March 24, 2005
Competition Within Europe
The formation of the European Union allowed citizens of the member countries to legally live and work in any country within the EU. This policy of open immigration has had far reaching implication. Governments, in a sense, must now compete to keep citizens and businesses within their borders.
For example, in 2001, after Denmark's Brian Nielsen fought Mike Tyson, he promptly moved to Spain to collect his big payday. Why? It wasn't only to enjoy the Mediterranean lifestyle with his newfound wealth, but because taxes were lower in the Iberian Peninsula than in his native country. It follows that countries have quickly realized that a larger percent of nothing is much less than a smaller percent of something. Tax competition has ensued.
This table from a recent Wall Street Journal editorial speaks for itself with regards to the above. It should come as no surprise Ireland's economy is booming with an unemployment rate below 5%.
But the casualties of a mobile labor force have not been limited to high tax rates. Earlier this week France abandon their compulsory 35-hour work week. Originally, this policy was implemented with the flawed logic that shortening the work week for those already employed, would create jobs for the more than 13% of the population that found itself without work. The actually results were to make an already unfriendly business environment worse, and a system where government officials would routinely search the briefcases of businessmen/women as they left their places of employment to make sure they were not illegally bringing work to their homes to complete.
One question that remains is if Europe continues to move in this direction, how long will it be before the United States itself starts feeling the heat of economic competition from across the Atlantic?
Hat Tip: Hispanic Pundit
Posted by Peter Mork at 10:53 AM | Comments | TrackBack
February 9, 2005
Making the Top 1%
J. Howard Crews, in a letter to the editor of the Union Tribune today, makes an error with regards to who constitutes the top 1% of income earners. I point it out because the data he criticizes I used in a post a few months back. Crews states:
I must dispute the information given by Jerry Grossman (Letters, Jan. 27) that those making $293,415 and above constitute the top 1 percent of U.S. wage earners. This low end is nowhere near being in the top 1 percent. One must make at least $1.2 million annually to be in the top percentile according to a report by the nonpartisan Congressional Budget Office published April 9, 2004.
This is incorrect. The report Crews cites actually shows a lower figure ($238,000 in Table 1C "Minimum Adjusted Income") as the level above which individuals enter the top 1% of wage earners.
The figures Crews uses are average income figures for those in the top 1% (again in Table 1C, "Average Income"). So his figure reflects taking the average income of everyone who makes it to at least that minimum level, from the guy that makes a penny over that cutoff up to Bill Gates who sells $1 Billion worth of stock.
Also, not sure why Crews used it but it looks like the $1.2 million average is from 1999. In 2000 this average income for the top 1% of earners jumped to $1.3 million, while in 2001 (the last year of data) it fell to $1.05 million.
Posted by Peter Mork at 8:47 AM | Comments | TrackBack
January 19, 2005
The Taxman Cometh
With W-2s appearing in our mailboxes and April 15th fast approaching, I thought this story was quite appropriate:
Survivor winner faces tax charges
US reality TV series Survivor's first winner, Richard Hatch, is in trouble with tax authorities after allegedly failing to declare his $1m prize.
Mr Hatch, 43, has been accused of not paying tax on the $1.01m (£538,000) he got from the show in 2000 plus $321,000 (£171,000) salary from a radio station.
He could face up to five years in jail and a $250,000 (£133,000) fine for each of two charges of tax evasion.
Posted by Peter Mork at 10:40 PM | Comments | TrackBack
December 28, 2004
Who Wants To Be A Millionaire?
The Wall Street Journal had an article today on how financial firms are beginning to focus their marketing efforts on younger investors.
This fall, Fidelity Investments launched "SimpleStart IRA," which is targeted at people ages 21 to 40. The IRA's offerings are centered on Fidelity life-cycle funds, which grow more conservative as an individual ages. And instead of requiring the usual $2,500 minimum to open a Fidelity account, SimpleStart incorporates an account-building feature that allows investors to direct a set amount to be transferred automatically from a bank account each month. Applying for the IRA just involves choosing a monthly investment and a projected retirement date. SimpleStart is Fidelity's first IRA product specifically marketed to so-called emerging investors.
