November 12, 2003
With a year to go before the election, a new economic idea
has surfaced. Unfortunately for the
Democrats, it is coming from the White House.
For some time, I had been wondering whether the Bush
administration had a structure in its tax cutting other than returning what was
viewed as excess taxes to the people. It
is now apparent with this latest idea that tax restructuring is very much a part
of the Bush agenda.
The idea floated by the White House is to establish savings
accounts whose earnings would be tax free, much as the Roth IRA is today.
However, the deposit limits would be raised from $3000 to $15,000 and the
income limitation on contributors, currently $160,000 for joint income
households, would be removed.
To simplify the increasingly complex structure of tax
treatment of earnings on property, the current IRA program, a $2 trillion asset
base, would be capped at current levels. There
are some problems with respect to the employer sponsored 401K program and there
would be matching contributions to the savings plan for low income households by
the government. However, the effect
over time would be to sharply reduce taxes earned on property.
Some would say the program also would sharply increase
savings. This is unlikely, as only
4 percent of eligible households currently maximize their allowable
contributions to the existing tax advantaged accounts.
While the removal of income limitations certainly will sharply increase
deposits into these programs from wealthier individuals, most of those assets
probably will be transferred from existing holdings in accounts not now
receiving tax advantage.
If the program will have limited impact upon savings, why
do it? I already mentioned one
reason, to sharply reduce taxes paid on earnings from property income.
The vast majority of those earnings go to high income households.
However, the $15,000 limitation still will not alter the after tax
returns for the last dollar of dividends or capital gains earned.
Lowering taxes without changing rates for the last dollar earned does not
alter behavior. (A slight
fabrication, but good enough for politicians).
In short, it is another reduction in the tax liabilities of
the wealthy without significantly altering the desire to save.
The insurance annuity industry, which provides financial
instruments with tax deferred earnings that might be forgiven at death,
certainly would lose some customers. Some
small businesses might defer to the new savings programs and abandon their
pension programs completely.
There might be a desire to get the employer out of the
retirement savings business for its employees.
That probably will not be successful.
(Workers will want both savings approaches). Indeed, hopes of reducing or abandoning social security could
be wrapped around successful growth in these savings balances.
However, the largest desire is to slowly convert the tax
system from one that extracts resources from those creating value to one that
taxes the use of resources.
Despite long term consolidation of tax deferred savings
programs and the possible reduction in employer based pension offerings, the
proposal does not lead to tax simplification.
A dividend paid to an IRA or non-profit
endowment is tax deferred or tax exempt. Dividends also would not be taxable in
these newly proposed accounts. Dividends would
be taxable at a reduced rate if paid directly to investors in a taxable account
and would be treated as income, not as tax preferred earnings, if the dividend
is paid into a margin account.
I defy any economist to determine the percentage of that
last dollar of dividends paid that will go to the government in the form of
taxes after this proposal is initiated.
Frankly, I believe in the goal of taxing the use of
resources rather than the creation of wealth (although I have serious problems
with the transfer of wealth to those who chose their parents wisely.)
I have argued for tax advantaged savings programs as a first step in
moving toward that goal for many years.
But there is a better idea that will lead to simplicity
rather than complexity. Tax
consumption directly and forget about income.
Send a check to every legal resident large enough so that households at
the poverty level of income will
get all their consumption taxes covered with that check. Those with less than that income will receive more than they
are taxed. Collect from the
providers of goods and services and forget about all the income tax records and
Where we are now using government tax treatment to alter
behavior, use direct subsidies (virtually all economic studies show that the
cost of behavior alteration is lower through direct subsidies than through tax
There are even trade advantages to a consumption based tax
system that are within the trade guidelines.
Consumption of imports would be taxed.
Sales of exports would not.
There is structure in the White House tax proposals, but there is no simplification. Why can't a Democrat come forward and propose both?