Straight talk on mutual funds, bonds, real estate, and annuities
Techniques for avoiding financial disasters
Tools to help readers track their debt and create a plan for staying out of it
Road maps to buying a home and saving for college and retirement
Order your copy today!
At Arm's Length: 10.15.04
What does it take for the markets to change the current course of sideways sliding as if stuck in an endless spin on ice? It takes, I'm afraid, a little bit of moxy combined with the ability to work against the markets themselves.
Today's Commentary: 10.12.04
Long After the Election: Taxes
I listened, somewhat in awe, at a phone-in caller to a recent edition of NPR's Talk of the Nation. With a noticeably Southern drawl, the gentleman suggested that as single father he worried about whether the Democratic candidate John Kerry would raise his taxes. Describing himself as a single father, was his worry unfounded? Is the Bush tax cuts designed to improve this parent's life by putting more money in his pocket? Or perhaps he has bought the rhetoric of the campaign trail, an oft repeated and just as often incorrect portrayal of who is paying and who is not. Long after the election is over, taxes will need to be reformed. But which candidate has the best idea?
A quick listen to the candidates during this very heated campaign, usually delivered in sound bites, has the President calling for the reformation of the tax code, a document he tells the crowd of pre-screened supporters, is over a million pages long. So long he tells the crowd with his patented smirk, that Americans will waste over 6 billion hours doing taxes. Instead he speaks about a "simpler, fairer, and pro-growth" kind of a tax plan built on the one that currently gives the greatest tax breaks on the very ones that are counted on to spend it. Although this wealthy group has not been proven so anxious to part with their tax breaks even with the growth that has come since 2001.
The problems arise when the President suggests that the tax plan can be changed. He has instituted polices that are at odds with what he says. But his consistent shift of the tax burden away from the wealthy and toward the pocketbooks of the middle class would need to come into play to accomplish the goal of a simpler code.
That complicated tax code, as difficult as it is to completely comprehend, would prove equally challenging for either candidate to change in any significant way without setting off a firestorm from almost every corner of the country.
At the heart of the problem are special interests. Yesterday, for example, the House and Senate brought tax reform to the manufacturing sector in response to a cry of foul from the European Union concerning global trade rules. But in a hefty appendage (the bill runs over 700 pages), far more special provisions were written in to the bill in order for Congress to even consider the bill for a vote. Even Secretary Treasurer John Snow saw little advantage for the average tax payer in the bill suggesting that it would benefit only a few.
Even as Mr. Bush denounces tax loopholes for special interest groups, he essentially creates them at every opportunity. His newest idea, which resembles a consumption tax is a devilish as that smile of his.
First, I should explain how a consumption tax works. It is a voluntary tax that requires no end of year reporting on income. Instead, the tax is levied, much like a national sales tax on consumable goods.
This sort of tax benefits manufacturing at least on the surface. The tax will essentially act as an additional cost for the goods they are trying to sell. The flaw in this thinking is almost too simple to state. These businesses would have raised prices if they thought the consumer would buy them. The inflationary effect of higher prices, even with the elimination of income taxes would not offset each other equally.
Nay sayers are quick to point out the gap between what the government now receives in income tax and the cost of the goods with taxes included would be wide enough to create a lucrative black market.
Supporters of such a tax plan point out that dividends and savings would be free of the long reach of IRS. And that is true but the IRS should never of had a hand in that particular pocket in the first place. As I explain below, this is of greater benefit to the wealthy but every tax payer would benefit in some way if this was the only reform enacted.
States would be faced with the problem of converting to some sort of similar program in lieu of their current revenue gathering methods. States that currently have sales taxes instead of income taxes would find themselves wondering if the newer, higher prices in the marketplace as a result of the federal effort would create a paradox. Often cited as a negative, consumption tax may discourage consumption at exactly the same rate that it fails to raise revenue. Predicting the outcome of that problem would be harder for many states than their current budget balancing efforts.
Taxes are admittedly too complicated and too easily evaded by the lawyers that Mr. Bush talks so much about - the ones who aid the wealthy in their quest to keep even more of what they earn. With a consumption tax, Republicans believe that dilemma will be solved . It may be called many things from a flat tax to a sales tax, but at the core of the suggestion is a tax based on consumption.
Edward J. McCaffery published a book several years back attempting to explain the virtues of just such a system. Fair Not Flat: How to make the Tax System Better and Simpler was not the first workable portrayal of a reformed tax code. Unfortunately though, it is also an inherently flawed attempt at appeasing both sides of the argument. Republicans want savings and investment to be free from taxation. Democrats want the code to be fair which means progressive.
Even with McCaffery's suggestion in his book, the complications are many and complex. Progressive consumption tax as yet to be outlined by the administration would likely include a flat sales tax and a graduated supplemental tax. To make value added taxation (VAT) a workable solution, exemptions would be made for a level of income, perhaps the cut-off point for the Census Bureau's poverty level. This would allow for the taxation of everything beyond those expenditures at a flat national sales rate.
Higher income earners would find their rates accelerating much faster as they spend more. The author also points out that the removal of savings and investment deductions makes income subject to consumption tax. The hope is in the creation of Trust Accounts to hold this previously taxable income and keep it until it is needed. Only then, would it be taxed as income.
Dating back to 1921, the first time consumption taxation was introduced, Republicans were trying to place the burden of taxation on the consumer not the industries that create jobs. Twice again it would be attempted, dissected for flaws and rejected with the most recent attempt in 1995. Mr. Bush's plan is clearly looking for angels in the abstractions rather than the devil in the details.
Mr. Kerry objects to any proposed tax reforms that hint at consumption or flat tax changes. And with good reason. The regressivity of such changes would hit the lower income spenders more, largely because, on a percentage basis, they spend more of their income. Adding further complexity to the issue, suggestions have been made that this group be excluded from VAT in favor of a simple income tax form.
The truly wealthy would still be able to avoid a good deal of tax through greater savings incentives and the ability to borrow from those savings, not only tax free but interest free as well. This would be significant shift with a return to monetary power akin to nothing this country has seen since the days of the Revolution.
The President's attempt at shifting to consumption tax as a way to keep the wealthy from legally dodging taxes is misplaced. The change to VAT would instead create more wealth in a group that was recently reported to be controlling two thirds of the cash and three quarters of the investments.
With only 33% of a wage earners income in excess of $200,000 spent on consumption, the lion's share of that taxes would be shifted to those least likely to afford it. Currently, on an income of $30,000, 93% of that money is spent and under the Bush tax plan, would be taxed.
The Blue Money Report
Financial Commentary covering a wide range of topics concerning money, investing, and how it effects the average investor and their financial health.
It is the World of Money and Investing Explained.
Our Publication
If you are interested in providing your readers with our syndicated column, you can request it here
