. To facilitate verification, the government requires all income earners to possess taxpayer identification numbers -- an SSN, in the case of the individual. The income tax -- like other bad taxes -- is creating a widespread contempt for the government. Just as slavery and prohibition were abolished, it is time to replace this odious system with a more efficient and equitable one.
A hallmark of the communist form of government is the centralized planning and control of the economy. In addition, communist governments exercise substantial economic and social control over the lives of the individual members of society. Through the intrusiveness of the personal income tax, the US Government has established a citizen-monitoring system that rivals those of the communist nations. The US citizen should be able to come and go as he pleases, without having to "check in" with the IRS every April 15.
Close government monitoring of individuals is inconsistent with the American heritage of freedom of the individual. For over 100 years, this country maintained the tradition of personal liberty. That freedom has been considerably eroded since the imposition of the income tax. In the tradition of the framers of the Constitution, it is time to reclaim that individual liberty, and reject continued government monitoring of individuals.
For years, reports of IRS outrages against US citizens have surfaced. In the past year, for example, we have read the newspaper accounts of the little fourth grade girl whose life's savings were seized by the IRS to pay for her father's back taxes. Alarmed that its excesses might expose it as a large, uncaring, insensitive agency, the IRS moved to correct the perception that it confiscates children's savings. Earlier this year, an incident was reported in which a Catholic church in Yuma, Arizona, underpaid its employers' withholding tax by one cent ($15,662.54 versus $15,662.55), and was fined $453.60. Last winter, a Tucson, Arizona, businesswoman was fined $315.48, also for underpaying her August federal deposit tax by one cent.
Unfortunately, many encounters with the IRS do not end with a reasonable resolution, but in personal tragedy. Such occurrences are not mere isolated incidents in which an overzealous agent makes a mistake. They represent but a few cases in a systematic program of fear waged by the IRS against US citizens. This book will not dwell on the subject of IRS abuses -- many books have already been written on the subject. Instead, I will simply summarize two recent books on the subject: Tax Revolt, by Martin A. Larson, and To Harass Our People, by George V. Hansen. Both books are recommended reading for anyone who is unaware of IRS excesses committed in the name of the income tax system.
An excellent book describing the excesses of the IRS is Tax Revolt, by Dr. Martin A. Larson. He cites many abuses committed by the IRS against US citizens and many practices of the IRS that are either illegal or in violation of the Bill of Rights:
· Monitoring of private telephone conversations
· Opening of private mail
· Burglarizing of people's homes and offices
· Electronic surveillance of private citizens
· Use of undercover agents
· Forcing US citizens to testify against themselves
· Forcing US citizens to prove their innocence on pain of severe punishment
· The widespread use of deceit, concealment, misrepresentation, threats, and lies
· Forcing full disclosure from taxpayers, in violation of the Fifth Amendment
· Requiring taxpayers to confer power of attorney on anyone representing them
· Using testimony of informants, who may not be questioned or cross-examined
· Seizure of property or money due taxpayers but held by others
· Payment of bribes to spies, informers, and undercover agents
· The establishment of intentionally obfuscatory regulations which are contradictory and difficult to understand, and the use of these regulations to bluff taxpayers into paying more than is due
· Threatening fines and imprisonment
· Grants of immunity from prosecution to its agents
· Seizure of property of third parties who owe nothing to the taxpayer (warehouses containing taxpayer's property, for example)
In his book, Larson describes numerous cases of IRS atrocities against US citizens. One such case is that of a Colorado couple who were notified in June of 1974, without explanation, that they owed $4,451. A letter soon followed indicating that they owed $4,206. A few months later, they were notified that they owed $13,700, then $15,000, then $16,000 -- all with no explanation! The IRS then moved into action against this couple, in their sixties. It seized their savings accounts and other assets, valued at $13,000. It seized their home, worth $100,000, and sold it for $16,000. They were evicted -- the wife in a wheelchair. The man who bought their home threw their personal belongings into the street. The news media contacted the IRS for an explanation, but were told that the Privacy Act prevented the IRS from making any statement.
The Case of Congressman George Hansen
Another, more famous, case described by Larson is that of Congressman George Hansen, author of the 1980 book, To Harass Our People, and the 1981 book, How the IRS Seizes Your Dollars and How to Fight Back, coauthored with Larrey Anderson, Jr.
The title of Hansen's book has an interesting derivation, which indicates the parallel of the relationship of the King of Great Britain to the American colonists and the relationship of the IRS to the American people. The US Declaration of Independence includes the statement, "He has erected a multitude of New Offices, and sent hither swarms of Officers to harass our people, and eat out their substance," from which the title is derived.
Hansen characterizes the IRS as the American Gestapo. He writes of the American people's fear of the -- "a runaway arm of government" -- and cites the following excesses:
· Attachment of 100 percent of a taxpayer's wages, salary, and/or property
· Invasion of the privacy of a citizen without a court order
· Seizure of property on the basis of conjecture, without a court order
· Trial of citizens in a special court governed by the IRS
· Forced submission of documents, records, and other material without a court order
· Publication of a citizen's debt to the IRS
· Subjection of citizens to electronic surveillance without a court order
· Waiver of the statute of limitations
· Threatening of witnesses
· Violation of written agreements
· Reprisals against citizens
· Maintaining of lists of private citizens for the purpose of harassing and monitoring them
· The use of fear and intimidation as a technique in performing its function
The income tax is a costly tax, indeed!
With the advent and incredible growth of the income tax, the principal function of the IRS has become one of monitoring, intimidating, and prosecuting private US citizens. All of this machinery has been established to enforce a tax that the framers of the US Constitution declared specifically to be illegal.
Gestapo-like Tactics of the IRS
In their book, How the IRS Seizes Your Dollars, Hansen and Anderson document many of the Gestapo-like tactics of the IRS in its enforcement efforts. Hansen and Anderson provide several chilling accounts of cases in which US citizens have been brutalized by the IRS. In one instance, for example, in 1977 an Alaska couple was told, without explanation, that they owed the IRS $3,300. When the couple asked for an explanation, they were dunned for $4,700, once again, without explanation. Next, the IRS informed them that they owed $4,200 and placed a levy on the husband's wages, which reduced the couple to below the poverty level. The IRS then informed the couple that they owed $9,600 in back taxes. When the couple went to the Fairbanks federal building, the IRS attempted to tow their car away. The couple entered the car, at which time the IRS surrounded their car with other vehicles. After a seven-hour standoff, the IRS obtained a search warrant, at which time they began smashing the windows with billy clubs, hurled the husband from the car, dragged the wife through broken glass from the car, and slammed her to the pavement, bruised and bleeding. They confiscated the car. The next day the IRS informed the couple that they now owed only $4,010. The IRS then proceeded to sell the couple's car for $500.
In another instance, Hansen and Anderson describe the case of a Maryland couple. The IRS alleged that the husband had not paid his taxes in 1971 and 1972. Without benefit of a trial, or even a search warrant, on February 20, 1981, IRS agents burst into the couple's home with automatic rifles aimed and ready to fire. Outside, IRS agents armed with M16 rifles surrounded the couple's property. Ten IRS "storm troopers" then took possession of the couple's home until late afternoon, when an IRS van confiscated the couple's household goods, workshop equipment, vehicle, and tractor. The IRS proceeded to sell the confiscated property at public auction.
All of these actions were committed without a search warrant and without benefit of due process. Hansen and Anderson point out that the husband had committed no crime, and that the IRS would not accuse him of a crime because this would afford him the opportunity of a trial by jury. Since no crime was committed, a search warrant could not be issued. Instead, the IRS used a writ of entry. Along with Section 6331 of the IRS Code, this order of entry allows the IRS to forcibly seize a citizen's property without due process of law. This is an absolute violation of the Fifth Amendment.
A third episode narrated by Hansen and Anderson is the case of a Minnesota farmer and crop duster. He claimed that he did not owe the IRS $39.65. He asked for an explanation, but received no response. He contacted his bank to put them on notice not to honor any IRS demands on his account, except by his consent or by court order. The IRS nevertheless proceeded to confiscate $39.65 from his account, with the bank's acquiescence. The farmer was furious over the bank's cooperation with the IRS. The incident escalated. On July 29, 1980, in an encounter with the local sheriff stemming from the incident, the farmer, in the presence of his wife and son, was shot in the head with a shotgun and died one week later from extensive brain damage.
As a result of his book exposing the IRS' tactics, Hansen is convinced that the IRS began a concerted campaign to defame him. He cites several examples of instances in which the IRS went to extraordinary lengths to discredit prominent persons who speak out against it. Hansen describes the IRS' approach in dealing with prominent citizens. A powerful weapon is simply the act of launching an investigation against someone. It doesn't matter whether the individual is innocent or not, and the IRS does not have to prove anything. After visiting a few friends or leaking word of the investigation to the press, the individual's reputation is suspect, and the damage is done.
Hansen and Anderson describe the elaborate police-state system that has been developed by the IRS for monitoring individuals and maintaining lists of citizens suspected of giving them trouble. They describe how the Tax Court has been set up to dispossess citizens of their property in lieu of a proper constitutional trial by jury in a legitimate court (a court inferior to the Supreme Court and bound by the Constitution). They noted that in 1981 (the time of writing of their book), ten of the 16 Tax Court "judges" were former employees of the IRS. Refusal to obey the orders of the Tax Court is considered a felony. If the citizen refuses to obey the orders of the Tax Court, he is charged with a felony and can get a jury trial -- not relative to the disputed income taxes, but for refusal to pay taxes assessed by the Tax Court!
Under Article I, Section 8, Paragraph 9 of the Constitution, the Congress has the power "to constitute tribunals inferior to the Supreme Court." The Tax Court is not inferior to the Supreme Court. It is not even in the Judicial Branch of the federal government at all, but rather in the Executive Branch, within the Treasury Department. This is a clear violation of the Constitution.
Hansen and Anderson summarize the secret-police activities of the IRS:
· IRS procedures are set up to intimidate, harass, and bankrupt individuals and businesses. If the IRS decides you owe a certain amount, it can levy a "jeopardy assessment," which can impound all of your assets.
· The IRS system makes it very difficult for the taxpayer to seek redress outside of the agency. Under its regulations, the IRS can seize property, confiscate records, and levy bank accounts without accusing the taxpayer of any crime. Within its own system, acting as judge, jury, and prosecutor, it can arraign and convict a taxpayer.
· The IRS has ruined the careers of elected officials who attempted to expose its atrocities.
· The IRS has allowed the Sixteenth Amendment (allowing the income tax) to take precedence over all other Amendments. In effect, current IRS procedures, ostensibly justified by the Sixteenth Amendment, nullify the First, Fourth, Fifth, Sixth, Seventh, Eighth, Ninth, and Tenth Amendments. The Sixteenth Amendment has had the effect, in the seven decades since its enactment, of virtually destroying the Bill of Rights.
· Night raids, arrests without warrants, incarceration without trial, beatings, and physical abuse have been part of the IRS' tactics. The IRS, by setting up its own separate judicial system, is in effect setting itself above the Constitution and outside of the law. By analogy, the KGB and Gestapo placed themselves above the law in the name of the security of the state. The IRS is a dreaded national police force with totalitarian powers and methods. The US citizens' attention has centered on the FBI and the CIA, and overlooked the threat to individual rights represented by the IRS.
· To promote secrecy, the IRS keeps much information on suspects on tape. Since the documents are not typed up as final documents, they are not subject to the Freedom of Information Act.
· Contrary to the statute of limitations principle that no one should be subject to contingent liability for crimes or civil wrongs indefinitely, the IRS uses threats of extortion to coerce citizens to grant extensions of time or waiver of the defense of statute of limitations. The extortion threat is that the agent will make an assessment without reference to any evidence then in possession. If it were not for the fact that the burden of proof in tax matters lies with the taxpayer, and that the IRS has its own courts, no one would agree to extensions.
· The IRS maintains an elaborate Data Services System that maintains files on over 115 million US citizens and 25 million businesses. The Data Services System collects newspaper clippings, police reports, court proceedings, personal correspondence, and tapes or transcripts of conversations obtained by electronic surveillance.
Hansen's book characterizes the IRS as an American Gestapo that uses terrorist tactics in committing atrocities against US citizens. Some people view this characterization as too strong -- that the IRS simply ruins people financially, but does not kill them. On the other hand, the IRS does operate outside the Constitution, has set up an illegal court outside the Judicial Branch, confiscates property without due process, and engages in many police-state-like activities, such as threats, intimidation, and spying.
With respect to the preceding examples of IRS actions against US citizens, some may respond, "The government has to collect taxes; that need takes precedence over individual rights." That may be so, but there are taxes available that are far less intrusive than the income tax and do not create the need for extreme enforcement procedures against individual citizens. Business taxes such as the VAT do not require individual citizens to reveal their incomes, expenditures, or wealth to the government. The income tax creates an intrusive, confrontational, and adversarial relationship between the citizen and government. This is totally unnecessary and undesirable.
Mr. Hansen's characterization of the IRS as the American Gestapo is severe. As might be expected, however, few win a fight with the IRS. Recently, Mr. Hansen was imprisoned. Congressman Hansen was found guilty in 1984 of ethics violations for failing to report more than $300,000 in personal loans on financial disclosure documents required by the House of Representatives ethics rules. He had been assured that he did not need to report his wife's financial affairs, and did not. He was sentenced to 15 months in prison. He served six months of the sentence, but was imprisoned again in April 1987 on a parole violation.
Hansen became a target. Other members of Congress were allowed to amend their ethics documents, but he was not. He was arrested in Omaha, Nebraska, where he was to speak against the federal government.
As Hansen himself noted in his book, the IRS needs resisters. It needs them to justify its existence and expansion, and to create well-publicized examples that periodically reveal its awesome power to destroy persons without due process, thereby creating an atmosphere of fear and intimidation that cows the majority of US citizens into compliance. The use of confrontation, of escalation to violence, is an established IRS tactic.
The IRS goes after its targets with a vengeance. If it can prove that the taxpayer erred in any way, it persecutes him endlessly, with the tenacity of a pit bulldog. Consider, for example, the case of bandleader Woody Herman, which was recently in the news. His band faltered in its indentured-servant role of collecting payroll taxes for the federal government. His business manager failed to submit some of the band's payroll taxes in the 1960s and gambled the money away. Twenty years later, the IRS was still persecuting Herman, up to his death on October 29, 1987.
Woody Herman labored for over 20 years to repay the taxes squandered by another, plus severe penalties and interest. Most of the money he earned since the sixties went to pay for tax liens. Even this year -- his 74th -- he was on tour, earning to repay the never-ending penalties relentlessly imposed by the IRS. In March, he fell ill with a heart ailment contracted after taking medication for high-altitude sickness during a tour through Colorado and Utah. He suffered a series of heart attacks in the past six months, and declined steadily until his death. With Herman in his seventies, after 20 years of paying for another's wrongdoing, one might expect that the IRS had surely extracted its pound of flesh -- no? No way!
Bedridden, requiring oxygen and 24-hour nursing care, no longer able to work, Herman was now easy prey. The IRS sold his house of 41 years at a tax auction. His earning ability gone, he was unable to pay the rent to the new owner of his home. The new owner moved to evict him. Hearing of his plight, his friends and supporters rallied to his side. Los Angeles radio station KKGO offered to pay the back rent.
Since the 1960s, the IRS collected $1.6 million in fines, penalties, and taxes from Herman. The IRS went after Herman personally, even though it was Herman's business that owed the money. Money alone is not enough, however, for the IRS. The IRS enforcement system thrives on spine-chilling examples of its power to destroy.
What is wrong? Why is the American public so frightened of the IRS? Why has the IRS mission to achieve a high level of voluntary compliance resulted in a massive citizen-monitoring bureaucracy that engenders fear and contempt by the citizen for the US government and led to a massive underground economy? The answer is simple: the US has adopted a personal income tax system as its major source of revenue. With high rates, voluntary compliance does not occur and the IRS hence must force compliance through fear and intimidation.
The 85,000 employees of the IRS are not traitors, nor are they Gestapo agents. In many cases, however, they have been forced to engage in Gestapo tactics to enforce an inhumane tax. The employees of the IRS are not an evil, malicious group of people; they are American citizens who have accepted the necessary job of tax collection. The problem is that the personal-income-tax-based system is a corrupting one; it corrupts not only the taxpaying citizens through its intolerable incentives to evade, but it forces other citizens -- IRS employees -- to violate the personal rights of their fellow citizens to collect an unreasonable tax. Through the personal income tax, the government has set up a complicated, unfair system with intolerable room for error and incentives to evade; consequently it has set up an elaborate, tyrannical bureaucracy to enforce the tax.
The solution to this problem is easy -- replace the US personal tax system with a business tax system. Impose taxes on businesses, not on individuals. Apply the IRS conscientiousness, diligence and efficiency toward the collection of taxes from businesses rather than from individuals, and the problem will be resolved. No one disputes the necessity of a government's collection of taxes. In a modern economy, however, collection of those taxes at the personal level is not only inefficient and ineffective, but also extremely damaging to the citizen / government relationship.
The alienation of the US citizen from his government is a symptom of an intrusive, oppressive tax system. The rampant tax evasion and alienation are symptoms of a bad system. It is time to stop treating the symptoms (through more intrusion and oppression) and address the cause of these problems. The personal-income-tax-based US tax system needs to be scrapped and replaced by a humane one.
The 85,000 employees of the IRS are loyal, hardworking Americans who in some cases are being forced to violate their fellow citizens' constitutionally endowed personal rights to collect a bad tax. Recently, the IRS published a document entitled The Internal Revenue Service Strategic Plan (May, 1984). This document is a frightening plan to further destroy the personal rights of the US citizen in the name of voluntary compliance and to advance the development of a society with a high degree of governmental monitoring and control of the citizen. The zeal of the IRS in collecting taxes should be oriented toward businesses, not toward the private citizen.
Hansen and Anderson describe how the IRS uses the guilty-until-proved-innocent device not only to harass individual taxpayers, but organizations as well. He cites the case of a private religious school claiming church exemption from taxation. The IRS regulations for Revenue Procedure 75-50, Federal Register, Vol. 43, No. 163, states that ". . . the Service will consider these schools to be racially discriminatory unless the schools can show that they now have a significant minority enrollment or that they are in good faith operated on a nondiscriminatory basis. If the schools cannot make such showing, the Service will consider the schools to be racially discriminatory, and tax exemption will be revoked or denied." Note that the burden of proof, as in all tax matters, is placed on the taxpayer, not on the government.
