A legislator’s guide to tax reform

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The Iowa state legislature is back at the table trying to tackle tax reform for the umpteenth time. Prior business tax preferences have not had their anticipated effect of raising total revenues. Indeed, the total cash available for crucial government spending has fallen well short of the estimates of the Republican-dominated revenue prediction team for the last several years.

So, as your representatives go back to the table, let me suggest that the following rules for legislators engaged in tax reform apply to not just Iowa, but every U.S. state and the Federal government. Please send them as far and wide as you can.

Tax receipt shortfalls have a cause, and you are probably it

Iowa is not the only state with persistent shortfalls in tax collections, even as business profits are a record high, unemployment is at a record low, and the economy is booming. This is because your predecessors (and many of you specifically) were almost always wrong in overestimating the effects of past attempts at tax reform and business incentives.

It can be embarrassing to drag out old estimates, but you really need to learn that the stuff you say now about generating more tax revenue was said many times before in legislative sessions past. And they were wrong. Many of these statements were based on economic and political ideologies that have never been proven in practice, often the continued cultic belief in the Laffer Curve and supply-side economics, whose benefits are always somewhere around the bend.

Income is income

Legislators spend an inordinate amount of time dreaming up tax rate preferences, credits and deductions that favor one type of income over another. But every dollar given in tax preference to one constituent or special interest is really a tax on the constituents NOT so favored. Somebody needs to kick into the top line of the state and federal budgets to meet crucial shared obligations for education, public safety, transportation and public health. Anybody taxed below the required average rate for maintaining governmental operations is being subsidized by everybody else. And if you think these tax preferences will magically generate more income than they cost, see above.

What is missing from your analysis is that the size of the “unfavored” in the economy is many times bigger than the special interests who buy tax breaks from you through their political donations. Someone, somewhere needs to make up the economic effect of past gifts to special interests, that that someone is the ordinary worker and the businesses who plug along without special favors.

All income should be treated the same as a starting point principle. States are limited in their ability to counter this principle by federal tax rules and their numerous current distortions, but they certainly should not make the preferences worse.

Any tax preference used by a small percentage of taxpayers is a parasitic special interest

Every state and federal taxing agency knows (or should know) the percentage of individual or corporate taxpayers who actually use each particular line on every form to their favor. You need to see that number. If there are less than one out of 1000 taxpayers (or more commonly, fewer) whose taxes are reduced by a particular line or form on their tax return, they are, by definition, special interests.

These special favors are unfair to the other taxpayers who don’t get these tax reductions, and they add to the complexity of both tax preparation (for millions of taxpayers, mind you) and enforcement. I personally would set the line even lower, at perhaps one out of 100 taxpayers, but in any case, every one of these lines on the tax forms needs to be marked for sunset, to be re-visited as to their proven effectiveness and their “special interest taint.” [1]

Marginal tax rates are much less relevant than the spread

With either personal or corporate taxes, undue focus is placed on the top marginal rates. Most states and the federal government could significantly lower all marginal rates across the board if they would focus on reducing the spread actually paid between high-rate payers and low-rate payers at any given level of gross income. One study has found, for instance, that real estate developers pay only one percent of their net income in taxes. Everybody else is subsidizing that rate. If they would pay a fairer share, the marginal rates for all could drop. [2]

A significant part of the cause for widening income inequality over the past thirty years has been the massive tax-subsidized wealth accumulated by those who have used special-interest favors to lower their net effective tax rate on wage and capital income to minimal levels. The “future value” of these compounded tax benefits are huge and ever-growing. [3]

Corporations are NOT “double taxed”

Either a corporation is a “separate legal person” from its owners or it is not. Many corporate owners want to have it both ways, They want the benefits of corporate ownership, mostly in the “insurance policy” granted by the state in the form of limited liability separating their personal assets from the assets of the business. But when it comes to taxation, they want the corporation’s income and their personal income to be treated as one income stream. So, is it one economic entity or two?

“Limited liability” has a societal cost, especially when states allow open financial malfeasance by corporations who take on excessive risks and exhibit bad societal behaviors. The local community, the employees, the creditors and the vendors of a poorly-run corporation bear the bulk of bankruptcy costs without compensation. Taxation of corporations recovers part of that societal cost. [4]

The overall tax burden outside of income taxes has a strong regressive bias

While many legislators are bent on “flattening” state and federal income tax rate computation, the reality of life for most poor people and many middle class people is that the largest taxes they pay are very regressive in nature. FICA , sales taxes and highway taxes place a much higher burden on the lower tiers of income than they do on the wealthy. As a result, state and federal income taxes need to have progressive rate tables in order to compensate.

Poor people are not “getting off free” when they pay little in income tax. Rather, their taxes have already been assessed in less-visible, but very “real” ways. Missing from all charts on “Who pays taxes?” is the measure of “Can I pay the rent this month?” or “Can I afford to travel to work?”

Economic growth is not really the “top down push” to the extent that state and federal legislators often believe it to be. The strongest economic growth comes from a healthy, secure consumer base, including the poor, who spend almost every dime of income in their local economy. Businesses who wish to profit will find these folks, efficiently meet their needs at a competitive price, and then the economy will prosper.


Notes:

  1. For a deeper dive in how to simplify taxes, see this earlier post.
  2. Ehrenfreund, Max. “How Donald Trump and Other Real-Estate Developers Pay Almost Nothing in Taxes.” The Washington Post, 4 Oct. 2016.
  3. For more about the math of income inequality, see my earlier post on “Income inequality and the Rule of 72.”
  4. See my recent post on “The ‘double taxation’ myth.”

2 thoughts on “A legislator’s guide to tax reform

  1. Pingback: How SHOULD you tax a corporation? – When God Plays Dice

  2. Pingback: Doing stupid stuff with the economy – When God Plays Dice

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