Replace All Federal Taxes on Income with the Fair Tax Act , HR 25
Tax - Generated Economic Distortions and Instabilities
Fellow Fair Tax Leaders:
Many actions of government central planning or legislation including the tax code produce behavior outside what would happen by willing participants in a market. Some claim that is good and intended. Elitist politicians certainly often like that power, or for political payback to supporters, and lobbyists bribe politicians with campaign contributions to rig the tax code and other laws to their advantage.
The purpose of this discussion is to outline these so Fair Tax leaders can advocate tax simplicity and fairness of the Fair Tax with more conviction from deeper insight into the problems of tax code complexity and coercion on business and consumer choices.
I will start with a couple very fundamental distortions caused by the tax code that I believe contribute to business cycle instability such as the financial crisis of late 2008. Politicians are still using this financial mess to justify further mangling economic decisions of Americans to enhance their own power and pocketbooks. But this (in addition to wasting compliance cost and time) causes more risk and instability in the future. So the topic is timely.
I invite and request insights from others as well, including cataloging other distortions and instabilities caused by income taxes (including capital gain), business, "safety net" and other taxes the Fair Tax will replace with a simple "linear" consumption tax.
-ABE
Many actions of government central planning or legislation including the tax code produce behavior outside what would happen by willing participants in a market. Some claim that is good and intended. Elitist politicians certainly often like that power, or for political payback to supporters, and lobbyists bribe politicians with campaign contributions to rig the tax code and other laws to their advantage.
The purpose of this discussion is to outline these so Fair Tax leaders can advocate tax simplicity and fairness of the Fair Tax with more conviction from deeper insight into the problems of tax code complexity and coercion on business and consumer choices.
I will start with a couple very fundamental distortions caused by the tax code that I believe contribute to business cycle instability such as the financial crisis of late 2008. Politicians are still using this financial mess to justify further mangling economic decisions of Americans to enhance their own power and pocketbooks. But this (in addition to wasting compliance cost and time) causes more risk and instability in the future. So the topic is timely.
I invite and request insights from others as well, including cataloging other distortions and instabilities caused by income taxes (including capital gain), business, "safety net" and other taxes the Fair Tax will replace with a simple "linear" consumption tax.
-ABE
Replies to This Discussion
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Permalink Reply by Adrian B Early on
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The tax code encourages more debt than would otherwise be deployed since its use is tax deductible. If there were not business or personal income taxes, this would not be the case.
Debt is money "owned" by one person (or economic entity) and used by another, "rented" at the cost of interest. But risk is a large issue since owners take better care of their own properties than renters do those of their "lenders" of the property, even cash transferred in a loan. The financial meltdown was largely initiated by debt sold "hot potato" to third parties, especially with government backing (transferring the risk further away from actual participants in the transactions).
The capital for business has a cost estimated by the Weighted Average Cost of Capital or WACC (see http://en.wikipedia.org/wiki/Weighted_average_cost_of_capital) as follows:
WACC = Wd Cd (1 - T) + We Cy
Wd and We are the weights (proportion of total capital of the business) of Debt and Equity. Cd and Cy are the average returns or yields demanded of "the market" for providing that money to finance business. The factor (1 - T), T being Taxes of the corporation, is the advantage that the company gains by using debt (with its interest rate cost, Cd tax deductible) for using debt over equity.
So the tax code as a very fundamental influence, encourages more debt than would otherwise be in the capitalization of companies. This leverage is "dangerous" because in any downturn, the company MUST continue to "service" the debt, and lenders then want to call in (certainly not loan more) those obligations. The creditor cares not at all about the long term goals of the business, only that THIS loan be repaid. The separation of ownership from decision making of what to do with the money is an inherent issue. The Fair Tax will eliminate this incentive to leverage businesses by eliminating business income taxes.
Similarly on the consumer side, mortgage payments for housing are tax deductible. So, even if paying down family debt would make the economic system (and that family) less vulnerable, the tax code encourages aggressiveness partly to avoid taxes. This should stop, and the Fair Tax will dispense with this distortion in "home economics" financing choices.
Much of the financial meltdown was due to "sub-prime mortgage" crisis where Acorn and politicians allegedly encouraged (and extorted) lending to people who could not afford houses of that given cost, for political and financial gain. The practice, picked up by Wall Street, replaced previous "credit standards" especially when the mortgages could be bundled and sold (Fanny and Freddy backed by the government) to third parties as "safe".