The US Government touts the US income tax system as a "voluntary" system. That is one of the finest examples of "doublespeak" in use today. It is not voluntary. It is a compulsory system based on rigorous enforcement by means of threats, intimidation, force, violence, defamation, invasion of privacy, spying, confiscation of property, and tribunals that are outside the framework of constitutional law and in flagrant violation of the Bill of Rights.
A particularly grating aspect of the personal income tax
is the impressment of firms by the IRS to collect the personal income tax,
under threat of severe penalties. In
this country, most personal income taxes are collected by businesses, in the
form of withholdings. The estimated tax
is deducted from each paycheck and forwarded to the government by the
employer. The business is forced to
conduct all of the accounting necessary to accomplish this tax collection. Businesses are not reimbursed by the government
for their tax collection services. While
expecting a firm to be responsible for its own taxes is reasonable, forcing it
to be responsible for the collection of another's taxes is offensive. Moreover, it is unconstitutional.
It should be recalled that one of the particularly galling acts of England against the new US republic was impressment of seamen.
It might be argued by some that forced tax collection by firms is nothing more than a "tax in kind" -- the "tax" is exacted in the form of labor required to assess, collect, and forward the individual's tax. While this is a nice theory, one should take note of Amendment 13, Section 1 of the US Constitution, which reads:
Neither slavery nor involuntary servitude, except as punishment for crime whereof the party shall have been duly convicted, shall exist within the United States, or any place subject to their jurisdiction.
Originally conceived as a tax on the rich, the income tax did not pose serious collection problems. When it was extended to a mass tax in the Second World War, however, it was no longer feasible to collect the tax -- the administrative costs were too great and the "leakage" and nonpayment too likely. Congress should have recognized this as a clear warning that something was terribly wrong with the concept of the individual income tax as a mass tax. Instead, refusing to acknowledge error and repeal the tax, it pressed blindly, stubbornly, and brutally on, and passed the Current Tax Payment Act of 1943, which imposed withholding on wages and salaries on the middle class. It was recognized that few middle-class Americans would save sufficient money for payment of a high-rate income tax, and so the US Government would simply make these savings for them. Firms were impressed into servitude as tax collectors, in patent violation of the Thirteenth Amendment.
Some might argue that the term "involuntary servitude" in the Thirteenth Amendment refers to forced labor of natural persons, not firms. That argument is specious. Firms don't work, people do. Forcing a firm to engage in labor is tantamount to forcing the people in the firm to engage in labor.
The Constitution empowers the Congress to levy taxes on firms. It does not empower the Congress to impress firms into service as tax collectors; in fact, by Amendment 13, it explicitly forbids this activity. The personal income tax is a bad idea that just keeps spawning problems, additional legislation, and further regimentation of citizens and firms. The income tax is perhaps the worst of all taxes, from a humanistic point of view.
How long will Congress persist in forcing this system on the US population? How long will Congress resist the cry to free the American people from this bondage?
The bulk of all income taxes is not collected directly from the 100 million taxed individuals. Instead, they are collected by the seven million businesses that employ most of those individuals. These collections are made by means of "withholding" the estimated tax from the employees' pay and forwarding it to the government.
The current system is, in essence, a payroll tax system in which the individual simply verifies his income every April 15 and makes a minor adjustment to his tax payment.
Given that the current tax system is essentially a wage tax system rather than an income tax system, it is reasonable to ask why 100 million citizens must be subject to government monitoring, to enable income verification, rather than the actual collection of taxes. Also, it is reasonable to ask why US businesses are burdened with the job of determining income tax payments for 100 million workers, when the use of a different form of taxation, such as the VAT, would obviate this burden.
Businessmen frequently complain about the burden of being forced to collect individual income taxes and execute all of the corresponding paperwork. If this work were necessary in order to determine the firm's tax liability, this burden would set much better. The fact is, however, that the burden represents forced labor, caused by the use of a ridiculous method of taxation.
Most taxes are paid by businesses. Personal income taxes are levied on individuals, but are paid mainly by businesses (through withholding). The percentage of the personal income tax that is collected directly from individuals is small. The personal income tax was in essence converted to a business tax with the passage of the Current Tax Payment Act of 1943. Since these taxes are already mainly collected and paid by businesses, why not acknowledge this fact and replace the personal income tax by a business tax (such as the VAT), and accomplish the significant goal of eliminating the needless monitoring of 100 million Americans and the impressment of firms to collect taxes from them?
The only defense you have against a police state is privacy. By passing the Sixteenth Amendment, the Congress has in effect abolished the right of privacy; the Supreme Court has given precedence to the Sixteenth Amendment over all the personal-liberty guarantees of the Bill of Rights, and the Executive Branch has implemented a police state, through the IRS. If you want to take back your freedom, you are going to have to start by accomplishing the repeal of the income tax.
The Constitution of the United States denied the federal government the power of imposing direct taxes that were not apportioned, or allocated, to the states in direct proportion to population. (Recall that a direct tax is one for which the burden of the tax falls on the taxpayer.) The federal income tax is a direct tax. When the federal government attempted to adopt a personal income tax in 1895, it was declared unconstitutional.
Congress accomplished passage of the income tax by first accomplishing passage of the Sixteenth Amendment to the Constitution. This amendment allowed the federal government to collect personal income taxes without allocating the revenue to the states.
The founding fathers of the US and the framers of the Constitution had sound reasons for limiting the power of the federal government to levy direct taxes. The power to levy such taxes severely weakens the position of the citizen with respect to the government. Direct personal taxes are severely intrusive of privacy, and pose a substantial threat to individual liberty. They are appropriate in a small society, in which the individuals share directly in government; they are not in a large one, in which individuals vest significant power in a central government.
The strong intent of the framers of the Constitution was severely undermined by the adoption of the Sixteenth Amendment. The passage of the Sixteenth Amendment, legalizing the personal income tax and the establishment of the IRS to collect personal income taxes, has led to the virtual destruction of the Bill of Rights. As noted by Larson in his book Tax Revolt, the IRS has arrogated vast legislative, judicial, and executive powers -- powers far beyond those to which an agency of the Executive Branch of the government is entitled. These powers nullify the personal freedom guarantees of the Bill of Rights. US citizens have lost their right to protection from unreasonable searches and seizures of their persons, houses, papers, and effects (Amendment 4); they have lost protection from being arrested and tried for a serious crime unless indicted by a grand jury (Amendment 5); they have lost the right not to be compelled to take witness against themselves (Amendment 5), to be deprived of liberty or property without due process (Amendment 5), to be confronted by the witnesses against them (Amendment 6), to obtain witnesses in their favor (Amendment 6), to a jury trial for cases involving amounts in excess of $20 (Amendment 7), and to the right of privacy (implied in most of the amendments comprising the Bill of Rights, especially the tenth).
In their book How the IRS Seizes Your Dollars, Hansen and Anderson note that the extreme complexity of the US Tax Code, in effect, violates the principle of equality before the law because the wealthy can afford to hire tax accountants and lawyers to interpret the code and protect their client from its assessments and penalties, whereas the poor lack the wherewithal to appreciate the code or protect themselves from its provisions. No area of law is so fraught with unneeded complexity and so removed from common sense as the tax code. Whereas the average citizen may be confident that his general knowledge of the law and common sense can keep him out of trouble, ignorance of the complex tax code is common, and the fear of tax prosecution is widespread.
The Constitution has failed. It has failed to protect the citizen from a strong central government. The framers of the Constitution created three branches of government -- the Legislative, Executive and Judicial -- and delegated powers among them in a system of "checks and balances" that was intended to check the power of the government and prevent any one branch from becoming too powerful. Powers not explicitly delegated to the federal government were reserved to the states and to the people (Amendment 10). And that's where the Constitution failed!
While the system of checks and balances to some extent preserved the relative powers of the three branches of government, a dramatic shift in power gradually occurred, from the states and people to the federal government. The federal government has grown in size, from a handful of senators and representatives to a massive bureaucracy with three million employees. The federal government budget now represents 20 percent of GNP.
The sheer size of the federal government perhaps is not alarming in and of itself, were it not for the Sixteenth Amendment, which legalized the personal income tax. That single amendment has, in essence, led to the demise of the Bill of Rights and to the establishment of a national police force, the IRS. The Sixteenth Amendment has subverted the intent of the framers of the Constitution. At the time of its passage, the income tax was not viewed as a mass tax and its insidious role in indenturing the US population to the government was not envisaged. As demands for revenue grew, this tax was extended to the point where it forms the major basis of the relationship between the US citizen and the government. The government is now so heavily dependent on the income tax that it ruthlessly crushes any attempt to resist the tax.
Had the original Constitution remained in force and the Sixteenth Amendment not been passed, the evolution of a police state based on the personal income tax would have been avoided. In their wisdom, the framers outlawed direct federal taxes, but they could not prevent the passage of the Sixteenth Amendment over 100 years later.
The US citizen will not regain his freedom until the Sixteenth Amendment is repealed. Until then, he will not be let alone. The IRS will force his registration and that of his children, monitor his activity in detail, demand annual revelation of his private affairs, and perpetuate its ever-increasing registration of the population. It will continue its tribunals in which the citizen, without benefit of a jury trial, is guilty until he satisfies IRS "judges" of his innocence. It will continue to confiscate property without due process. It will continue to maintain files on virtually all US citizens and to destroy the reputations and careers of any who resist or attempt to bring it under control or within the framework of the Constitution.
Concerning the shift of power from the people and the states to the federal government, the states have raised no voice in slowing this trend, especially since the defeat of the South in the War Between the States. States now act mainly as "rubber stamps" for the federal government, vehicles for administering federal law and dispensing federally funded services. Contrary to the intent of the framers (Amendment 10), the takeover of state functions by the federal government has been essentially complete. The federal government has been able to do so as the result of collusion between the Legislative, Executive, and Judicial branches of government. Article I, Section 8 gives Congress the power to "provide for the common Defense and general Welfare of the United States." The Supreme Court has interpreted this statement in an "expansive" manner, which in essence transfers all power to the federal government and none to the states, contrary to the intent of the framers. Congress steadfastly has refused to overrule the Supreme Court's rulings, even though it has the power to do so (Article III, Section 2, Paragraph 2). The Executive Branch of government has grown to extreme size and power, on the basis of Congressional actions.
Originally, the states acted as buffers, protecting the citizen from the power of a strong federal government. By having, in essence, two governments, the citizen had some protection from abuses from either one. That buffer has now been destroyed, reduced to a vestigial role of little more consequence than the Electoral College. With the states out of the way, the citizen has little defense against the federal government, and it is free to continue its program of regimentation and control.
The passage of the Sixteenth Amendment was an attempt to introduce social legislation aimed at improving the lot of the common citizen. Inadvertently, this single amendment has subverted the entire Bill of Rights and resulted in the creation of a police state which some refer to as an American Gestapo. It was a nice try, but it failed, and created a Frankenstein monster. The experiment failed. It is time to take back our freedom by repealing the Sixteenth Amendment and eliminating the personal income tax.
The income tax is unfair, for a number of reasons. It penalizes individuals who increase their incomes by working longer hours or taking a second job. It penalizes those who increase their income by going to school. It severely penalizes the earnings of a spouse who goes to work to help increase the family's income. It places a very heavy burden on older Americans by imposing taxes on their lifetime savings that may exceed 100 percent of the earnings of their investments. The US tax reform system imposes a heavy "marriage tax" on low-income families with children; for such families it is a cruel antifamily tax. This chapter explores the many inequities of the US income tax system.
In order to appreciate why the income tax is so unfair, it is necessary to understand the basic structure of the income tax and the definition of certain terms. Two very important terms are the "average tax rate" (or "effective tax rate") and the "marginal tax rate." The average tax rate is simply the proportion of a person's income that he pays in taxes. The marginal tax rate refers to the tax rate imposed on the next dollar of income that a person earns, at a specified level of income. The marginal tax rate is often referred to as the "tax bracket."
For example, suppose that a married person with no dependents other than his wife earns $50,000 per year and files a "joint" federal tax return. Under the tax reform law, this person is entitled to a "standard deduction" of $5,000 and "personal exemptions" of $2,000 for himself and $2,000 for his wife -- a total "tax deduction" of $9,000. His taxable income is hence $43,000. He pays 15 percent tax on his taxable income between zero and $29,750 (a tax of $4462.50), and 28 percent on taxable income above $29,750 (a tax of .28($41,000 - $29,750) = $3,150). His total federal tax is hence $7,612.50. The proportion of his income that he pays in tax is 7,612.50/50000 = .15, or 15 percent. Hence his average tax rate is 15 percent. At an income level of $50,000, he is taxed at the federal rate of 28 percent on each additional dollar he earns. His marginal federal income-tax-rate, or federal "tax bracket," is hence 28 percent.
It is important to realize the distinction between the average tax rate and the marginal tax rate. Most economic decisions depend on the marginal tax rate, not on the average tax rate. For example, a person in the 28 percent tax bracket saves 28 cents on every dollar he is able to shelter from taxation. It is that 28 percent saving that represents an incentive to obtain the tax shelter; the level of the taxpayer's average tax rate (for example, 15 percent) is not a factor in this decision.
A tax for which the marginal tax rates change as the income level increases is called a graduated tax. A tax for which the average tax rate is higher for higher incomes is called a progressive tax. A flat-rate tax is a progressive tax if personal exemptions are allowed. Both the previous personal-income-tax scheme and the current personal-income-tax scheme are graduated and progressive.
Tax Rates Under Tax Reform
Under tax reform, there are five income tax brackets for individuals or families. For families (more specifically, for married taxpayers filing joint returns), the rates are: 0 percent on tax-exempt income (personal exemptions, standard deduction, itemized deductions); 15 percent on taxable income between zero and $29,750; 28 percent on taxable income between $29,750 and $71,900, 33 percent on taxable income between $71,900 and $149,250, and 28 percent on taxable income over $149,250. The top marginal tax rate is hence 33 percent. This figure -- the maximum marginal tax rate for individuals -- will be referred to later, since it plays a role in many of the undesirable incentives of the personal income tax.
If you do not "itemize" your deductions, the "basic standard deduction" is $5,000. The personal exemption is $2,000 for the individual, spouse, and each eligible dependent.
The 33 percent tax on income between $71,900 and $149,250 is represented as a 5 percent "surcharge" imposed in addition to the 28 percent rate. The purpose of this surtax is to remove the benefit of the personal exemptions and the 15 percent tax rate on income up to $29,750, so that the tax rate on families earning over $149,250 is a flat 28 percent of all income.
For businesses, as for individuals, there are also five tax brackets. The tax is placed on a measure of corporate profit -- "taxable income," as defined by the IRS. The tax rates are: 15 percent on taxable income between zero and $50,000; 25 percent on taxable income between $50,000 and $75,000; 34 percent on taxable income between $75,000 and $100,000; 39 percent of taxable income between $100,000 and $335,000; and 34 percent on taxable income above $335,000. The top marginal tax rate for business is hence 39 percent of taxable income. This figure will also be referred to later.
The US income tax system is progressive: as your income goes up, the government taxes a greater and greater proportion of it. A progressive income tax system is adopted if one accepts the principle that citizens having a greater ability to pay should bear a heavier burden of the tax, and that current income is a good measure of a citizen's ability to pay. Even if you accept the ability-to-pay principle, and accept current income as a good measure of ability to pay, there is no theoretical basis for setting the degree of progressivity. Economic theory provides no answer to the problem of determining the number of tax brackets and the bracket rates.
Under tax reform, there are five tax brackets, as described above. These tax brackets are completely arbitrary. They can no more be justified than the previous system with its 14 brackets, or a one-bracket (flat-rate tax) system. Why, for example, should a person earning only $9,000 pay no tax? Does he not have any responsibility to help pay for schools, social services, highways, and defense? It could be argued that it would be better to tax him at the same rate as everyone else and give him a strong sense of participation and pride, than to give him a sense of being a freeloader, unable to carry a proportional share of the burden, with someone else paying his share. With a flat-rate tax, he could at least claim that he was paying the same share of his income as anyone else, even though that share may be small for him and large for someone else. Or, some argue that the poor have no ability to pay taxes. From this point of view, a "negative income tax" may have appeal -- the government should not only impose no tax on the poor, but should send them cash supplements. (The apparent dilemma posed by these arguments results from considering the income tax independently of other government social and economic programs. The inadequacy of this approach is addressed later.)
The point is that the number of brackets (extent of graduation) and the degree of progression is arbitrary and a subject for mutual discussion and agreement. There is no right or wrong answer to the problem of determining these items. While there are no economic arguments that support a particular progressive rate structure, there are numerous economic arguments both for and against progressive taxation. The paragraphs that follow summarize these arguments. On balance, despite the academic appeal of the principle of ability to pay, empirical evidence suggests that progressive taxes are generally regarded as unfair.
One rationale for increasing the tax rate for high-income earners, that is, for a progressive tax, is that it may be argued that the "utility" of money grows less as the amount of money that the person earns increases. In other words, the first $25,000 that a person earns means more to him, in terms of the pleasure or satisfaction or happiness that it buys, than the next $25,000. Said another way, he doesn't "need" the second $25,000 as much as the first $25,000. Because of this, he should not mind giving more of the second $25,000 to the government, than he gives of the first. Under the concept of taxing according to ability to pay, the government is tempted to take a greater and greater percentage of the additional dollars that he earns. The maximum marginal-federal-tax rate in this country, set at 50 percent just prior to tax reform and 33 percent under tax reform, has been as high as 94 percent.
From another point of view, because of the diminishing return of utility per additional dollar earned, a high-income earner must be taxed at a higher average percentage in order to suffer the same loss of utility, or realize the same burden, as a low-income earner. This point of view assumes that both persons have the same "utility function"; in other words, that money means the same to both of them with respect to the satisfaction it brings.
It also assumes that additional dollars earned have the same utility to the individual. For persons who increase their earnings by taking on additional jobs, this is definitely not a reasonable assumption. For example, a person who already works 40 hours per week may double his income by taking on a second 40-hour-per-week job at the same rate of pay. Because he is bone-weary on the second job, because he will never see his family or friends, and because it may cost him his marriage, the value of the second 40 hours is undoubtedly significantly greater to him than the first 40 hours.
