The Transaction Tax on Deposits: Has the IRS Finally Met Its Match?

If I made you the President, Congress, and Supreme Court and you can change one thing, what would it be?

Many of us feel the U.S. is headed to the point of no return and feel the American dream is no longer attainable. How many of you are tired of hearing about government shutdowns, raising the debt limit every year, or you aren’t paying enough taxes?

The Founding Fathers gave the Federal Government the power to establish a means of monetary exchange and to protect our property rights. The government has a right to charge a fee for these services, a brokerage fee if you will that serves to facilitate a voluntary exchange of rights between two or more parties.

But things changed in 1913 when the 16th Amendment gave the government the power to tax income, thus creating the IRS. We were told only the rich would pay it; that it would even the playing field between the rich and poor, the have and have-nots. 100 years, and 74,000 tax code pages later, what happened? How did we get here? What would Ben Franklin, George Washington, Thomas Edison, or Henry Ford think if they were around today?

Today, the rich are still rich, the poor are still poor, tax revenues as a percentage of GDP have averaged 18% over the past 100 years (no matter if rates were 34% or 94%), we are $19 trillion in debt, and the dollar has lost 96% of its value. This doesn’t even include the future promises that were made with Social Security and Medicare.

What if there is a better way than the one we have now? A way that:

• Addresses these issues and reverses these numbers

• You can keep close to 100% of your paycheck and you decide how it is spent

• Government can run more efficiently

• Increases foreign investment in the USA, creating job opportunities

• Increases US competitiveness internationally

• Reduces your tax bill by 85% or more

• Replaces the current tax system, not adds to it

By now, you may have realized the answer to my question for me it to repeal the 16the amendment and eliminate the income tax. But what do we replace it with?

The Founding Fathers were adamantly against giving the government the power to tax income. In fact, taxing income was a basis for the American Revolution which, in their minds, took too much power from the people and transferred it to the government.

It wasn’t until the late 1890’s, early 1900’s that taxes went from not only as a means of generating revenue for the government, but also as a vehicle of social justice, which is a redistribution of wealth from the rich to the poor.

The U.S. tax system is unique in that it is both progressive and regressive at the same time. Progressive (Regressive) means as income increases (decreases), the tax burden as a percent of income increases. The argument for a progressive tax is the ability to pay. Those who make more should pay more. But how much more is the question.

Today, the tax code is over 74,000 pages long, most of which goes to the definition of income. No one could possibly know what is in those 74,000 pages. Even those who wrote it don’t know. It costs approximately $12 billion to administer. This doesn’t even include fraud or the underground economy that pays no taxes at all. Since we live in a global economy that is linked electronically at the push of a button, it isn’t difficult to move funds around to avoid high taxes. Americans spend countless hours trying to comply with the tax code. We are told that tax policy is designed to stimulate economic growth. Many of us believe that it is designed to promote a certain type of behavior (spending) while discouraging others (saving).

There has to be a better way. There is. It’s just a matter of will.

There have been several alternatives proposed to eliminate the current tax system. Some have been taken seriously, meaning a bill was introduced into Congress. Others have only been discussed theoretically. Most deal with replacing the income tax with some form of consumption tax. A consumption tax is a tax on spending for goods and services. You may have heard of some of these: A National Sales tax, a VAT Tax, the Flat tax, and the Fair tax.

All of these are better than what we have now. They are simpler, don’t punish savings and investment, progressive on consumption, improve US competitiveness overseas, and encourage foreign investment. But they still have flaws like administrative and compliance costs, regressive on wages, don’t replace all income taxes (except fair tax), calculating an accurate tax base, preventing fraud and evasion. Of course, all of these costs get passed on to consumers

So, how do you eliminate the tax code, fund the federal budget, and provide for the future entitlements that were already promised while providing businesses and families a tax cut? Find a tax base that is 100 times larger than the one we have now, and then provide an automated system that operates in real time.

The Automated Payment Transaction Tax (APT) was created by University of Wisconsin economics professor Dr. Edgar Feige and presented by William Hermann in 2003. The idea came from the fact that since so much of the economy is electronic due to advances in technology, why not take advantage of this same technology and simplify the way the government collects its revenue. The APT tax is intended to replace all federal, payroll, corporate, and estate taxes. It’s not intended to be an additional source of revenue for the government. It’s the simplest and most efficient way for the government to collect its revenue at the lowest possible cost to the taxpayer. Finally, it is intended to eliminate income tax returns (and the IRS!), reduce the opportunity for fraud and evasion, and broaden the tax base.

