Tags: Tax | GDP | income | reform

A Fiscal Blueprint for America

Friday, 12 Oct 2012 07:43 AM

By Barry Elias

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During the past half-century, fiscal policy regarding healthcare, finance and real estate have had devastating impacts on our society.

Based on the most recent report from the Congressional Joint Committee on Taxation, income tax deductions are responsible for nearly $1 trillion in foregone tax revenue. In 2011, healthcare, finance and real estate were responsible for $277.1 billion of this loss, approximately 25 percent of the total.

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The income exclusion of employer contributions for healthcare, health insurance premiums and long-term care insurance premiums resulted in lost tax revenue of $109.3 billion in 2011. This preferential treatment, along with open-ended Medicare expenditures since 1965, has artificially increased demand for healthcare products and expenditures. Since 1940, healthcare expenditures as a percentage of gross domestic product have grown from 4.5 percent to nearly 20 percent. Despite this extraordinary amount of spending, our morbidity statistics are rather dismal with respect to the rest of the world: 50th in life expectancy, 49th in infant mortality and 48th in maternal mortality, according to the CIA World Fact Book.

Reduced tax rates on dividends and long-term capital gains decreased tax revenue by $90.5 billion in 2011. As a result, demand for financial assets exploded. According to the Federal Reserve Bank Flow of Funds report, the ratio of financial assets to GDP remained constant at 4 for the three decades prior to 1980. However, by 2010 (three decades later), this ratio increased to 10. Lower capital reserve requirements for financial institutions and consumer debt purchasers, along with financial-derivative deregulation, exacerbated this demand causing debt levels (public and private) to expand considerably — from nearly 150 percent of GDP in 1970 to over 370 percent in 2008, based on analysis from the Bureau of Economic Analysis, the Federal Reserve Board and the Census Bureau. The total value of derivative products increased from virtually zero in 1980 to more than $700 trillion in 2011, according to the Bank for International Settlements.

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Mortgage interest deductions reduced tax revenue by $77.6 billion in 2011. This policy artificially increased demand for real estate and the associated mortgages. Lower borrowing standards and financial deregulation also increased demand for derivative mortgage products, which severely burdened our society with debt that led to the financial implosion of 2008.

Excess demand for these items might not warrant the preferential tax treatment, since they have not had a commensurate impact on society in terms of increased employment and income. Since 1980, we experienced a 50 percent decline in fixed investment as a percentage of GDP (from 22 percent to 12 percent). More importantly, the economic multiplier fell more than 50 percent, from 3.5 to 1.5, according to the St. Louis Federal Reserve Bank.

The economic multiplier is key, since it describes how much income is created from a given expenditure. In 1980, $1 of expenditures generated $3.50 of income. Today, that same dollar only generates $1.50 in income. This fall is the result of lower levels of investment relative to GDP in productive, sustainable businesses that generate high value products, stronger employment and greater income growth.

I suggest we alter the federal tax code to promote more investment, employment and income. I recommend that we provide a single tax deduction to families that equals the federal poverty level (FPL) plus direct domestic investment. According to the Department of Health and Human Services, the FPL would be approximately $20,000 for a family of three. Any income above this level would be taxed at a flat rate. Profits from direct investment would be subject to the current maximum long-term capital gains tax rate of 20 percent, with no additional payroll taxes. This would save nearly $400 billion in tax compliance expenditures, which could be used more effectively and efficiently elsewhere.

For the median annual family income of $50,000, this would translate to a 25 percent tax rate, which includes the 15 percent payroll tax, leaving 10 percent for federal income tax. This rate can be reduced if government expenditures are lowered and/or if income is increased.

Corporate tax revenue represents roughly 10 percent of all federal tax revenue. Permitting deductions for dividends and capital gains and reducing the tax rate in half would reduce corporate tax revenues in the short term. However, this reduction would be offset by the increase in personal income tax revenue. In addition, these corporate incentives would increase the propensity to invest, employ and generate income, thereby increasing tax revenue in the future.

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This methodology would limit the ability of politicians to carve out special exemptions for special interests, since these proposals would be more transparent and not camouflaged by a lengthy, highly complex tax code.

Greater political responsibility would be achieved by tying compensation to performance. We could provide a starting level salary for Congresspersons equal to the 98th percentile of all earners, with an annual growth rate equal to the Consumer Price Index (i.e., $250,000 per individual with a family plus annual cost of living adjustments). Additional compensation could be received if the annual deficit is reduced or surpluses are generated.

Also, as with the executive branch, all assets of the politician and his or her immediate family would be placed in a blind trust to minimize the creation of legislation that unduly benefits the politician at the expense of society.

This construct seems fair, transparent, less susceptible to manipulation by special interests and focused on direct investment, employment and income generation. I believe it warrants serious consideration.

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