In other words, each additional dollar earned in the second 40 hours "costs" him much more of his health, family, and social life than each dollar earned in the first 40 hours. Because the second-job dollars are earned with far greater "blood, sweat, and tears" than the first-job dollars, the utility of the second-job dollars is far greater than the utility of the first-job dollars. For each second-job dollar that he relinquishes (to spend more time with his family and friends), he receives a much greater return of "pleasure" than he would from relinquishing a first-job dollar. It is very difficult to see why a government ostensibly "for the people" would wish to tax the second-job dollars at a higher rate than the first-job dollars, but that is exactly what it does under a progressive tax system.
Most people would agree that the utility of earned and unearned income is different -- that "clipping coupons" is intrinsically different from managing a store every day of one's life, or teaching school. Notwithstanding this important distinction, for most taxpayers’ earned and unearned income are taxed at the same rates. And yet the income tax system is proclaimed to be equitable!
A progressive tax is often touted as a socially desirable means for extracting more tax income from individuals who earn at a high rate, and therefore have a greater ability to pay. No provision is made, however, for those who increase their income by working longer or harder (for example, through lower rates or deductions for "overtime" hours). The progressive income tax, in fact, constitutes a penalty for being successful, for investing long hours in additional work, for furthering one's training and education, for taking entrepreneurial risks, or for taking any actions that lead to increased income.
A drawback of the personal income tax is that it introduces a disincentive to work. Previously, when marginal income tax rates were relatively low (10-20 percent), there was a strong economic incentive to earn more income; the family could keep a large proportion of additional income earned by working longer hours or by entry of a spouse into the labor market. With marginal tax rates currently totaling 50 percent or more (federal income, state income, and payroll taxes) for many individuals and families, the incentive to earn more is reduced. Instead, people have an incentive to invest time and effort in less productive areas where high taxes may be avoided, such as taking more time off, vacationing longer at lower-cost times or places, operating a "gentleman-farmer" ranch, or investing in risky ventures with high tax reduction (write-off) advantages.
Some economists argue that a progressive income tax system incorporates the concept of ability to pay very well by forcing large-income earners to pay heavy taxes. Others argue that wealth and purchases are better indicators of ability to pay than personal income and profit. On the basis of the rationale that ability to pay should be related to how rich one is, a heavier burden should be placed on wealth, not income or profits. A millionaire who has no income in a given year undoubtedly has a greater ability to pay than a person with zero net worth who earns $30,000. Yet our tax system will tax the zero-net-worth individual heavily, and may not tax the wealthy individual at all. Clearly, the income tax system is a very imperfect means of taxing on the basis of ability to pay. Contrary to the assertions of many economists, income is not a good measure of ability to pay.
A problem with taxing wealth, of course, is that it is more difficult to locate and measure than income. An old argument against taxes on wealth is that they destroy capital, which is the basis of economic productivity.
Another example of the inequity imposed by the progressive income tax system arises in the case of working mothers. Many families strongly prefer that the mother stay at home to care personally for their children, rather than to go to work in the competitive (paid) labor market. In the past few decades, taxes have increased dramatically for middle-income earners, such as skilled workers and professional people. Because of this burden, many families now have to send the mother out to work in the paid labor market, just to make ends meet. As a worker, the mother incurs extraordinary work-related expenses: childcare expenses, different clothing for herself, paid meals for herself, transportation costs. In addition, there are substantial psychic costs: the loss of her children to another primary caretaker, and less energy to give to her family. The husband and the children incur the cost of loss of attention and care when the mother is forced to go to work. Also, many working mothers still have to do most of the housework, cooking and cleaning, or pay for housekeeper services.
In spite of the high social cost of the mother's working, the government, under the progressive income tax system, will tax her income at a heavier rate than her husband's income if she gets a job to supplement the family income. If her working moves the family from the 15 percent tax bracket to the 28 percent tax bracket, her earnings are, in effect, taxed at approximately twice the rate of her husband's.
In summary, the mother and the family may pay dearly when the mother goes to work in the paid labor market, both in terms of attention and care, but also in terms of extraordinary work-related expenses. Because of this, the mother's earnings are particularly hard-earned dollars. Yet, under the progressive tax system, the government sees fit to tax these dollars at a higher marginal rate than it did the husband's income when he was the sole income earner. Not a very pretty picture.
The issue being addressed here is not whether mothers should or should not work -- that decision is up to the woman and family. The issue is whether it is defensible for the government to encourage or discourage this activity through tax policy. Some women prefer to stay at home in a traditional family situation. Some women prefer to work in the paid labor market. Under current tax policy, with high rates and high progressivity, both are discriminated against.
The woman who wishes to work in the paid labor market faces a very high marginal tax rate on the additional income she brings home: a marginal rate of 50 percent for many families of modest incomes. Since wives are often the secondary earners in a family, it is generally their income that is taxed more heavily by the progressive tax system, and her working that is discriminated against. This is not an equitable situation.
The woman who wishes to stay at home faces strong pressure to enter the paid labor market because the high personal-income-tax rates in force under the current progressive tax system have made it difficult for many families to make ends meet on a single income. This is particularly true for families that work hard to earn the extra income to purchase a home, because of the government's severely progressive income tax system. If the personal income tax were terminated, the government tax policy would be essentially neutral on the issue of working mothers.
A recent study conducted by Princeton economist Harry S. Rosen and published by the National Bureau of Economic Research analyzed the perverse antifamily incentives of the Tax Reform Act of 1986. Under tax reform about 40% of US families will pay a "marriage tax" averaging $1,000. The term marriage tax refers to situations in which a married couple pays more in taxes than they would if they were unmarried with the same incomes. The marriage tax occurs because there are different tax rate schedules for single persons and families.
The new law can provide either a marriage tax or a marriage subsidy, depending on the incomes of the man and wife and the number of dependents. Partners with quite different incomes would receive a subsidy (since, because of the progressive tax scheme, tax on the combined income is less than the combined tax on the separate incomes).
The marriage tax falls particularly heavily on low-income families. For example, in a family with two children with one spouse earning $10,000 and one earning $7,500, the marriage tax amounts to $1,500; that is, the family pays $1,500 more in taxes than two single persons having the same incomes. The marriage tax under the Tax Reform Act is substantially greater than under the old law. Under the old law, in this example the marriage tax would have been less than $500. What is the point in having an antifamily tax system?
On the other hand, the tax reform laws can provide hefty marriage subsidies. For example, a family having two children, with one spouse earning $50,000 and the other nothing, would receive a $3,000 marriage subsidy; that is, the family pays $3,000 less in taxes than two single persons with the same incomes.
This situation, of marriage taxes and subsidies, is but one more example of the gross unfairness and illogical nature of an income tax. Other taxes, such as the VAT, are available that do not possess this perverse property; the amount of the VAT would depend only on the amount consumed by the family, regardless of its marital status.
Eventually, in response to cries of unfairness, the Congress will likely introduce further complexities into the tax code in an attempt to undo the complication it introduced by having separate tax rates for families and single persons. This has, in fact, been done before; under the tax law prior to tax reform, working married couples were allowed a small deduction.
The income tax approach to taxation is an absurd approach. An income tax system inevitably possesses inequities, and the inequities lead to modifications that further complicate the law. This process never ends. A fair, uncomplicated income tax cannot be devised. Tax reform is a laugh. The US tax system is complicated and unfair, and will remain so until the income-tax-approach to taxation is abandoned.
A problem with concepts such as utility, equity, and ability to pay is that they are very abstract. It is very difficult to determine a person's utility function or the average utility function for all taxpayers, so determination of a "good" or "appropriate" or "best" progressive tax schedule is not possible. It is not even a "given" that a tax schedule should be progressive -- recall the arguments about the second job. The point of view that it should be is an arbitrary value judgment.
Over the past two decades, a concerted effort was made to achieve social and economic goals and equity by means of the imposition of a vast array of exemptions, deductions, incentives, disincentives, and progressive rates. The net effect of this approach was the creation of a tax system that was generally perceived to be highly inequitable and to favor the rich or tax-wise. Although the concepts of equity and ability to pay have theoretical value in discussing alternative tax methods, the attempt to set up specific tax rules and structures to implement, or "operationalize," these concepts failed miserably. Workers have, in fact, objected the least to the payroll tax and retail sales taxes; taxes that are regressive, but are applied at low, uniform rates.
Two decades of trying to develop an equitable tax system based on the income tax, special deductions, and progressive rates have met with dismal failure. The concepts have seductive appeal and charm, but they fail in practice. In spite of theoretical arguments asserting its equity, decades of experience have resulted in the empirical realization that the progressive income tax is perceived as inequitable, pure and simple. Based on this experience, attempts to implement it should be abandoned.
The progressive income tax is one manifestation of the "politics of envy." The politics of envy has been distinguished from the "politics of greed." The politics of greed refers to the tendency of individuals to use political power to increase their own wealth. The politics of envy refers to the tendency of poor individuals to want everyone to be poor, if they have to be poor. Under the politics of envy, the nonrich want the rich to be taxed simply to deprive them of their riches, regardless of whether that action will improve their own situation. It is a basis for the appeal of the communist viewpoint, "From each according to his ability, to each according to his need," to the wretchedly poor in many developing countries.
The rich can be deprived of their riches by means of confiscatory income taxes and confiscatory wealth taxes. Whether this is desirable is a value judgment. If some individuals become extremely wealthy, they may represent a concentration of power that threatens the security of nonwealthy individuals. Extreme concentrations of wealth not only generate envy and social discontent, but also are considered to contribute to recessions and to amplify the severity of depressions. If all wealth is confiscated, however, the economic means of production will be so weakened as to lower the standard of living for everyone. The centrally planned economies of the various communist systems of government provide unequivocal and ample evidence of this. The cost of an egalitarian society is universal poverty. Some concentration of wealth is a prerequisite for the accomplishment of great works: of art, of architecture, of technology, of economics, of humanity. Until recent times, for example, great works of art and architecture were sponsored primarily by the church or the state.
Most of the individuals who are involved in the tax legislation process are economists. Many economists are not wealthy and are therefore susceptible to the politics of envy. They generally are in favor of a progressive income tax. The use of a progressive income tax is a sign of the workings of the politics of envy.
The politics of envy is a strong force and it has had an influence in areas other than taxation. An excellent example of the politics of envy is legislation prohibiting a retired military officer from representing his employer to his former service branch. After a lifetime of serving his country at a modest salary, the Congress would deny him the privilege of capitalizing on his skills and contacts. Note that congressmen do not require of themselves the restrictions they place on the retired military. With far less stringent restrictions, an ex-senator, ex-representative, or ex-cabinet member can go to work for a Wall Street law firm or accounting firm at a quarter-million dollars a year and capitalize heavily on his knowledge and contacts. The politics of envy is a strong force.
Taxing the rich or productive members of society by means of a severely progressive mass income tax may realize the objective of confiscating their income or wealth, but it carries with it a high cost: the loss of privacy of all of the nonwealthy who must relinquish their privacy in order to implement the income tax. Since the wealthy are few in number and relatively easy to identify, it is feasible for the government to confiscate their wealth without invading the privacy of the masses of nonwealthy through the mechanism of a mass personal income tax.
The personal income tax is suited to taxing earnings from salary, wages, rents, and interest, but it is not well suited to taxation of profits from the purchase and sale of property, that is, from capital gains. Two major problems arise in using the income tax to tax capital gains. First, the verification of what constitutes the profit from the sale requires the government to have access to details on when the purchase and sale was made and to a description of the property. This requirement is highly intrusive of the privacy of millions of citizens.
Second, in many cases capital gains do not reflect profit in any sense, but solely increases from inflation. The "profits" are apparent, not real. Inflation in the US is mainly government caused. Relatively little US inflation is caused by external price increases, such as the oil price increase in the early 1970s. Most US inflation is caused by inadequate US Government fiscal policies (in particular, an inadequate US tax system), under which the US spends more than it collects in tax revenue. Since US inflation is mainly government-caused, it represents a "hidden tax." The fact that, in many instances, capital gains are manifestations of inflation results in a gross inequity.
An example will illustrate this problem. Suppose that you purchase a house for $50,000 and sell it for $100,000. The profit from the sale of the house is a "capital gain." Under tax reform, capital gains are taxed at the same rate as ordinary personal income: up to 33 percent (federal rate) for a family filing a joint return.
Suppose that, in this example, you purchased the house in 1970 and that you sold it in 1982. During that time, the price of housing inflated by approximately 8 percent per year, or 150 percent over the 12-year period. This means that, on the average, the price of a house in 1982 was 2.5 times that of a comparable house in 1970. Or, a 1970 dollar spent on housing was worth, or equivalent to, 2.5 1982 dollars spent on housing. Stated in terms of "1982" dollars, the value of your house at the time of purchase was $50,000 x 2.5 = $125,000. Or, stated in terms of "1970" dollars, the value of your house at the time of sale was only $100,000/2.5 = $40,000. From either point of view, taking into account the effect of inflation, your house actually lost real value -- either $10,000 1970 dollars or $25,000 1982 dollars. Nevertheless, the government will assess you a tax of 33 percent on the apparent "profit," or .33 x $50,000 = $16,500.
Suppose that your next-door neighbor bought a house in 1982 for $50,000 and sold it later in the same year for $100,000. The tax on his $50,000 profit was exactly the same as in your case, $14,000. In other words, you suffered a real loss (measured in 1982 dollars) of $25,000 on your house, and your neighbor realized a real gain (in 1982 dollars) of $50,000. Yet you both pay the same capital gains tax, $16,500. Because the government causes most inflation (essentially, by printing too much money), it has, in effect ripped you off. It has charged you a tax on an apparent "inflation-caused" profit, when you actually suffered a real loss. The profit was illusory: nothing more than an artifact of inflation. The tax is on the "nominal," or apparent, capital gain, not on the real capital gain. This is not fair because, as in the example presented above, two people realizing quite different real profits are treated very differently. From a basic equity point of view, people who realize the same real profit should pay approximately the same tax.
The statement has been made that under tax reform inflation will not result in tax increases. That statement is not true. While that may be true for labor earnings, it is certainly not true for earnings from sales of property. Inflation will continue to produce apparent profits, which will be taxed at standard rates and result in effective tax rates far beyond those that would apply to real profits (adjusted for inflation). It not only causes inequities but it also represents a cruel way in which the government confiscates a substantial portion of the value of a person's home at the time of sale. In view of the fact that for many people their home is their principal means of saving throughout their lifetime, and may represent their life's savings, this is a shameful practice. As a deception, it is comparable to bracket creep, which was practiced for over half a century by the IRS. Income tax zealots may argue that a solution to the problem of capital gains on inflation-caused "profits" would be to provide an inflation adjustment on capital gains -- thereby making the tax code even more complex.
Capital gains are, in essence, business transactions (purchase and sale of goods and services). There are tax types that are much better suited to taxing business transactions than the personal income tax. Capital gains taxes on income should be eliminated and replaced by a tax designed for business transactions, such as a property transfer tax, a sales tax, or a VAT. Occasional sales of property by individuals should be exempted from taxation; attempts to tax them lead to privacy-invasive monitoring by the government.
The US Government's treatment of inflation-caused capital gains as the same as ordinary labor earnings works particularly heavy on older Americans, and can represent a nominal tax of up to 38 percent on lifetime savings. Consider the following example.
It's 1990. The provisions of the Tax Reform Act of 1986 are in full force. Consider the case of John and Mary Smith, a middle-income couple who have worked all of their lives and raised three children. Now, at age 50, they have just paid off a 30-year mortgage on their home in Wisconsin and, with the last child gone from home, are moving to Yuma, Arizona. They bought their home for $25,000, but, because of inflation, just sold it for $160,000.
John and Mary sell their home and move to Yuma, where they buy a mobile home for $15,000. Their home represented their savings of a lifetime. With it, they can live out their retirement years on these savings. Right? Wrong! Under tax reform, the increase in the value of the home is considered "income." John and Mary's combined labor earnings in 1990 are $39,000. With the "profit" on their home, the government considers their income in 1990 to be their labor earnings ($39,000) plus the increase in value of their home ($160,000 - $25,000 = $135,000), less the cost of their new home ($15,000), for a total of $159,000. Under tax reform, the federal tax on $159,000 is a flat 28 percent. Let's say that the state tax rate in 1990 is 10 percent. The total "income" tax is hence 38 percent times $159,000, or $60,420. The tax on their $39,000 income would have been computed as follows. Taxable income = $39,000 less standard deduction ($5,000) less personal exemptions (2 x $2,000) = $30,000. Tax = .15 x $29,750 + .28 x ($30,000 - $29,750) = $4,742.50. The tax on the home is hence $60,420 - $4,742.50 = $55,677.50.
In simple terms, the US Government, under the guise of an "income tax," is levying a property tax of $55,677.50 on John and Mary's home -- 35 percent of its value. This is an incredible action. The increase in the value of their home was not the result of 30 years of buying and selling houses: it represented the increase in the price due to government-caused inflation. The real value of their home is essentially unchanged since they bought it. The $135,000 increase in the value is an artifact of inflation, not a real profit. To tax this in the same way as earned income is grossly inequitable. Not even the most socialistic countries of Europe impose property taxes of 35 percent. The inheritance and estate taxes on $135,000 would be zero.
Many older couples have larger homes than they need after their children leave, and so it is a common desire to move to a smaller home. Furthermore, many older couples enjoy relocating to warmer climates in their retirement years. Under tax reform, they'd better sit tight in their large homes in Wisconsin, unless they want to be socked with an effective property tax of up to 38 percent. For many older Americans, their home represents their lifetime savings. They need to have the option of moving to a smaller one, without having the government descend like a vulture and devour almost half their lifetime savings, if ever they have to sell it. Alas, through the income tax, the eagle has become a vulture.
The citizens of California rebelled at a 2.5 percent property tax when they passed Proposition 13 in 1976. Why do they not protest a 38 percent property tax?
The increase in the value of John and Mary's home was not earned income, and it should not have been taxed as such. It represented savings -- the savings of a lifetime. Under tax reform, the income tax on these savings can range up to 38 percent (assuming a 28 percent federal income tax and a 10 percent state tax).
This incredibly inequitable treatment of lifetime savings illustrates the type of inequity that arises with an income tax. Under a VAT, John and Mary would be able to keep every penny from the sale of their home. Their tax in 1990 would be proportional to their purchases, which would be about the same as usual, plus the VAT on their mobile home.
