Tax Reform 2025 and Tax Avoidance

Finance: The 2025 Tax Policy Debate and Tax Avoidance Strategies, September 12, 2024

There are a number of tax avoidance schemes currently in play, as well as poor taxes and one potential scheme that would evolve should the Fair Tax be taken seriously, as well as a way to cut administrative costs if enacted. 

The most notorious tax avoidance is when the wealthy borrow money against their unrealized assets to live a lavish lifestyle and/or to develop new business lines. That money is borrowed avoids selling assets - which would trigger income tax events. Unrealized capital gains, when inherited below the level where inheritance taxes accrue, are a huge transfer of wealth (and for some, power over employees). Using life insurance and trust arrangements to avoid taxes are in the same ballpark.

Collection of capital gains taxes (and using dividends to avoid paying one - or capital gains to avoid the other) are based on the honor system, so that much of the required income disclosure and tax payment is never made. Long-term asset holding (including doing so to not recognize gains) is taxed at a lesser rate. 

The current regime also allows the taxation of gains to be offset by losses - literally failure or the overuse of available deductions - particularly in real estate. Moving tax events from an end of the year accounting to taxing each transaction will end the ability to hide gains forever - especially if the borrowing of unrealized gains is no longer advantageous due to the transition to consumption taxes.

The deductibility of wages of employees, which forces employees to pay taxes and to pay experts to prepare these taxes, is a huge tax break for business.  The reality is that business collects the revenue and submits it to the Treasury, along with a mountain of information to subsidize the tax preparation industry - who are consistent donors to both Chambers - especially the revenue committees. 

Payments to preparers to help families file the Earned Income Tax Credit is a poor tax. Higher minimum wages, paired with a higher child tax credit, provides more to those who need income subsidies while not making them wait for their money. Having such a refund paid in one lump sum makes it look like a windfall, while putting families in the position of needing such a windfall because they cannot make ends meet.

Deducting wages also leads to the taxation of wages and profit at different rates, which spreads inequality and interferes with the economy. The offloading of labor costs is the chief reason that corporate (and non-corporate) tax breaks are so ubiquitous. 

If labor and capital were taxed together through value added taxation, the justification for special tax breaks on profit goes away. This also eliminates any benefit from moving company locations off-shore, even when headquarters staff remain in the United States. There would also be no need for an international agreement on corporate income tax rates - because such taxes would no longer exist if our proposed reforms are enacted.

The proposed Fair Tax’s use of a retail sales tax, rather than use of a value added tax at each purchase (but note - the tax is only paid on the base markup  - not the taxes owed because of the markup) will lead to fraud as retail purchase are credited as wholesale - which under the FT is not taxed. This is a huge potential loss. This schema is proposed by Fair Tax sponsors because they misunderstand who VAT works. For the Fair Tax to ever pass, than being a talking point for fundraising, it must work like a VAT.

When VAT is paid by a merchant or manufacturer, the VAT that they paid for that good or service supplied is refunded to them. Currently, firms and individuals who charge sales taxes deduct these tax payments from income. These deductions should be credits instead, as the current regime is simply a subsidy to states who collect sales tax.  This small TAX CUT will remove the resistance to enacting a VAT - and the customer at the end of the supply chain pays the same amount of tax as they would for a retail sales tax. There is no tax on top of tax paid.

The proposed prebate to either Fair Tax or VAT provides for tax payment refunds only. This forces current subsidies for working class families to move from the tax system (which is the biggest source of such support) to a reconstituted social welfare system with the attendant bureaucracy. 

Some Fair Tax supporters like the idea of simply ending these subsidies - while also refusing to raise wages for the working class.  Not raising the minimum wage - and refusing to index it - suppresses wage growth for working families making under $110,000 per year - which is 80% of the population. Such premeditated inequality is abhorrent in any civilized society and those who support the Fair Tax to do so, especially if they also support banning abortion, are acting shamefully.

During the American Rescue Plan Act, the IRS distributed the enhanced refundable child tax credit. Instead, this should be distributed with wages, and Vice President Harris’ proposed credit size should be enacted for all children - not just during the first year. To pay this credit without an income tax system, as well as to distribute health insurance subsidies, a subtraction value added tax is necessary - although taxes collected at the base rate should be revenue neutral - in other words, the tax rate should fund the subsidies provided to wage earners on average. Some firms would be given a refund, while some would pay if their employees have fewer children than other firms. The refund would be limited to an offset against the collected credit invoice goods and services tax that we have proposed.  The higher child credit rate can also be used to justify deeper cuts in social welfare plan benefits and administrative costs.

Cutting taxes while borrowing money from those who would be taxed is another huge tax avoidance problem. What is even worse is that, for the highest income taxpayer/bondholders, the bonds that are bought for their high yield mutual fund account are used for speculative investments, some of which are actual junk masquerading as AAA+ bonds. 

Should the economy begin to falter when the Dow and housing prices hit their ceilings, increasing tax rates on the wealthy, as well as on asset sales, will increase consumption and speed recovery. Indeed, if we were to increase these tax rates as soon as possible next year, the high asset values will come down without crashing.

Attachment: Consumption Taxes (Video links included)

Attachment: Asset Value Added Taxes Video