In January, T. Rowe Price Group plans to roll out a similar offering called "SmartChoice IRA." The IRA also offers only funds targeted to specific retirement years, and the account holder is required to choose just one. Among other offerings, E*Trade Financial Corp. rolled out a no-fee, no-minimum IRA in February.
The companies are looking to make it easier for young investors to open IRAs by simplifying the process. The new IRAs from Fidelity and T. Rowe Price, for instance, basically involve picking one life-cycle fund based on a specific retirement date. With such funds, young investors don't have to worry about asset allocations or rebalancing their investment choices because the funds' investments automatically grow more conservative over time -- for instance, moving toward more bond holdings than stocks as an individual gets closer to retirement.
What individuals at the younger end of the retirement market "needed was a simple way to get started and an affordable option," says Sean Belka, senior vice president of personal investments at Fidelity.
The younger someone starts saving for retirement in these tax free accounts, the more they get to take advantage of the powerful effects of compounding.
For example, if someone puts $2,000 each year under their mattress beginning at the age 20, by the time they reach 65 they will have set aside $90,000.
However, if this same amount is invested in a stock index that averages a 9% return over the same period of time, instead of having $90,000 they will have $1,251,725.52. That's a difference of $1,161,725.52.
So the lesson is simple: save early and often. It's worth it in the long run.
Posted by Peter Mork at 11:00 PM | Comments | TrackBack
December 10, 2004
Abolish the Corporate Income Tax?
Richard Rahn says yes:
Good economists have long known the corporate income tax causes more problems than it solves. Many countries, seeking higher economic growth and employment, have sharply cut their tax rates. Ireland cut its corporate tax rate from 43 percent to only 12 1/2 percent, attracting investment from around the world and, in turn, becoming not only one of the fastest-growing but one of the wealthiest economies in Europe.
The new market economies of Eastern Europe seeking high growth and rapid job creation have also been cutting their corporate tax rates. Slovakia, Lithuania and Poland have a 19 percent corporate rate; Hungary 16 percent; Slovenia and Latvia 15 percent; and Bulgaria just announced it will move to a 15 percent rate next year. Montenegro, not to be outdone, announced it will go to a 9 percent rate. Estonia has become the champion by going to a zero rate on reinvested profits.
As a result of this competition, even France (34 percent) and Germany (38 percent) have been forced into modest corporate tax reductions, giving them lower rates than corporations face in the United States. American companies now have an average 40 percent rate (including state corporate taxes), and only very poorly performing Japan with its 42 percent rate is higher.
Looking at these numbers, it is easy to understand why corporations doing business around the world elect not to have the United States as their legal home, because it makes them noncompetitive.
Posted by Peter Mork at 1:11 PM | Comments | TrackBack
November 26, 2004
A National Sales Tax... Revisited One More Time
My second post on a national sales tax once again generated quite a response. Before I address the subject for a third time, I must say that a national sales tax, as proposed at FairTax.org, would not be my preferred form of funding the government. Ideally, I'd like the government to be funded through voluntary means such as contract insurance and national lotteries. However, these proposals are far fetched in today’s fiscal environment and as such a revenue neutral sales tax holds much more promise.
Many of the concerns over a national sales tax expressed by several of my readers I formerly shared myself. Specifically, two concerns were at the forefront of readers’ responses. First many were concerned that a consumption tax would shift the burden of taxation towards the poor and the middle class. Secondly, there was a concern that the U.S. is a consumption driven economy, and as such a tax on consumption would have detrimental effects on economic growth. As mentioned above, I originally shared both concerns when learning about a national sales tax. In fact, initially, they led me to believe such a tax should not be implemented. But upon further study I have changed my mind on both accounts.
In addition to the critiques above, another criticism was that under a sales tax those who "work for a living" would be responsible for the entire tax burden, while rich investors would be off the hook to live tax free. This analysis can easily be turned on its head by simply reviewing the nature of the tax.
Below I will address all these concerns.
But one thing to keep in mind during the discussion is that the purpose of taxes is to fund a functioning government that protects our rights and allows us to live peacefully amongst one another. I think we all can agree that the creation of a tax policy, that both fairly and efficiently raises this revenue, is a common goal we all can share.