The example given above is, in fact, extremely conservative. Because capital gains realized on the sale of a home that has been owned many years may represent mainly appreciation due to inflation, the real tax is in most cases much greater than the nominal rate (up to 38 percent). Because of inflation, the real tax rate on the capital gain may easily exceed 100 percent! This happens, for example, when the real, uninflated value of the home is less at the time of the sale than when the owner bought it, but, because of inflation, the house sells for more than the marginal purchase price. (The "real" tax rate is the tax expressed in uninflated, constant dollars, as a proportion of the original value of the house.)
Under tax reform, older Americans get a "kick in the teeth": the government will strip them of half their lifetime savings, if their home represents the bulk of their savings and they must sell it to live off those savings. Because of inflation, the tax may actually exceed 100 percent. The government touts tax reform as an equitable system. This is a total misrepresentation, a cruel deception, a subterfuge. The progressive income tax is a pernicious tax and it should be abolished.
Is stripping our older citizens of their lifetime savings any way to treat people who have paid a lifetime of taxes? Some primitive societies put their old out to die when they are no longer productive. Under tax reform, the IRS would confiscate the savings and security of our older citizens. Some economists have proclaimed the income tax as one of the best taxes ever devised. That assertion can be made only from the government's point of view; from the citizen's viewpoint, it is one of the worst taxes ever devised.
The government will no doubt criticize the above example as unfair, pointing out that under certain conditions, the couple may be entitled to a tax break on the sale of their home (for example, by somehow holding out until age 55). But why should ridiculous tax incentives control the timing of the sale of their home? Why should couples that can't wait until age 55 be discriminated against so severely? In fact, under tax reform, the law contains a perverse incentive to break up marriages. It has been noted that if a couple obtains a divorce, after three years each of them may qualify for a $125,000 one-time tax exclusion of capital gains from the sale of their homes, whereas if they remain married, they qualify for only a single $125,000 tax deduction. If they wait for three years before remarrying, the statute of limitations will prevent the IRS from nullifying the deduction on the basis of an "insincere" divorce. Why should the tax system motivate couples to divorce? This is but one more example of the insanity of the income tax.
Moreover, since this incentive is illogical, it engenders contempt for the law and a strong motivation to evade it. With its economic distortions and illogical incentives, the income tax is corrupt and is corrupting America. This topic is addressed in detail in the chapter that follows.
There are several ways in which American citizens are purposely and needlessly being corrupted by a tax system that offers incredible temptations to evade. A major factor underlying the evasion incentives of the US income tax system is that income taxes are simply too high. This factor is the principal one that has led to the development of an underground economy -- a "tax-free zone" where citizens engage in barter and cash transactions to avoid payment of an oppressive, illogical tax.
Another factor that creates an incentive for tax evasion is the complexity of the tax code. Many rules are not only complicated, but also vague. This complexity and ambiguity creates an undesirable atmosphere in which businessmen are motivated to push deductions to the limit; they are unnecessarily tempted to make tax-related decisions that may be challenged by the IRS as attempts at evasion.
Some of the factors that create a strong incentive to evade taxes are structural. One of them is "double taxation" of dividends. The other is the strong incentive to make purchases through one's business, caused jointly by the tax deductibility of business purchases to the firm and taxation of income to the individual.
This chapter explores the many ways in which the income tax, through its perverse, malicious incentives, is corrupting America.
People pay sales taxes without much objection. Few people will drive hundreds of miles to buy a car where the sales tax is less. People pay Social Security taxes without wasting much time trying to avoid paying them. People pay unemployment taxes, luxury taxes, cigarette taxes, alcohol taxes, gasoline taxes, and airplane ticket taxes -- all without much objection. Many people object to the personal income tax, however, and invest considerable effort in trying to avoid paying income taxes.
The reasons for this behavior are several. A principal one is, of course, that the income tax is the only tax that one can reasonably avoid. That the income tax by its intrinsic nature unduly tempts avoidance activity is one of its worst features. If a person refuses to pay a consumption tax (such as an alcohol, or telephone, or airplane ticket tax), he must (from a practical viewpoint) do without the product or service. Aside from this reason, however, there are several other reasons why many people spend a lot of time and effort engaged in the practice of income tax avoidance.
First, income-tax rates are extremely high. The government has, through high income-tax rates, created a strong incentive to avoid them. Next, the complicated tax system and the oppressive burden of the personal income tax demands that a prudent individual spend time determining how to structure his income and investments to minimize the tax burden -- he owes it to himself and his family to pay no more tax than necessary. If he does not engage in tax avoidance, the taxes on his next-door neighbor, having the same income, could be significantly less than his own.
Note that tax avoidance is perfectly legal: it is just the practice of attempting to find out -- in the face of the incredibly complex and changing tax code -- what is the minimum tax a person is legally required to pay. It is distinguished from tax evasion, which is the practice of paying less tax than the law requires. The income tax motivates both avoidance and evasion.
The use of a high-rate income tax, when lower-rate nonincome-type taxes are available, is unreasonable. Instituting a "voluntary" tax system that had rates on the order of one percent was one matter; use of a "voluntary" tax system when the rates are 50 percent is ridiculous. At these high rates, the "voluntary" tax system is nothing more than an elaborate entrapment scheme. Imposing high income tax rates on 100 million Americans when the same taxes could be levied on and collected from a few million business establishments is as ridiculous, for example as collecting a one-cent tax on Popsicles directly from every child who eats a Popsicle, when he eats the Popsicle, rather than collecting the tax from the businessmen who deal in Popsicles in quantity -- the manufacturer, the wholesalers, the distributors, and the retail merchants.
Income taxes are too high!
Some people believe that the overall tax burden (from all types of taxes, not just the income tax) in the US is too high. Compared to other developed countries, however, the overall tax burden is not very heavy. The Organisation for Economic Co-operation and Development (OECD) publication Revenue Statistics of OECD Member Countries, presents a list of all member countries, showing the size of their overall tax burden (total tax revenue) as a percentage of gross domestic product (GDP). (Gross domestic product, or GDP, is the same as the more familiar gross national product, except that the value of foreign goods used in production has been removed. Gross national product, or GNP, is the total value of all goods and services produced by the nation in a year.) The US has one of the lowest overall burdens -- 29.03 percent of GDP in 1983. Of the list of 21 countries, only Japan and Turkey are lower: Japan at 27.71 percent of GDP and Turkey at 18.78 percent of GDP. All 19 other member countries have higher overall tax burdens, ranging up to Sweden, at 50.50 percent of GDP.
This book does not address the issue of whether the overall tax burden is too high. It objects to the attempt to extract this revenue from the imposition of a personal income tax on individuals.
The total income tax burden is the sum of the federal income tax, the state income tax, and the payroll tax (both the "employer" and "employee" contributions, since the incidence of the payroll tax burden is generally considered to fall mainly on the employee). The personal income tax as a percentage of GDP is 8.03 percent; the US ranks fourth highest of all OECD countries. The payroll tax represents 4.32 percent of GDP; the US ranks 12th. The US places its tax burden more heavily on individuals than most other nations in the world. While the overall tax burden (from all tax sources) on US citizens may not be very high compared to other industrialized nations, US income taxes are too high!
Under tax reform, as discussed in the preceding chapter, there are five tax brackets. For convenience, those brackets are repeated here. For married taxpayers filing a joint return, the rates are 0 percent on all nontaxable income (deductions and personal exemptions); 15 percent on "taxable" income from zero to $29,750; 28 percent on taxable income from $29,750 to $71,900; 33 percent on taxable income from $71,900 to $149,250, and 28 percent on taxable income over $149,250.
The 28 percent rate applies to a large proportion of families -- approximately 20 percent of all families have incomes over $29,750. When the 28 percent rate is added to other taxes, the total rate is extremely high. For example, the employee's Social Security tax is 7.15 percent of income up to $43,800 (not even counting another 7.15 percent Social Security tax on earnings, which is euphemistically called the "employers" tax); a state income tax might be 10 percent; a property tax might be the equivalent of 5 percent of income; a sales tax might be 7 percent of expenditures, or about 3 percent of total income. When combined with the 28 percent federal income tax, these amounts represent 52 percent, or over half of a person's income, for a large proportion of the population. Many people assert that a government should not take half a person's income, that taxing 50 percent of a person's income is confiscatory, and that 20-30 percent is quite high enough. Tax reform, with a 28 percent federal tax, when combined with other taxes, will represent a total personal income tax of approximately 50 percent for a large segment of the population. That is too high.
Income tax rates are now so high that a large proportion of the population now actively evades taxes. Tax reform will exacerbate the problem because, for many people, tax rates are even higher than before.
In response to a burdensome, unjust, and hassling personal income tax system, an underground economy has arisen, involving millions of US citizens. These are professional people and independent businessmen who fail to report some of their income, or who engage in barter (that is, trade their goods or services), without declaring the dollar value of the trade as income.
There are several factors that have led to the growth of the underground economy, in addition to the oppressive tax burden. Americans are reacting to the extreme regulation of our current society, to the regimented social welfare system, and to being unnecessarily hassled by government. Many Americans do not want government involved in their private affairs. They do not want government looking over their shoulders when they make small private sales. They object to being taxed at swap meets. They resent government's immediate confiscation of gambling earnings. They are fed up with being hassled on a personal level. They want, quite simply, to be left alone.
The problem of suppressing the underground economy is a difficult one to address by enforcement, because the number of taxpayers is very large -- 100 million. Having similar rates on businesses would not represent nearly so great a problem, because the number of businesses is much smaller (3 million corporations, 11 million proprietorships, and 1.5 million partnerships) and they are more easily monitored.
The size of the underground economy has been estimated to be several hundred billions of dollars. The growth of the underground economy has been fueled by a tax system that is widely perceived as heavy, unjust, and intrusive.
The government learned in the alcohol prohibition era that it is unwise to promote laws that result in the turning of large numbers of citizens into lawbreakers. Such laws don't generally last, but while they are in effect they cause the bad side effects of creating a resentment and dislike of the government and a general lack of respect for the law. The government has created a monster in the personal income tax system -- a very costly system that requires close monitoring of the citizens by the government, the needless expenditure of much effort on the part of the individual, and the creation of a strong adversarial relationship between the government and the citizen.
A principal cause of the underground economy is the very heavy burden of the income tax. Another cause is the hassle factor -- many Americans do not want to be continuously hassled by government. Envy contributes to the problem, but it would not be a significant factor if income tax rates were low. The Tax Reform Act addressed the issue of envy to some extent, but it did not address the issue of the heavy burden of the income tax, nor did it address the hassle factor -- in fact, both were made worse! Under tax reform, the overall tax burden is greater, and the tax burden for a large proportion of the population will be significantly heavier.
Instead of addressing the issue of the heavy personal income tax burden or the hassle factor, the Tax Reform Act concentrated on the problem of envy. Before tax reform, people in similar economic situations often paid vastly different amounts of tax. Also, people with similar incomes also often paid vastly different amounts of tax. This happened because some were able for various reasons (high incomes to retain tax experts and to take advantage of tax shelters, a superior knowledge of tax law) to take full advantage of the complex tax system to pay little or no tax. The existence of this perceived inequity caused strong and widespread resentment. According to a 1984 IRS survey, four out of five believed that the tax system was unfair to the average citizen and that favored the rich.
By removing most tax shelters, the income tax paid by people having similar incomes will vary much less than before, and it will be very difficult for wealthy people to avoid paying income taxes altogether. Unfortunately, the new tax system is, overall, more burdensome than the system that preceded it. The 1984 IRS survey reported that three of four taxpayers considered their income taxes much too high. That problem has not been addressed by tax reform; in fact, for a large segment of the population, income taxes will increase.
The IRS survey reported that the public believes that a large percentage of the public cheated on their taxes; one in five admitted to cheating on his own taxes.
Income taxes are too high!
The underground economy will not disappear because of the Tax Reform Act. The hope that it will is unfounded. The underground economy is caused more by the oppressive burden of high tax rates as it is by envy. The overall income tax burden has not been reduced by the Tax Reform Act; on the contrary, it has been increased. Moreover, the burden has been increased most for the very people who can profit most from the underground economy -- moderate-income earners.
With the passage of the Tax Reform Act, the federal government would have the US population believe that the US tax system is now fair, and therefore, that people should and will pay. On the one hand, this is a subterfuge; on the other, it is folly. The income tax is not the correct vehicle for producing the massive revenue required by the modern US Government. The tax base is too narrow, and the burden on individuals and families is too great. The Tax Reform Act has not addressed this problem, and it does not represent a solution.
If the income tax is continued to be used to raise a major portion of the required revenue, the IRS not only will have to continue the operation of a police-state organization, but also will have to expand its powers. In this regard it is interesting to note that the monitoring of individuals will increase significantly under tax reform (for example, the mandatory SSN registration of all dependents over the age of four, the reporting of tax-exempt income), and the penalties for noncompliance have been increased.
The US people have called out to be freed of the oppressive yoke of the personal income tax. Like George III, the US Government has hardened its heart, and refuses to listen. The cause is just, however, and like George III, the US Government will yield, or it will not endure.
The US Government, through its enforcement of an inhumane tax system, has corrupted the moral fiber of the US population. A large proportion of the population now believes that they are quite justified in evading taxes. To many, it no longer matters what the law says, because the law is wrong. The government has opened a Pandora's box, and has ruined its ability to depend on voluntary collections as a means of administering the income tax system. It had best look to another method of taxation. Trying to force citizens to once again do voluntarily what government incentives, inequities, and intolerable burdens motivated them to reject is unrealistic, if one wishes to avoid a police state.
One of the reasons why tax evasion is on the increase is that the line between tax avoidance and tax evasion is not always very clear. The tax code is so complex that it is impossible for a layperson to invest the time required to understand the tax code and know the tax status of his activities and how to structure them to legally reduce his tax burden. News reports have occurred describing how famous individuals (actors, politicians, industrialists) have participated in tax shelter schemes that have been declared invalid. When highly successful and intelligent people cannot determine the tax base or cannot afford the time necessary to determine it, it is clearly too complicated.
The problem is even worse for the businessman. To determine the tax base (profit), he must make numerous judgments, such as whether a payment to himself should be represented as a labor cost or as a dividend; how fast to depreciate an asset; whether an automobile represents a business or personal expense; whether a business open-house represents a tax-deductible effort to advertise or establish goodwill, or a simple party; whether a visit to a tropical island to visit the US Agency for International Development is all business or part business and part pleasure, and if the latter, how the costs should be allocated between business and pleasure.
These problems have no place in business. They arise because of a nonsensical business tax system. The tax base should be simply defined, such as sales receipts, or sales receipts less easily defined expenses. A businessman should not have to worry over whether a particular purchase is tax deductible; that should be clear from the definition of the tax base. Because US income tax rates are so high, the current system produces an intolerable incentive to evade taxes.
Because the rules of the game are not known, it is easy to understand how businessmen are not only frustrated, but on occasion led astray by the insidious system. The current system not only includes high incentives for tax evasion, but in many cases it is not clear whether a decision represents (illegal) tax evasion or (legal) tax avoidance. The tax system should not be a "guessing game"! The tax code is so complicated that the determination of what is taxable in many cases must be arbitrarily decided in the Tax Court.
Knowing that the government created this monstrous game, believing that the rules of the tax game have been set up in favor of the wealthy, it is little wonder that, in the frustration of record retention, tax pamphlet reading, and the attempt to avoid the cost of a tax adviser or tax preparer, many individuals cross the line from tax avoidance to tax evasion. The dramatic rise of the underground economy in the past decade is a reflection of the strong objection of a large segment of our country to the personal income tax.
In 1984, the IRS conducted a public opinion survey in which it was reported that four out of five taxpayers consider the tax system unfair, that three out of four consider income taxes too high, and one in five admitted to cheating on his own taxes. The US income tax system is turning ordinarily law-abiding citizens into criminals. The incentives for tax avoidance and tax evasion are intolerably high. The high proportion of the nation's tax burden that is placed on individuals encourages tax avoidance and evasion. It is an inhumane system, not well suited for human society.
The irrational, burdensome, envy-causing, evasion-tempting income tax system not only tempts citizens to cheat, but it creates tremendous resentment against the government. The system is ridiculous, and it invites ridicule and contempt for the government. It has created a schism between citizens and their government, an adversarial relationship that contributes to a general lack of respect for the country and its ideals.
Americans are basically honest. The Puritan tradition is strong. When one in five Americans admits to cheating on his income taxes, something is terribly wrong with the tax system. This type of general disrespect for the law by a basically honest society -- especially the flaunted violation of the law -- occurs when laws are perceived as improper or unjust. The income tax system is a bad one; it has undermined the respect that Americans had for the law and their government.
When a law -- such as alcohol prohibition, the 55 miles-per-hour speed limit, or the personal income tax -- is so unacceptable that many people break it or spend much time and money trying to avoid its consequences, it is time to reconsider its merits.
The US public does not like the income tax. It tolerates other forms of taxation (such as the sales tax), but cannot abide the income tax. There are two principal reasons for this reaction. First, income tax rates are too high. Second, it is perceived as complicated and inequitable. The tax code has become so complicated, and the personal income tax burden is so high, that many people have become not only frustrated, but also angry at the absurd level of complexity and inequity of the current system.
One reason why some people object to the personal income tax is that it is unnecessary. This nation operated quite well for over 100 years without an income tax, that is, with business taxes rather than personal taxes. The argument that US citizens now demand a higher level of government-funded services, and therefore the government needs an additional source of revenue, is specious. The same level of revenue that is currently collected by personal income taxation can be collected more simply, efficiently, and equitably from businesses.
How much revenue the country can afford to take out of the economy depends on the size of the economy. The government can remove this revenue in a variety of ways; it does not have to extract any of this revenue by income taxation of individuals. Why waste 100 million individuals' time (in learning the tax code, in reading instructions, in collecting and maintaining records, in completing tax forms, in submitting to audits) and intrude in their privacy to collect revenue that could be collected more equitably and with less cost at a different point in the economy -- from 15 million businesses rather than from 100 million individuals?
In the final analysis, human beings are the source of economic productivity, and they are therefore the ultimate source for all tax revenue. It is not at all necessary, however, to collect the tax directly from every family. This is particularly true in a highly developed economy consisting of business organizations. In the US economy, most production is channeled through economic units (businesses) at a higher level of aggregation than the family. The individual family is not the basic unit of production in the US, and it is not at all necessary to collect taxes at the family-unit level. Moreover, it does not even make sense to collect the revenue from individuals rather than businesses. Businesses, by their very nature, deal in money and keep records; they are the natural point in the economy from which to extract tax revenue. Families should not be burdened with the hassle of keeping records for tax collection purposes.
