Federal Taxation: A Physician's Prescription For Reform
."We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence (sic), promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America." - The Preamble to the Constitution of the United States
“The government is the only legal issuer of the thing it demands for the payment of taxes.” - Warren Mosler, godfather of MMT.
“Labor is prior to, and independent of, capital. Capital is only the fruit of labor, and could never have existed if labor had not first existed. Labor is the superior of capital, and deserves much the higher consideration.” - Abraham Lincoln
The federal government creates trillions of US dollars annually. In 2015 it created $3.8 Trillion or 21% of US GDP. As the single entity responsible for more than 1/5th of all productive business activity, as the issuer of the currency and controller of the base interest rate, it is the nation’s price setter.
The tax debate. Congress and the President, amplified through the corrupt lens of the corporate media, are perennially consumed with the tax debate. The debate can be framed in many ways, but it will always touch on that mythical problem we call the deficit, and the deeper problem of accumulating deficits, the debt. We are constantly told the deficit is unsustainable, that our grandchildren will be stuck paying off the now $21 Trillion national debt, that soon we’ll be bankrupt and China will stop loaning us money. This is all myth. Our leaders scold us. We are the wealthiest nation in history, but we have to reduce spending, and the health care, education, and social services enjoyed by the citizens of our allies and trading partners are all beyond our economic reach. They tell us we must increase our GDP to increase tax receipts, so taxes are cut on capital to enhance investment, and of course the tax receipts go down and the myth goes on. They pass these and other poorly tailored proposals and call them tax reform, but in reality, it is one tax cut after another aimed at enriching the already rich, and throwing bread crumbs to the masses. It does not require deep analysis to demonstrate that it is the tax structure itself that bears the greatest responsibility for the dangerous and growing disease gripping our nation: the affliction of accelerating disseminated economic inequality.
As a retired professor of radiology and surgery, the analytical processes of medicine have shaped the way I view much of the world. In medicine, before you study disease you must learn and understand what is known of the normal function of the body: its physiology. Physiology views whole organism as its component systems and sub-systems, and those as their individual channels and pathways, and provides insights into their regulation, functions and interactions. Once the system is well understood, the how and why of each system's dysfunction in a particular disease state, the pathophysiology, illuminates the path of the treatment or intervention. Here we hope to apply this same approach to understanding a part of the economy with its myriad systems and sub-systems. Of those component systems comprising a modern economy, the microeconomic systems of stocks and flows of financial assets within the economy will not be a part of this discussion. Instead the focus will be on the macroeconomic systems of stocks and flows affecting the economy as a whole. The macroeconomic system we address here is the nation’s monetary system, and specifically its major sub-system: federal taxation.
The physiology of a monetary system can be described in depth with reference to Modern Monetary Theory (MMT), and the work of Mosler, Wray, Kelton and many others. Briefly, for the USA, the nation’s spending and taxation activity is governed by its fiscal policy, which in turn is a product of congress and the president. The nation’s monetary policy, which controls the interest rate and influences the money supply, is governed by the Fed. The US economy is currently managed largely by monetary policy set by the Fed using its only tools, interest rates and jawboning (managing expectations) to influence the credit markets. The Fed’s legal mandate is to maximize both employment and price stability, but this is a system where these are set as two opposing forces. A key difference in the MMT approach is it advocates managing the economy with a fiscal policy based on intelligent utilization of our human and physical resources for the public purpose, to improve the standard of living for our people. In an economy managed by fiscal policy, it is possible to maintain the mandate of price stability, but with full employment rather than a partially idle workforce.
Monetary systems are instituted first and foremost to provision the government to serve the purposes of the sovereign. In the USA, the sovereign is We the People as declared in the Preamble to the Constitution. Our purpose is the public purpose. Since all of the people are benefitted by the collective efforts of government, each of us owes a proportion of that effort to the whole. That burden is widely shared as the direct recipients of US dollars through federal employment, purchases, and transfer payments, spend and continue to circulate those dollars throughout the economy. The government pays the aircraft factory, the aircraft factory pays the worker, the worker pays the grocer, the grocer pays the farmer, the farmer pays the equipment manufacturer who pays its worker and on and on, all contributing to that aircraft we all bought together. As long as the dollar circulates, the burden of supporting the sovereign (that’s us) is distributed and dispersed. When those dollars become idle and no longer circulate, they no longer contribute, and neither do their holders.
