How Tax Reform Will Simplify Our Broken Tax Code and Help Individuals and Families

Comments for the Record

United States House of Representatives

Committee on Ways and Means

Subcommittee on Tax Policy

Hearing on How Tax Reform Will Simplify Our Broken Tax Code and

Help Individuals and Families

Wednesday, July 19, 2017, 2:00 PM

By Michael G. Bindner

Center for Fiscal Equity

Chairman Roskam and Ranking Member Doggett, thank you for the opportunity to submit these comments for the record to the House Ways and Means Committee Subcommittee on Tax Policy.  As usual, we will preface our comments with our comprehensive four-part approach, which will provide context for our comments.

• A Value Added Tax (VAT) to fund domestic military spending and domestic discretionary spending with a rate between 10% and 13%, which makes sure very American pays something.
• Personal income surtaxes on joint and widowed filers with net annual incomes of $100,000 and single filers earning $50,000 per year to fund net interest payments, debt retirement and overseas and strategic military spending and other international spending, with graduated rates between 5% and 25%.  
•  Employee contributions to Old Age and Survivors Insurance (OASI) with a lower income cap, which allows for lower payment levels to wealthier retirees without making bend points more progressive.
• A VAT-like Net Business Receipts Tax (NBRT), which is essentially a subtraction VAT with additional tax expenditures for family support,  health care and the private delivery of governmental services, to fund entitlement spending and replace income tax filing for most people (including people who file without paying), the corporate income tax, business tax filing through individual income taxes and the employer contribution to OASI, all payroll taxes for hospital insurance, disability insurance, unemployment insurance and survivors under age 60.

Simplify our broken tax code

Probably the most broken part of our tax code is how businesses are taxed. Corporations pay separate taxes while sole proprietors and ”pass throughs” pay taxes through the personal income taxes of their owners. This has some people being taxed twice, regardless of whether this is appropriate to extract taxes on higher incomes not collected through the business, while others face complexity on their personal forms, as well as a different set of rules. In 2003, President Bush and the Congress tried to fix this but could not, settling instead on a lower rate for dividends and capital gains.

The results of simply cutting rates were not pretty. CEOs and investors had an incentive to keep labor costs in check and pocket all productivity gains, which were huge through automation and outsourcing. Higher tax rates would have put a damper on such behavior. Of course, because not every rich person can be a CEO and because most companies borrowed money rather than issued stock, there were few good investments, which had beneficiaries of the 2001 and 2003 tax cuts seek more exotic vehicles, like oil futures and mortgage backed securities. This (not any action by the GSEs) led to the mortgage boom and the Great Recession (as well as provisions in the 1986 tax reform that let home owners use their houses as ATMs, a provision Trump wants to keep).

The President proposes simply lowering the tax on ”pass through” income, which will increase the number of companies fronting what would have been pay to individuals for salary and rent in order to take advantage of the lower rates. This is tax DEFORM not reform. We tried such cuts in 2003 and the proposed cut will yield the same result, especially if the President succeeds in defanging Dodd-Frank through regulatory reform (again deform).

There is a better way. Value Added Taxes and Net Business Receipts Taxes (Subtraction VAT) will both simplify taxation and treat all businesses in the same way. While some special tax breaks might be preserved in the NBRT, most would not because there would be no way to justify taxing the labor or an activity and not the associated profit or taxing research salaries one way and production wages another. All profit and wage would be taxed at the same rate, which also removes the tax bias against wage income.

The proposed Destination-Based Cash Flow Tax is a compromise between those who hate the idea of a value-added tax and those who seek a better deal for workers in trade. It is not a very good idea because it does not meet World Trade Organization standards, though a VAT would. It would be simpler to adopt a VAT on the international level and it would allow an expansion of family support through an expanded child tax credit. Many in the majority party oppose a VAT for just that reason, yet call themselves pro-life, which is true hypocrisy. Indeed, a VAT with enhanced family support is the best solution anyone has found to grow the economy and increase jobs.

Some oppose VATs because they see it as a money machine, however this depends on whether they are visible or not.  A receipt visible VAT is as susceptible to public pressure to reduce spending as the FairTax is designed to be, however unlike the FairTax, it is harder to game.  Avoiding lawful taxes by gaming the system should not be considered a conservative principle, unless conservatism is in defense of entrenched corporate interests who have the money to game the tax code.