US citizens are not stupid. They can understand the concept that the basic economic issue regarding taxation is what the total tax burden on the economy is. They can perceive that this burden can be distributed in an infinite variety of ways -- between businesses and individuals, between rich and poor individuals -- and that the decision on how to distribute the burden is arbitrary. The current system of distributing the burden, as embodied in the tax code, is extremely complicated and unfair. The current tax system could be replaced by a simple, uniformly applied, equitable tax system. Collection of taxes at the family-unit level is absurd in an advanced economy such as the US. Why should US citizens go along with an inefficient, costly, intrusive, and unnecessary system for extracting tax revenue from the economy?
Under the US income tax system, corporation earnings are taxed twice -- once as corporate income, and again as personal income after distribution (of what remains after corporate taxes) to shareholders in the form of dividends. This procedure is called double taxation. A book on this topic is Must Corporate Income Be Taxed Twice? by Charles E. McLure, Jr. Under double taxation, a businessman who makes a profit in his business must first pay a business profit tax (say 49 percent: 39 percent federal income tax and 10 percent state income tax) on his profit, and then pay a personal income tax (say 43 percent: 33 percent federal income tax, 10 percent state income tax) on the remainder, which is paid to him as a dividend: a combined tax of 71 percent (1 - (1-.49)(1-.43) = .71).
Double taxation represents a strong incentive for a business owner to convert profit to income, to avoid paying the profit tax (since labor costs are tax-deductible to the firm). Because the line between what is a reasonable income for the owner and what should be paid as a dividend is a fuzzy one, this feature of the business profit tax system not only generates an incentive to evade taxes, but the evasion is defined on the basis of a subjective assessment on the part of the IRS or the tax court as to what constitutes a reasonable income for the owner. In other words, the tax base is not well defined. This is an absurd situation. It places the firm's owner in an awkward position of not knowing what is right and what is wrong, relative to his tax responsibility.
The "reasonableness" of a businessman's salary should never have been an issue for government consideration in the first place. Determination of the legitimacy of his salary would not be a problem if the government had not structured the business tax as a profit tax, with the concomitant problem of determining what constitutes profit (taxable income).
The government really has no business trying to tell a business what expenses are "legitimate" and therefore tax deductible. The government can't make those decisions as well as the free market, and the attempt to do so either hassles the owner, or creates incentives to evade or avoid taxes, or distorts the economy and produces a lower standard of living for all. A tax structure that requires the government to make such decisions is a bad tax structure, from both economic and social points of view. The government evidently prefers, however, to have an excuse for monitoring the affairs of business, just as it does for individuals, and so it is naturally drawn to methods of taxation that require such monitoring. Without the business income tax, tax audits would be tremendously simplified, and this intrusion of the government on the private affairs of business would be unwarranted. Collecting an unobtrusive, economically neutral business tax is one matter; telling business how to run business is bad business.
The business profit tax and the personal income tax are ill-conceived ideas, and they should be eliminated. The US set an example for the rest of the world in establishing the income tax; the US should set an example by abolishing it.
In spite of the expressed intent of the Tax Reform Act to reduce the impression that the tax system is unfair, it barely touched one of the most perverse aspects of the system: the strong incentive for business owners to avoid or evade taxes by keeping their income in their firms and making personal purchases (such as an automobile or computer) through their firms. The incentives for this are in many cases about the same as before tax reform, and in some cases greater than before.
The incentive for a business owner to make purchases through his firm arises in two ways. First, by keeping some of his salary in the firm to make purchases, he avoids paying personal income taxes on the salary. Second, if, as is usually the case, the purchased item is tax deductible to the firm, the firm saves the corporate income tax on the extra profit that would have resulted had the purchase not been made. Since the owner owns the firm, the owner saves this amount. Together, these two factors result in a discount of up to 71 percent on the cost of items purchased through the firm.
Before tax reform, the combined discount represented by making purchases through one's firm was about 82 percent, for items that were tax-deductible to the firm but not to the individual. Under tax reform, that discount has been reduced to about 71 percent. The discount was very large before, and it remains very large. Under tax reform it has been reduced hardly at all.
The paragraphs that follow describe in detail how the tax law creates incentives for businessmen to make purchases through their businesses.
Under both previous tax law and the new tax reform law, there is a very strong incentive for individuals to use their businesses to make purchases of a personal nature. This is easy for the owner of a business to do because many "big ticket" items, such as health and disability insurance, cars, computers, trips and buildings, can legitimately be characterized as business related expenses. Such expenditures are generally not tax deductible to the individual, but are tax deductible to the business. For this reason, the individual has to earn substantially more than the price of such an item in order to purchase it.
The amount of the saving realized by buying an item through one's business depends on whether the firm buys the item (say, a car) out of funds that would otherwise have been used for some other tax-deductible purpose, or out of funds that would otherwise represent profit. Suppose, for example, that on the one hand the firm buys the car out of funds that would otherwise be paid to the owner in the form of salary. In this case, the owner saves his personal taxes and the firm's payroll tax on the salary, by purchasing the car through the firm. On the other hand, suppose that the firm buys the car out of profit from which he would otherwise pay himself a dividend. In this case, the owner saves his personal taxes and the corporate profit tax.
The extent to which a business owner pays himself by salary or by dividends depends on how much money he wishes to take out of the business and what salary is reasonable, in the eyes of the IRS, for his services. As mentioned before, he may pay himself at most a "reasonable" salary; payments beyond a "reasonable" salary are regarded by the IRS as dividends. The owner is motivated to pay himself in the form of salary rather than dividends, since salary is income-tax-deductible to the firm, whereas dividends are not. The only tax on salary is the payroll tax, and that drops to zero after $43,800.
The tax saving is greater if the owner buys the car "out of profits" rather than "out of salary." Let's consider first the case in which the owner buys the car through the firm using funds that would otherwise be paid to himself in the form of salary. Suppose, for example, that an individual's marginal tax rate (federal, state, and local) is 50 percent: 33 percent federal, say 10 percent state, up to 7 percent Social Security. In order to purchase a $10,000 automobile, he must earn $20,000, because the government will take half of the $20,000 salary in the form of taxes. Furthermore, the firm may have to pay up to an additional 7 percent payroll tax on the salary (if the salary is less than the payroll tax ceiling of $43,800), so that the total labor cost to the firm may be as high as $21,505. The car is a 100 percent tax-deductible expense for the business. If the businessman purchases the car through his business, it costs him only $10,000 -- a saving of between $10,000 and $11,505, depending on whether his salary is over or under $43,800. In summary, because the marginal tax rate on the employee's income is approximately 50 percent, every purchase that can be made by the business costs approximately one half as much for the business as for the employee.
Let's consider now the case in which the owner buys the car using funds that would otherwise be paid to himself in the form of dividends out of the firm's profit. This situation could occur, for example, if the owner's salary was already high and any additional payment would be considered a dividend by the IRS, rather than salary. Since the car is tax deductible to the business, the owner also saves (through his firm) the income tax that would have been paid on the profit with which the car was purchased. Under tax reform, the business profit tax is up to 49 percent (39 percent federal tax plus, say, 10 percent state tax). Let's assume that the individual's tax on dividends is 43 percent (33 percent federal income tax, 10 percent state income tax, but no payroll tax). Combining the 43 percent saving from his own personal taxes with the 49 percent saving on the corporate profit, the total saving amounts to 71 percent. (The formula for the amount of the discount is: 1 - (1 - personal marginal-income-tax rate) x (1 - business marginal-income-tax rate) = 1 - (1-.43)(1-.49) = .71. Alternatively: Cost of car to owner if purchased by firm = $10,000. Cost of car to owner if purchased through earnings = $10,000/(.57)(.51) = $34,400. Discount = $24,400 / $34,400 = 71 percent.)
Hence we see that the owner of a firm may realize a discount of on the order of 50-70 percent, depending on whether he buys the item out of salary or out of profit. The opportunity to receive a 50-70 percent discount on a car is quite a temptation.
Before tax reform, the marginal individual-tax rate was about 60 percent (50 percent federal plus 10 percent state), and the marginal rate for the firm was about 56 percent (46 percent federal plus 10 percent state). In that case, the discount was 1 - (1-.60)(1-.56) = 82 percent. In other words, tax reform has hardly reduced the discount at all. It was very great before, and it is still very great. What is the reason for adopting a tax system that contains unnecessarily and extremely high incentives to evade for certain individuals? With respect to this evasion incentive, the US income tax has a very low "vertical equity": individuals with high incomes are subjected to high incentives to evade, whereas individuals with low incomes are not. Other tax systems (such as the VAT) are available in which these incentives are far lower than for the current income tax. The imposition of a tax system having high incentives to evade is a highly corrupting influence that should be ended.
Cars are not the only things that the business owner may buy at half-price because of the income tax laws. Complementing the car, the business may also buy the gas (say, $2,400 per year if purchased by the business, but $4,800 per year in pretax earnings if purchased by the owner as an individual), the car insurance (say, $3,000 per year for the business, but $6,000 for the employee), parking (say, $1,000 per year for the business, $2,000 per year for the employee), and repairs and maintenance (oil changes, car washes, tires, and repairs -- say $500 per year for the business, but $1,000 for the employee).
A business owner may buy medical, dental, and disability insurance through the business. For these fringe benefits, there is not even a question of their tax deductibility. Fringe benefits are tax deductible to the firm, but not to the individual; that is, the individual must pay for them in after-tax dollars. This arrangement may generate envy in persons who do not own their own firms (or have employer-paid fringe benefits), but, because it is perfectly legal to make such purchases through one's firm, it does not constitute an incentive to evade taxes. Why should employee fringe benefits be tax deductible to a firm but not to an employee? Who knows? This is just another example of the illogical, arbitrary income tax rules.
For items other than fringe benefits, the item is tax deductible only if it is reasonably needed by the business for the production of income. In many cases, it is not clear whether an item is reasonably necessary. The problem that arises is that, under a very high income tax, there is a tremendous incentive for a business owner to purchase such items through his firm to realize the tax saving. This incentive would be much less under alternative tax systems. The very high income tax creates a strong incentive to evade taxes; that unnecessary incentive is a corrupting influence on US business.
The following paragraphs describe some of the many items that a business owner may be tempted to purchase through his firm, whether they are truly necessary for the production of income.
Suppose that the business owner wants to treat several of his friends to an all-expense-paid resort visit every year. He can arrange to have the board of directors' meeting at Lake Tahoe each year -- a several-day visit to the finest hotels, in beautiful surroundings, with all meals, lodging and salaries paid for by the business.
Suppose that he enjoys brief trips to foreign vacation spots. He can set up a real-estate investment firm, make his wife and several of his associates officers, directors, or partners, and visit luxury resorts around the world to investigate their investment potential. For example, a week in Costa Rica may be required to investigate the "time-sharing" vacation condominium resorts in that country.
Whatever your interests, you can readily identify enjoyable activities that can be justified as business activities. Suppose, for example, that your business is data processing and that you would like to visit Las Vegas or other resort city for a few days. There are, in any given year, thousands of seminars and professional meetings presented in very nice settings: Las Vegas, San Francisco, Miami, New Orleans, Honolulu. A visit to any of these meetings to attend a technical seminar or to present a technical paper qualifies the visit as a business activity. The cost of visiting these places -- the air fare, your labor cost, meals, lodging, local transportation -- all are legitimate business expenses. No matter who your clients are, the visit to Las Vegas can cost you half, if you take it when the next data processing seminar is located there.
Suppose that you are in the construction business, and you like to give large parties. The next time you open a new business-office complex, throw a large open-house party, introducing your new complex to the public. The entire cost of the party can be "written off" as a business expense. The cost to you -- because you pay for it in pretax dollars -- is half the cost of the same party, given by you as a private individual, to the same guests, at the same place, at the same time.
Suppose that you want to buy a powerful personal computer. Buy it through your business. Cost: half what it would cost if you bought it as an individual.
The above examples illustrate some of the many items that may or may not be legitimate business expenses. In those cases in which they are not, or are questionable, the current high-rate income tax is a pernicious incentive to represent them as business expenses to avoid the high taxes. This incentive, which can be dramatically reduced by other methods of taxation, is harmful for society in several ways: it encourages the wasteful activity of tax avoidance and the illegal activity of tax evasion. It generates envy in those non-business-owners to whom the advantage is not available and resentment against a government that promotes a tax system that contains such strong corrupting incentives. Finally, because the government has instituted a tax system with such high incentives to evade, the leakage resulting from this evasion might be considerable, and the government is hence highly motivated to monitor firms closely to minimize the practice. Having established an income tax system with strong incentives to evade, the government is consequently highly motivated to implement strong administrative procedures to control this problem (that it created in the first place!). These administrative procedures further boost the cost of the income tax system.
The IRS is already seriously intrusive of the privacy of firms and owners of firms, yet the practice of an owner's making personal purchases through his firm continues. If the IRS wishes to eliminate this practice under the current income tax system, it may begin by totally destroying the privacy of all US citizens, and by making business decisions for all business owners. To the IRS, this may seem to be an appropriate solution, and a low price to pay, in spite of the fact that the practice of making purchases through one's firm is an opportunity available only to a relatively small proportion of the population.
Destroying the hearth to kill the cricket makes little sense.
There are several types of laws. On the one hand, there are laws that prohibit intrinsically offensive behavior, such as stealing, assault, and murder. Such crimes may be called intrinsic, or inherent, or essential crimes; the crime is offensive by its very nature. Another type of law relates to the regulation of activity that may be considered objectionable on moral grounds; laws prohibiting gambling, prostitution, indecent exposure, or pornography are examples. In a third category, some laws are implemented to enforce citizen compliance with government-established rules and regulations that do not relate directly to intrinsically objectionable activities, or to morally disapproved activities. Laws against income tax evasion fall in this third category. Such laws serve to preserve the income tax system.
The worth of such laws depends on the worth of the system they support. The value of the law in this situation derives from the value of the income tax system. In this book, we will refer to the crime of income tax evasion as an "artifactual" crime. The crime is an artifact of a synthesized tax system.
While it may be argued that all laws should be enforced and all crimes (including artifactual ones) should be punished, this situation should be examined more closely. It costs money to enforce the law and punish crimes. In the case of artifactual crimes, it is necessary to ask whether this cost is justified by the value of the system that the laws support.
Since the collection of some type of tax is necessary, tax evasion is necessarily a crime. Because the investigation, prosecution, and punishment of crimes costs a lot of money, however, the cost of punishing the artifactual crime of tax evasion must be examined, as part of a rational analysis to determine whether a particular tax system is reasonable.
In general, the income tax system scores very poorly relative to the matter of the artifactual crime of tax evasion. The system creates 100 million taxpayers, and sets up strong incentives for tax evasion. The system not only generates much artifactual crime, but also requires the expenditure of massive resources to examine and audit tax returns, and investigate possible tax law violations.
Personal income tax evasion is an artifactual crime. It exists only because the income tax system exists. It occurs frequently because the government has created a system that has very strong incentives for tax evasion.
Society's synthesis of some artifactual crimes is justified. For example, a value-added business tax is an efficient, equitable, and low-cost method of collecting tax revenue. The artifactual crime of business tax evasion is justified on the basis of the worth of the system it enforces. The artifactual crime of personal income tax evasion has no such justification.
With other types of tax methods, the cost of artifactual crimes would be far lower. With a VAT, for example, the system generates only a few million taxpayers (that is, 15 million businesses), and the incentives and opportunities for evasion are far less.
If the personal income tax system were efficient and equitable, the creation of the artifactual crime of personal income tax evasion would be justified. The system is, however, costly, inefficient, and inequitable. The social and economic cost of prosecuting these artifactual crimes derives no justification from a useful end, namely, the maintenance of a system that is beneficial to us. The millions of dollars that are allocated to tax auditing, enforcement, and tax crime punishment are not invested to maintain a beneficial system, but are invested in the preservation of a costly, inefficient, inequitable and intrusive one.
The drawback of artifactual crimes is that they consume law enforcement and judicial resources. Instead of using these limited resources to pursue intrinsically real crimes, resources are shifted to the investigation and prosecution of synthetic crimes. If the amount of revenue produced by the tax system is low, or if the system generates an unreasonable level of artifactual crime (for example, by reason of high incentives for tax evasion or very high numbers of taxpayers), these resources are wasted.
The crime of fraud against a ridiculous Rube Goldberg tax system that is woefully inadequate on economic and sociological grounds is different in its essential character from the crime of fraud in which a person steals directly from other people. This difference arises because the economy would be far better off without the income tax system -- better alternatives are available. If this income tax system were superior to others, there would be a rationale for investing massive law enforcement resources in its perpetuation. This is, however, not the case. It is an inadequate, costly system that does not stand on its own merits. Wasting law enforcement resources to perpetuate it accomplishes nothing more than the diversion of law enforcement and judicial resources from investigation and prosecution of real crimes.
The US Government invests billions of dollars every year in monitoring its citizens relative to the artifactual crime of personal income tax evasion. That money could be spent going after real criminals for real crimes. It could even be spent building schools, factories, and resort hotels in Honduras.
From one viewpoint, laws should be obeyed, regardless of how poorly conceived they may be. From time to time some very poor laws are created. The personal income tax is an example of a law that does not serve us well; it should be eliminated.
If tax laws were reasonable, creating the artifactual crime of tax evasion would be justified, and punishment for it would be warranted. Unfortunately, that is not at all the case with the personal income tax. Few people object to penalizing individuals who break the law. The rules for which infractions are punished should, however, serve some good purpose. There is little point to the elaborate, costly, and totally unnecessary game of the income tax system.
Tax evasion is a crime, and citizens who break this law should be punished. The tax, however, should be a reasonable one. The imposition of a costly, complicated, inequitable, economically inefficient, privacy-intrusive burdensome tax is absurd. (This is especially true when a low-cost, low-rate, economically efficient, and non-privacy-intrusive alternative exists for raising the same revenue.) The use of such a tax, with the inevitable temptation it presents for tax evasion, is not reasonable. Tax evasion is an artifactual crime that has been synthesized by a freedom-threatening tax that the Constitution framers in fact prohibited.
