The Implications of Revenue-Neutral Tax Reform

By Laurence M.Vance

Tax season is over, but tax-reform proposals are perennial.

America’s current income-tax system was inaugurated in 1913 with the adoption of the Sixteenth Amendment. It began quite modestly, with a 1 percent tax on income above $3,000 ($4,000 for married couples). A series of surcharges up to 6 percent were applied to higher incomes, with the maximum rate being 7 percent on taxable income over $500,000. Very few Americans actually paid a tax on their
income — until the United States entered World War I.

The minimum rate soon doubled, and the maximum rate rose to 77 percent. Neither fell significantly until 1925, only to rise again during the Great Depression, and then again during World War II — which also marks the institution of the withholding tax. Although income-tax rates have both fallen and risen since the 1960s, the size and complexity of the tax code has increased astronomically.

That has led not only to more and more calls for tax reform, but to the rise of organizations solely dedicated to tax reform such as Americans for Tax Reform, Reform AMT, Citizens for Tax Justice, and Americans for Fair Taxation. The federal government has jumped on the tax-reform bandwagon as well, establishing things such as the President’s Advisory Panel on Federal Tax Reform.

Some tax-reform proposals are longstanding while others are introduced during the yearly tax season.

For years Rep. John Linder (R-Ga.) introduced FairTax legislation in Congress to institute a national sales tax on the final sale of all goods and services to replace the personal and corporate income tax, estate tax, gift tax, unemployment tax, Social Security tax, and Medicare tax. That task has now fallen to Linder’s successor, Rep. Rob Woodall.

House Majority Leader Dick Armey (R-Tex.) pushed the idea of a flat tax after the Republicans gained control of the Congress during the Clinton administration. It was preceded by the flat-tax plan of Hoover Institution economists Robert Hall and Alvin Rabushka and followed by the plan of former Republican presidential candidate Steve Forbes. Under a flat tax, every American’s income is taxed at the same rate, and most credits and deductions are eliminated.

Earlier this year, House Ways and Means Chairman Dave Camp (R-Mich.) introduced a radicaltax-reform plan that called for reducing the current seven tax brackets (10, 15, 25, 28, 33, 35, and 39.6 percent) to just three (10, 25, and 35), switching to a territorial corporate tax system that would exempt from domestic corporate taxation 95 percent of all active foreign income, cutting the corporate tax rate from 35 to 25 percent, increasing the child tax credit to $1,500, increasing the standard deduction to $11,000 ($22,000 for married filing jointly), and eliminating many tax credits, exemptions, and deductions.

Building on the work of Camp is the tax-reform proposal found in House Budget Committee Chairman Paul Ryan’s proposed FY2014 budget. It has four major elements:

• Consolidate income-tax rates to 10 and 25 percent.
• Lower the corporate rate to 25 percent.
• Broaden the tax base by closing loopholes.
• Adopt a “territorial” system of taxation.

All of these tax-reform ideas suffer from the same problem — they are revenue-neutral. They all talk about lowering certain tax rates, but then they call for broadening the tax base, closing loopholes, and eliminating deductions.

Not in any particular order, here are some implications of revenue-neutral tax reform — none of them good.

Revenue-neutral tax reform implies that the problem with the tax code is its length or complexity. According to the Mercatus Center at George Mason University, 4,428 changes were made to the tax code from 2001 through 2010. But an income tax based on a shorter and simpler tax code is still an income tax. Tax reform should not result in making it easier for people to pay their taxes or feel better about paying their taxes.

Revenue-neutral tax reform implies that the government has a claim to a certain percentage of one’s income. That is true even if tax reform actually includes the across-the-board lowering of tax rates. As Frank Chodorov explains in his book The Income Tax: Root of All Evil (1954), the income tax means that the state says to its citizens, “Your earnings are not exclusively your own; we have a claim on them, and our claim precedes yours; we will allow you to keep some of it, because we recognize your need, not your right; but whatever we grant you for yourself is for us to decide…. The amount of your earnings that you may retain for yourself is determined by the needs of government, and you have nothing to say about it.”

Revenue-neutral tax reform implies that the tax code contains too many exemptions, credits, loopholes, shelters, exclusions, and deductions. Actually, it doesn’t contain enough. What tax reformers mean is that the tax code contains too many ways for Americans to keep their money out of the hands of the government. Tax deductions are not subsidies that have to be “paid for.” Lowering or eliminating tax deductions has the same effect as raising tax rates: higher taxes. They should be retained as long as the tax code is in existence.

