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Real Tax Reform:  A Century Late and a Few Trillion Dollars Short

From The Federalist

(This is the third in a series of essays on vital national-policy issues which must be addressed head-on by the second Bush administration and the Republican Congress).

The two most invasive authorities of the federal (central) government are the power of the judiciary to legislate by diktat, and the power of Congress to levy taxes -- both of which were sources of great concern to our Founders. The extra-constitutional actions of judicial activists have frequently been censured in this column. But an equally insidious threat to liberty resides in the tax code.

The author of our Constitution, James Madison, wrote in The Federalist

Papers: "The powers delegated by the proposed Constitution to the federal government are few and defined. Those which are to remain in the State governments are numerous and indefinite. The former will be exercised principally on external objects, as war, peace, negotiation and foreign commerce. ... The powers reserved to the several States will extend to all the objects which in the ordinary course of affairs, concern the lives and liberties, and properties of the people, and the internal order, improvement and prosperity of the State." Madison further noted, "If Congress can do whatever in their discretion can be done by money, and will promote the General Welfare, the Government is no longer a limited one, possessing enumerated powers, but an indefinite one, subject to particular exceptions."

So how did the limited central government defined by our Constitution inflate to its current bloat? The answer lies in the unrestrained power of Congress to levy taxes.

All of our Founders were rightly concerned about this power -- indeed, our nation was born out of revolution to unjust taxation. No sooner was our Constitution ratified than Madison challenged his colleagues to refrain from extra-Constitutional expenditures: "I cannot undertake to lay my finger on that article of the Constitution which granted a right to Congress of expending, on objects of benevolence, the money of their constituents...."

Of the "General Welfare," Benjamin Franklin observed, "I am for doing good to the poor, but...I think the best way of doing good to the poor, is not making them easy in poverty, but leading or driving them out of it. I observed...that the more public provisions were made for the poor, the less they provided for themselves, and of course became poorer. And, on the contrary, the less was done for them, the more they did for themselves, and became richer."

As for the effect of excessive taxation on the economy, Alexander Hamilton wrote, "If duties are too high, they lessen the consumption; the collection is eluded; and the product to the treasury is not so great as when they are confined within proper and moderate bounds." Apparently Hamilton, et al., understood supply-side economics.

It was clear to our Founders, as it is today, that congressional power to levy taxes is directly proportional to the authority of the central government, and there has been little restraint in last century when it comes to increasing taxation in order to expand central-government power.

In 1819, John Marshall observed, "An unlimited power to tax involves, necessarily, a power to destroy; because there is a limit beyond which no institution and no property can bear taxation." Congressional tax levies have been testing that limit since passage of the 16th Amendment and implementation of a direct income tax. By the end of the 20th century, only one president had forthrightly lobbied for limited taxation -- and that was Ronald Reagan.

Enter George W. Bush.

"No one in America should have to pay a third of their income to the federal government," then-Governor Bush protested during his first presidential campaign. Upon his election, the President began cutting taxes, with Congress passing most of his first-term tax-reduction proposals. These included an average tax decrease of

$1,586 per income-tax payer; marriage penalty reductions for low- and moderate-income taxpayers averaging $2,602; a doubling of the child tax credit; and phasing out the death tax. Congress also approved tax relief to millions of small business owners.

Upon his re-election last month, President Bush declared, "Because we have done the hard work, we are entering a season of hope. We'll continue our economic progress. We'll reform our outdated tax code." There is much debate, however, about how bold the President will or should be in reforming, if not replacing, the current revenue system.

With productivity increases hinging on U.S. fiscal policy, this isn't much ado about nothing. At a recent gathering of conservative leaders, House Majority Leader Tom DeLay committed himself to the prospect of crafting and passing real reform of the tax code within the upcoming congressional session. Explaining that we're not just talking about cutting taxes here or protecting deductions there, DeLay detailed specific plans for drawing up a comprehensive proposal. This proposal requires the replacement of income and payroll taxes with a progressive national retail-sales tax, the use of a rebate to protect low- and fixed-income Americans, and the repeal of the 16th Amendment. In other words, scrapping the current income tax system -- and the IRS -- as we know it.

Here, the seriousness of the Bush administration and the Republican-controlled Congress brings to the fore the decade-old debate among conservatives as to which system would best replace the current tax code -- both in terms of constitutionality and in maintaining current federal tax revenues. While leaders in the conservative movement have argued the merits of both a "flat tax" and a "fair tax," many have tabbed the flat-rate system envisioned by former Texas congressman and House Majority Leader Dick Armey as the best alternative to our current code.

A flat income tax would set a national percentage rate at which all Americans, except those under the poverty level, would pay their fair share. This means that whether you make $1 million or $30,000 per year, you'll hand over the same percentage of those earnings to the government. The current wisdom places this flat rate somewhere between

13 and 15 percent.

Armey's initial flat-tax legislation would have eliminated the payroll deduction -- that insidious tax involuntarily taken directly from our paychecks. This would have placed the responsibility of saving for, filing, and paying taxes fully in the hands of the taxpayers. And this, of course, would have tended to make those taxpayers much more likely to keep a watchful eye on the Congress's penchant for tax hikes and indiscriminate spending. Unfortunately, Leader Armey bowed to heavy lobbying pressure and reinstated payroll withholding early in his fight for the flat tax.

