If ease of enforcement, ease of compliance and the broadest base possible, describes an effective tax, the current United States (US) income tax fails the test. If fact, taxes on income do not make economic sense from several perspectives. It punishes productivity, invites evasion, and it is costly to comply, collect and enforce. So what would work better? Examining the current system suggests that there are at least a couple better options.
As the principal enforcer-collector for the US federal government, the Internal Revenue Service (IRS) extols the fact that only 53 cents are spent for every $100 collected. True, the proposed IRS budget for 2012 is $13 billion, but that figure ignores another 24 billion dollars that it costs for taxpayers to comply with the tax code (Arduin, Laffer & Moore, 2006). Few would argue with the statement that the current IRS system has become a leviathan, with over 67,000 pages of tax code (Fair Tax, 2011) and 155 forms (Coleman, 2010). Logically, the current income system rewards those who work off the books or evade taxes, and criminals (who are probably not going to report drug sales or proceeds from selling your stolen television as earned income) at the expense of those paying taxes. In order to enforce the current income tax system, law abiding citizens have to prepare, (and the IRS has to process) approximately 141,000,000 individual tax returns (IRS, 2011) and try to comply with complicated and confusing laws. While the IRS only has 95,000 employees, this ignores the fact that companies are forced to provide defacto employees, who process W-2 forms, maintain records and calculate withholding for every legal employee in the United States. Perhaps providing a more comprehensive analysis of overall cost of the current taxing system, the Government Accounting Office, estimated the true total cost of the US income tax as being 2-5% of GDP (GAO, 2005) or roughly between 300 billion and 750 billion dollars.
The current debate in Congress about raising the debt ceiling and reducing the deficit (by cutting spending or increasing spending) may give U.S. lawmakers an opportunity to look at more effective ways to collect taxes. One obvious improvement would be to replace the income tax and payroll taxes entirely. Any tax that which places a tax on productivity and work is a bad idea. Every economy needs its people working and producing without the disincentive of taxing. If we are going to tax something, one should choose a tax that is the most cost efficient to comply with, is the easiest to enforce, and extends itself to the broadest base of those that benefit from the system,. The income tax fails on all counts. Without going into history and the constitutionality of an income tax, what can be said, is that it is reality for workers in the United States. Arguably, there is no perfect tax, but one could view a User Tax as the fairest of them all. Simply stated, if you use the service, you pay for it. For instance, if you use a toll road or access a park, you would pay a fee. While this seems logical, in today’s reality,this is a problem because Congress wants you to pay for a service or program that they are going to provide to someone, who is not willing or able to pay for it. Sidestepping the efficacy of these efforts, what can be said is that the U.S. federal government is in a hole, and continues to dig at an alarming rate. What can also be stated, without much argument, is that even the freest market needs some government to set rules and provide basic infrastructure, and thus must receive funding. So the discussion becomes, which is the best way to collect the tax?
There is a better way, actually two: starting with a national sales tax, and the elimination of income and payroll taxes. A consumption tax would allow every worker in America would keep all their income and be able to choose what they buy with their earnings. The Fair Tax Organization estimates a 23% national sales tax would need to be implemented in order to cover a 3 trillion dollar budget of the federal government. While this sounds like a large number, each person’s disposable income would increase immediately. The IRS no longer has to process all those individual tax returns, nor does it have to worry about tax deductions and what constitutes income. The tax payer no longer has to worry about collecting receipts or even filing a income return. The best part of this proposal is that the base of the national sales tax would include every person that enjoys the benefit of the US economy. Even the criminals buy products and services and would no longer be able to exempt themselves from paying taxes. The second best part of this proposed tax would be that normal taxpayers would no longer have to worry about how much income was earned. In addition, the IRS can focus on a much smaller number of businesses who collect the taxes. The national sales tax scores a positive on all three of the requirements of a good tax: cost of compliance, broadness of base and cost of enforcement.It may however, raise the ire of those that are currently dodging the system. The national sales tax makes sense, but will face significant opposition from politicians and major industries which have grown accustom to wielding influence and enjoying the favor of income deductions, respectively.
Despite what many economists claim, this is not technically a regressive tax. Does the amount of tax paid represent a more critical part of a lower earners income? Without a doubt it does. Even if the worker has the pre-tax earnings in his pocket to begin with, a tax of 23% impacts someone making $20,000 much more than someone making $100,000. However, this fact alone should not discount the efficiency and the benefits of national sales tax; and the abolition of income and payroll taxes. Low income earners do spend a substantial part of their income on shelter, transportation and food. Those sincerely concerned with the issues of lower incomes, could propose similar exclusions to be implemented, but once one exception is made, the game is on for the remainder of products and services in the economy. So, is there a better choice?
Consider a Business Receipts tax to replace the all the US federal taxes collected from citizens and businesses. Currently, all businesses are required to pay tax on income. At the risk of sounding elementary, income is what is left over, after all the costs of operation are subtracted from gross receipts. While wages and salaries make up most of business expenses, this practice of collecting tax on business income creates an environment which rewards a company for creatively taking expenses against income. Businesses have incentive to spend revenue for the tax benefit alone, thus reducing income subject to tax. This subsidized purchase decision distorts a normal business decision based on improving profits. Intuitively, more of these types of decisions, caused the IRS to create voluminous laws about what is and is not an acceptable deduction; businesses hire tax attorneys and lawyers to take advantage of the laws; fines and threat of possible prison time follow. And the dance goes on. With a business receipts tax, the IRS would no longer be concerned about how much income a business reports, what is considered income, or what is eligible to be considered an expense. On the business side, accountants and attorneys would have shift their focus to some other more productive function of being profitable. Shifting to the notion of operating efficiently, businesses would once again make business decisions primarily on a cost/benefit analysis, rather than considering the expense from a subsidized purchase perspective. To make the point, businesses in the United States (32 million) registered $34.3 trillion dollars in business receipts in 2007, yet reported income of only 3.7 trillion dollars (BEA). If the US dumped income and payroll taxes, a business receipts tax would fund a 3 trillion dollar federal budget with a 9% tax. The workers of the United States would be free to work tax free, and the IRS would no longer have to worry about how to classify expenses or income. Eliminating the business income tax (including the 6% contribution to Social Security), the IRS would simply collect a flat tax on all business receipts. If a business chooses to pay executives large salaries, or buy corporate jets, or inhabit an expensive building, that is their business — they would simply pay a percentage of whatever revenue collected for their products or services sold. Economists will note that this tax will certainly makes it way down to the consumer, but all Americans would be free of the IRS, and businesses would make business decisions based on a direct cost/benefit analysis rather than tax benefits. There is no perfect tax, but there are options that are more efficient and effective than the current income tax system. A national sales tax makes sense, but a business receipts tax scores on all three of the required elements of an efficient and effective tax.
Arduin, Laffer & Moore Econometrics, (2006). A macroeconomic analysis of the Fairtax proposal.Retrieved from http://www.fairtax.org/PDF/MacroeconomicAnalysisofFairTax.pdf
Bureau of Economic Analysis (2011). National Income and Product Accounts, Table http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=5&FirstYear=2010&LastYear=2011&Freq=Qtr
Coleman, D. (2010). What a fine mess: Responding to the economic chaos of government. Tate Publishing; Oklahoma.
Fair Tax (2007). What the federal tax system is costing you — besides your taxes! Retrieved from
Government Accounting Office GAO (2005). Summary of the estimates of the costs of the
federal tax system. Retrieved from http://www.gao.gov/new.items/d05878.pdf
Internal Revenue Service (2011). IRS FY 2012 Budget Proposal Summary. Retrieved from