The United States income tax system does not take into consideration the effect of globalization and automation taking jobs from the working class. In addition, income taxes have become a political football with groups vying for tax rates, income definitions, deductions, and credits that favor each group’s special interest. It’s complex and unfair.
This paper uses US data from Gross Domestic Product (GDP) to demonstrate that a 7% flat tax for all is simple and fair and would replace 100% of the receipts from income taxes. It puts the burden of tax on factors of production (labor, other factors, capital, and imports/exports) rather than income. For example, taxes paid by labor would drop from 66% to 38%, which would more fairly represent labor’s contribution to overall US production.
Payroll taxes that pay for Social Security and partial payments for Medicare are also addressed separately with suggested improvements thereof.
A hot topic today is the effect of globalization and automation on American jobs. This paper proposes a tax plan that more effectively deals with American jobs lost due to offshoring of manufacturing and services to low labor cost countries and to automation. In addition it proposes a simple and fair way to replace the very unfair and broken US federal tax system that exists today.
It begins by describing the effect of offshoring of jobs from globalization, automation, and aspects of the broken US federal tax system.
Globalization and Offshoring of Jobs
Up until the beginning of the 20th century means of travel and communications were slow and expensive. The primary means were human, animal power, and wind for ships. Although trade existed it was minor as compared to the overall production of a country.
Early in the 20th century travel and communication costs declined rapidly making trade between countries highly feasible. Companies saw the opportunity to move manufacturing and sometimes services to low labor cost countries because it was now cheap to transport goods and services to consuming countries. By the beginning of the 21st century these actions, which we now call globalization, was in full swing.
The effect of globalization has had a material impact on labor in America. Not only were jobs lost, but wage rates were lowered in order to be competitive. As one will see later, most countries have a border-adjusted tax to level the playing field. This is not tariffs on individual goods. The United States does not have a border-adjusted tax, putting American jobs at risk.
Automation Taking Jobs
There has been a fundamental shift in the relationship between man and his tools. Up until very recent times, man’s tools for the most part required a man to operate them, providing many jobs. Again, about the middle of 20th century that began to change.
Computers with increasing capabilities of artificial intelligence were being developed to operate man’s tools. The era of automation had arrived. With automation, man was now needed to a far lesser extent than before to operate his tools. Inexpensive computers had simply replaced many workers. Of course, some new jobs were created to support this automation, but not as many as those lost.
The possibility of greater goods and services at a cheaper price has certainly been made available with man’s new artificial intelligent tools. The downside is the displacement of workers by these intelligent machines.
The following chart displays the percent of wages and salaries to Gross Domestic Product (GDP) from 1960 to August 6, 2015. GDP is the total monetary value of all goods and services produced in the United States each year.
As one can see, as other factors of production increase, wages and salaries from labor declines. In this case, wages and salaries accounted for about 50% of GDP for the years 1960 through 1975 as compared to about 43% today. As other factors of production continue to increase (especially with automation) wages and salaries from labor will continue to decline as a percent of total GDP.
Before proposing a new and fairer United States tax code, it is best to briefly look at what’s currently in place. The following is a table of major Federal United States tax revenues for the year 2012. The year 2012 was chosen due to the availability of data needed to make the new proposed tax plan shown later in this paper.
Sources of Total Federal Tax Revenues 2012 (in billions)
Individual Income Taxes $1,132
Corporate Income Taxes 242
Subtotal for Income Taxes $1,374
Payroll Taxes 846
Excise, Estate, & Other Taxes 230
Total Taxes $2,450
Over the years, income taxes have become a political football with groups vying for tax rates, income definitions, deductions, and credits that favor each group’s special interest. For example, it has allowed for offshoring of income to escape taxation. Some of our major corporations pay little to no US income taxes. There is little fairness in the way Congress or regulators create and apply income tax provisions. The tax code and regulations are a hodgepodge of laws and regulations that is complicated and unfair to many groups.
As other non-labor factors of production, which include automation, contribute more to production than labor, labor bears the brunt of taxation with other factors contributing little to none. In addition, other countries have border adjusted taxes while the US has none, therefore putting America in a less competitive position. Maybe there is a simpler and fairer way for taxation to be applied to counter job losses due to automation and globalization.
The remainder of this paper will deal with proposed replacements for individual and corporate taxes, change in payroll taxes and a discussion about excise, estate, and other taxes.