The Fair Tax will eliminate the tax incentive to distort consumers and businesses into more risk from leverage than they otherwise would shoulder (though "moral hazard" http://en.wikipedia.org/wiki/Moral_hazard shared with their credit suppliers).
-ABE -
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Capital markets are believed or asserted to be mostly "efficient", meaning that securities prices are about what they "should be". So, I ask, which stock market prices were "right", those of September 2008 or of March 2009? Well, behavioral finance has shown some areas where stock pricing is not "efficient". Among other things, http://en.wikipedia.org/wiki/Behavioral_economics#Behavioral_financ... says:
"Behavioral finance highlights certain inefficiencies and among these inefficiencies are underreactions or overreactions to information, as causes of market trends and in extreme cases of bubbles and crashes). Such misreactions have been attributed to limited investor attention, overconfidence / overoptimism, and mimicry (herding instinct) and noise trading." The Bold emphasis is mine.
To the "inattention, overconfidence, and overoptimism", I want to add tax consequences of selling (including especially overpriced securities). The tax code penalizes taking securities profits. This is especially true for holding periods below one year. Such short term gains get penalized at the full marginal income tax rate of the investor. What is the effect on "market efficiency" of selling costs equal to the tax rate of an investor?
Tax planning is a major duty of financial planners and money managers (and wasted time when the Fair Tax could eliminate this distortion of economic choices). So, instead of selling at the right time, the investor or their representative holds out for a long term gain (and then waits longer to avoid even the "milder" taxation of large increases over long times. This feeds back on the other "behavioral biases" to accentuate the bubble and later crash. In housing, the leverage discussed last posting enhances housing bubbles and crashes as well.
It has been noted by other Fair Tax proponents that consumption is "smoother" than income, so the government revenue will be more consistent under the Fair Tax than with income taxes or tax on business profits (down during recession, remember). But the capital gains taxes are even more "volatile"; these instabilities enhanced by the tax code itself.
This is true and quite significant. But it relates to tax revenue RESPONSE to EXISTING business cycles and instability. I am here asserting that these bubbles, crashes, and cycles are ENHANCED or partly CAUSED by the Tax code and its penalties on taking profits (refusal to sell at peaks).
Let's enact the Fair Tax and eliminate this portion of the US contribution to global market instabilities. Is it not our duty to improve this rather than make things worse? And would our lives not be more pleasant with boom and bust cycles of much lower amplitude?
Fighter jets sometimes use electronic "active controls" (faster than any pilot can react) when performance dictates pushing into "naturally unstable" system operation. But passenger planes and the economy should not be run this way. And what "performance" do we really get from government intrusion through tax code and legislative complexity? It seems more like a performance degradation.
What does your congressperson say about this long term solution instead of government and federal reserve "managed" "stimulus" to seek to compensate for tax code induced instabilities in the business cycle? Can we eliminate this form of "central planning" even if we think congress and bureaucrats so much smarter and more ethical than we?
-ABE -
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Permalink Reply by David Nelson on -
I believe the claim that it was ACORN and politicians demanding capital be lent to low income people is masking the real blame. The real force behind such tactics came from the people who previously owned those houses and wanted top dollar for thier investments so they could move to a bigger and better house.
I've done it myself in completely legal ways when I had a property to sell. I hired the buyer to do yard work and paid him almost a third of what he needed as a down payment--about ten times what I would have paid someone else to do the same work. It happened that he was not one of the millions foreclosed upon, but his ability to get a loan slightly higher than he probably should have had nothing to do with ACORN.
The bulk of the problem wasn't first mortgages anyway, it was primarily second mortgages and refinancing. As a salesman in Florida at the time, I saw lots of people "cashing in th equity" in their homes to buy things they could have gone without and probably couldn't afford. Many of the people I sold fence to did lose their houses. When people of means (like myself at the time) were able to get "stated income" mortgages instead of proving where the income comes from, most of us stretched the truth a little. I assure you, first time mortgages to the lower middle class folks championed by ACORN et. al. were not able to avoid income verification.
The other need for those "stated" income loans is the tasset understanding that nobody tells the government what they really make. Thus, the biggest reason I want to see the FairTax enacted.