It may be asserted that the argument that the crime of personal income tax evasion need not exist is equivalent to the argument that the crime of smuggling need not exist -- but we have decided as a society to impose import restrictions, and those who violate them are breaking the law. The difference is that many laws proscribe activity that is inherently offensive, such as property theft or assault. In the case of income tax evasion, however, the government has created a totally unneeded system of procedures (because the same tax revenue can be collected with far less cost in other ways) and the legal machinery to severely punish anyone who refuses to participate. If laws against assault were repealed, assaults would continue to occur and would go unpunished; it is not possible to eliminate the assaults. On the contrary, it is quite possible to eliminate the activity of personal income tax evasion, simply by eliminating the personal income tax. Not only would the country then have an improved tax system, but also it would save billions of dollars in collection and enforcement costs in doing so.
Despite its high cost of collection, intrusive nature, and inequity, the government has a strong incentive to continue the income tax; its collection and enforcement provide a basis for the state to monitor individuals, and to investigate, interrogate, and punish, in a highly discriminatory manner, individuals whom they view as "troublemakers" or "protestors," or suspect of other crimes. Investigation for income tax evasion is an effective weapon against tax protestors. Prosecution for tax evasion may be used as a surrogate for prosecution for crimes, which the government suspects but cannot, prove.
Personal income tax evasion is easy to prove in a technical society in which every person's income is subject to monitoring by the government. Individuals have been singled out for intensive investigation and prosecution under tax laws, based on issues that have nothing to do with their taxes. The very process of an IRS investigation of a person's taxes is an inquisition that may cause serious damage to his reputation and financial status, regardless of whether he is guilty of evasion. In view of the damage it inflicts, the IRS investigation can be a punishment, inflicted on the individual unlucky enough to come to the attention of the IRS. In his book To Harass Our People, George Hansen presents several graphic examples of how the IRS has used this tactic against individuals who spoke out against it.
Although this method has been used since the time of Al Capone, the prosecution of persons for income tax evasion as a surrogate for prosecution for other suspected crimes has a serious drawback: it denies US citizens the right to equal treatment under the law. When any of us is denied equal treatment, our constitutional rights are weakened, and we all lose.
Under our concept of justice, citizens should not be subjected to intensive investigation and punished because they are considered to be "bad." They are to be punished, supposedly under a uniform code of justice, for specific crimes. To intensively investigate someone for tax evasion because the government cannot prove its case in some other area or because the individual has spoken out against the IRS constitutes discriminatory treatment under the law, and becomes unreasonable search and seizure.
The government has little to lose if it investigates someone for tax evasion and cannot prove the case. The individual may lose his reputation, income, and business, but IRS agents (under IRS regulations) are immune from prosecution. The individual may be tried, convicted, and punished merely by the process of an IRS investigation, even if no charges are ever brought.
With its inquisitional powers, the IRS can cause great damage to individuals. That power has been abused.
If the personal income tax were eliminated, personal income tax evasion would cease to exist as a crime. Personal income tax avoidance would cease to exist as a waste of economic productivity. The adversarial relationship between the US citizen and his government that is caused by the income-tax-audit process would cease to exist. The underground economy -- to the extent that it exists to avoid income taxes -- would shrink.
The current personal income tax system is unjust; it is so absurdly complex, and places such a heavy burden on individuals, that it understandably creates a desire to avoid payment. "It's the law" does not constitute sufficient justification for this unjust tax system any more than it did for slavery, persecution of Jews in Hitler's Germany, or denial of the vote to women. Even at its best -- a low, flat-rate, no-deduction system -- it still invites government monitoring of individuals (to verify income) and undermines the good relationship between the citizen and the government. Thomas Jefferson's maxim, "That government governs best that governs least," is not possible to promote in the context of a personal income tax (or a wealth tax, either), where government monitoring and control is implemented at the level of the individual citizen.
This chapter discusses the complexity of the income tax. It explains why an income tax is typically a complex tax and describes the nature of this complexity. It describes what happened with another complex tax, the turnover tax.
The effects of complexity are explored. The hopelessness of the citizen in the attempt to determine his income tax liability is described. The complexity of the tax places you at a terrible disadvantage -- in an audit, the IRS is almost certain to find errors in your return. The detrimental effect of this situation on the government-citizen relationship is discussed.
The income tax system is terribly complicated. The tax base for the tax is defined in thousands of tax code and IRS regulations. In many cases, the rules and regulations are arbitrary and irrational. They reflect well the primitive, illogical process that designed the system -- a lack of theme, of methodology; a myriad of rules to favor special-interest groups; the lack of a systematic systems-engineering approach to system design.
The system has evolved over seven decades into a complete monstrosity. The tax base is now, in fact, unknown -- it is an amorphous, intangible, constantly changing thing, whose definition and interpretation require an endless series of court cases to interpret the unspecified intent and illogical rules of the tax code.
The personal income tax requires filing of tax returns by over 90 million individuals. The form is complicated. In 1986, for example, the basic form contains 16 pages of schedules and 52 pages of instructions, with 54 additional schedules and instructions referenced. The system is so complex that many individuals -- even those having low-wage incomes and few deductions -- consider it necessary to pay professional income-tax preparers to complete their returns. The Internal Revenue Tax Code of 1954 contains thousands of pages of tax rules and regulations. The so-called Tax Reform Act of 1986 simply adds more pages to these regulations. The regulations on income tax, with which every filer must comply, comprise eight volumes, consisting of over 5,000 pages.
The US income tax system is an incredible, labyrinthine system of rules and regulations. The goal of finding a correct, minimum-tax return is an almost hopeless goal, certainly without employing a specialist. The complexity of the system has spawned an industry that feeds on this hopelessness and offers the promise of aid. In recent years, there has been a proliferation of books on tax advice. Every year near tax-return filing time, bookstores realize large sales of books on advice on how to save money on taxes and how to complete income tax forms.
A recent example is the book Audit-Proofing Your Return, by Jack Warren Wade, Jr., a former IRS Revenue Officer. This 482-page book offers advice on "how to reduce your chances of an IRS audit," and "how to fight and survive a tax audit." The book points out that the number of IRS auditors will soon grow by 40 percent, and that over two million returns will be examined every year. Neither the "fear and loathing" generated by the income tax system nor the storm-trooper tactics of the IRS has any place in a society ostensibly dedicated to freedom of the individual. The current situation constitutes an indictment of a disgraceful income tax system that has no place in a democratic society.
Because of the complexity of the personal income tax code, there is a good chance of making an error in your return. You may overpay and waste money, or underpay and risk penalties. Many people believe that they need professional help in completing their tax forms. The complexity of the income tax returns has given rise to a large industry of lawyers and tax accountants, who advise on income tax matters, and tax preparers. The fact that many average US citizens retain tax-preparation services testifies to the fact that US tax laws and regulations are too complicated.
Since passage of the Tax Reform Act, a spate of books has been released, describing the new tax law. Under tax reform, the US tax system is a complicated Byzantine mess, just like the system that preceded it.
It may be argued that only those with unusual sources of income, or desiring to take full advantage of available deductions, must be aware of and refer to many of the tax regulations. The fact stands, however, that tax laws and regulations are viewed with consternation by so many US citizens that a large number retain professional tax preparers, even though there is nothing unusual about their income and they qualify for no special deductions. The complexity of the income tax is beyond the comprehension of many taxpayers.
A major flaw in the US income tax system is that the tax base is not simple in concept (such as sales or income); rather, it is an incredibly complicated base defined in terms of thousands of pages of IRS regulations. A tax base that is so complex leads to high administrative costs, favoritism, suspicion, distrust, and anger.
One of the factors leading to the complexity of the income tax is its progressivity. Under tax reform, there are five tax brackets. The tax is highly progressive, with rates jumping from zero to 15 percent to 28 percent to 33 percent as income increases. Progressive rate structures are themselves complicated. They are impossible to justify, and inevitably lead to "adjustments," such as itemized deductions and inflation adjustments. Special provisions are instituted, for example, in the case of income from capital gains from the sale of a home.
The income tax base is both elusive and ridiculous. When the personal income tax and business profit tax were initially established, at low rates, income was simply defined. As rates grew higher, however, the inequity of the income tax became apparent, and special deductions were introduced. While favoring some, these deductions invariably hurt others, so that more deductions or exceptions to deductions were added. Creative individuals were able to use this complexity of deductions to an advantage not anticipated or intended by the federal government, so additional rules and restrictions were added. As the complexity of the code grew, new inequities, disincentives, and irrationalities were revealed, leading to still more regulations. The inequities, irrationalities, ambiguities, and complexities led to court cases, with more rulings. The tax code grew like a cancer.
Under the previous and current (tax reform) systems, the individual does not know the magnitude of his tax liability until the end of each calendar year. In a number of cases, the individual finds that he owes a substantial amount and has difficulty paying. The IRS moves into action in such cases, threatening the individual with enforced collection, with fines for late payment, and a fine ($500) for not estimating his tax liability sufficiently well.
With a simple business tax (such as a sales tax), the amount of the tax can be determined immediately, with certainty.
In many cases, because of the incredible complexity of the tax code, the individual may reasonably believe that he is not liable for taxes, and therefore may claim exemption from withholding. If the IRS later decides that he is liable for taxation, he may be fined $500 or more for failure to withhold.
In an attempt to withhold at rates that will keep tax over- or under-withholding at low levels, the government has designed, this year, a new W-4 form, which is quite complicated. Strong objections to this form have been raised.
These difficulties would be eliminated if the personal income tax were abolished.
Because of the complexity of the tax code, many individuals make errors on their tax returns. In response to this, the IRS has established a billion-dollar investigation and audit service. This year, about two million US citizens will be audited -- cross-examined on their returns. The audit process creates an adversarial relationship between the US citizen and the government that need not exist. It is humiliating for a person's word to be questioned and for him to be forced to prove his innocence; that is one reason why the framers of the Constitution specified that a US citizen be considered innocent until proved guilty. Tragically, the IRS has succeeded in abrogating that right for tax cases.
Because of the absurd complexity of the tax code and the practical impossibility of taxpayers to know this code, however, there is a very high likelihood that errors will be found in your return. The US taxpayer has, in a sense, been "set up"; the tax system has been made so complex that he is doomed to failure. Ralph Nader's Tax Reform Research Group sent a sample tax return to 22 IRS offices for review -- every office calculated a different tax liability! Why should US citizens be put in the uncomfortable position of having to explain errors they made in attempting to comply with a tax system that has needlessly been created, and is so complicated that even the IRS cannot complete the forms correctly? The government has fabricated a ridiculous and unnecessary income tax game whose compulsory play accomplishes nothing but the needless alienation of large numbers of US citizens.
The IRS audit process is the principal means by which a US citizen will interact with a US Government official, and it is not a wholesome relationship. The audit process at best annoys, but at worst needlessly frightens and antagonizes US citizens. It is a destructive mechanism that serves no useful purpose. Taxes can be collected in ways that do not promote distrust and dislike between the government and the citizens. A friend of mine was recently audited by the IRS. He had two telephones in his home: a personal phone and a business phone. He brought all of the telephone bills -- business and personal -- to the audit. By mistake, he had interchanged two of the bills, and recorded a business bill as a personal bill, and vice versa. My friend noticed this error in going through each of the bills with the auditor. Upon noticing this error, he immediately called it to the attention of the auditor, at which point the auditor arrogantly sneered, "How many other 'mistakes' like this are there in here!" He was clearly insinuating that my friend had deliberately attempted to cheat on his taxes. My friend does not cheat on his taxes.
Why is the income tax so complicated? What is it about an income tax that causes the income tax system to become more complex each year? The principal factor underlying this characteristic of the income tax is that economists have been unable to agree on a definition of income. Some economists, in fact, argue that it is impossible to develop a practical, measurable definition of income.
Many economists consider the income tax a desirable type of tax because use of it theoretically enables the government to tax on the basis of ability to pay. This viewpoint is adopted on the theory that a person's income is a good indicator of his ability to pay. That theory is accepted by many, but by no means all, economists.
To implement an income tax, it is necessary to have available an acceptable conceptual, or theoretical, definition of income and a practical means of measuring income relative to that definition. And there's the rub! While a consensus exists on a conceptual definition of income, it has proven totally impossible to achieve a consensus on a practical means of measuring income relative to that definition. Some economists claim that it is impossible to specify a practical, measurable, definition of income. Because of this difficulty, the goal of taxing on the basis of income is impossible to achieve. This impossibility has not, however, stopped the government from trying. Every year, the government decides that the definition used last year isn't quite right, and makes changes to the definition. Since no consensual measure of income exists, this process never ends. The tax code grows more and more complicated.
Many economists accept, as a general conceptual definition of income, the Davidson-Schanz-Haig-Simons (DSHS) concept of income (Joseph Pechman's book Comprehensive Income Taxation presents a detailed discussion of the definition of income). Haig's definition is that income is the increase, or "accretion" in one's power to satisfy his wants in a given period, insofar as that power consists of money or anything susceptible to valuation in terms of money. Alternatively, Simon's definition is that personal income is the sum of consumption plus change in net wealth. This definition of income has existed and been accepted for a long time (Davidson, 1889; Schanz, 1896; Haig, 1921; Simons, 1938) as a general conceptual statement. To date, however, a massive academic literature has been developed in an attempt to operationalize this theoretical definition; that is, to determine a rigorous conceptual definition, to obtain an objective measure of income relative to this definition, and to determine a practical means of collecting data to numerically evaluate the measure. One of the problems deals with taxation of income from unrealized capital gains, the increase in value of an item that has not yet been sold. No method has been devised for dealing with this problem -- only realized capital gains are taxed.
The problems that arise in measuring income are several. Problems exist both with respect to measuring personal consumption and measuring net worth. With respect to consumption, it is not clear, for example, how to allocate the purchase of an automobile used partially for business and partially for pleasure to personal consumption versus a business expense. With respect to net worth, it is not possible to take into account all changes in the value of assets and liabilities because of price level and interest rate fluctuations. For example, it is difficult to assess the monetary value of capital assets until the asset is sold. Furthermore, even when the asset is sold, the gain may be more apparent (due to inflation) than real. The monetary (present) value of an income-yielding asset fluctuates as the current interest rate and expectations of future interest rates fluctuate.
The difficulty in measuring consumption prompted economist Henry C. Simons to admit that measurement of consumption presents as insuperable difficulties as a rigorous conceptual definition of personal income. Similarly, with respect to difficulties in measuring changes in net worth, economist Nicholas Kaldor asserted that the problem of defining individual income, quite apart from the problem of practical measurement, appears in principle insoluble (for additional discussion and citations, see Richard Goode, The Individual Income Tax).
In summary, economists are in disagreement on a rigorous definition of income. While some (for example, Simons) have asserted that income can be measured "well enough for tax purposes," others (for example, Kaldor) advocate the use of other types of tax (such as an expenditures tax) that avoid the measurement problem. The fact that, year after year, the government is unable to settle on a fixed definition of income is clear evidence that income cannot be defined well enough for tax purposes. The difficulty in measuring income was a primary factor leading to the complexity of the income tax law. These difficulties showed up in the wide array of depreciation schedules, income and loss averaging, and alternative methods for treating capital gains. The use of income as a basis for taxation is incompatible with the goal of simplicity. The failure of the past seven decades to develop an income tax that is both fair and simple pays testimony to this fact.
In view of the impossibility of defining and measuring income, it is reasonable to question to what extent the income tax reflects taxation on the basis of ability to pay, when economists cannot produce an acceptable definition of income and there is therefore no way of knowing how valid a measure of income the IRS definition of income is.
Some economists justify the terrible social and economic costs of the income tax on the basis that it enables taxation on the basis of ability to pay. In view of the inability of economists to produce a satisfactory operational definition of income and, moreover, in view of the inability of economists to produce a satisfactory operational definition of ability to pay, the belief that the individual income tax is a fair tax is difficult or impossible to justify.
The attempt to tax on the basis of a concept of ability to pay that is related to income has not proved practical. It leads to a tax base that cannot produce the revenue needed by today's economy at reasonable rates. In his book The Economics of VAT, Professor Richard W. Lindholm discusses the efforts of German economists to address the problem of defining income, earlier in this century. Some of the questions that must be resolved under a satisfactory definition of income include whether a beggar earns income, or whether there is a difference between a waiter's tip and a child's allowance. The German economists maintained that the return to capital or income required to maintain capital, including human capital, could not be considered income, under a "preservation of source" principle. The problem that arises is that these considerations lead to the elimination of much of the income tax base, which is associated with preservation of human capital. These concepts basically eliminate income for tax purposes for the majority of US families. Elimination of a large portion of the tax base leads to a narrow base, and with today's large revenue requirements, to high taxes. The conclusion is reached that in an economy with large revenue requirements, it is not possible to have a tax system based on the income tax. The attempt to do so leads to high rates, budget deficits, or both, as is the case in the US today.
It is interesting to note that when the income tax was
first introduced in the US, exemptions were so high that the tax in fact did allow for exclusion of almost all of
a family's income -- and, in fact, all
income for most families. As the US
leaned more heavily on the income tax to provide large amounts of revenue, the
point was reached where, on the one hand, the exemptions and deductions no
longer exempted sufficient income to reasonably support a family, and, on the
other hand, the tax base became too narrow to provide the needed revenue at
Because of the impossibility of defining income, the goal of developing a fair, simple tax based on income has eluded Congress, and it will continue to do so. Nevertheless, the quest continues. Economists delight in conducting research on how to measure income and how to tax on the basis of some abstract, ill-defined concepts of income and ability to pay. The problem is an academician's delight, because it has no solution.
The relentless, seven-decade attempt to develop a tax system based on taxation of income has produced nothing more than a system that is both complicated and unfair. A simple alternative, such as the use of a sales tax, has far less "publication" potential than discussion of a tax system based on an undefinable construct. In the interest of both simplicity and fairness, it is time to abandon the futile search for a fair and simple income tax. It simply doesn't exist.
The same sort of experience -- increasing complexity -- occurred with the turnover tax, which was used in Europe before its replacement by the VAT. A turnover tax is a tax imposed at several stages of production: manufacturing, wholesaling, and retailing levels. The problem that occurs with a turnover tax is that the tax "pyramids," or "cascades." Each time the item "turns over," the tax builds up. If a large number of stages is involved in the production and distribution of the product, the tax becomes intolerably high. Producers are motivated to absorb their suppliers. To avoid these incentives, governments attempt to introduce rate modifications. These modifications lead to other inequities, and further modifications. Eventually, the tax evolves to an inequitable administrative nightmare. For these reasons, the turnover tax has gone out of use.