The APT tax is certainly an out-of-the-box way of thinking. The current system taxes income (GDP). The transaction tax is based on all of the transactions that make up that $13 trillion GDP. It is important to note that for the transaction tax to be revenue neutral, it must have an accurate number from the Bank of International Settlements, and an economist who knows how to interpret it. Once this is accomplished, it’s simple to administer. The rate is simply the Budget/# of transactions.

Here’s how it works. Every institution that generates a transaction would set up a Federal Government Tax Collection Account called a TPA (Tax Payer Account). The government only has access to the total aggregate sum of payments in the TPA. It wouldn’t have access to the individual transactions of a taxpayer. This ensures individual taxpayer privacy.

The technology already exists in the current systems of payments used by banks and credit card companies. This should help reduce the initial setup costs as opposed to starting from scratch. Simply post a credit to the deposit account of the payer and debit to the TPA. Institutions would only need to add a computer chip or some other software enhancement that would create a virtual tax payer account linked to every customer financial account.

For example, let’s say the rate is 5%. Mary goes to the grocery store and buys $100 worth of items. The tax of $5 (100*.05) is automatically transferred to the government TPA. All taxes are assessed and collected in real time.

Every transaction is treated in this manner, whether it’s receiving your paycheck, buying a car, or investing in a stock. No longer is there a need to file a tax return on April 15th and the government doesn’t incur collection and enforcement expenses. Also, individuals and business don’t incur the cost of compliance, including time.

By now, I’m sure you’re wondering what the rate is. The latest data available is from 2005. GDP was $13 trillion and the number of transactions was $856 trillion. Dr Feige then took a conservative approach in anticipating future behavior to try and avoid the tax. He deduced that a worst case scenario would be that the number of transactions would be cut in half. This is the only proposal that anticipates a worst case scenario. Most of the others present a best case scenario. Could you imagine the worst case scenario of those proposals where the rates were doubled? Debate over. Back to the income tax.

The base is $428 trillion ($856*.50). With government revenues of $2.4 trillion, the tax rate is.56% ($2.4/$428). Each side of the transaction would pay half. Going back to our grocery store example, the tax is $0.56 ($100*.0056). The buyer and seller each pay $0.28.

Let’s take a look and see how this affects the average American. Mary has an annual income of $50,000. After deductions, she is in the 15% bracket for a tax liability of $7,500 ($50,000*.15). Add another 7.65% for Social Security (6.20%) and Medicare (1.45%) or $3,825, we get a total tax bill of $11,325. Under the transaction tax, Mary has a base of $100,000: $50,000 coming in as income and $50,000 going out in spending and/or saving. It doesn’t matter how the $50,000 is used. It’s treated the same under the transaction tax. Her tax liability is $280 ($50,000*.0056) or ($100,000*.0028). That’s it. Plain and simple. No more calculating deductions and exemptions, trying to figure out if you qualify for some credit, or worrying if you’re going to get audited. No more tax returns. Period. April 15th is just another day. Plus, Mary has an extra $11,000 in her pocket.

Now, let’s see how it works for a rich guy. Mr. 1% has an annual income of $1,000,000. After deductions, which either took a considerable amount of time to calculate or cost to have someone else do it, he is in the 30% bracket for a tax liability of $300,000 ($1,000,000*.30). His payroll taxes are approximately $8,000, for a total tax bill of $308,000. Under the transaction tax, he has a base of $2,000,000 ($1,000,000 in, $1,000,000 out). His tax bill is $5,600 ($1,000,000*.0056) or ($2,000,000 *.0028). If we did the calculation for a corporation like Microsoft, we’d see similar savings.

I’m sure by now the question you’re asking yourself is “how can the government possibly pay its bills under such a system?” Then the one after that is “if the rich aren’t paying the taxes, then who is?” The answer lies in what makes up the $856 trillion tax base. Income only makes up 1.5% of the base ($13 Trillion GDP/$856 Trillion transaction base). Mr 1% is pretty close to that at 1.8% ($5,600/$308,000). Mary is at 2.4% ($280/$11,325). So what makes up that 98% difference?

