Thursday, June 30, 2011

How to Fix Jobs

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Changing Our Tax System - Rather than Just Tax Rates - Would Go Along Way to Improving the Job Outlook and America's Economy

Americans have a pessimistic outlook on the future of the U.S. Many feel something is wrong, but few see the U.S.Income Tax as the economic obstacle holding our country back. Fifteen million Americans are out of work today. I believe the structure of the Income Tax is a major contributor to America's joblessness as well as its ongoing trade and budget deficits. Its effects are hidden, but harmful. To jump start the US economy, America should consider changing to a National Sales Tax.

Of the many arguments advanced against the Income Tax, the most crucial is that it puts domestic enterprise at a labor cost disadvantage to foreign competition. That's bad for jobs in America, and good for jobs overseas.

Who Really Pays the Income Tax?

We tend to think it's the individual tax payer. Thus the name “Income Tax,” its graduated structure, and the very philosophy for its existence. The idea that each taxpayer pays based on his or her level of income sounds good - but in practice it doesn't work out this way.

Let's consider workers receiving a fair market wage based on the laws of supply and demand. Now a part of this wage is taken away by a tax. The workers require higher wages to compensate. Wage rates increase, passing the tax on to their employers. The employers then have to pass the cost on in the price of their goods and services (or they go out of business - as we have seen in the manufacturing sector). The end result is the Income Tax is paid by the consumer through higher prices on anything domestically produced.

This might all work if we had a closed system (that is, a system where international competition were not present). The root problem is the Income Tax is assessed only on domestic labor, putting US based businesses at a cost disadvantage in the global arena.

The Income Tax Functions as a Domestic Tariff

A tax levied on goods imported to or exported from a foreign county is called a tariff. Tariffs are considered counter-productive by most economists. Through the Income Tax, the United States has imposed a tariff on itself - on its own labor.

If we understand that the Income Tax in practice functions as a self-imposed tariff, then a number of things start to make sense. These include the loss of labor intensive jobs in the US, and the intractable trade deficit, which is running at approximately $35 billion per month.

Who Benefits (Or Thinks They Benefit) from the Income Tax?

Besides the workings of the Income Tax being misunderstood, there is a related problem: the Income Tax is popular. Yes, popular. Consider how many different constituencies benefit, or at least think they benefit:

- Government: the Republicans and Democrats on Capitol Hill may disagree about health care reform, but not the Income Tax. They may argue about relative rates, but never the structure of the tax itself. Elected officials find their importance and job security enhanced by the nature of an income tax. Giving out tax deductions is a good way to stay popular, no small consideration for the political class.

- Unemployed: there's no Income Tax to pay. An unemployment check may be in the mail. It's easy to not realize one reason for the unemployment is the income tax which is raising the cost of the job.

- Self-employed: quarterly estimates and Social Security matching is unpleasant, but businesses expenses are deductible, and unreported income is a possibility.

- Traditional Employees: employees will not pay the tax due to withholding. Come April, a refund check may be in the mail.

- Tax Favored Industries: those employed in industries such as accounting, law, and real estate benefit. Tax deductible services are good for business.

- The Upper Middle Class: deductible savings programs like 401ks and Roth IRAs help, as well as myriad itemized deductions.

- The Rich: many loopholes and planning strategies are offered by the complex tax code. The rich are often rich in assets, rather than earned income. Under an income tax, income - not assets - is taxed. Tax free bonds and other tax advantaged investment options exist.

- Foreign countries: they may complain about trade barriers, but not the US Income Tax. Note: every industrialized country other than the US levies a Value Added Tax (VAT). Do these countries, with their rapidly expanding export based economies, know something we don't?

The Controversial 16th Amendment had to be Passed to Make the Income Tax Constitutional.

It has often been pointed out Karl Marx listed a graduated income tax as the second point in his Communist Manifesto for the steps necessary for the transition from Capitalism to Communism. The Founding Fathers, however, were not so keen on the Income Tax. The controversial 16th Amendment had to be passed to make the Income Tax constitutional.

The Income Tax Puts Pressure on US Based Companies

The Income Tax puts tremendous pressure on businesses based in the USA. This is why many manufacturing firms relocate outside the US. The US Government is dependent on one main source of revenue – a tax on the jobs of American workers. This can't be good for jobs. The only way US businesses can lower their tax burden is to reduce the number of employees on their payrolls. Is this the incentive we wish to create?

Eliminating the Income Tax, and Implementing a Sales Tax Would Benefit the US Trade and Budget Deficits

Eliminating the Income Tax and implementing a Sales Tax (or a Value Added Tax) would address many issues. A Sales Tax would apply to all goods and services sold in the United States. Imports would be taxed on an equal basis with domestically produced goods. Note: US exports would not be subject to a Sales Tax since they wouldn't be purchased in the US. Companies based in America would become more competitive both here and abroad.

The most intractable problems of the modern US economy would be addressed. The trade deficit would be favorably impacted, as US exports would be less expensive and imports would cost more. The budget deficit would benefit because an increase in taxes would not penalize American businesses versus foreign competition. Government would be more accountable and transparent. The complex system of deductions and regulations would not be needed. Government micromanagement of our economy would be reduced.

Proponents of a National Sales Tax often argue that Americans would pay less with a Sales Tax. This isn't the key issue. Isn't it better to have an income and pay taxes than to have no income at all? What is needed is a tax system which allows Americans to fairly market their goods and services in a competitive global economy. The Income Tax fails at this, and in so doing, fails the unemployed - and all Americans.