Saturday, March 5, 2011

(Natural) Tax Policy

What if the same tax avoidance strategies (income deferral, loans as income replacement, and income splitting) were made easier for everyone rather than complex tools accessible only by elites?  Since preventing tax avoidance is impossible, then the only fair solution is to make it available/accessible to everyone.  Similarly, since large corporations are able to escape all taxes, all companies should have a socially productive way of eliminating their tax bill.

Other issues with the tax code, are eliminating/addressing arguments that high taxes discourage work, and eliminating double taxation as an excuse to favour investment income over work.  Taxing cash flows rather than paper profits would simplify taxes and eliminate avoidance opportunities available through interpretive accounting or audit difficulty.  To offset increased tax minimization ease, simply raise the tax rates sufficiently to achieve target social tax revenue.

Short version of proposed tax policy
Corporations would have all cash inflow taxable and outflow tax deductible including a tax deduction for dividends.  International transfers, dividends received, or international service payments would have a 10% tax payable by the recipient in the originating jurisdiction.

Individuals will be entitled to treat all investment accounts as the equivalent of unlimited RRSP/401ks in that contributions to investment accounts become tax deductible, and withdrawals count as taxable income.  All dividends, capital gains, interest, and work income is taxed at 10%.  Remaining income (including after-10%-tax portion of preceding work and investment income)  is taxed according to tradional marginal tax brackets, but the lower tax brackets can be significantly lowered, while higher brackets

Consumer borrowing would increase taxable income by the amount borrowed, and at least some opportunities for income splitting should be permitted.


Corporate Analysis
The major differences in taxing cashflow compared to profit is that traditional tax policies allow slower deductions for investment in assets such as equipment, and some transactions such as stock options and loan guarantees are impossible to value objectively.  Traditionally, investment inflows (loans or share purchases) into the corporation are not taxable, and dividends paid/loan repayments are not tax deductible.

Incoming investment inflows should have 2 years to be spent before they are taxed.  This is to allow sufficient time for the corporation to spend its capital infusion on assets and expenses.

Dividend/capital gain recipients (whether individual or corporate) pay 10% non-avoidable tax on such payments (10% deduction on capital losses) in addition to counting the untaxed portion as income or cash inflow.  Corporate interest (and financial service fees) revenue (net of interest expense) would also pay a 10% non-avoidable tax on that net revenue.

Because dividends and share buybacks become a corporate tax deduction,   whether the nominal corporate tax rate is 90% or 15%, virtually every corporation would pay 0 taxes, by paying out all profit as a dividend.   The choice to lower total after tax profit by withholding dividends and paying taxes on profit would only be viable for corporations that are not worth reinvesting in.

The reason for the 10% tax on international transfers and services is to prevent corporations from bypassing dividends as a way to repatriate funds from one nation to another.  The 10% taxation on international dividends by recipients serves local jurisdictions ability to tax the profits of imports, and can encourage reinvestment instead.  The intractable problems caused by accounting profit based taxation are that the avoidance loopholes cannot be closed.  Only transfered into move complex avoidance schemes.  A superficially justifiable excuse for the 100s of shell corporations Enron controlled was that it was a normal tax planning structure rather than a risk and balance sheet manipulation structure.  Cash-based taxation policies is the only way to close those loopholes, and simplify objective audits if loopholes are invented.  The 10% tax on international service payments is meant to tax transfers between international shell corporations that take the form of consulting fees.

An illustrated example of offshore tax-haven transfers  has the additional negative consequence of apparently trapping the capital offshore unproductively.  This activity results in the current lobbying effort to grant new tax loopholes to permit corporations to repatriate those funds tax free.  This lobbying could be interpreted as a brazen attempt to excuse tax evasion with sweet, sincere(?), promises of job creation.  By making dividends tax deductible, it would directly increase corporate after tax profits if they paid the full profit as dividend, and therefore an obvious reason to always do so.  The funds aren't trapped anywhere and 90% of them can be directly reinvested in the corporation if it asks nicely.