Won’t a National Sales Tax Shift the Burden of Taxation to the Poor and Middle Class?
Looking at the most recent data from the IRS, this indeed could be a cause for concern.
As we can see the top 1% of income earners paid over a third of the total income taxes collected by the IRS. Conversely, the bottom half of the income scale pays a scant 3.5% of total income taxes. Any reforms to broaden the tax base would then seem to surely increase the burden on lower income individuals.[1]
One thing to remember though is that the income scale above does necessarily translate into a scale from rich to poor. To demonstrate this point, imagine a family where a husband and wife both work, earning $55,000 and $40,000 respectively. This would put their household in the top 10% of income earners, but it would not mean that they are wealthier than 90% of the country. In fact if they are putting a child through college, have a mortgage, a car payment, etc., finding dollars to spend at a country club would probably be impossible. Similarly, take a family where the head of the household is unemployed, but they sell their home for a one time capital gain of $150,000. While this would push them into the top 5% of income earners, the comfort of this cash windfall would most likely be short lived.
Conversely, consider a retired couple who owns their home outright, has very few expenses, and retires with a pension of $50,000 a year. While this would place them lower on the income scale than the families in the two examples above, who could seriously argue that they are poorer?
This is a key flaw in our current tax system that is partially addressed in the article authored by Baum. Each individual with a valid social security number would receive a check from the government, reimbursing them for their taxes paid on purchases up to the poverty level. Therefore the poor, as defined by the Census Bureau, would pay no taxes. For a family of four the poverty level is currently $18,810 a year. A family that made $100 over this level, and decided to spend that money on a new television would pay a total of $23 in taxes (an effective tax rate of 0.12%). A family that made $1,000,000 over the poverty level and decided to spend it all on a new yacht would need to pay $230,000 in taxes (an effective tax rate of 22.58%).
So while the truly poor would face a minimal tax rate, if any at all, what about the middle class? Here I must defer to calculations on the fairtax.org website. They compare various middle income families' tax returns under the proposed national sales tax and the current system. The results look very favorable and can be viewed here.
Now can I vouch for these calculations personally? While they look correct, there certainly could be something that I am missing. But taken at face value, at the bare minimum, they show promise. If we find there is a segment of the population that would be unjustly burdened under the plan, we could (and should) tweak the minimum refund level to address these concerns.
Of course, it would also take quite an effort to reform the current tax code but in my opinion the benefits would outweigh the costs. The question that follows is what are the benefits that make it worthwhile?
A flat national sales tax would have the enormous benefit of simplifying the tax code. It would eliminate both the wasteful spending of billions upon billions on tax compliance and a 45,622 page tax code that not even the most intelligent tax lawyers and accountants can understand. But what intrigues me most about such a tax it would shift taxation to consumption, rather than savings.
But if Consumption Drives the Economy, Won't a Sales Tax Kill Economic Growth?
It is an excellent question. For even if a national sales tax could be implemented without shifting the tax burden to the less fortunate, could it not have disastrous economic consequences? It’s said that consumption drives the economy, and thus taxing it would seem to surly hurt economic growth.
To take this viewpoint though is to ignore the important role that savings play in consumption. Let’s take the most obvious example: the housing market. Would it be possible for the average middle class family to buy a house if they had to do so out of their present income? Clearly the answer is no. Yet everyday people pay for expensive items such as houses, cars, large appliances, or college tuition that exceed their disposable income. How can this be? They can do so by relying on the savings of others to finance these purchases. Without savings, consumption of these expensive items would be severely limited, if not impossible.
Similarly, a majority of the country earns a living by selling their labor (i.e. they receive wages). The majority of these wages are then used to consume goods that are essential (such as food, shelter, medical, etc.) or for pleasure (i.e. entertainment, vacations, etc.). But wages would also be impossible without savings. Factories and businesses that employ so many of us could not be constructed without a source of funds. In addition, wages themselves could not be paid if the owners had not put money aside to pay them. Products take weeks, months, even years to produce before they are finally sold for a profit. But employees don’t need to wait until the product is sold to collect their wages, they are paid out of savings. Can you imagine how poorly the economy would function if everyone had to wait until the final product they helped to produce was sold in order to collect the money they had earned? Such an economy would fall apart.
