Tax Policy Change We Can Believe In

Earlier this month, Dan Caplinger of The Motley Fool called on President Obama and Congress to make fixing the tax code a high priority. His laundry list of action items consisted mostly of revisiting provisions that have already expired, such as the inflation patch for the Alternative Minimum Tax, and provisions that will soon expire, such as the Bush tax cut rates. But he did call for one new reform: addressing "[t]he link between lobbying and corporate tax benefits ... [which] disturbs many taxpayers' sense of fairness." I think this suggestion constitutes the kernel of a great idea.

Historically, humans managed pretty well for most of our existence with no taxes, and not much government. But around 10,000 years or so ago, some combination of our success at populating the planet and environmental changes pushed us past the level where the tribal hunter-gatherer subsistence mode of existence could produce sufficient food. By necessity, we invented agriculture and cities... and the inherent necessity for planning entailed in making that work engendered more government... and the constant need for funding its activities and functions. Basically, the 99% surrendered their liberty and the right to make most decisions about their own lives in return for a (usually) reliable food supply.

And that's pretty much the way things were for thousands of years... until something unprecedented happened about 250 years ago, when the pace of engineering and technical innovation began to lower the price of stuff -- first food, and then other goods and services -- so dramatically that the quality of life began improving for more and more of the 99%.

In terms of personal liberty, we are probably closer to the level of freedom of choice enjoyed by virtually everyone in hunter-gatherer society than we have ever been. Which is probably not all that close considering all the tenant farmers and Foxconn workers on the planet, but the vector is looking good.

Howsoever, a mere 250 years of moving in a "good" direction after 9,750 years of moving in a "bad" direction does not confer immunity against the tendency of The Powers That Be to want to consolidate authority. The typical pattern is that we fall into a period of chaos where not everyone has enough to eat, some talented and ruthless individual or group takes the opportunity to seize control and sort out the mess -- in our Mesopotamian days, this principally involved getting the irrigation system working again -- and things are relatively good again for a generation or two. But eventually, those in control at the top get complacent and greedy, and start exploiting their power for self-aggrandizement, the infrastructure is neglected, and we are back to chaos and starvation again. Rinse and repeat.

Which gets us back to the U.S. tax system. When Mr. Caplinger opines that "[t]he link between lobbying and corporate tax benefits ... disturbs many taxpayers' sense of fairness," he is engaging in masterful understatement. Our tax code is rife with exemptions, dispensations, credits, special preferences, incentives, and loopholes, most carefully crafted and steered through the legislative process by a bevy of highly skilled lobbyists who are well-bankrolled by one corporatist interest or another. The purpose of these "improvements" to the income tax law is to benefit that particular corporatist interest, either directly by providing some sort of tax relief or indirectly by encouraging otherwise irrational behavior by other taxpayers that boosts the fortunes of the corporatist.

So not only are individuals encouraged to do things that they otherwise might not -- even things that are socially destructive, such as take on mortgage loans they can't afford -- but they have to struggle with incredibly complex tax returns each year. And it gets worse still. While the direct benefits of the loopholes afford large corporations one sort of unfair advantage, the hassles of coping with and complying with the arcane rules constitute a significant barrier to entry for small businesses that can barely afford to pay accountants to help with compliance... forget about hiring lobbyists to gain their own "special preferences."

This behavior is not nefarious. If you were charged with maximizing the success of a large corporation, it would be not merely irrational, but irresponsible to eschew the tax lobbying game. All your competitors are playing, and by not competing, you would be handing them a significant competitive advantage and betraying the interests of your employer.

However, the cumulative effects of this sort of activity are per force corrupting. About half the lobbyists on Capitol Hill are engaged in tax code work, which means a lot of money is flowing. And we are not just talking campaign contributions. Legislators and staff who play ball with respect to tax code "improvements" certainly tend to get special consideration for lobbyist, legal firm, and board of director sinecures after retiring from government service. Mr. Caplinger has this right: It is not a pretty picture.

But the thing is, if we leave an open honeypot in the woods, we really shouldn't complain if it attracts bears to our campsite. And funding our government with income tax revenue is, metaphorically speaking, a big open honeypot. So, given that modern civilization requires at least a modicum of central authority and that the actions of government need funding, how can we address this problem?

The answer is that we have to look beyond a laundry list of marginal tinkerings with our current tax code. And having a president at the start of his second term looking for a win-win opportunity to make a positive difference just might be the catalyst that could make it happen.