Revenue-neutral tax reform implies that government revenue should not be decreased. I don’t mean that as a tautology. I mean that advocates of tax reform — including conservative Republicans — consider it unthinkable that the government should have less money to spend than it did last year. They are addicted to spending the taxpayers’ money.

Revenue-neutral tax reform implies that there is such a thing as a fair amount of taxation. But that is like saying that there is a fair amount of stealing, robbery, burglary, theft, mugging, expropriation, embezzlement, and larceny.

Revenue-neutral tax reform implies that taxation is not government theft. Try as tax reformers might to make the tax code simpler, shorter, fairer, less intrusive, flatter, or less progressive, the income tax is still legalized government theft. As the late Austrian economist Murray Rothbardexplains, “It would be an instructive exercise for the skeptical reader to try to frame a definition of taxation which does not also include theft. Like the robber, the State demands money at the equivalent of gunpoint; if the taxpayer refuses to pay his assets are seized by force, and if he should resist such depredation, he will be arrested or shot if he should continue to resist.”

Revenue-neutral tax reform implies that increased government revenue resulting from lower tax rates is a good thing. We always hear this from conservatives when they trot out the Laffer Curve while they are arguing for lower tax rates. A letter from the House Ways and Means Committee to Paul Ryan mentions this: “More employment and higher wages would lead to higher tax revenues which would simultaneously address both the nation’s economic and fiscal problems. While the Committee is committed to tax reform that strengthens the economy, the Committee will continue to oppose any and all efforts to increase tax revenues by any means other than through economic growth.” From a libertarian perspective, the “goal” of tax policy should be to maximize neither revenue nor economic growth, but individual liberty.

Revenue-neutral tax reform implies that congressional spending is not the fundamental problem. But as Congressman Ron Paul (R.-Tex.) said regarding the mirage of tax reform, “The real issue is total spending by government, not tax reform.” The vast majority of things the government spends money on are either immoral wealth-redistribution schemes and income-transfer programs or unconstitutional foreign wars and government programs.

Revenue-neutral tax reform implies that the income tax is necessary. There was no regular, permanent income tax in American history until 1913. If government spending were strictly limited to just what is constitutionally authorized, there would be no “need” for an income tax in the first place.

Revenue-neutral tax reform implies that it entails no tax increases. But any revenue-neutral tax-reform scheme can, by definition, only shift taxes, not lower them. If someone’s taxes are lowered, someone else’s taxes must be increased. Just look at the Camp proposal. It introduces an excise tax on banks that are deemed “systemically important financial institutions,” shifts the tax burden from individuals to businesses, raises the top marginal income-tax rate on capital gains and dividends, and effectively raises taxes on high-income earners.

Revenue-neutral tax reform implies that the income tax is the most burdensome tax. For many Americans, it isn’t. According to data from the IRS, the top 50 percent of taxpayers (in terms of adjusted gross income) paid 97.64 percent of all federal income taxes. It is the 6.2 percent Social Security tax and 1.45 percent Medicare tax that are deducted from Americans’ paychecks that is the most burdensome tax for the other 50 percent of taxpayers.

Revenue-neutral tax reform implies that there is a difference between Democrats and Republicans when it comes to taxation. Although they may differ on the number of tax brackets, the tax rates, and the amount of tax credits and deductions, neither group has any philosophical objection to the government’s taxing Americans’ incomes. Liberals simply prefer that more tax money be spent on the welfare state than the warfare state while conservatives simply prefer the reverse.

All revenue-neutral tax-reform proposals are nothing more than the proverbial rearranging of the deck chairs on the Titanic.

The tax burden doesn’t need to be shifted, the tax base doesn’t need to be broadened, tax loopholes don’t need to be closed, the “rich” or the “poor” don’t need to pay their “fair share,” and the tax code doesn’t need to be reformed, revised, or replaced — it needs to be repealed.

Laurence M. Vance is a columnist and policy adviser for the Future of Freedom Foundation, an associated scholar of the Ludwig von Mises Institute, and a columnist, blogger, and book reviewer at LewRockwell.com. He is also the author of Social Insecurity and The War on Drugs Is a War on Freedom. His newest books are The War on Drugs Is a War on Freedom; His most recent books are: War, Christianity, and the State: Essays on the Follies of Christian Militarism and War, Empire, and the Military: Essays on the Follies of War and U.S. Foreign Policy.. Visit his website: www.vancepublications.com. 

The above originally appeared at The Future of Freedom Foundation and is reprinted with permission