This is not to demean those who earn wages compared to those who save in any way. Clearly, saving money wouldn’t do much good if there was nowhere to invest it. And more importantly, this classification ignores the fact that these groups are often one in the same. I’m simply pointing out that savings are key to any economy and to consumption, no matter the source of the funds.
For me it is always easiest to look at such a system in very simple terms. Imagine an economy that is represented by one farmer with one product: corn. The farmer can use the corn he possesses in one of two ways. He can eat the corn to feed himself or plant it to grow more corn for the future. Now obviously if the farmer were to eat his entire supply of corn he would have none to plant, and while content today, he would starve in the future. On the other hand, if the farmer were to plant his entire supply of corn, he would starve before he could reap the future benefits. Clearly, there is a trade-off. That which is planted (i.e. saved) needs to produce enough in the future to equal his current consumption. If the farmer plants enough so that the future yield is greater than his current consumption, not only will he be able to consume more in the future, he will be able to save more as well. By saving, his corn field will grow larger than it is today… and this is equivalent to economic growth.
Now our economy consists of much more than corn but the analogy is still valid. By saving instead of consuming we increase our capital stock. Our savings flow into the technologies, factories, and business of tomorrow and that allows us to both produce and consume more than we currently do. Wealth is created. Again, this is the definition of economic growth and savings is what spurs it.
To look at it another way it’s beneficial to everyone if someone who has earned a small fortune invests $500,000 in a new company that creates products and expands our economy. If instead they use this money to buy a new sports car they are spending their money not on something that will create wealth, but something that will be of use only to themselves and will be worth less and less as it is worn out. We're all better off if this rich individual saves his money, for it benefits us all.
And remember, if you want people to stop smoking, tax cigarettes and people will do less of it. On the flip side, if you want people to save, make savings tax-free and people will do more of it. That’s the essence of a national sales tax.
The Rich Will Live Tax Free
"...to me it is morally wrong to say that if you work for a living you should pay taxes, but if you are rich and live off of other peoples [sic] work you shouldn’t. "
This was the conclusion of a rant against my previous post on a national sales tax over at San Diego Politics by friend Patrick Finucane. I'm not sure that he realized it, but he actually makes a strong case for the sales tax he is trying to demonize.
Even ignoring the erroneous Marxian undertones, the statement is still absurd as proven by the discussion above. Missing from Pat’s analysis is the straightforward fact that the reason people save and invest their money now is so that they can spend and consume products in the future. If someone has saved $20,000 and they pull this money out of the bank to buy a new car, they will pay taxes, even if they are the richest person in the world.
If you’re worried about the wealthy not paying taxes you need look no further than our current system. A family with $10,000,000 in municipal securities (i.e. state and local bonds) pays absolutely no federal income taxes.[2] If these bonds yielded 5% this would mean an annual income of $500,000 without paying a dime in taxes. If you think this is an unrealistic assumption, think again. The Kerrys, who are worth hundreds of millions of dollars, had an effective tax rate of a little over 12% last year. This is lower than the average rate of a middle class family from the most recent IRS data. Their tax rate was so low largely because they were invested in tax free bonds. Even taking away municipal securities, wealthy individuals can afford tax attorneys that can help them redefine income, or stash it offshore. These are options not available to the poor and middle class.
Implying that the basis for a national sales tax is that the “rich” shouldn’t pay taxes is blatantly false. The basis is that when anyone invests and saves their money (something that helps the economy grow and thus helps us all) they should not be taxed. But everyone is taxed when they spend their money consuming what we could call luxury items.
In short, the rich in no way get off tax free.
In conclusion…
… I realize there needs to be a debate on this issue and I myself have many more questions. I do believe though that some of the initial fears are overblown. I’m looking forward to a vigorous discussion on this issue, as I think it’s clear that our current system of taxation is in dire need of repair. Undoubtedly, we could surely do better than our progressive income tax. Hopefully I’ve demonstrated that a national sales tax might be a viable replacement that would make us all better off.