To be sure, Armey's Flat Tax presents some serious drawbacks. First, any flat tax system would leave the IRS intact. A perennial thorn in so many Americans' sides, the IRS has been criticized -- and rightly so -- for egregious counts of abuse, political targeting, and corruption from top to bottom.

A second and equally important drawback is that although the rate for every taxpayer would remain equal, Congress would be left with the power and propensity to raise the rate. Suppose the system institutes a 15 percent rate. What's to stop the serial spenders in Washington from running up a deficit "requiring" a rate increase to 18 or even

25 percent? Some counter this argument by insisting that the new system will hold Congress more accountable to the taxpayers and will thus force them to act more responsibly. Tell that to the wealthiest one-percenters among the "Greatest Generation" who watched their tax rates skyrocket from a mere one percent to 50 percent or more. So much for FDR's seven-percent-ceiling guarantee.

A third omission of the flat tax proposal is its failure to address legal loopholes and income-tax evasion.  This system would further encourage those that engage in illegal off-shore shelters and tax evasion, enabling them to report income levels lower than actual and thereby pay a smaller percentage of their income.

Last, the flat tax does not address the core issue: the constitutionality of an income tax.  Honest argument can be made on either side of this question, but to the constitutionalist, certainly, the flat tax's legitimacy is  at least questionable.

In contrast, Tom Delay's FairTax proposal offers many benefits.

Rather than create an entirely new tax system, the FairTax would simply piggyback on the current sales tax systems already in place in the states. The states' current infrastructure could be used to collect the tax with no new agency needed. Nine states, including Florida, Texas, Washington and Tennessee, already operate without state income taxes and provide great models for the efficacy of a sales-tax-based revenue system.

The conservative economist will note that generating federal revenues from sales taxes instead of withholding part of taxpayers' income will actually generate more tax revenue. As supply-side economics dictates, when people have more of their own money in their pockets, they spend it. With the FairTax in place, revenues would likely surge, new investments would be spurred, and a general economic boom would occur. With Social Security's collapse looming in the not-so-distant future, this proposal is highly palatable.

Current proposals require, conservatively, that a rate of 23 percent be implemented to maintain current levels of federal revenue, in order to compensate for the income and payroll taxes that would no longer be withheld. Critics charge that this would in fact have the opposite effect on consumer spending and that sticker shock would drive wallets back into pockets and purses. Further analysis, however, suggests that sticker shock shouldn't occur, as prices will probably remain at current levels. A great deal of federal-tax revenues are generated from corporate levies and Social Security matching, which average around 25 percent. These are costs, along with the cost of compliance in collecting payroll taxes, that weigh heavily on the income of corporations. Corporations, with the bottom line always the top priority, merely pass these costs on to consumers in the form of higher prices. With the income tax eliminated, corporate taxes and compliance costs vanish. Free market principles then take effect, causing a race to the finish with retailers dropping their prices to gain new customers -- while generating the same profit margins. Since the FairTax is revenue-neutral, raising no more tax than the current system, prices would remain at their current levels. Furthermore, consumers would be more conscious of tax increases, as they'll be evident on the shelf at the grocery store.

An additional benefit of the sales-tax system would be the potentially huge reduction in tax fraud. With the income tax gone, loopholes and tax evasion would be virtually non-existent. That criminals and tax evaders alike still frequent the mall, buy cars and houses, and generally behave like consumers will raise revenues significantly from this largely untaxed segment of our economy. This is new tax revenue, and it will be supplemented by the funds the federal government doesn't have to spend to find and prosecute these hooligans.

A second criticism many have with a national sales tax is that it eliminates the credit given to those under the poverty line and in effect taxes the poor. This may be true for national retail-sales taxes, but it is simply not true of the FairTax. Current proposals set aside a market-basket value of goods -- including food, medicine, and other basic commodities -- that is rebated to all Americans. The bottom-line benefit of the FairTax: If you can't afford to pay taxes, you don't have to.

Last, and certainly of the greatest benefit of the FairTax proposal, is the elimination of the federal income-tax system and the IRS, leaving the constitutionality question moot. As Ben Franklin noted, "A penny saved is a penny earned." With billions spent per year on staffing the IRS and enforcing the current tax code, the revenue saved would certainly decrease the burden on the American taxpayer both in terms of how much he must pay and how much stress he has to endure every year on and around April 15th.

Flat or fair, with a second Bush term secured, the time to begin serious debate of tax reform is now, not later.  Along with border security and the nomination of constructionist judges to federal courts, the issue of taxation -- an issue debated in this country even prior to our nation's inception -- deserves top billing once again.

For a point-by-point comparison of the FairTax, Income Tax and Flat Tax, see --  HYPERLINK "http://federalistpatriot.us/news/compare.asp"

http://FederalistPatriot.US/news/compare.asp

ABOUT THE FEDERALIST PATRIOT: Link to -- http://FederalistPatriot.US/main/about.asp

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