To the recipients of federal spending, those US dollars are payment for labor, services rendered, equipment and asset purchases, or paid insurance benefits. However, to the government (the Treasury and the Fed), all of that money represents one thing: tax credits; US dollars waiting to be taxed. When more dollars are injected into the economy than are taxed away over a specified period of time, we define that as a federal deficit. It is equally valid, and significantly more useful, to think of this as a private sector surplus, as savings and profits. In the reverse case, where fewer dollars are added than taxed away, we call that a government surplus as we had during the Clinton administration in the late 1990’s. However, the other side of that reality is a private sector deficit, an increase in private indebtedness that became extreme in 2001 and unbearable in 2008. Understanding this, it is apparent that economic growth is contingent upon government’s unlimited spending and taxing authority and the private sector’s limited capacity for credit expansion.
MMT provides us with a forensic description of the function of the monetary system as it actually exists. In the United States, we have a sovereign money system where US dollars in the form of cash, treasuries and reserves are an exclusive product of the US government. Nobody else can create US dollars; no person, no firm, no other country, not even China. When the government imposes liabilities upon the private sector in the form of taxes, fees, fines, etc., they are always denominated in and exclusively payable in the government’s unit of account, the US dollar. No other form of payment is acceptable, not gold, not euros, not chickens. That is what makes the US dollar valuable. The quality of value arises because without US dollars to satisfy liabilities to the government, property will be confiscated and sold for US dollars, earnings will be garnished, and there is the threat of imprisonment for fraud. Thus, taxation imbues the US dollar with the quality of value, while individual need and markets determine its quantitative or nominal value. For example, were it not for his unbounded greed, Jeff Bezos would value a dollar far less than you or I simply because he has 150 billion of them.
The MMT description of our monetary system begins with the creation of money by the government. The money is created by an act of congress becoming a law, signed by the president, and executed by the US treasury through its bank, the Federal Reserve Bank, and its affiliates and counter-parties. Other than transfer payments and payroll, the majority of the money created goes to mobilizing private assets into the public sector, ostensibly to serve the public purpose. To this end, the sovereign (We the People) might expect and reasonably demand that our federal government institute policies to mobilize all the necessary resources to support society, business and trade, national defense, and economic stability. This should include elements such as universal single payer health care to relieve US business of massive costs not born by foreign competitors and relieve the people of their forced subsidy of a systemic market failure. It should encompass infrastructure maintenance, restoration and expansion of the nation’s highways, bridges, rails, schools, ports, airports, energy systems, water systems, waste disposal systems, etc. We should expect universal retirement, survivor and disability income (expanded Social Security), universal child care, and PreK, K-12, and Vocational/Technical education with performance-based public higher and graduate education at public expense. It is essential to fully support programs that augment the nation’s future, expand its productive capacity and increase efficient resource utilization, such as NASA, NOAA and the national institutes and laboratories. It is vital to the human spirit to support the arts, music and the humanities. Taxation itself imposes the need for paid employment. If the private sector cannot utilize the entire available workforce, then the government should bear that obligation. A federal job guarantee program should exist to maintain full employment and a readily employable buffer stock of workers for the private sector.
The federal government creates trillions of US dollars annually and its spending accounts for more than 1/5th of all productive domestic business activity. However, in the private sector and the other 4/5ths of the economy, nearly all transactions are through credit instruments. Checks and credit cards, bank “loans” and accounts, and everything else except cash and coin, are all credit instruments. As more new US dollars are spent into and circulate through the economy, their addition has the aggregate effect of reducing leverage making credit easier to acquire and savings easier to accumulate. Easier to acquire takes us back to the basic tenet that a dollar’s quantitative value is what one will do to earn it. For the individual, a dollar more easily obtained is relatively decreased in value making it easier to spend and reducing resistance to price increases. Easier to accumulate means those dollars are withdrawn from the productive economy.
Savings, along with foreign purchases, are the major sources of economic leakage, of hemorrhage from the economy’s circulatory system. Federal spending replenishes this leakage unevenly causing or allowing money to pool into hordes. Without regulation this becomes a cycle where the government essentially spends directly into the hordes as is currently the case with the quarter trillion dollars of annual interest paid on treasuries. This is an unnecessary gift to the wealthy that will only increase as the Fed boosts interest rates. Taxation judiciously applied has the capacity to relieve the build-up of excessive money hordes, but in its current form it focuses on taxing money flows rather than money stocks, that is, income rather than savings. This results in worker income being diminished while the wealthy’s savings are enhanced. This problem has been exacerbated by 40 years of increasing payroll taxes at the bottom and relentless income tax cuts at the top.