The (S&P) 500 largest US companies are worth $12T.  If they distribute 10% of that as dividends, and 10% of it is collected as unavoidable tax revenue, then it would amount to $120B in tax revenue.  More than half of the $225B total 2009 corporate tax revenue from 2.5m US corporations and is the same amount as actual S&P US corporate taxes paid in 2007.  Therefore, even if investors are able to shelter dividend income in perpetuity, the 10% unavoidable tax on dividends is not a tax decrease compared to existing corporate tax structure.  It excludes the 10% tax that would be paid by financial services firms on interest (net) revenue. Furthermore, by increasing the flow of funds to and from corporations and investors through incentives for both investment and repayment on those investments, considerable more taxable financial activity occurs, and it is constantly rechanneled towards the most promising investments rather than merely hoarded by incumbents.


Every political group concerned with the undue influence that corporations have over social governance should support this corporate tax plan.   Corporate empire building is made possible by its evasion to repaying its investors.  Compelling corporations to pay dividends is an important restriction on their power to corrupt society, or more accurately, their power to influence society without investor justification on the use of those funds.


Individual tax analysis
By allowing all investment account contributions to be tax deductible, it allows individuals to defer taxes easily and as long as they feel like it.  But someone with a $1M investment account, might be earning 40k to 100k in investment returns per year on it, and paying 10% tax on those earnings even if not withdrawn. At one point he will want to withdraw all of those earnings (and more) each year, adding to his taxable income.  The primary purpose of any investment is future consumption.

Another feature of the tax proposal is that loans taken out by individuals would be added to their taxable income, but they may amortize the income-value of the loan over 5 years (7 to 10 years for homes).  So a consumer borrowing $50k for say a car purchase would count an additional $10k for each of the next 5 years as taxable income.  Interest repayments would be tax deductible.  Because home and car purchases are paid for with taxed funds, there is no need to tax any of the proceeds on the resale of those assets.  Homes for principal residence, and even cottages for personal use, would count as consumption.  For large purchases, individuals could lend themselves from their investment accounts in order to take advantage of the 5 year amortization of that income (loans not for major purchases should still be allowed, but are not amortized, and have no obvious advantage over withdrawals).

Investment homes (those rented in full) would qualify as businesses.  Purchase costs counting as an investment deduction from income.  Collectibles (stamps, art, gold) including collectible cars would count as consumption and have no taxes due on resale even if they appreciate in value.  Savings accounts would behave as a deductible investment amount, the increase in the lowest balance of the year over the previous year.  If your lowest savings account balance during all of last year was $1000, and this year it was $3000, then you may deduct $2000 from taxable income.  If it was $0 this year, you would add $1000 to taxable income.

For Estates/inheritance transfer to heirs all in-kind goods are tax free, but their investment account is fully taxed in heir's hands, though they can reinvest it as a deduction to taxable income.

Income splitting is a difficult issue for social tax revenue policy makers because it allows income to be split into multiple people at lower effective tax brackets, thereby lowering total tax revenue.  However, income splitting has social cohesion benefits by promoting marriages, communes, or even tight-knit communities.  Income splitting would remain an avoidance option for the wealthiest through businesses or trust, and if Individual investment accounts are able to lend to themselves, why couldn't they be allowed to lend to spouses, family and friends?  The only disadvantage to allowing income splitting is that single people who wish to remain single do not have the same opportunities.  Though single people have the advantage of not having to compromise their taxable income any higher than they desire it.  So, income splitting is allowed  through loans from an individual's investment account with the small regulatory caveat that an individual may not loan to someone who is not current (at least interest repaid) on existing loans outstanding to that individual, and who has not repaid past loans given more than 10 years ago in full.  One of the features for income splitting loans intended to be gifts with this rule is that it would prevent excessive gifts as an estate tax planning strategy.  Another possible restriction on income splitting might be either lifetime or annual maximums of loans to one individual.