Consumption Tax Based on Factors of Production to Replace the Income Tax
In the past, tax on individual and corporate income was used as the basis for financing the general fund of the United States government. A new method of taxation based on factors of production for a consumption tax is proposed.
Other factors of production, which is now a large share of GDP, paid nothing in taxes. In addition, there was no adjustment for across border imports and exports. It is proposed that factors of production for goods and services produced be used as a basis for a tax, rather than income.
The table on the left shows the current major components of GDP as it is normally computed for the year 2012. The table on the right shows a proposed revised method of computing GDP that will later in this proposal be used as a basis for applying a tax. The total GDP is the same for both tables, only the components are different.
Sources: The source for GDP spending is from US economic data. The source for GDP labor and capital is from consolidated all Individual and Corporate tax returns. Other Factors was derived by subtracting Labor and Capital from total GDP.
The following is a description of each of the factors of production that could be used for the basis of taxation.
For the purposes of this concept paper the category “other factors” is comprised of the total GDP less labor and capital adjusted for imports and exports. Other factors include a wide range of activities which includes but is not limited to automation
The determination of other factors would be quite simple when applied to every firm in the United States. Every firm would compute their total expenses and deduct labor to determine other factors valuations each year. An issue is that firms transfer goods and services from firm to firm, therefor double counting could occur. Upon a sale the other factors and labor costs of one firm are passed on to the next firm in terms of the sales price so it would be taxed twice if adjustments were not made.
In order to avoid a major portion of double counting, goods purchased for resale would also be deducted along with labor from total expenses to arrive at other factor valuations. The accounting for goods and services purchased and not to be resold but consumed will be discussed later.
In addition exports and imports would be border adjusted. Exports would be deducted so as not to be taxed because exported goods are not consumed in the US but in another country. Imports would be reported separately because those goods are now consumed in the United States.
Companies would find it extremely easy to compute the valuation for other factors that would be used as the basis for application of the US tax each year. The following worksheet example shows just how simple it is.
It couldn’t be any easier, a one page tax return. Firms would be responsible for payment of an estimated tax on a monthly basis.
Labor would be paid in the same way as it is today through wages and salaries. Deductions would be made by employer’s also as it is done today. The matching amounts paid by employers today is considered in other factors rather than labor for purposes of this analysis. Individuals receiving the wages and salaries would be responsible for paying their tax, not the employer.
Social Security, pensions, annuities, and other type of retirement account payments would be considered the same as wages and salaries. They are only delayed income from past employment.
The tax return would be a simple one page tax return. Individual recipients would be responsible for paying the tax that may be due over and above amounts withheld, or they may enjoy a refund.
Capital is the financing for enterprise and governments. Capital is usually rewarded for its use with payments of interest, dividends, distributions, and gains/losses on sale of investments.
Today taxes are paid on net income of companies as well as on dividends, and interest. In many cases there is double taxation. A simpler way is proposed.
The plan proposes that only interest and cash/property dividends, distributions, and/or gain on investment sales would be taxed as received. The actual payments made to the suppliers of capital would be the basis for applying the tax. It is very easy to compute. Any person or organization receiving these capital cash/property payments would be subject to the tax.
Again it would be a simple one page tax return. Estimated taxes would be paid on a quarterly basis with a true up at the end of each fiscal year.
Not only is the plan simple and easy to operate but it eliminates the need for offshoring of net income that many international companies currently utilize in order to stop payment of income taxes to the US.
Consumption Tax Based on Factors of Production
Now that the basis for applying a Consumption Tax has been established, the actual tax can be set. The following are the factors used to produce goods and services consumed, the percentage of each, and the application of the Consumption Tax for each factor of production for the year 2012.
The difference between GDP and Tax Basis is that GDP measures production done in the United States while Tax Basis measures consumption. Exports which are goods manufactured in the United States but not consumed in America will not be taxed. Conversely, goods that are imported are consumed in the United States and therefore are subject to taxation.
In actual practice the tax rate for the other factors tax would be lowered so as to adjust for double counting of the other factor basis. The adjustment is simply taking the other factors value computed in aggregate divided by the sum of other factors values computed by individual firms. It would be very easy to do with IRS computers. The following is an example.
Taking this example a little further, one will be able to see that the total consumption tax collected is the same even though the tax rate has been lowered.
The lower other factor tax rate times a higher other factor basis for individual firms would produce the same tax as if done in with aggregate GDP.