What happened to the turnover tax is happening to the income tax: the income tax has evolved to a complicated, unfair tax. The only difference is that Congress has yet to throw in the towel on the income tax. Tax reform was promoted to try to clean it up. Unfortunately, tax reform did not scrap the income tax system and implement a new, improved tax system in its place. The cosmetic "fixes" of tax reform only delay the inevitable, and sentence the US public to a few more years under an unbearable system. It may not be possible to achieve complete equity with a simple tax system; recent US tax experience would indicate, however, that it is impossible to achieve equity with a complicated one.
The income tax system is now out of control. Today, no one knows what the tax base is. The definition of the base has switched from a simple definition to a definition not only in terms of a myriad of rules and regulations, but in thousands of court cases as well, and in thousands of court cases yet to come. To know whether an item should be included in or excluded from taxation, it is necessary to review decades of Tax Court case rulings and anticipate future Tax Court rulings. The tax base is now defined in terms of legal precedence. The situation is similar to the contrast between the English Common Law and the Napoleonic Code approaches to law: one defined in terms of general rules, precedence, and judgment, the other defined in terms of specific rules. While the precedent-based English Common Law is a humane approach to law, it is a disastrous approach to defining the tax base. No one knows what the tax base is any more. It is a continually changing, amorphous, daedalian enigma.
While the subject of tax policy analysis may be somewhat arcane, the definition of the tax base need not and should not be. It does not have to be income -- a complex and impossible-to-measure concept. It can be as simple as sales, with no measurement problem whatever. Use of a complicated, essentially unknown, tax base leads to frustration, resentment, and anger on the part of the citizen, and subjects the government to ridicule and contempt. Several decades of experimentation with the income tax have proved it to be unworkable. It is time to give up on this intrusive system.
This chapter explains the many ways in which the income tax is deficient, from an economic viewpoint. These deficiencies do not arise simply because the US income tax is a poorly designed income tax. They arise because an income tax has intrinsic economic deficiencies. By its very nature, it causes economic distortions, inefficiencies, and undesirable incentives.
The economic inadequacy of the income tax has been appreciated for a long time. Many economic textbooks have been written describing the economic inadequacies of the income tax. The American economy and people pay a high economic cost because of the US Government's clinging to the income tax. The tax discourages saving, investment, productivity, creates an incentive for businesses to go into debt, subsidizes inefficient firms, and stifles economic growth (employment and production). The paragraphs that follow show how.
The business profit tax discourages saving and investment. The reason for this is that a very high tax is imposed on the return on investment -- approximately 43 percent for individuals (33 percent federal plus 10 percent state) and 50 percent for businesses (39 percent federal plus 10 percent state). Because of the high tax on investment returns, an investment must provide very high returns in order for it to be justifiable and desirable.
The personal income tax does not encourage saving. Consumption taxes do. A consumption tax is a tax on the sale of goods and services, such as a sales tax or a VAT. The consumption tax encourages saving because no tax is imposed on saving; it is imposed on spending. The tax encourages saving because the less the consumer spends, the lower his tax. With the income tax, the only way he can cut his tax bill is by reducing his earnings.
Many other countries (in particular, Japan) have much higher savings rates than the US. A low savings rate means that little money is available for investment; this contributes to economic stagnation. An income tax discourages saving, by placing a heavy tax on the return to investment. We can ill afford a tax system that discourages saving. Consumption taxes such as the VAT, on the other hand, encourage saving. If you spend less, your taxes are less. The structure of the tax creates a definite incentive to save.
Under tax reform, interest paid on home mortgages is tax deductible, but interest on other types of consumer loans is not. This means that home mortgage loans are, in effect, much cheaper than other types of loans -- half as expensive, for a person whose marginal tax rate is 50 percent. Already, before a year has passed under tax reform, bankers are predicting a massive increase in the amount of "home equity" loans, from $25 billion in 1985 and $35 billion in 1986 to perhaps $100 billion eventually, out of a total second-mortgage market of approximately $200 billion. The availability of government-subsidized credit represents a disincentive to save and an incentive for families to go deeper in debt. Moreover, this trend makes it less likely that many Americans will ever own their homes. The economic incentives of an income tax structure may seem academic or insignificant, but they can cause massive economic distortions.
In Japan, the gross private saving rate is about 30 percent of GDP, and personal saving is about 20 percent of disposable personal income. In the US, the gross private saving rate is about 17 percent of GDP, and the personal saving rate is about 5 percent of disposable personal income (1985 data). The saving rate in the US is, in fact, one of the lowest of the industrialized nations. With inadequate saving, investment is crippled, and the US dooms itself to a second rate position in the world economic community.
Gross private saving includes personal saving, undistributed corporate profits, and capital consumption allowances (depreciation). Gross saving is gross private saving plus government surplus or less the government deficit. Annual US Government deficits are now massive: 5 percent of GDP for the past several years. If we subtract the government deficit from gross private saving, US gross saving is seen to be about 12 percent of GDP.
By promoting a tax system that cannot produce the needed revenue, the US Government cripples the US saving effort in two ways -- it introduces tax incentives that discourage private saving, and it creates massive deficits that reduce the country's saving rate even more. If, for example, the 5 percent government deficit were a 5 percent surplus, the US gross saving rate would be 22 percent of GDP instead of 12 percent.
The US Government, through its adoption of an insane tax system, is selling the country short. It is thwarting the efforts of responsible US businessmen and private citizens to prepare for tomorrow by saving, exposing US citizens to a future of penury, and dooming the US to a position as a second-class citizen in the world economy of nations.
Through its large deficits, the federal government is placing a millstone around the neck of responsible citizens who do save. It irresponsibly jeopardizes our future, while prudent citizens attempt to prepare for it. Worse, its fiscally irresponsible policies are depleting the private credit market; these policies threaten to kill US economic growth, and have the potential to cause both a national and worldwide economic collapse.
As a direct result of the inadequate income tax system and the resulting massive US Government deficits, the US finally reached the point where the nation's debt exceeded the capacity of the US domestic credit sources. In 1985, we became a debtor nation; counting both public and private debt, we owed more to foreign nations than they did to us. As one of the world's wealthiest nations, this is a morally bankrupt position. The world's developing nations depend upon the wealthy nations for capital. As a debtor nation, the US is using capital that is desperately needed by poorer nations. Through its irresponsible tax policy, the US Government is squandering not only our own economic potential, but that of developing nations as well.
The federal government is acting like an immature couple with a new credit card. Faced with a choice between increasing income and reducing spending to balance the budget, the government has chosen to do neither. It has refused to cut programs; it stubbornly refuses to abandon a defunct tax system that not only cannot produce the needed public revenue, but discourages private saving as well. This crazy tax policy could not continue forever. The day of reckoning has arrived; the nation is now bankrupt; it is time to face reality and discard the income tax system.
As our society becomes more productive because of the industrial revolution, a larger and larger proportion of the population may engage in activities that are not directly related to the basic "sustenance-related" tasks of providing food and shelter. As noted earlier, we currently waste approximately $35 billion per year in unnecessary personal income tax collection and avoidance activities. We currently spend over $200 billion in national defense.
The more productive we become, the more we can channel into nonsustenance activities. An issue that needs to be addressed is do we really want to spend our "discretionary" productive resources on activities such as income tax avoidance, rather than on more pleasurable activities such as earlier retirement, travel, or construction of homes.
Many of the 85,000 IRS workers are performing nonproductive activities -- activities that are totally unnecessary, since the income tax is unnecessary. The government has decided to waste their labor in playing an elaborate tax game whose rules are the tax code. Do US citizens really want to spend their discretionary economic productive capacity in this way? Why not use their $3 billion in wages to repair roads, bridges, and dams; to renovate cities, reduce pollution, and clean up rivers; to repair roofs and mow lawns; to provide some free health care services to the elderly; or maybe even to fund free vacations on a lottery basis? Do we really want to support an agency of 85,000 to monitor our personal activities?
One of the greatest wastes associated with the complexity of the income tax system is the tremendous waste of skilled accounting and legal personnel in the business of tax advice, analysis, and return preparation. The demand for these skills is created by the labyrinthine tax system, which requires a massive amount of effort to learn. Since the income tax system is completely unnecessary, all of this skilled labor is wasted. This contributes to a great loss in productivity. These resources could be used productively in accounting oriented toward real business decisions and operations, instead of wasted on analysis of a fantastic, synthesized tax system.
Under current tax law, interest charges are tax deductible to a business. For this reason, there is an incentive to make loans to acquire capital equipment (such as issue bonds), rather than to use equity financing (float stock issues).
This incentive is not a good one. It raises the rate of return needed to justify an investment. If interest rates are high, the return needed to justify an investment may be so high as to cause the elimination of many investments, and the rate of investment may decline. By creating an incentive to borrow, it tends to drive interest rates up. The increased use of debt financing by firms raises the risk of bankruptcy. This perverse incentive serves to introduce an unnecessary source of instability in business. It is an example of how tax laws distort economic decisions. Such distortions reduce the economic efficiency of the allocation of resources.
By its very nature, the business profit tax is a tax that falls more heavily on firms that, by reason of their efficiency, show a profit. Firms that show no profit pay no tax. Firms that show a loss may carry the loss forward to future years in which they show a profit.
The net effect of the business profit tax is that firms that are profitable are penalized, and firms that are not profitable are subsidized. In general, profitable firms are employing resources more efficiently; that skill should be rewarded, not penalized. The business profit tax subsidizes inefficiency over efficiency. It is undesirable from an economic point of view.
Countries that use the VAT have an advantage over the US, with respect to international trade. As discussed earlier, under the GATT a country that uses a VAT may subsidize its exports by the amount of the VAT, and may impose a border tax on imports also equal to the VAT rate. The US does not use a VAT, and cannot impose such subsidies and penalties under the GATT. The income tax does not qualify for preferential treatment under the GATT; US firms cannot subsidize exports by the amount of the income tax. To the extent that income taxes raise prices, US firms are placed at a competitive disadvantage in international trade.
Almost 40 countries have adopted the VAT. It is not only a tax method that can generate massive resources at low rates, but it offers significant advantages in international trade. As more and more countries turn to the VAT, the US will find itself at a greater and greater disadvantage.
Under the income tax, firms receive a tax deduction each year for the wear and tear on capital assets, buildings and equipment. This tax deduction is computed as a depreciation allowance that represents the "using up," or consumption, of the capital. If the depreciation allowance in a year bore a close relationship to the reduction in value of the asset during that year, the depreciation of capital assets would not cause serious economic problems. It would be simply a needless burden on firms and a waste of the firm's accounting resources.
A problem that arises with depreciation of assets is that, under US tax law, firms are allowed to depreciate assets at rates that are significantly higher than the actual consumption of the capital. This depreciation method, enacted in 1981 and maintained with little change under the Tax Reform Act of 1986, is called the Accelerated Cost Recovery System (ACRS). It enables "fast write-offs" of business assets. The economic problem that accelerated depreciation of capital causes is that it places capital-intensive industries at an advantage relative to labor-intensive industries. Capital-intensive industries receive, in effect, a tax subsidy through the preferential manner in which capital consumption is treated.
This situation represents an incentive for people to invest in capital-intensive industries. Whenever a government, through its tax laws, creates incentives for consumers to alter their preferences, economic inefficiencies result. The efficient allocation of economic resources, in response to consumer preferences, is perturbed. The result is that society obtains a lower return in terms of consumer satisfaction on its investment of economic resources than would otherwise be the case. The tax law has introduced a distortion in the economy. The government, through its tax policy, has interfered with the efficient allocation of society's economic resources, thereby reducing the benefit realized by society from the use of its resources.
Note that the economic distortion caused by the preferential tax treatment of capital in the US derives from the conscious and substantial effort to extend tax advantages to capital consumption. The magnitude of distortion caused by this preferential treatment of capital would be less if depreciation were closely linked to fair estimates of useful lifetimes, without accelerated depreciation rates. In other words, an income tax does not have to distort the allocation of economic resources as much as it does in the US. There will always be some distortion, however, because of the impossibility of estimating the actual decline in value of all of a company's assets in a particular year.
Because of the tax preferences that invariably exist with an income tax, the income tax is in general not neutral with respect to tax preferential treatment of capital versus labor. The US income tax system makes no attempt to achieve neutrality. It strongly favors capital-intensive industries, and distorts the economy because of this preferential treatment.
The preferential treatment of capital assets points out a key defect of the income tax. Its mind-boggling complexity camouflages the undesirable effects of the tax. Special-interest groups can work to incorporate rules and regulations (such as accelerated depreciation) that may appear to be nothing more than arbitrary, mindless complications, when in fact they have serious deleterious effects on the economy.
The US does not have to put up with a seriously distortive tax system. A single-rate, universally applied VAT, for example, is economically neutral. It contains no incentive to change the mix of capital and labor from that that would exist in the absence of the tax.
The income tax distorts the economy in other ways. Because profits are taxed, the income tax penalizes efficient, profit-making firms and subsidizes inefficient firms. Because of the double taxation of dividends, it discriminates against the corporate form of business. Because fringe benefits are untaxed, it provides an incentive to reimburse employees through fringe benefit payments-in-kind. A VAT, on the other hand, contains no incentives regarding business structure, and taxes fringe benefits in the same manner as labor costs and other factors of production. The VAT encourages efficiency, since a firm that reduces the costs of its inputs pays a lower tax.
The preceding discussion has centered on the business income tax. The personal income tax also contains tax shelters that distort the economy. For example, individuals may deduct the interest cost of up to two homes. This preferential treatment of housing benefits the US construction industry, at the expense of the taxpayer. The US citizen would be better off overall if the government did not distort the economy by introducing tax preferences that favor certain special-interest groups.
One of the complaints that is voiced about the personal income tax and the business profit tax system is the fact that it forces double taxation, in the form of a heavy tax burden on dividend earnings. As was briefly mentioned in Chapter 8, this happens as follows. A business pays a tax on its profit, and then pays a dividend to the owner or a stockholder. The owner or stockholder then pays a personal income tax on the dividend income. Let's say that the total marginal tax rate is up to 49 percent (39 percent federal, 10 percent state) on the business and 43 percent (33 percent federal, 10 percent state) on the individual -- a combined tax rate of 1 - (1-.49)(1-.43) = 71 percent. Economists generally believe that the tax on dividends falls on the stockholders. In this case, the corporate profit tax is an additional burden on the dividend earnings that is not imposed on other types of earnings. Before tax reform, the double-tax rate was 1 - (1-.46-.1)(1-.5-.1) = 82 percent. Under tax reform, the level of double taxation, that is, the additional burden on dividends, has not changed significantly.
What's wrong with double taxation? From the viewpoints of economic impact and equity, there is plenty wrong. From an equity viewpoint, the double tax is a very heavy tax imposed on the earnings of individuals who depend on stock dividends for their earnings, for example, a retired person. The additional tax burden associated with double taxation is actually heaviest for those in the lowest income classes. For example, a person in the zero-rate income-tax bracket suffers an additional tax burden of 49 percent -- the tax on the business profit (39 percent federal and 10 percent state). A person in the 43 percent tax bracket (33 percent federal, 10 percent state), however, suffers an additional tax burden of only (1-.43)(.49) = 28 percent. The burden is reduced because he would in any event pay a 43 percent tax on the earnings. With the addition of the corporation profit tax, the tax burden is 49 percent and 43 percent, or 1 - (1-.49)(1-.43) = 71 percent. The additional tax burden caused by the corporation profit tax is 71 percent - 43 percent = 28 percent. In other words, a retired person living on dividend income realizes a heavier additional tax burden from the double taxation of the personal income tax and the business profit tax than the high income earner in the highest tax bracket (49 percent versus 28 percent additional burden).
From an economic-impact viewpoint, the double tax represents a very heavy tax on the earnings of an investment; the practice hence discourages investment. In addition, it illogically discourages investment in corporations, rather than unincorporated business structures that are not subject to double taxation. What is the purpose of this deliberate economic distortion?
The personal income tax and the business profit tax are not well integrated; just one more example of America's hodge-podge tax system. They work together to impose a heavy tax burden on low-income earners who are dependent on dividend earnings, and represent a disincentive to invest (because the earnings from the investment are so heavily taxed). The additional tax burden represented by the combination of the personal income tax and the business profit tax is much greater for low-income earners than for high-income earners.
The cost of collecting income tax from over 90 million individuals is staggering. The total cost includes the cost of return preparation, the cost of tax advice and preparation services, the cost of maintaining tax-related records, and the cost of the IRS to collect, process, and audit tax returns and prosecute income tax cases.
The personal income tax is a very costly tax, both in terms of the cost to the government in collecting the tax and the cost to citizens in complying with the tax. These two types of cost are referred to as the administrative cost and the compliance cost.
The administrative cost of the tax includes the cost of processing tax returns and making audits. The compliance cost includes the direct cost of tax lawyers, tax accountants, and tax-preparation services. The indirect cost of compliance includes all of the effort that is expended by the individual in preparing his return.
The US income tax is sometimes touted as a low-cost tax, by citing the fact that the cost of administering the tax is only one half of one percent of the tax collected. This figure is, however, grossly misleading. First, since the income tax is the country's primary source of tax revenue, .5 percent of the total income tax is a very large amount. Second, the administrative cost of the income tax is a small portion of the total cost of the tax; the compliance cost of the US income tax is extremely high.
The IRS budget is approximately $3 billion per year, with much of this amount going toward the collection of personal income tax -- the printing and distribution of millions of tax return forms, instructions and pamphlets, the cost of processing the returns, the cost of auditing selected returns, and tax court costs. If the tax revenue that is collected as income tax were collected in other ways (for example, as a VAT tax on business), much of this cost could be eliminated.
The use of a personal income tax imposes a heavy administrative burden of monitoring the incomes of the population. In order for a near-universal income tax to be feasible, a high level of compliance and effective administration are required. The personal income tax is not widely used in countries where compliance is not high and administration is not effective. Compliance was high in the US when rates were low, but sentiment against the income tax has increased considerably in recent times, as rates have moved to high levels for a large portion of the population.
The tax collection cost is, however, just part of the cost associated with the personal income tax. From an economic point of view, all of the labor associated with preparation of the returns is an economic cost of collecting the tax.
Many people do not feel capable of completing the tax forms themselves. The imposition of a personal income tax has given rise to an entire industry of tax accountants, tax lawyers, and preparers. All of the time that these organizations spend on tax analysis, advice, and return preparation is an economic cost of the personal income tax. The direct cost of professional assistance (lawyers and accountants) has been estimated by various sources to be about $3 billion per year. While people seek professional help for a variety of reasons -- medicine, accounting, architecture, employment search -- the need for tax preparation assistance for individuals is a need that is totally unnecessary. It is a synthetic need that derives solely from the government's imposition of an unnecessary and complicated form of taxation on individuals.