How about a solution that politically speaking would galvanize instant support from virtually every small business and Chamber of Commerce in the country, and be greeted enthusiastically by middle-to-upper bracket taxpayers -- especially anyone who has ever been audited -- while providing the prospect of lots of new jobs to un- and underemployed folks? And, of course, would both eliminate the loopholes now on the books and prevent any new ones from being created?

The solution is a simple one: Eliminate all income taxes -- personal (including estate) and corporate -- disband the IRS, and implement a revenue-neutral consumption tax. The tax would be collected on the sale of services and new products to individuals (not on business-to-business sales or the resale of used products to individuals).

Come to think of it, why are we even taxing income in the first place? Why create a disincentive for people to be as productive as they can be and maximize their income? Isn't that a prerequisite for capital formation and investment that promotes growth? And in a world of limited resources -- particularly in the USA where, with 5% of the planet's human population, we consume 25% of the goods and services produced -- shouldn't we be taxing consumption to discourage wasteful over-indulgence?

To make this work fairly, you would need one basic exemption: for folks near and below the poverty line. This could be accomplished relatively simply by issuing every taxpayer rebate checks to zero out the tax on the first x thousand dollars of purchases each year. In effect, poor folks -- or anyone who limited their spending to a minimal amount -- would pay no tax. But for richer folks, the more you buy, the more you pay.

This would be a huge boon to our economy. U.S.-based producers could price their products cheaper, not having to account for the cost of the income tax, and thereby gain a competitive advantage against imported goods and, potentially, in the export markets. It would make more economic sense to produce goods in the USA again, and we'd gain jobs... lots of jobs!

Speaking of which, small businesses historically provide 70% of job growth and the elimination of the estate tax would strengthen such privately owned businesses. With no taxes on interest, dividends, or capital gains, investment decisions could be made strictly on an ROI basis. Retailers should not be affected too much because the increase in sticker prices will be mitigated by both the elimination of payroll taxes --consumers will have their entire paychecks to spend -- and fact that producers will no longer have to "price in" the cost of their own corporate income taxes, so they can afford to charge less.

Of course, while eliminating all corporate income taxes would be popular with small businesses, eliminating the personal income tax and IRS would be a hit with most middle-class taxpayers, and the prospect for more jobs would make it a hit with virtually the entire 99%, there would be significant opposition to this proposal because it would sweep away all the loopholes and preferences that the corporatists have invested their lobbying money in over the decades.

Big businesses that benefit from the competitive moat afforded them by the income tax code -- energy companies such as ExxonMobil, defense industry companies such as Halliburton, Big Pharma companies such as Merck, Big Insurance companies such as UnitedHealth -- would fight it with all their lobbying power. Tax lawyers and accountants would generally be unhappy. And legislators would be loath to surrender the power -- and attendant remuneration -- of being able to dispense favors to the rich and powerful.

But if President Obama is looking for a signature issue that would enable him to bring together a strong coalition of both have and have-not citizens, all of whom would benefit from this solution, demonstrate that the government does not (always) favor corporatist interests over those of the public at large, and increase the odds he can deliver on his 12-million-new-jobs promise, he could scarcely do better.

And by restoring a more reasonable balance between the exploitation of centralized state power for purposes of self-aggrandizement by the few and the rights of the citizenry to life, liberty, and the pursuit of happiness, Mr. Obama can build himself a lasting legacy of accomplishment that will ensure the gratitude of future generations.

Plus, think of what the USA could accomplish once the brainpower and persuasiveness of all those high-powered former tax code lobbyists are redeployed to work that is socially redeeming!

The article Tax Policy Change We Can Believe In originally appeared on Fool.com.

Brad Hessel currently has no position in any of the equities mentioned; however, Brad's clients may have such positions. The Fool'sdisclosure policyincludes certain trading restrictions that apply to Brad. However, his clients are not subject to our disclosure policy and thus are free to trade any such equities. The Motley Fool owns shares of ExxonMobil and Halliburton. Motley Fool newsletter services have recommended buying shares of Halliburton and UnitedHealth Group. Motley Fool newsletter services have recommended creating a diagonal call position in UnitedHealth Group.The Motley Fool has a disclosure policy. The tax proposal outlined in this article is conceptually based on the Fair Tax; for more detail on how it could work and considered responses to frequently posed questions and objections, check out www.fairtax.org.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.