Our VAT rate estimates are designed to fully fund non-entitlement domestic spending not otherwise offset with dedicated revenues.  This makes the burden of funding government very explicit to all taxpayers.  Nothing else will reduce the demand for such spending, save perceived demands from bondholders to do so – a demand that does not seem evident given their continued purchase of U.S. Treasury Notes.

Value Added Taxes can be seen as regressive because wealthier people consume less, however when used in concert with a high-income personal income tax and with some form of tax benefit to families, as we suggest as part of the NBRT, this is not the case.

This is not to say that there will be no deductions. The NBRT will be the vehicle for social spending through the tax code.

The NBRT base is similar to a Value Added Tax (VAT), but not identical. Unlike a VAT, an NBRT would not be visible on receipts and should not be zero rated at the border – nor should it be applied to imports. While both collect from consumers, the unit of analysis for the NBRT should be the business rather than the transaction. As such, its application should be universal – covering both public companies who currently file business income taxes and private companies who currently file their business expenses on individual returns.

In the long term, the explosion of the debt comes from the aging of society and the funding of their health care costs.  Some thought should be given to ways to reverse a demographic imbalance that produces too few children while life expectancy of the elderly increases.

Unassisted labor markets work against population growth.  Given a choice between hiring parents with children and recent college graduates, the smart decision will always be to hire the new graduates, as they will demand less money – especially in the technology area where recent training is often valued over experience.

Separating out pay for families allows society to reverse that trend, with a significant driver to that separation being a more generous tax credit for children.  Such a credit could be “paid for” by ending the Mortgage Interest Deduction (MID) without hurting the housing sector, as housing is the biggest area of cost growth when children are added.  While lobbyists for lenders and realtors would prefer gridlock on reducing the MID, if forced to chose between transferring this deduction to families and using it for deficit reduction (as both Bowles-Simpson and Rivlin-Domenici suggest), we suspect that they would chose the former over the latter if forced to make a choice.  The religious community could also see such a development as a “pro-life” vote, especially among religious liberals.

Enactment of such a credit meets both our nation’s short term needs for consumer liquidity and our long term need for population growth.  Adding this issue to the pro-life agenda, at least in some quarters, makes this proposal a win for everyone.

The NBRT should fund services to families, including education at all levels, mental health care, disability benefits, Temporary Aid to Needy Families, Supplemental Nutrition Assistance, Medicare and Medicaid. If society acts compassionately to prisoners and shifts from punishment to treatment for mentally ill and addicted offenders, funding for these services would be from the NBRT rather than the VAT.

The NBRT could also be used to shift governmental spending from public agencies to private providers without any involvement by the government – especially if the several states adopted an identical tax structure. Either employers as donors or workers as recipients could designate that revenues that would otherwise be collected for public schools would instead fund the public or private school of their choice. Private mental health providers could be preferred on the same basis over public mental health institutions. This is a feature that is impossible with the FairTax or a VAT alone.

To extract cost savings under the NBRT, allow companies to offer services privately to both employees and retirees in exchange for a substantial tax benefit, provided that services are at least as generous as the current programs. Employers who fund catastrophic care would get an even higher benefit, with the proviso that any care so provided be superior to the care available through Medicaid. Making employers responsible for most costs and for all cost savings allows them to use some market power to get lower rates, but not so much that the free market is destroyed.  Increasing Part B and Part D premiums also makes it more likely that an employer-based system will be supported by retirees.

Conceivably, NBRT offsets could exceed revenue. In this case, employers would receive a VAT credit.

The income surtax is earmarked for overseas military, naval sea and international spending because this spending is most often deficit financed in times of war.  Earmarking repayment of trust funds for Social Security and Medicare, acknowledges the fact that the buildup of these trust funds was accomplished in order to fund the spending boom of the 1980s without reversing the tax cuts which largely benefited high income households.

Reduce the burdens on American families and individuals

The shift from an income tax based system to a primarily consumption based system will dramatically decrease participation in the personal income tax system to only the top 20% of households in terms of income.  Currently, only roughly half of households pay income taxes, which is by design, as the decision has been made to favor tax policy to redistribute income over the use of direct subsidies, which have the stink of welfare.  This is entirely appropriate as a way to make work pay for families, as living wage requirements without such a tax subsidy could not be sustained by small employers.

