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 forms. 

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 advantages).

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?


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