Comparison of Current Income Tax to Proposed Consumption Tax
The following table compares the current income taxes for the year 2012 to the proposed consumption tax. Corporate income taxes was considered similar to other factors tax since both are paid by companies. Incomes from aggregate 1040 tax returns for labor and capital were used to allocate total individual income taxes. Although this method is not totally correct, this example provides a good approximation for comparison purposes.
Notice that taxes on labor dropped from 66.1% of taxes paid to 38.0%. The reason is that other factors (which include automation, etc.) as well as imports (effect of globalization) now are paying their share of the taxes. Capital participates with lower taxes along with labor.
Advantages of the Current Income Taxes to Proposed Consumption Tax
- Low rate of 7.0% for all and for firms a rate could be as low as 3.5% which adjusts for double counting.
- Fair as to allocation of resources used for production of goods and services consumed. Labor and capital no longer pay a disproportionate share, other factors and imports now pay their share.
- Levels the playing field with foreign countries as to imports and exports with border adjusted taxes.
- Easy to apply, simple tax returns and virtually eliminates the requirement for the IRS
- Difficult to manipulate.
- Not subject to political football of special interests groups vying for an advantage.
Federal Retirement Plan to Replace Payroll Taxes
Payroll taxes are primarily used to fund Social Security. The new Federal Retirement Plan would be very similar but with the following adjustments.
Social Security Fund would be separated from General Funds
The Federal Retirement Plan would be totally separated from general fund and activities of the US government. It would stand on its own as opposed to the current situation.
The Employer and Employee Portions would be Adjusted by Aggregate Other Factors/Labor Percent each Year
The employee and employer portions paid would be prorated based on the respective share of labor and other factors of their total.
For the year 2012 the total payroll taxes (both employer and employee) was $846 billion dollars. Under the proposed plan employers would have paid $497 billion dollars (48.6%) and employee’s $536 billion dollars (51.4%) based on the above allocation formula.
Surplus Funds would be Invested in US Treasury Bills, Notes, and/or Bonds for Interest
Rather than borrowing from Social Security surplus funds by the Federal government, the proposed plan calls for investing the surplus in US Treasury bills, notes, and/or bonds that pay interest.
The US Retirement fund would be funded by employees and their employers and operated totally independent of other US government financial operations. It would earn interest income and be protected from US government manipulations.
Excise, Estate, & Other Taxes
There would be no change in the excise, estate, and other taxes for now without further review. Excise taxes are generally specific tax on users or a tax to discourage use (like sin taxes on cigarettes). The goals of estate taxes is to level the playing field so all people have a chance for success based on their own wits and labor rather than wealth handed to them without any effort.
The following are bullet points used to summarize the concepts in this paper.
- Globalization is Taking American Jobs – Due to low cost transportation and communications, other low labor cost countries are taking American jobs.
- Automation is shrinking the Amount of US Labor Used in Production Goods Consumed – With the advent of artificial intelligence manning tools, production is shifting away from labor as a factor of production. Yet under the current tax structure labor is footing a large share of the bill.
- The United States Tax Code is Complex and Does not Resemble Fairness – Special interest groups have butchered the US tax code to gain advantages for themselves, which is simply unfair to many groups.
- Factors of Production for Goods & Services Consumed is a Better Basis for Taxation than Income – The factors of production used for goods and services consumed of other factors, labor, capita, and imports is a better basis for taxation than income.
- A Simple Easy to Use Consumption Tax would Replace Income Taxes – One tax rate for all, based on the valuations of production factors is an extremely fair method of taxation. In addition, it is also extremely easy to complete one page tax returns. The IRS would not be necessary any more except for a very low level of audit compliance.
- Across Border Tax Adjustments for Imports and Exports Begins to Level the Playing Field with Foreign Countries – Exports are not consumed in the United States so they are not taxed while imports are consumed and taxed.
- A Federal Retirement Plan would Replace Payroll Taxes/Social Security – The current tax/social security plan currently in place would be replaced with a very similar Federal Retirement Plan. The US government would still operate it but the fund would be separate from US government general funds. The new Federal Retirement Plan would operate almost the same except for modifications such as employer/employee contributions adjusted annually. Interest would be paid on surplus funds invested in US government debt instruments.
It is believed that a Flat Consumption Tax based on factors of production with border adjustments is a fair and simple way to fund the budget for United States each year rather than the current method based on income.
Federal Retirement Plans would be operated similarly to today in that employees and employers fund the employees’ retirements. Major differences are the separation of operations and interest paid.