Our current tax system runs to more than 60,000 pages of laws, regulations and rulings. It’s so confusing that many, if not most, Americans mail their return with no idea whether or not they’ve filled it out properly.
So it makes sense that we simplify the tax code. And in fact, most of the tax reforms being considered by a presidential advisory panel on federal tax reform would simplify taxes and, as a bonus, stimulate economic growth. This would do a lot of good for all Americans.
However, a handful of tax reforms would do more harm than good. One such scheme — the so-called two-track system — is being promoted under the false flag of tax simplification. The advisory panel should reject it outright.
The proposal sounds simple: Only high-earning Americans would be required to file annual tax returns and pay income tax. Everyone else (about 90 percent of all eligible voters in the United States) would be “free at last” — free from the annual ritual of filing tax returns and, in their own minds, free from having to pay taxes.
They would, of course, not be free from tax at all. Under this scheme, they would pay their share through a high-rate value-added tax (VAT) (search) similar to that used in Europe, which is a hidden tax on wages, dividends and consumer purchases.
But just because a tax is hidden doesn’t mean that it doesn’t bite. Under the VAT, most Americans would pay as much or more in taxes than they do now. The difference would be that they would be mostly unaware of it. Because they wouldn’t be filling out an annual tax return, they wouldn’t know how much tax they paid during the year and therefore wouldn’t know the price they were paying for all the ostensibly “free” government services.
Filling out a tax return and paying some amount of tax, even if it is small, is an important rite of citizenship. Besides, every American deserves to know how much government actually costs. That right should never be taken away under the guise of tax reform.
According to “two-track” proponents, the total amount of tax collected would be about the same as now, and the top tax rates would never be more than a modest 20 percent or so. However, it seems obvious that once a majority of voters have been bamboozled into thinking that government services are “free,” they will demand more of them, and Congress will gladly oblige.
Thus, the two-track system is a prescription for enormous expansion of government and escalating tax rates. The increasing taxes will especially burden the minority of voters subject to income taxes as well as the VAT.
The proposed two-track system is repugnant to the American dream. It would intentionally divide Americans into two classes: those who knowingly pay their taxes as full citizens and those of a lower status who simply have their pockets picked by the IRS without knowing when, why or by how much.
From a civics perspective, categorizing Americans as taxpayers and non-taxpayers is an open invitation to the kind of “soak the rich” political demagoguery that has occasionally torn the social fabric and might do so again.
The two-track system also would harm the economy. It would place a surtax on hard work, productivity and success. It would penalize Americans who have already succeeded and discourage others from even attempting to succeed.
That’s because even if they worked harder and more productively, they’d know that income taxes would take a large bite out of their earnings. A reasonable person near the income-tax threshold would likely decide that the increased income wasn’t worth losing his exemption from the income tax and, in his view, having to start “paying taxes” for the first time. That disincentive would frustrate economic expansion and harm all Americans.
For those already paying income taxes, the laws of economics dictate that increased work and investment would be discouraged, since ever-higher taxes would eat away at their gains. Moreover, this perverse incentive for these higher-income individuals to reduce their efforts would hurt the economy, since such individuals tend to provide most of the capital and high-value skills that drive economic growth.
As they reduce their own efforts, the ripple effect would inevitably lead to fewer and lower-paying jobs and fewer and less profitable investment opportunities for all Americans. Lower economic growth, or even outright stagnation, would result.
Given all the good, simple and pro-growth tax reform options available, there is no place in tax reform for a proposal that is both economically unsound and contrary to basic principles of American democratic government. We can fix the system so that it gives more people the opportunity to save, invest and become a capitalist. A VAT would constitute a giant step away from that worthy goal.
Ernest S. Christian is executive director of the Center For Strategic Tax Reform, and Gary Robbins is a visiting fellow at The Heritage Foundation.