As a result of all of these easy tax deferral and tax planning opportunities for individuals, maintaining traditional revenue levels is simply accomplished by raising the tax rate at each marginal bracket, but as shown below no large tax rate increases are necessary.  We can eliminate regressive social security taxes on work income, and equalize work and investment income tax treatment (substantially boosting investment income tax revenue)

Even if some restrictions on income splitting are favoured, imagining a world where all income is split evenly as a tax avoidance strategy allows us to determine precisely the minimum tax revenue generated at a tax rate on average income, and to do so within this paragraph.   First, under this proposed tax plan, using the income approach to GDP, at least 10% of GDP is inescapably taxed each year (excludes the 10% corporate tax on interest, dividend and capital income) because the 10% flat on work and investment income directly taxes all GDP components.  Another direct effect of this tax policy (by compelling profits to be paid as dividends) is that Average GDP income becomes average personal income.  GDP per capita $47,132 is nearly 60% higher than average personal income, and so this tax policy would directly result in a near 60% increase in average personal income.  At a $15T US GDP, at least $1.5T is guaranteed to be raised every year from the 10% rate, and if the average tax rate on remaining income is 10%, another 1.5T is raised.  $3T in tax revenue would severely reduce current deficit ($619B higher revenue than 2010 revenue excluding duties,excise and other).  To have same revenue as 2010, then only a 6% tax on average income is needed (effectively 16% total tax).  Some arrangement for state/provincial taxes are not included in the analysis.

The benefits of the proposed tax policies are substantial 
First, and foremost, it irrevocably eliminates any argument that taxes can discourage work.  If you have the ambition and ability to earn $1M in a year, under current high progressive (50%-70%) tax rates, you might choose to work less than you are capable of, targeting earnings that would place you in a lower tax bracket, and depriving society of any of your value contributions.  Under a 10% flat tax on those earnings, then there is no arguable disincentive to work.  Earning 1M results in 100K in taxes, but $850k of the remaining 900k can be invested, resulting in taxable income of 50k for the year, and what is likely at least 50k per year every year in the future as a result of investment growth and withdrawals.

It creates absolute fairness in the tax system by making all fund flows taxable revenue to one party and tax-deductible expense to the other, except for consumption. It essentially taxes only consumption, and taxes it progressively.  It simplifies the main tax minimization strategies of income deferral and income splitting, making them available to all tax payers instead of just the wealthy.  Income deferral provides needed financial security to people, and income splitting can both promote long term relationships, and through loans or gifts in the form of loans with minimal repayment expectations, substantially enhance demand for maid/childcare/gardening/accounting/legal personal services.  This job creation, in turn substantially enhances the full labour market's competitive position (higher wages if fewer unemployed), and allows society to self organize itself into more egalitarian wealth and income distribution, since those with accumulated wealth are incentivized to transfer it to many people, rather than consume it all.  Fairness is also increased by having only one level of taxation, and at the consumer level.  Costly-administered regressive sales taxes can be eliminated.  But specific excise taxes on discourageable (sin or pollution) consumption can be permitted. The term Natural taxation of consumption can be applicable to this fair single taxation system

Consumption is not unduly discouraged due to the allowance for amortizing loans over several years.  Service based consumption can be enhanced by using "gift" transfers from investment accounts.  Multi-million dollar home purchases are still possible through rent from corporate-owned home, though regulation for fair market rent in related party situations is likely deserved.  Since the main ultimate purpose of any wealth is eventual consumption, then that wealth is eventually taxed, and consumption eventually takes place.

Under this plan, even a top marginal tax bracket of 100% would not discourage work, because the tax payer has complete control over when his income is taxable, and even who to give it to instead of the social coffers. Modest progressive marginal tax rates for taxable income in the 30k to 100k range would reinforce consumption in those ranges.  Higher marginal rates above 100k can be used to either collect substantial tax revenues or encourage individuals to behave in socially beneficial income splitting or investment instead.