[1] Keep in mind that while I am focusing on income taxes, the proposed Fair Tax would replace "the entire federal income and Social Security tax systems, including personal, gift, estate, capital gains, alternative minimum, Social Security/Medicare, self-employment, and corporate taxes."
[2] I understand that the tax free status means a lower yield but the point is that no taxes are being paid to the federal government.
Additional note: I owe much to the teachings of George Reisman and his book Capitalism for the discussion on savings and consumption.
Posted by Peter Mork at 4:17 PM | Comments | TrackBack
November 18, 2004
Is a National Sales Tax Realistic?
A Stitch in Haste took me to task on my post on flat taxes from a few days ago. In his post, KipEsquire questions the logic behind the quotation I lifted from a Bloomberg article saying that the poor would be exempted from both a flat income tax and flat sales tax:
I found this statement utterly bewildering. How exactly do you give the poor, or anyone else, an exemption from a sales tax?
You exempt products from a sales tax, not people. Is the point that “basic necessities” (i.e., what poor people spend their money on) will be exempt? If so, then you can’t simultaneously argue fairness for the poor and simplicity, since a sales tax peppered with exemptions meant to ease the tax burden on the poor will not be simple, it will be very complicated.
Look at any state that has less than a ubiquitous, prophylactic sales tax, and you find a complex web of lists, exemptions, schedules, etc., often the result of politics and lobbying more than common sense... Not a road I’d like to see the federal government go down, given its track record with the Internal Revenue Code (currently at 2.8 million words and growing).
While I agree the wording sounds off, I just assumed that exempting the poor meant exempting products deemed as necessities (i.e. food, medical, housing). As for this leading to a complex list of exemptions, the sales tax out here in California seems to work fairly well without too much confusion. Why not use it as a blueprint.
Yesterday though, Caroline Baum wrote a follow up to her original article that I quoted. She reviews a sales tax proposal called the FairTax currently sitting in Congress and addresses several of the topics discussed above:
A bill to do just that -- and abolish the Internal Revenue Service to boot -- has been introduced in the House of Representatives (H.R. 25) by Congressman John Linder, Republican from Georgia, with an identical bill in the Senate (S. 1493).
Under the FairTax, workers would take home their entire paycheck; nothing is withheld.
Instead of paying taxes on income, Americans would pay a 30 percent mark-up at the cash register on new goods or services. (The sales tax would be 23 percent if expressed as an income-tax equivalent.) Used goods aren't taxed. Neither are business purchases.
That sounds like a big loophole. (``The Porsche is not a recreational vehicle. It transports key documents to and from the office every day.'')
And perhaps it is. Unfortunately, there is no tax system that's immune from non-compliance. It's only a matter of degree.
and:
No one pays tax on consumption up to the poverty level under the FairTax. Every U.S. resident with a valid Social Security card gets a monthly rebate to cover the tax on purchases of essential goods and services.
Read the entire article if you get a chance.
What ultimately attracts me about the idea of a national sales tax is that A) it seems fair and B) investments would not be taxed, which would be great for economic growth. I agree with KipEsquire that there are undesirable issues with the tax (i.e. 30% seems high to me) but I'm not willing to write this plan off yet. To the contrary, the more I read, the more appealing it sounds.
Posted by Peter Mork at 6:26 AM | Comments | TrackBack
November 11, 2004
Flat and Fair?
Caroline Baum takes a look at the possibility of a flat tax on income or consumption. Could it be done fairly?
Any attempt to lower the tax rate, broaden the base (by eliminating deductions) and effectively tax consumption produces cries of ``unfair.''
And it's a legitimate criticism from a nation steeped in a progressive, graduated income tax system. The poor can't save; they spend everything they earn. A sales tax would be regressive.
Even in the pure flat tax envisioned by Hall and Rabushka, ``there are two brackets: zero for the poor and 19 percent for everyone else,'' Hall said.
Under either a flat tax or sales tax, the poor would be given an exemption ``that recognizes the right of a family to provide for itself before it provides for the government,'' said Pete Sepp, vice president for communication at the National Taxpayers Union, a non-partisan advocacy group in Washington.