Simplicity and burden reduction are very well served by switching from personal income taxation of the middle class to taxation through a value added tax.  For these people, April 15th simply be the day next to Emancipation Day for the District.  The child tax credit will be delivered with wages as an offset to the Net Business Receipts tax without families having to file anything, although they will receive two statements comparing the amount of credits paid to make sure there are no underpayments by employers or overpayments to families who received the full credit from two employers.  

Small business owners will get the same benefits as corporations by the replacement of both pass through taxation on income taxes and the corporate income tax with the net business receipts tax.  As a result, individual income tax filing will be much simpler, with only three deductions: sale of stock to a qualified ESOP, charitable contributions and municipal bonds – although each will result in higher rates than a clean tax bill.

The expansion of the Child Tax Credit in the NBRT is what makes tax reform worthwhile. Adding it to the employer levy rather than retaining it under personal income taxes saves families the cost of going to a tax preparer to fully take advantage of the credit and allows the credit to be distributed throughout the year with payroll. The only tax reconciliation required would be for the employer to send each beneficiary a statement of how much tax was paid, which would be shared with the government. The government would then transmit this information to each recipient family with the instruction to notify the IRS if their employer short-changes them. This also helps prevent payments to non-existent payees.

Assistance at this level, especially if matched by state governments may very well trigger another baby boom, especially since adding children will add the additional income now added by buying a bigger house. Such a baby boom is the only real long term solution to the demographic problems facing Social Security, Medicare and Medicaid, which are more demographic than fiscal. Fixing that problem in the right way definitely adds value to tax reform.

A Value Added Tax gives everyone the privilege and responsibility to fund discretionary government services delivered in the United States. Everyone pays a proportional share of their consumption. If taxes really are too high, we will know where to cut. The NBRT will fund social services thorough employers. It allows people who need more to get more, even if in an unregulated economy they could not afford it. Starvation is not liberty, especially for children. The high income and inheritance surtax undoes the redistribution up by shifting payment for net interest and debt reduction to those who benefited the most from out of control tax cuts under Reagan and Bush. Those debts are not universal, they adhere to future taxpayers who with the income to pay higher rates, the children of the wealthy.

Deliver economic growth that creates jobs and improves the quality of life of all Americans

The tax reforms detailed here will make the nation truly competitive internationally while creating economic growth domestically, not by making job creators richer but families better off. The Center’s reform plan will give you job creation. The current blueprint and the President’s proposed tax cuts for the wealthy will not.

In September 2o11, the Center submitted comments on  Economic Models Available to the Joint Committee on Taxation for Analyzing Tax Reform Proposals. Our findings, which were presented to the JCT and the Congressional Budget Office (as well as the Wharton School and the Tax Policy Center), showed that when taxes are cut, especially on the wealthy, only deficit spending will lead to economic growth as we borrow the money we should have taxed. When taxes on the wealthy are increased, spending is also usually cut and growth still results. The study is available at  

http://fiscalequity.blogspot.com/2011/09/economic-models-available-to-joint.html

and it is likely in use by the CBO and JTC in scoring tax and budget proposals. We know this because their forecasts and ours on the last Obama budget matched. Advocates for dynamic scoring should be careful what they wish for.

Value added taxes act as instant economic growth, as they are spur to domestic industry and its workers, who will have more money to spend.  The Net Business Receipts Tax as we propose it includes a child tax credit to be paid with income of between $500 and $1000 per month.  Such money will undoubtedly be spent by the families who receive it on everything from food to housing to consumer electronics. 

The high income and inheritance surtax will take money out of the savings sector and put it into government spending, which eventually works down to the household level.  Growth comes when people have money and spend it, which causes business to invest.  Any corporate investment manager will tell you that he would be fired if he proposed an expansion or investment without customers willing and able to pay.  Tax rates are an afterthought.

Our current expansion and the expansion under the Clinton Administration show that higher tax rates always spur growth, while tax cuts on capital gains lead to toxic investments – almost always in housing.  Business expansion and job creation will occur with economic growth, not because of investment from the outside but from the recycling of profits and debt driven by customers rather than the price of funds.  We won’t be fooled again by the saccharin song of the supply siders, whose tax cuts have led to debt and economic growth more attributable to the theories of Keynes than Stockman.

Thank you for the opportunity to address the committee.  We are, of course, available for direct testimony or to answer questions by members and staff.