The cost of lawyers, accountants, and tax preparers is, however, just part of the tax compliance cost. From an economic viewpoint, the total compliance cost of the income tax includes the dollar value of the time that the individual taxpayer spends in analyzing tax matters, assembling information, and filling out tax forms. The estimates of this cost vary considerably, from about $10 billion to $35 billion, depending on the assumptions that are made. (Detailed, comprehensive sample survey data are not available on compliance cost.)
For example, suppose that it is assumed that it takes 100
million filers approximately six hours each to prepare their returns. Assuming an average labor cost of $8.00 per
hour, this totals $5 billion of wasted productivity per year. This amount is a very conservative estimate
of the cost of tax compliance. If the
cost of collecting tax-related data (that is, saving receipts throughout the
year, determining mortgage interest amounts, reading tax-form instructions,
reading tax articles and books, researching tax law) is included, the total
economic cost of income tax compliance is many times greater than the
return-completion cost. A total
compliance-cost estimate of $35 billion (corresponding to a loss of 42 hours,
or approximately a week of time, during the year) is not unreasonable.
In addition to the preceding compliance cost, US businesses expend considerable resources on accounting activities related to collection of the personal income tax.
Much of the cost of tax compliance is associated with time spent in tax avoidance. Tax avoidance is the (perfectly legal) practice of structuring one's income to minimize tax payments. Because income tax rates are so high, there is a strong incentive to engage in tax avoidance. Because of the tremendous complexity of income tax law, however, the practice of tax avoidance requires the investment of substantial time and resources. This investment not only includes the time of the individual taxpayer, but the productive effort of tax lawyers, tax accountants, and tax preparers. Their effort, wasted in the practice of tax avoidance for an unnecessarily complicated tax, could be used to increase the productivity of the US economy. The lost productivity caused by the income tax system's high incentives for tax avoidance is massive. All of this economic productivity is wasted, since it is unnecessary, and could be better spent.
Many US citizens do not want to bother with the hassle of having to keep track of all of their bills and receipts, as is required to comply with our perverted tax system. They resent this imposition. They may sense that this is somehow unnecessary, that the income tax is a silly, hassling way to collect tax revenue.
The incentive for tax avoidance is costly from two points of view. First, it wastes the individual's time and money. Second, it deprives society of the product of the labor of educated, skilled workers. Tax attorneys and accountants are college-trained individuals, many of whom have post-college training (such as Certified Public Accountant certification). In recent years, the growth in productivity in the US has tapered off to the point where we are now in an unfavorable position relative to other nations. In some areas (for example, protection of the environment, concern for workers' health) the benefits of decreased productivity due to government regulations are desirable and real, and the costs are justified.
In the case of the income tax, however, the effort invested in tax avoidance is totally wasted -- millions of hours of skilled labor poured down the drain in the analysis and interpretation of a complicated, arbitrary, totally unnecessary set of rules. The US cannot afford to waste the talent and time of its educated citizens. This skilled labor can be put to much better use, either in support of a humane tax such as the VAT or applied directly to non-tax-related economic production.
For many types of taxes, the number of tax collection points (taxpayers) is small (for example, natural resource severance taxes) or the tax is sufficiently simple (such as a sales tax), that its collection is relatively easy, inexpensive, and unintrusive. This is not the case for the personal income tax. It requires a massive investment of time and resources on the part of the taxed individuals, and on the part of the government. It is a costly, inefficient form of taxation.
The Inevitable Leakage in Wage or Income Taxes Drives Collection Costs Sky High, Creates Citizen Resentment, and Narrows the Tax Base
One of the worst features of an income tax system is that it is extremely costly to develop a system that ensures that all individuals pay their intended share of the tax. As we have seen with the tax system before tax reform, it is easy enough to tax individuals who work for companies, but self-employed individuals such as physicians, consultants, house painters, and waitresses can easily avoid being taxed on at least some of their income. Moreover, the marginal tax rates are high, creating a strong incentive to do so.
In the guise of being "fair," the government expends considerable funds in setting up systems to attempt to reduce this problem. Without assuming total control of employment, the government cannot hope to eliminate this problem. The resentment and leakage in the current system have demonstrated unequivocally that, with a budget of $3 billion and a work force of 85,000 employees, the IRS has failed completely in eliminating leakage, and has succeeded, instead, in instilling anger and resentment in the US population toward its government.
The problem of attempting to tax the income of 100 million individuals in an equitable fashion, given the diversity of our economy and the private ownership of the means of production, is impossible. The attempt to do so incurs astronomical costs, instills suspicion on the part of the population, and results in failure. Experience has shown that the income tax simply cannot be implemented fairly -- or at reasonable social or economic cost -- in a free-enterprise economy.
There are 15 million businesses versus 100 million individual taxpayers. Extracting the federal tax revenue from 15 million points in the economy is much simpler that extracting revenue from 100 million points. It is much easier to monitor businesses than individuals. Intrusion of privacy is not the issue for business that it is for individuals.
A major problem with the current tax system is that, because it is so burdensome, and because to date it has not been practicable to enforce total compliance on 100 million citizens, a large portion of the taxpayers successfully evades taxes. The IRS has estimated that, in 1986, the tax gap (the difference between what taxpayers should pay and what they do pay) is $103 billion, compared to $39 billion ten years ago.
The success of the underground economy has narrowed an already-narrow tax base to the point where the rates are very high, and yet the revenue is still not sufficient to cover the national budget without deficits.
In summary, the income tax is an extremely costly, inefficient tax. This chapter has identified some of the costs of the income tax and estimated their magnitude. The estimates presented here are very conservative. Other writers present even higher estimates. For example, in their book The Flat Tax, Hall and Rabushka present the following estimates: lost output associated with tax-advantaged investments -- $100 billion; compliance cost (filing and buying expert advice) -- $35 billion; tax evasion -- $120 billion. Comparing this cost -- $255 billion -- to the total income tax revenue ($350 billion in 1984), the income tax system is seen to be an extremely costly and inefficient means of taxation.
Given the reaction of taxpayers to the system, and the inability of the IRS to halt the growth of the underground economy, it is time to consider an alternative tax system. The motivation of the Tax Reform Act was the assumption that taxpayer dissatisfaction derives mainly from the inequity of the previous income tax system. That assumption is wrong. Taxpayers are responding more to an intolerable burden than to envy caused by tax shelters. The leakage will continue; the tax gap will persist. These are symptoms of an inhumane income tax system. They will not disappear until that system is dismantled and replaced by a humane one.
The US income tax system is contributing to an economic collapse both in the US and worldwide, in two ways. First, the system cannot produce the level of revenue needed to cover the government budget, and massive budget deficits have resulted. Second, the system has not prevented the development of extreme concentrations of wealth.
Both of these conditions threaten to result in economic collapse. Massive US government debt results either in massive borrowing by the government or in the printing of large amounts of money. The result is either very high interest rates, or inflation rates, or both. Either of these conditions is not conducive to economic stability and growth.
Extreme concentrations of wealth are considered to contribute to economic depressions for two main reasons. First, there is high demand for loans by the large nonwealthy portion of the population; because of the extreme concentration of wealth, these many borrowers do not have substantial assets and the loans tend to be risky. Second, wealth concentrations lead to speculation and risky investments by the very wealthy. Extreme concentrations of wealth hence contribute to unstable economic conditions. The natural economic fluctuations (expansions and contractions) of a free-enterprise capitalist economy are amplified, heightening the likelihood of extreme economic booms and depressions.
This chapter discusses the ways in which the US income tax system is contributing to an economic collapse.
The US income tax system causes budget deficits in two ways. First, the tax cannot produce the level resources needed by a modern economy. The income tax base is so narrow that Congress is reluctant to impose the high tax rates that would be required to produce the desired level of revenue. Second, the system causes deficits because it produces volatile (highly fluctuating) levels of revenue from year to year. A government deficit in a few recession years is not cause for concern. The important thing is that government deficits be covered when economic conditions improve. If, over the course of the business cycle of economic expansions and contractions, the government uses surpluses in boom years to offset deficits in recession years, no serious economic problems arise because of the government debt. Under the inadequate US income tax system, however, the government debt is not being retired in good economic times. In fact, even in boom years, massive deficits are being run up! The national debt is steadily increasing, even in the good years of the business cycle.
The US Government adopted the business profit tax in 1909 and the personal income tax in 1913. When it adopted these taxes, the rates were very low -- one percent on profits and not over one percent for most individuals. The government chose the personal income tax as an alternative to higher or varied indirect business taxes (such as a national retail sales tax) in an attempt to promote social equity through the redistribution of income. When introduced in 1909 and 1913, the personal income tax and the corporation income tax were comparable in burden to other taxes. During the first half of this century, the demand for tax revenue grew dramatically, especially as the result of World War II. Because the bases for these taxes are narrow, however, they cannot produce the massive revenue now needed, at low rates. As the need for revenue grew, the business- and personal-income-tax rates grew to very high levels. The tax burden in the US is approximately one third of GDP, and most of the revenue comes from the personal income tax, the business profit tax, and the payroll tax. The personal-income-tax and business-profit-tax rates are now (even under tax reform) very high.
The government has not faced up to the issue that the personal-income-tax and business-profit-tax bases are too narrow to provide the revenue it requires at reasonable rates. Instead of dropping these taxes in favor of a tax with a wide economic base and low rates (such as the VAT), it has, under tax reform, simply eliminated some deductions and tax brackets. Tax reform did not address the fundamental issue that the income tax base is simply too narrow to provide the needed revenue at reasonable tax rates. The government passed the Tax Reform Act of 1986 in the face of mounting opposition to high income tax rates. It has not solved the problem; income tax rates are still high. The Tax Reform Act is a sham; it pretends to be a solution to the income tax problem, but it is not. The reform that is needed is to scrap the personal income tax and the business profit tax. They are too narrow for today's needs.
To understand the nature of the problem of a narrow tax base, it is helpful to know something about national income accounting. Table 1 shows a breakdown of the GNP into its major components. The GNP is simply the total value of all goods and services produced in the US in a given year. Total GNP for 1983 was $3,305 billion. The tax base for the personal income tax in that year was only $1,300 billion, or 39 percent of GNP. For corporate taxes, the tax base (corporate profit) was only $219 billion, or seven percent of GNP. Together, these two tax bases total $1,519 billion, or less than half of GNP. These bases comprise too small a part of GNP to produce needed government revenue at reasonable rates. On the other hand, the potential VAT tax base is approximately total national income -- $2,647 billion, or 80 percent of GNP. This income base is much larger, and can produce the desired revenue at much lower rates.
Billions of Dollars
Gross National Product
Capital Consumption Allowance
Net National Product
Indirect business tax and nontax liability
Contributions for social insurance
Government transfer payments to persons
Personal interest income
Personal dividend income
Personal tax and nontax payments
Disposable personal income
Source: US Bureau of the Census, Statistical Abstract of the United States: 1985 (105th edition), Table No. 717, p. 433, US Government Printing Office, Washington, DC, 1984.
a. The VAT tax base is National Income, which is 80 percent of GNP.
b. The corporate income tax base (that is, corporate taxable income) is $219 billion, which is 7 percent of GNP (Source: Statistics of Income, 1983, Corporation Income Tax Returns, Department of the Treasury, IRS, Statistics of Income Division, Publication 16 [Rev. 8-86], p. 2, US Government Printing Office, Washington, DC, 1986).
c. The personal income tax base (that is, taxable income less zero-bracket amount) is $1,300 billion, which is 39 percent of GNP (Source: Individual Income Tax Returns, 1983: Tables Emphasizing Returns Filed, Sources of Income, Exemptions, Itemized Deductions, and Tax Computations, Statistics of Income Division, IRS, Publication 1304 [Rev. 4-86], Table A, US Government Printing Office, Washington, DC, November 1985).
As can be seen from Table 1, both the corporate-profit-tax and the personal-income-tax base are relatively small proportions of the total national production, as measured by GNP. If the US Government revenue requirements were small, the needed revenue could be raised using these tax bases. Since the US revenue requirements are so large, however, it is necessary to use a larger tax base in order to keep tax rates low. An alternative that uses a large proportion of GNP as a tax base is the VAT. With a VAT, the tax base is sufficiently broad that the needed revenue can be produced at low tax rates.
Imposing heavier taxes on the personal-income-tax base and the corporate-profit-tax base is not practical. A basic motivation for the Tax Reform Act of 1986 was the fact that the taxes on those bases were already so high that people were voicing strong objections. The Tax Reform Act accomplished little more than a shuffling of this heavy tax burden over the taxable income base. The US population already objects to the current high levels of the personal income tax and the business profit tax, and will not accept a heavier income tax burden.
Under tax reform, the relative size of the tax bases for the personal income tax and the business profit tax are not expected to change very much. The reason for this is that the major effect of the Tax Reform Act is to eliminate tax shelters for a relatively small proportion of the population.
Another problem with the business-profit-tax base is that it is so volatile that the revenues provided from it are unstable, that is, they fluctuate widely from year to year. Total national corporate profits can fluctuate 20 percent a year. Unstable tax revenues make government budget planning difficult, and contribute to a growing national deficit because tax revenue surpluses in boom years are generally not used to reduce deficits in recession years. The temptation to reduce taxes or expand spending programs has proved irresistible.
Because of the progressivity of the personal income tax and the business income tax, the revenue from these taxes is unstable. Fluctuations in the business cycle are amplified in tax revenues, under the current system. Furthermore, the success of the "built-in flexibility" feature of the income tax (that is, the reduction in taxes when business activity is in recession) in moderating recessions has been questioned (see, for example, Lindholm's book A New Federal Tax System).
The massive deficits that the US Government has been piling up will continue until it scraps the current inadequate tax system and adopts one that can produce the needed revenue. The massive US deficit has the potential not only to destroy the US economy, but also to trigger a world economic collapse. Congress has been "fiddling while Rome burns," relative to the issue of the US Government deficit. Its impotence on this matter is a planetary disgrace; the danger that this represents to all nations is an outrage. The time for a new tax system is long past. A means must be found for prodding Congress to responsible action on this critical matter.
One of the objectives of a tax system in a democratic system is to prevent extreme concentrations of wealth. Extreme concentrations of wealth are considered undesirable for several reasons. The wide disparity in wealth causes envy in the nonwealthy, contributing to social unrest and instability. Private concentrations of wealth provide considerable power to the wealthy; this power may threaten the personal security of the nonwealthy. Finally, concentrations of wealth are considered to contribute to recessions, and extreme concentrations may contribute to severe economic depressions.
The US tax system is not effective in reducing concentrations of wealth. In the US, taxes are imposed primarily on income, not on wealth. Even though income taxes are high, they have not prevented massive accumulations of wealth. This situation is due partly to the fact that in recent years US tax laws have greatly favored the wealthy. A second factor is that US inheritance taxes are not high and have little effect in preventing an intergenerational transfer of wealth.
Dr. Ravi Batra discusses the relationship between concentrations of wealth and depressions in his book, The Great Depression of 1990. He draws many parallels between economic conditions in the 1920s (just before the Great Depression of the 1930s) and the 1980s. Based on the similarities, he predicted a stock market crash in 1989 followed by a great depression starting in 1990 and lasting for at least seven years. It is interesting to note that in October 1987, the stock market indeed crashed.
Dr. Batra promotes the opinion, shared by many economists, that an uneven distribution of income contributes to recessions; further, he asserts that extreme concentrations of wealth cause great depressions. He notes that in 1929 (the year of the Great Crash of the stock market) and in 1986, the richest one percent of the population owned more than one third of all of the wealth. (The richest one percent in the US generally possess on the order of one fourth of the wealth.)
As mentioned at the beginning of this chapter, extreme concentrations of wealth are considered to contribute to depressions basically for two reasons. First, because of wealth concentrations a large proportion of the population has few or no assets. This means that a large proportion of bank loans are risky. Second, the extremely wealthy tend to make speculative or risky investments. The result is an unstable economic situation.
The US economic system is a capitalist, free-enterprise system. A capitalist system is one that allows private ownership of the means of production. A free-enterprise system is one in which businessmen are free to maximize their profits. In a capitalist, free-enterprise system, economic fluctuations are natural and inevitable; economic conditions continually change in an unending sequence of recessions and booms. The random fluctuations of the business cycle occur because of the many uncontrolled actions of the large number of individuals and firms in the economy. Although government actions do not eliminate these fluctuations, it appears that government actions can dampen or amplify their magnitudes. Batra asserts that if the government were to take steps to reduce the massive budget deficit and decrease the concentration of wealth, the severity of the next economic contraction could be lessened.
The US tax system is contributing to massive, persistent government deficits, and is enabling the extreme concentration of wealth. These conditions can result in an economic collapse. The US income tax system must be replaced!
This chapter describes a methodology for developing a modern, adequate tax system. The "tax engineering" methodology presented here represents the application of the disciplines of systems analysis and systems engineering to the problem of analyzing, designing, and implementing a new tax system.
Before describing the recommended methodology for designing a new tax system, the chapter begins with a discussion of the goals of tax policy analysis and the legislative process currently used to develop the US tax system.
Tax systems are the result of an evolutionary process, in which the specification of the tax sources and rates evolves in response to changes in the governmental, economic, and social environment. Changes in the tax system may be minor or substantive. For many years, minor changes may be made in a basic tax system -- rules and regulations are introduced, modified, or eliminated. At some point, however, the social or economic environment will have changed so much that the basic structure of the system may no longer be appropriate, and a major change may be legislated.
Such major changes occurred in the US at the time of the Revolution, the Civil War (temporary income tax), 1909 (corporate income tax), 1913 (personal income tax), and the Great Depression of the 1930s (states move to retail sales tax). Since World War II, there have been about two dozen major tax bills, including three "Tax Reform Acts": the Tax Reform Act of 1969, the Tax Reform Act of 1976, and the Tax Reform Act of 1986. None of the tax law changes since World War II have been substantive, fundamental changes in the tax system. The most recent legislation, the Tax Reform Act of 1986, does not represent a major structural change in our tax system; it is simply a large number of modifications (changes in deductions) to the personal-income- and business-profit-tax system introduced early in this century.
When tax legislation is considered, the opportunity arises to analyze the current system and to develop alternative systems that are better suited to the economic, political, and social environment. The process of developing a new tax system involves the synthesis of alternative systems, the analysis of those alternatives, and the selection of a preferred alternative. Und