Let’s start with the cost of doing business in the United States. If we do the math for Microsoft, let’s see how close their tax bill is close to being 98% lower. Their tax liability for 2011 was 4.9 billion ( 18%). Remember, we are no longer concerned with income. They would now pay a 0.28% tax on every transaction they make to bring their products to market. It doesn’t matter whether it’s on a dollar of revenue or a dollar of expense. If their net income was $0 or negative, their tax liability would still be based on all of the transactions they incurred. Under the current system, their tax liability would be $0. They had revenue of 69.9 billion, expenses of 41.9 billion, and 5.4 billion in dividends, giving us a tax liability of 328 million (69.9+41.9+5.4)*.0028. That’s a savings of 93% (.328/4.9). This doesn’t include what they did with retained earnings or stock options and other financial perks. We will address those next.

This goes for every single company, partnership, and sole proprietorship that operates in the United States. Since the tax is paid in real time when transactions occur, there is no longer a need for compliance, preparation, or any other costs associated with taxes. Skills and expertise can now be utilized elsewhere.

Next, let’s look at those areas of the economy that are currently not taxed. The two biggest are financial transactions and currency transactions. The biggest argument against the transaction tax is that economic activity would be adversely affected since these transactions are so important to market liquidity. However, this has already been taken into account by reducing the tax base by 50%.

Empirical research has shown that a transaction tax will have an adverse effect on security trades and currency trades, mostly due to the small bid-ask spreads. To counteract this, we created an alternative called transaction tax on deposits, which is only imposed on deposits (financial institutions that hold personal, business, and investment accounts). Investment accounts would be taxed twice: once on initial deposit and once when withdrawn and deposited into a bank account. The second tax could be avoided by allowing direct checking and debit cards from these accounts, which would make them more popular. For this example, we used a 7 year projection of economic expansion making the numbers more accurate.

• The tax base rises from $856 Trillion to $1.0 Quadrillion

• Subtract 50% as only deposits pay the tax for a base of $500 Trillion

• Subtract another 35% for financial and currency transactions for a base of $325 trillion ($500*.65)

• As in the original calculation, subtract 50% for behavioral changes to avoid the tax, leaving us with a final base of $162.5 trillion ($325*.5)

• If the budget is $3.7 Trillion, the rate is 2.28% ($3.7/$162.5). It is a bit higher than the APT rate, but considerably lower than the current system and all of the other alternatives. Note, there is no tax on cash withdrawals because they are not considered deposits

Going back to our Mary example, her tax is now $1,140 ($50,000*.0228) for a 90% savings of $10,185 ($10,185/$11,325). To show how flexible the rate is at minimal cost, let’s say we increase the rate to 2.50%. Total revenue for the government would be $4.062 Trillion ($162.5*.025), for a surplus of $362 Billion. Simple math: numerator divided by denominator. If we add compliance and enforcement savings of $500 Billion, we have close to an extra $1.0 Trillion to pay down debt or fund unfunded liabilities like Social Security and Medicare. I’ll leave you with these closing thoughts:

All of the alternatives presented are better than the current system. They are simpler and more efficient. But simpler doesn’t mean simple. The following issues still exist:

• Someone still has to collect the taxes and enforce the code

• Someone still has to determine what is income, a deduction, and an exemption

• It’s difficult to predict the amount of revenue that will be generated or anticipate changes in behavior to avoid the tax. None even attempt to.

• Since the tax is not collected immediately, the opportunity for fraud and tax evasion still exists

• Taxpayers still need to fill out forms and comply with the code (The IRS still exists, except with Fair tax)

• Perhaps most importantly, they are all regressive (wages)

The transaction tax on deposits solves all of these issues. Since it is paid in real time, the taxpayer doesn’t need to do any calculations, keep any records, or read 74,000 pages of the tax code. It’s efficient because the government doesn’t have to expend resources collecting the tax or enforcing the code. Real time payments also provide transparency. No longer is there ambiguity about who is paying the tax and how much they are paying. The calculation of the rate is simple: (Revenue needed/#of transactions). Finally, we won’t have to hear the “fair share” argument anymore because everyone is paying their fair share. Everyone has skin in the game. It’s fair because there is no more favoritism towards one group over another. No more pandering to lobbyist and special interest groups. Since wages, spending, and saving are treated equally, it’s not regressive. It’s progressive, not in rates, but through the skewness of the tax base, which makes it different from all other proposals. Since high net worth entities conduct most of the transactions, they pay most of the tax. The poor pay close to nothing.

The transaction tax on deposits is not foolproof. Any system can be manipulated. It won’t solve how our tax dollars are spent, only how they are collected. It won’t avert another financial crisis that is based on bad policy. It’s flexible enough in that the rate can be adjusted to meet projecting spending requirements (paying down debt and future entitlement promises), as long as we can calculate a reliable tax base.

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