Sorry if this is off topic. In a way it fits because one way the current tax laws distort lending behaviour is that institutions have a simple means of varifying income simply by asking for two yearrs of tax returns. I wonder what they'll do after the FairTax passes? -
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Thank you, David.
Ok, is there any drawback to the tax code encouraging maintaining debt by families and businesses above what they would otherwise? Acorn (as you said "off topic") was not the key question. That key question I intended was, "Should the tax code create advantage and encourage the use of more debt?". Does this lead to less economic stability, including the business cycle (near 10 % or so unemployment now, etc.)?
You do, David, bring up a good (set of) question(s) about tax filing documents being used for other purposes. Another use in the past of the IRS (I have mentioned elsewhere) was to take down organized crime bosses (Al Capone being the first "precedent"). But I am beginning to fear the government as it strives for wider monopoly power throughout the economy, more than the Mafia.
I welcome other comments on this set of topics or other issues. Should we retain the IRS for convenience in credit validations, police action of the state, and other uses?
But most importantly, does the tax code distortions of economic decisions lead to instability in the market and economy?
-ABE -
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One of the key distortions ("violation" of "efficient markets" http://en.wikipedia.org/wiki/Efficient-market_hypothesis) in the stock market is the "January Effect" http://en.wikipedia.org/wiki/January_effect. This rising in January is believed to be due (at least primarily) to tax loss selling in December of stocks that have declined. This "inefficiency" in the market would obviously go away under the Fair Tax.
The primary "inefficiency" is presently allocated to "Behavioral Finance" http://en.wikipedia.org/wiki/Behavioral_finance (which among other things causes bubbles) though as I have already indicated, this should (I now believe) be reevaluated in light of the contribution from tax-code-based coercion of investor behavior. The January Effect is further evidence that taxation moves markets, and we should look further for additional "damage" to efficiency that the Fair Tax would prevent (like financial bubbles and melt downs).
-ABE -
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Permalink Reply by Nancy L. Gatchel on
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This is an excellent discussion even if it is from last year. So glad all these posts are still here.
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Thank you, Nancy.
One way I encourage others to consider the Fair Tax is by pointing out the value to anyone (me as an example, or them) of developing wealth and income outside the US (in a corporate entity) rather than here. If we deteriorate into fascism or socialism, fleeing the country will "work better" with assets beyond the grasping claws of slave-masters bent on power (as all practical "utopian propagandists" turn out to be, or become). And maybe the extra effort of supporting that "construct" counterbalances time (no longer) wasted on IRS reporting. Is 1040 servitude and its prevention not an "economic distortion" of gigantic proportions? How much better to SIMPLY tax foreign and domestic suppliers to US consumers, rather than chase more production offshore.
The other tax reduction approach ("Tax Planning 101") is (1) Buy (appreciating assets like stock and seldom trade it) (2) Borrow (to live on if needed) and (3) Die (to reset the cost basis, passed to heirs).
When the wealthy own much but trade little (even under "spread the wealth" Obama), they pay few taxes. As capital replaces labor as the dominant economic input to production (land being almost negligible now), our president is enhancing wealth disparity (probably for fun and profit). Why do you think Soros and Buffet like high taxes for working people? Should you not join them, eventually forcing government to move to a Fair (consumption) Tax, somewhere in the world if not initially here? Then accounting slavery to the government will end (and we will all have more time for useful things).
-ABE -
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Look for tax - caused market changes in the news. One today is from Seeking Alpha http://seekingalpha.com/article/245942-emerging-market-etfs-investo..., saying among other things:
"Here’s the reality: Hedge funds, institutional advisers and money managers had remarkable unrealized gains in single country emergers. Many of these folks -- including yours truly -- deferred the recognition of those gains until after New Year’s Day. Put another way, investors are taking profits for profit sake."
Some know that market inefficiencies are caused by huge tax costs related to selling stock (in this example, where many investors waited until 2011 - January to take profits to avoid taxation last year).
One reason given for tax complexity is to effect public policy through that tax code. Is this market instability and inefficiency an example of public policy INTENTIONALLY written into the 3.8 Million line tax law? This is just one "tip of the iceberg" example of wasteful tax law constraints that make things worse, not better for society. The Fair Tax is also the efficient (and stable, less destructive of our economy) tax.
This (including avoiding government - caused financial meltdowns) is yet another reason to repeal the income tax mess, and deploy the Fair Tax.
-ABE
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