Busting Myths about US Taxes

We have some really bad tax policy here in the USA. I think one reason is that so many people believe myths told by both political parties to distort the truth toward their progressive or conservative agenda.

Here's my list of myths, half-truths and outright lies

1. Half the electorate pays no federal income tax at all
2. Contributions to Social Security and Medicare are held in an account for its beneficiaries
3. A flat tax will simplify the tax code
4. We need to broaden the tax base
5. Clinton's tax increases balanced the budget
6. Ending the Bush tax cuts will destroy the economy
7. Cutting or eliminating corporate taxes is the best way to stimulate growth

Half the electorate pays no federal income tax at all

True, but misleading. Everyone who works and reports their income is taxed around 6.5% (temporarily 4.5%) to pay for Social Security and another 1.5% to pay for Medicare (which is nowhere near enough to cover projected costs). Additionally employers pay another 6.5% on behalf of the employee, which either effectively comes out of their pay or in many cases costs them their job.

One big problem with this form of taxation is that people don't recognize it as taxation and feel entitled to the money they have contributed. The government doesn't treat your contributions this way; it decided long ago to account for this money as general revenues to fund the government.

Another huge problem with this form of taxation is that it only applies to wage income. People who make their money from investments don't contribute to these programs. People with huge salaries and bonuses stop contributing after a few paychecks (I had that experience one very good year.)  Just to be clear - payroll taxes are for the middle class and working poor. Is that right?

Contributions to Social Security and Medicare are held in an account for its beneficiaries

This is an outright lie.  The government makes it appear to be an account by tracking your contributions, but that money is actually spent to fund current beneficiaries.  Your only hope is that a future generation will still be willing and able to pay for you (if you live that long).

A flat tax will simplify the tax code

This is a less-than-half-truth. The number of tax brackets is not where complexity arises in the tax code. Complexity comes from deciding what taxable income is and what deductible expenses are. Don't believe for a minute that the lobbies in Washington will let their deductions and tax credits slip away. Any change to the tax code with the current crew of legislators and lobbyists will likely work in their favor and make the system more complex, not less. The flat tax is related to the next myth, which is broadening the tax base.

We need to broaden the tax base

Those who advocate this would like to raise more revenues from the middle class. Their argument is that most Americans do not participate in the income tax and therefore are not responsible for the basic services they consume. They also believe that you cannot raise significant revenues from the upper class because the diminishing numbers of very rich can't produce any meaningful increase in revenues without hurting the economy.

This is less than half-true because the very rich aren't really doing much for the economy now (in terms of hiring), and in many cases are doing things to hurt the US economy by offshoring manufacturing and information jobs.  Raising taxes on the middle class would likely hurt the economy as much or more than alternatives like letting the Bush tax cuts expire.

Clinton's tax increases balanced the budget

This is a half-truth.  The economy improved under Clinton because of two macro-economic factors largely outside his control, the end of the cold war, and the build-out of the internet.  Unless you believe Al Gore invented the Internet I have news for you, the Internet would have been developed and Y2K-related technology spending would have been about the same under a Republican president.  That had very little to do with politics.

The reduction of military spending allowed the entitlement state to grow without immediate budgetary consequences, and the Internet/technology bubble produced a wave of one-time stock market gains that created the illusion of a balanced budget.  The fact that tax rates were higher during that time amplified the income to the federal government and contributed to the surplus.

Actually that surplus contributed to the recession that started that year.  And it deceived our political leaders into believing that they had unlimited resources to increase entitlement spending and wage wars, while cutting taxes on investors.  So Clinton’s tax policy did increase tax revenues, but the net effect of the temporarily balanced budget was actually quite negative.

Ending the Bush tax cuts will destroy the economy
This is an outright lie.  Those tax cuts did little to help the economy and there are much better ways to use tax policy to produce economic growth today.  Capital gains tax breaks allow the investor class to pay much lower taxes while investing in companies like GE that use capital to create jobs in India and China.  Dividend tax cuts encourage companies to pay their shareholders, but this has the opposite effect on investment capital and doesn’t necessarily encourage companies or shareholders to create jobs or make other beneficial investments.

Who benefits from the Bush tax cuts?  The overwhelming majority of individual shareholders and mutual fund owners hold these investments in tax-deferred accounts.  Those who benefit from the tax breaks are wealthy investors who can’t participate or shelter their income in other ways.  Is it right that someone making their income from investments (like Warren Buffet) pays 15% while those making the same amount from working two or more jobs pay 28-35% of their income plus 15% to Social Security and Medicare?

Cutting or eliminating corporate taxes is the best way to stimulate growth

This is more than half true. Cutting corporate taxes would encourage offshore companies to locate headquarters here, and may encourage small business owners to incorporate and avoid double-taxation of their income.  But unless payroll taxes and regulatory burdens are lifted these companies may still employ offshore labor and manufacturing, thus missing the anticipated benefits and losing tax revenue.

If we’re serious about cutting corporate taxes the place to start is payroll taxes.  This is a tax that is levied on the thing we need most – employment.  And it is only levied on companies that employ Americans.  That is ridiculous and wrong.  Quite the opposite, the US government should be doing anything it can to reward companies that hire and retain American employees.  If there is a need to replace the lost revenues to fund those entitlement programs, it can be raised from tariffs and surcharges on cheap foreign labor.  And that may not even be necessary since the jobs gained from this policy would reduce unemployment costs and increase tax revenues from the new employees.

Finally, let’s talk about simplification of regulations on employers.  It is SO 19^th-century to look on employers as the enemy of labor.  Employers provide benefits and salaries to attract and retain good employees.  They provide record-keeping services and safe work environments and many other benefits, many as required by existing regulations.  Adding to this regulatory burden costs not only money but critical time and focus from businesses.  Now is the time to reach a balance that stops the tide of uncertainty and fear that is holding back our economy.

Businesses need a clear vision, not of short-term targeted incentives for particular types of business, but a long-term clear road ahead that is not barricaded by government regulators and bureaucrats.  And the road ahead should lead back to America.  This is an environment our elected government can help to foster and restore.