A fundamental insight of MMT is that in a sovereign fiat monetary system like ours, federal taxation is not necessary to raise revenue, but it is the principle regulatory control over growth and inflation. Taxation at the federal level, unlike state and local tax, has nothing to do with funding or financing spending. Treasury bonds, unlike municipal or corporate bonds, are US dollars, as are reserves, cash and coin. Most people basically understand cash, but treasuries and especially reserves are unfamiliar concepts to many. Under a convertible currency standard such as the old gold or silver standard or a fixed exchange rate, in addition to cash to clear transactions, reserves of gold, silver or the pegged foreign currency must also be held to satisfy demand for conversions. Without full reserves the currency can default. Treasuries sequestered currency making it untouchable for a period of time, thereby defending the reserves against demands for conversion. Under a non-convertible floating exchange rate as we have in the US today, reserves are simply dollar balances of accounts held at the Fed by the nation’s banks. They are the balances used for interbank clearing in what amounts to checking accounts at the Fed. Just as commercial banks offer checking and savings accounts, the Fed holds reserve and securities accounts. Treasuries are simply time deposits to securities accounts. Treasuries are not sold to borrow, but purchased to absorb the currency already spent and held as excess reserves. This is traditionally how the Fed has controlled the overnight inter-bank interest rate and prevented it from falling to zero. Treasury bond holders are not lenders, they are savers and investors. On the federal government’s balance sheet, federal spending creates US dollars, federal taxation destroys US dollars, and US treasuries are US dollars sequestered and stored risk free for a fixed period of time. To the government, the US dollar is nothing more than numbers on a spreadsheet or points on a scoreboard. The US dollar is simply a tax credit.
Federal and state employment and income taxes capture about 19% of a typical working family’s gross income, while real estate, property, sales, gas, utility, and other taxes consume another 5.4% according to a 2010 NPR report. Health insurance and out of pocket health expenses for that typical family of four are expected to cost $28,000 in 2018, with the employer picking up about half. For the median-income-family that’s another 21% tax, but this time paid to the insurance company instead of the government. This comes to more than 45% of the median gross income taken in ‘taxes’. We know that 30% ($8,400) or more of that health care tax goes to administrative waste engendered by the health insurance industry itself, and we know that our real estate and other local taxes go to local purposes like services and roads and schools, but what do federal taxes do? The government creates the money for spending, it doesn’t need to get it anywhere, so why impose the tax?
Functionally, federal taxation has the capacity to accomplish three tasks. First, taxation drives the currency, imbuing it with qualitative value. To accomplish this the tax base must be broad so the currency is needed across all economic strata. The federal employment tax structure does this in a ham-fisted and unnecessarily burdensome way since state and local taxation largely fulfill that function by taxing nearly every transaction and property holding. However, keep in mind that state and local government must balance spending against taxation over time as these entities, like families and firms, are users rather than issuers of the currency. Unlike the federal government, their spending is constrained by revenue. Second, federal taxation is the government’s most potent tool for control of inflation. For this, taxation must be focused and sufficiently burdensome to impact non-government spending behavior and reduce economic leakages such as discretionary foreign purchases (energy, mineral resources, offshore assets, etc.) and money hoarding. Federal employment taxes have been spectacularly successful here. By taking nearly 15% of labor earnings off the top and impoverishing everyone below the 50th percentile, inflation today can only be manufactured by the Fed driving up the interest rate and raising the price of credit. Third, taxation can be punitive and used to discourage deleterious and socially undesirable practices and activities. Sin taxes, excise taxes, and import taxes are examples, as are taxes and penalties on polluters and resource exploiters. These taxes are by intent self-limiting or self-extinguishing and, if well implemented, would have little lasting economic impact.
What would real tax reform look like? Certainly, it would be more than a simple collection of descriptive changes and rate adjustments as we’ve seen in the past. These have been pain relievers for the well-healed and the money-addicted. Genuine reform would entail radical changes, as were seen with the imposition of the income tax and the social security tax. Real reform would change the criteria upon which taxes are imposed, and it would profoundly alter how we think about money and the economy.
The current tax code recognizes income from various sources differently. Income from work is devalued and the most heavily taxed while income from economic rents, such as interest, dividends and capital gains, are treated to “preferred” rates. In other words, people are penalized for earning money through their own work and effort, and rewarded for making money off the work and efforts of others. This is morally wrong and the opposite of what should occur, but it is the very definition of predatory capitalism. All income should be called income, no matter the source. However, income should not be the basis of taxation. As discussed above, income is a flow. One person’s income is another’s spending. Effective taxation should be directed at the stocks of idle money and at limiting the pools and hordes that inevitably arise. Instead of taxing the flow of income and spending, the focus should be on unspent, excess, or surplus income.
