Plug the Leaks

Politicians and academics complain that we pay fewer taxes in the U.S. than other developed nations.

Nah. We’re just really fast at spending. For every dollar we collect we immediately spend 33 cents in social engineering. Federal tax revenues in 2012 were $3 trillion minus tax breaks of $1 trillion.

Tax breaks aka “leave no lobbyist behind” is how the U.S. Congress spends one-third its tax revenues. As Annuities. Clandestinely. What voter has the time or skills to ferret out the merits of tax breaks in a ten million word tax code containing thousands of tax breaks?

I describe here a proposal that per se eliminates social engineering in the Federal tax code. You want to give money to your political supporters? Then first you have to collect it.

Contents

  1. Plug the Leaks
  2. Confederated Taxes
  3. Benefits
  4. Q&A
  5. State Innovation
  6. Proposal

Confederated Taxes

We allow state and local governments to come up with alternate ways to collect Federal taxes on behalf of their residents. This sets up 50+ experiments on how to best pay for Federal spending. States compete with a comprehensive tax code (local, state and Federal) to attract investments, to attract talented workers, to minimize unemployment, etc.

States set up alternate tax codes. One they deem best for their local interests. Individuals and businesses calculate their Federal taxes using the tax code as enacted by the U.S. Congress (e.g., Progressive Income Tax, Flat Tax) but do not send cash to the Federal Government. This cash total is collected using the alternate tax code and paid by the state to the Feds on behalf of its resident taxpayers.

To illustrate. Suppose the residents of a state collectively owe $1 billion to the Federal Government using a Capitation Tax. The state collects $500 million through alternative taxing, say an Oil & Gas extraction fee, and remits this money to the Federal Government on behalf of its residents. Residents would then owe only the remaining $500 million, that is to say one-half their original Capitation tax.

Under this proposal, individuals would effectively pay Federal taxes following state rules, not Federal rules. We eliminate one-size-fits-all Federal tax policy. The Feds want to tax income? Fine. We’d prefer to tax commodities or transactions (e.g., Fair Tax II). The Feds decide on a Flat Tax? The socialists in Vermont can override that with a highly progressive income tax.

Best for local conditions? When a business invests in our state we reduce its tax. When they profiteer we increase its tax. Local government is best positioned to exploit the Chrysler Building approach to business taxation. Very personalized business taxes. Very nuanced tax codes.

Benefits

States have much greater latitude for experimentation in tax policy. It’s easier to change state constitutions. It’s easier to clamp down on Frankensteinian state taxes (e.g. Proposition 13). It’s easier to tweak tax codes based on changing socio-economic conditions. It’s easier to exploit tax bases nailed to the ground (e.g., buried fiber optic cables).

We eliminate per se both the rationale and public support for social engineering of the Federal tax code. Why fight for a Federal tax loophole if the money is just going to get rebated?

Whether the sins of the Feds get visited on the states remains to be seen. It’s going to be harder to practice social engineering in a smaller pool, especially in the competitive state-to-state showdowns I envision for this scheme. Neighboring states will give counter-examples, shining a bright light on your state’s tax loopholes.

We pit the checkbooks of 50 very powerful state-level officials against Washington D.C. bureaucrats and politicians. If Congress wants to game the tax code (or raise taxes) we have 50 very attentive taxpayers looking over their shoulder, knowing that one or few of them will have to make up for any shortfalls of the others.

Do you really want to lose those Electoral College votes in the next presidential election?

Q&A

Q. How is this different from just apportioning the Oil & Gas extraction fees directly to state residents? Why wait for Washington D.C. to enact this legislation? Why not just do it unilaterally?

A. We don’t want our residents sending money to the Feds. All Federal tax monies flow through the state treasurers, our tax advocates at the Federal government.

State alternate taxes will likely impact the same taxpayers as the Federal Income Tax, and not some dastardly Oil & Gas company. Some will pay more, some less, leading to lawsuits in the absence of Federal legislation defining the new rules (e.g., equal protection, yada yada).

We will probably need the support of the U.S. Congress to open up some avenues of state taxation should special interests prove too powerful (e.g., claims of restraint of trade under the Commerce Clause of the U.S. Constitution). This must be a Federal-state partnership, not a duel.

Q. Two tiers of Federal Taxation? Why so much complication?

A. The Feds need a politically defensible way to apportion the total tax burden across the states. We can’t just divide by 50. Not all states can afford the same level of Federal taxation (not even per capita).

Q. Will voters pay even less attention to what those rascals do in Washington D.C. once their Federal Taxes are being rebated?

A. Voters are still paying Federal Taxes, only the check’s being sent to a different address. State officials will take pains to make sure taxpayers know they’re paying a Federal and not a state tax. And the amount they’re paying will be more fully disclosed.

