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What is the purpose of a tax system?

In 1913, the United States passed the 16th Amendment and then enacted the income tax. Intended as a way of replacing revenues because of the perceived need to reduce the income from tariffs, it was only intended to apply to the wealthiest of the citizens.

However, as in other countries where it has been implemented throughout history, Congress saw the potential advantages of the income tax to reward their friends and influence behavior. One of the reasons that Karl Marx’s Communist Manifesto insisted on a “a heavy progressive or graduated income tax” is that an income tax allows a government to directly control people much more than any other form of taxation.

Almost from the day of its enactment, Congress has used the income tax not only to collect revenue for the government but also to influence behavior, to intimidate its foes and to reward certain groups of people. This is a major reason that the Internal Revenue Code (IRC) has grown to 74,000 pages and nearly 4 million words. However, the income tax is a very inefficient way to influence behavior.

HOME MORTGAGE INTEREST DEDUCTION

One example of the ineffectiveness of using the IRC to implement social policy is the home mortgage interest deduction. Congress has made a policy decision to use the IRC to favor our citizens who elect to purchase their own homes. Taxpayers are allowed to reduce their income subject to the income tax by the amount paid in interest on the mortgage on their home. For example, if a person made $50,000 and paid $8,000 in mortgage interest on their home, they would be able to reduce their income subject to income tax from $50,000 to $42,000.

If you ask most politicians, government officials or realtors, they will tell you that the mortgage interest deduction is vital and without it home ownership would collapse.

However, the facts tell a different story. According to a report issued by the Mercatus Center at George Mason University on January 8, 2013:

• Only 21.7% of all tax returns took the mortgage deduction;
• The mortgage interest deduction reduced the amount of income tax collected by $72 billion;
• 40% of the $72 billion in tax savings went to people with adjusted gross incomes over $200,000;
• 35% of the $72 billion in tax savings went to people with adjusted gross income over $100,000;
• A family with median household income of around $50,000 who took the mortgage deduction only received between $100 and $200 in tax savings over what they would have saved by taking the standard deduction and not itemizing their deductions

What do these facts tell us? Since the homeownership rate in the United States is 65%, this means that the mortgage interest deduction was not even used by 44% of our homeowners.

The Congressional Budget Office (CBO) has noted, “Despite the favorable tax treatment that mortgage interest receives in the United States, the rate of homeownership here is similar to that in Australia, Canada, and the United Kingdom, and none of those countries currently offers a tax deduction for mortgage interest.”

In fact, the Swiss Finance Institute Research Paper Series 12-06, February 9, 2012 points out that the United Kingdom phased out its mortgage interest deduction from 1975 to 2000, but the share of households that own homes rose from 53 percent in 1974 to 68 percent in 2001.

More interesting though is who receives the main benefit of the home mortgage interest deductions. There were 142 million income tax returns filed in 2010 and approximately 10% of the returns showed incomes over $100,000. This means that an estimated 14.2 million taxpayers received $56 billion in tax savings from the mortgage deduction or about $3,943 per taxpayer return. All the remaining taxpayers taking the mortgage interest deduction only received $16 billion of tax savings.

If Congress wants to provide substantial benefits to the wealthiest 10% of our taxpayers, then the home mortgage deduction is working very well. However, if the purpose is to promote home ownership for all Americans, then it is not doing a very good job.

It would be better if Congress made direct subsidies to those homeowners it wanted to help and used the tax system to raise revenue only.

A TAX SYSTEM TO FUND GOVERNMENT OPERATIONS

Of course, there has never been any form of taxation that did not favor the group with more influence on the taxing authority. There have always been lobbyists advocating that the taxing authority “…not tax me but tax the man behind the tree.”

If we were looking for a tax system that had the sole purpose of funding government operations which in turn could pay money directly for those things the government wanted to accomplish, it should have these characteristics:

• Gives the most freedom to the citizens while still collecting the needed revenues
• Is visible
• Shows the true cost of government
• Is considered fair
• Costs the least to collect
• Requires no paperwork from most taxpayers
• Rewards hard work and savings
• Encourages investment and economic growth
• Creates jobs and rewards companies who create jobs
• Does not subsidize imports that compete against domestic products
• Does not need a vast bureaucracy
• Encourages exports
• Is difficult to evade.

Our Founding Fathers designed a system that they believed incorporated many of the above points. Article 1, Section 8 of the Constitution of the United States provides, “The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defense and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States…”

While meeting most of the above requirements for a tax system, unfortunately, the duties, imposts (both charged on imports) and excise taxes provided in the Constitution were not exempt from favoring certain groups more than others. The Whiskey Rebellion was caused by an excise tax on whiskey imposed by the new federal government and only ended when an army led by George Washington arrived.

The decision to favor certain imports over others changed based on the party in power and the political influence of their donors. It is interesting to note that one of the primary grievances of the southern states prior to the Civil War was that the high tariffs on manufactured goods instituted to protect the manufacturers in the northern states were causing people in the southern states to pay much higher prices for manufactured goods that they needed and to suffer the effects of higher tariffs on the cotton and agricultural products it was exporting.

THE IDEAL TAX SYSTEM?

There is no perfect tax. A tax always is taking money from people and they will resent this unless they believe that they are getting a fair return on what they pay. The tax system that most economists agree will raise the most revenue with the least negative effects on freedom and the economy is a consumption tax. But all consumption taxes are not the same. The value added tax (VAT) used by many of our trading partners can be manipulated much like a tariff. However, the form of consumption tax that is most difficult to manipulate to favor one type of product over another is a sales tax on retail goods and services.

To be considered fair, a tax system should not favor people who can purchase better treatment. People in California remember the “Twinkie” sales tax that was introduced in the 1990’s. In California, food is not subject to the state sales tax. However, if you bought snacks, like Twinkies, the clerk was to make a decision. If the snack was going to be consumed before the purchaser got home, then it was subject to state sales tax. If it was going to be consumed at home, then it was not subject to tax.

It only took a short time before this ludicrous tax was repealed because it was not hidden but visible to all. Everyone will see any attempt by the politicians to favor one group over another. No more secret backroom deals or selling tax breaks for campaign contributions. If Congress wants to favor one product over another, then it has to be done in front of everyone.

There is a retail sales tax, the FairTax, which will tax retail sales and services only, will not require any paperwork filing by most Americans and will most efficiently and effectively be in alignment with the elements of the best way to collect tax that is outlined above.

In light of recent events, there is a growing understanding that the IRS must go. Only a national retail sales tax collected by the states will allow the elimination of the IRS. As Representative Tom Rooney (FL-R) stated when he recently became a sponsor of HR 25, the FairTax Act, “The revelations of the last week have confirmed that it’s time to reduce or completely eliminate the IRS, and build a new tax system that treats American taxpayers with the fairness, honesty and integrity they deserve.”

You can go to FairTax.org for more information.

Steve Hayes

Steve Hayes is a licensed California and Florida attorney. His legal training and experience help Steve understand legal and tax issues. He assists distressed companies that are confronting more than just legal issues. These companies need help in coordinating with their own legal counsel but also need help in understanding and determining their actual condition and if there are options that they have not been considering or been able to implement. In some cases, Steve was able to help the company survive. In other cases, Steve helped the company be sold and, in some cases, he assisted in the orderly liquidation of the companies. Hayes sits on the Board of Directors of Fair Tax Florida. He is an expert on the Fair Tax and writes and speaks about national retail sales tax legislation - HR 25.

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Categories: Must Read, News, Policy, Taxes

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