Prescriptions for Tax Reform:
DISCLAIMER. The foregoing discussion views the system of US fiscal operations through the lens of pathophysiology, applying MMT as the physiological model. That analysis of the system reveals a pathological positive feedback loop in the tax structure where US dollars are systematically redistributed into monetary hordes rather than recirculating through the economy. In formulating the following proposals, I broadly disregard the field of economics for which I have little formal training. These are proposals to intervene to correct the physiology of the tax system. Like a congenital heart defect, first comes the surgeon to correct the physiology, then come the internists to do the fine tuning. I advocate that we fix the physiology of the taxation system first, and then let the economists suggest how to adjust and fine tune the details.
1. Eliminate the Income Tax and Impose an Excess or Surplus Earnings Tax
Impose a highly progressive federal tax on unspent income and any income disposed of off-shore. Median and low-income earners have little opportunity to save and contribute virtually 100% of their income back into the economy. For surplus earnings, the tax rate should be bracketed based on income, so that a median-income person with a small surplus pays little and a high-income person hoarding a large pool of unspent income pays a lot. In a well-managed full employment economy, inflation should be mild, but it will always be present in a credit economy. Consequently, reindexing to inflation should be done annually. Taxing unspent income encourages consumption, which comprises 71% of the US economy. This measure strongly encourages consumption by the wealthy, adding real economic activity to our economy. Consider the many thousands of man hours of skilled labor encompassed in the building and maintenance of an estate or yacht or aircraft. When the wealthy consume, their spending is workers’ income in the real economy. When they don’t, their money hoarding and off-shoring are economic leakages which taxes must discourage by design.
2. Eliminate Most Payroll Taxes
Taxing a person for working is not only wrong-headed, it’s bad policy as it is a huge economic leakage that drains a vast amount of working money by preventing it from ever entering the real economy. The nation’s capacity to care for its people, its retirees, survivors and the disabled, is constrained by real resources (human resources, productive capacity and raw materials), not by the dollar tokens that the US government creates, sequesters and destroys as needed. Intelligent use of today’s resources insures the ready availability of needed resources in the future. Hoarding money from the productive economy today only impairs the creation and maturation of necessary future supply chains. However, in an economy operating at full employment and near full capacity, a small, variable employment tax could be used as an effective inflationary control where interest rate manipulation by the Fed is counterproductive.
3. End Corporate Income Tax
The corporate tax structure has become a haven where wealthy investors shield their gains from taxation. This was not the historical intent of corporate charters. The corporate veil was intended to shield investors from personal liability for corporate misdeeds, not to shield owners from tax liabilities. That is why surplus corporate earnings (profits) were equitably taxed at 35% until the recent giveaway. The corporate income tax should be eliminated altogether and instead all corporate profits and losses calculated on a cash basis and imputed directly to the shareholders as regular income. The same should apply to small businesses of all varieties. Income is income. Early stage enterprises will impute their losses to be used by shareholders and owners as offsets. Profitable enterprises will be incentivized to reinvest their profits in their labor force, capital improvements and expansion in order to avoid tax liabilities for their shareholders, or pay the profits out in dividends to support the stock price against its tax liabilities. Corporate executive compensation in shares will carry the tax burden of the shares. The claim of corporate personhood is supported in law by the corporation being a taxpayer. That claim is abolished by this proposal, while it encourages greater shareholder participation and improved corporate governance.
4. Strengthen Inheritance and Gift Taxes
Impose strong progressive inheritance and gift tax structure to limit the economic leakage of large intergenerational wealth accumulations. Today, estate planning is a euphemism for tax avoidance. Warren Buffet once said he would leave his kids enough to do whatever they want, but not enough to do nothing. That is wise counsel. The exempted limits should be set to some small multiple of lifetime median income, with progressive brackets above that bound, and all reindexed annually. For large fortunes, the rule should be: spend it, contribute it to society, or take it with you to the crematorium.
When viewed through the interpretive lenses of medical physiology, pathophysiology and intervention, it is clear that many of the symptoms plaguing American society arise from the disease state of severe wealth and income inequality. Further analysis tells us this not the result of an exogenous pathogen, like an infection, but an endogenous problem, like an inflammatory disease or a cancer. Like an inflammatory disease, where effector cells meant to protect the body instead attack it, our federal taxation system is attacking the body politic with crippling results. This analysis of the pathophysiology of the taxation system informs the four taxation proposals presented here, which are crafted on the observed mechanics of the US monetary system as described in MMT. These proposals, if adopted, would go far towards alleviating the symptoms and halting progression of the disease. With implementation of these structural changes, over the course of the next generation much of the damage of the last 40 years can be undone, our broken society can be repaired, and an acceptable level of economic justice can be restored.