Taxpayers are personally responsible for the full amount of their Federal income tax as legislated by Congress. This scheme merely calculates their state rebate check. Should the states not be able to back-fill the rebate, the full Federal taxes are still owed by the individual.

Q. Two tax forms?

A. Yes, but combined into one confederated filing for the state. You calculate Federal Taxes, and then your rebate, and the net is your Confederated Tax Bill. The Federal Income Tax content within the confederated filing should become much leaner since it’s only used to apportion taxes between states. It’s even likely the Confederated Tax can include State Income Tax filings to further reduce paperwork. It is not clear yet whether this tax option will increase or decrease the net complexity of tax planning and filing for individuals.

Q. Why should I exercise diligence in filling out my Federal Tax forms?

A. Individuals are still subject to Federal enforcement. An individual’s tax rules are still defined by the Feds. The state merely gives a corresponding rebate.

Individuals will have little reason to cheat since their payments will likely be rebated. States will take great pains to educate their citizens to take all offered Federal tax deductions and exemptions in order to reduce their state alternate taxes. Federal revenues could rise noticeably or not, based on the balance between savings from lower cheating and losses from greater claims for tax breaks.

Taxpayers can, of course, still cheat on their alternate state taxes. But the Confederated form will still be a Federal filing. You would still be liable to Federal prosecution even if you only cheated on the alternate tax.

Q. What about residents of one state working in another?

A. Reciprocity agreements.

Q. Won’t businesses practice beggar-thy-neighbor, pitting states against each other?

A. Not if tax commissioners have the authority to continuously tweak the tax code. See here. There may be a few specific cases (named global corporations) where it would be more effective to have one central authority collect taxes and credit individual states. This central authority does not have to be the Fed.

Q. Can this work under the current Federal Income Tax regime?

A. That’s its key strength. It can be implemented immediately. We don’t have to wait for repeal of the 16th amendment. It builds momentum to fix the Federal tax code gradually, as more and more states get on board.

Q. Does this undermine the power of the Federal Government?

A. Constitutionally it doesn’t change a thing. The U.S. Congress still decides levels of taxation, its basis for taxation, and how to spend tax revenues. The only change is we have a way-station for tax payments at the state level, before they voyage undiminished to the Federal coffers. It does reduce the power of those in the U.S. Congress to game the tax collection system for purposes of political patronage.

Q. Won’t this further inflame passions by highlighting how certain states pay much more than they receive?

A. Yep. States that design their alternate tax code in a way that increases their wealth will economically outpace those who don’t. The existing Federal tax code will punish successful states. State officials will join the fight for tax reform at the Federal level (e.g., fight for the Capitation Tax).

Q. What if the Federal government uncovers a lucrative foreign source of revenue in our state, unavailable to our state tax commissioners?

A. Wonderful. States will only partially reimburse the Federal government, and the Feds can keep taxing the foreign source.

Q. What stops states from being totally unimaginative with this new toolbox?

A. Since we’re plowing virgin soil, free of deeply rooted interests and preconceptions, we can more closely excite the taxpaying public about the pros & cons of different state-level options. This is experimentation under competition, and the few states that are successful will drag along the laggards. There will be first-mover advantages, so don’t be late out of the starting gate.

State Innovation

A huge pile of untaxed loot. Several trillion dollars.

Google earns revenue for its advertisements shown to taxpayer eyeballs. I consider this a ‘sale’ by Google Inc. Google claims tax‑exemption since the ads are purchased by foreign firms and are delivered globally via foreign computers. There are international tax treaties protecting Google from double taxation by federal governments, which Google exploits ruthlessly.

What tax options do states have for tapping into the loot of multinational corporations like Google who globally shift income to avoid paying taxes?

States charge infrastructure fees based on estimates of the value of having Google’s advertisements appear before their taxpayer’s eyeballs. These fees are charged to internet service providers, who in turn pass them onto Google. An eyeball tax.[1] If you want your advertisements in front of our taxpayers’ eyeballs then you pay taxes to make it happen.

Google tax lawyers may be smarter than our state tax commissioner. But are they smarter than the collective wisdom of 50 state commissioners?

If a product or service is delivered to our state taxpayers then it’s a target for our alternate tax.

Proposal

Enact the Plug the Leaks Act of 2014. Adopt the Confederated Tax. We don’t have to wait for Tax Reform. The Confederated Tax works even on top of the current Federal tax code.

I know it’s a stretch but this may even make our politicians less corrupt. Nah!


1. If internet service providers attempt to charge this tax to the consumers I’ll set up a competing business that charges it to Google, undercutting their business model. See: Internet providers could soon start charging websites like Google and Netflix to reach users.

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