Transfering tax burden to the wealthiest by equalizing avoidance strategies
Even if the rich can turn millions of dollars in income into taxable income well below 100k, this is a significant tax increase on the rich proportionally to the rest of the population (no matter what actual tax brackets turn out to be).  First, the rich currently already have the opportunity to defer income indefinitely by choosing investment sales, and US dividends and capital gains have about a 15% total taxation, instead of the the proposed 10% flat tax + the taxes on whatever eventual consumption will be used with those funds. So someone who earns and withdraws $1m in dividends at a 66% marginal rate would pay a total $700k in taxes instead of $150k under current US regulations.  Second by eliminating social security/payroll taxes and raising  in offset marginal rates on taxable income, you are both eliminating the disadvantages of work income vs investment income, and making it cheaper for employers to hire people (pay you more).  You're also increasing taxes on investment income which previously was not subject to payroll taxes.  The substantial tax revenue increase potential from the rich means that if the top 1% pay 40% of all taxes, then doubling or tripling them means that the rest of the population would pay less than 1/3rd of what they do currently and means that marginal tax brackets do not have to be set so high after all to meet revenue targets.  All, without the possibility of arguing that higher tax payments will discourage work, because all income is easily shelterable,  corporations effectively pay zero, only consumption is taxed, and there can never be a tax disincentive on investment returns because they increase net wealth regardless of the tax rate.

The real source of tax increase in this plan is taxation on investment income, and cash based taxation.  The purpose for allowing income deferral and income splitting is to eliminate arguments against tax-caused work discouragement, and to focus on consumption, and fairness between classes.

Transitioning to new tax model
The transition from traditional tax policies to natural taxation can involve choices that either punish some, or allow individuals to manipulate the system during transition.  The most important transition policy is that all investment accounts at time of transition can be withdrawn (that amount) from tax free.  This is to avoid people liquidating all investments to cash prior to transition so as to create future deduction opportunities.  Some choice may have to be made regarding controlling people from withdrawing these funds and reinvesting them as a tax deduction.  At transition time, there is also a significant incentive to mass borrow and consume large ticket items such as homes to avoid the imputed income effects of loans after transition.  The solution here is to treat the net proceeds (after loan repayments) of homes, cars, and collectibles owned prior to transition as taxable.  (Such items bought after transition are sold tax free).  On the whole, fair and generally ambivalent between the two options.  Except, choice for controls preventing people from borrowing prior to transition and keeping cash, and then using that cash for purchases (or investment) after transition are likely needed.  Choices need to be made on how to control or accept people with a history of likely illicit undisclosed cash income and wealth.

One general solution for the transition is to temporarily use a 15-20% undeductible tax on work and investment income with much lower marginal tax rates on consumption benefits, and then gradually reduce the undeductible tax down to the target 10% while making an offset increase in the rates on remaining taxable income.  The purpose of these temporary tax rates, is to mitigate any manipulations individuals will be able to come up with during transition, by reducing the tax cost of loans or tax benefits from additional savings immediately after transition.  Deductions for low income earners would likely be appropriate under this temporary plan.

Conclusion
I've avoided any comment on whether taxes are theft or what level of taxation society needs.  While I strongly believe that taxes are not theft, that wealth redistribution is a justifiable aim, and usually directly results in those paying the most taxes receiving the most benefits from respent distributed wealth (likely on their goods and services) and a peaceful and docile society (as result of less desperation, inequality, and oppression), I do believe that governments should be forced to justify all spending not redistributed equally to citizens as basic income, the same way that corporations should be forced to justify to shareholders all profits they wish to keep instead of distributing dividends.

1 comment:

  1. I really impressed after read this because of some quality work and informative thoughts . I just wanna say thanks for the writer and wish you all the best for coming!. Fresh start IRS

    ReplyDelete