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Overhauling the Tax System: The Transaction Tax

By John Gunther '72

Photo: iStockphoto.com/Brandon Alms

Background

Even those enriched by U.S. tax law generally acknowledge that it's a pitiable mess. Devoid of underlying principles and with provisions variously inspired by noble purpose, opportunism, and outright bribery, it's a labyrinth that annually absorbs billions of unproductive dollars in advice, preparation, and enforcement.

Perhaps its most outrageous feature is expenditures created within the tax law itself. Every tax exemption and deduction is equivalent to a perpetual fiscal appropriation—one without budget line item, annual scrutiny, or fixed-dollar amount. Prime examples are deductions that subsidize charities, mortgage interest, and business expenses.

Change is difficult because many taxpayers benefit individually from specific tax preferences. For example, unless they can see the larger picture, homeowners might oppose the loss of the mortgage tax deduction if it reduces their tax by $3,000 per year. Additionally, any fundamental overhaul must overcome aggregate self interest backed by hefty financing from organizations whose collective lobbying and influence create the continuing series of "Christmas Tree" tax bills. Think mortgage industry, petroleum industry, religious and charitable sectors, etc. Only a proposal with broad popular appeal and simplicity has a chance at adoption. Let me whet your appetite with one: the transaction tax.

Goals of a Tax System

I maintain that certain societal goals of a taxation system are axiomatic:

1. Low rate—A small tax is a minor irritant and has a small impact on financial decisions. A universal tax without exceptions generates the needed revenue at the lowest possible rate.
   
   
2. Simplicity—Taxation must be transparent and comprehensible to most citizens. A simple tax is one where the amount of the tax is obvious at the moment it's incurred, like sales tax. Exceptional provisions complicate understanding and increase the cost of compliance.
   
   
3. Fairness—Taxpayers must believe that the burden falls fairly on everyone. A complex tax scheme invites some taxpayers to game the system to their advantage leaving the remainder feeling abused.
   
   
4. Enforceability—Voluntary compliance will be high if avoidance is easily detected. Enforcement suffers when an event's taxability can be manipulated and requires expert analysis.
   
   Other goals, while more controversial, can garner popular support:
   
   
5. Revenue only—Regulating market forces through taxation is imprecise and rife for abuse. A tax's only purpose is to collect revenue. Appropriations laws authorize money for government purchases and monetary rewards for designated activities. Using taxation as a backdoor expenditure tool is political cowardice that evades hard decisions. Imagine the interesting debate if funds to support churches had to be appropriated every year instead of happening automatically through the charitable tax deduction.
   
   
6. Progressiveness—A persuasive argument can be made that those with more disposable income should contribute at a higher rate. In this regard, a perfect tax would fall more heavily on the affluent without being forced by discriminatory provisions.
   
   
7. Minimal distortion—Taxation should have little impact on business and financial decisions. When taxes are high enough and avoidable enough to become a major factor, it substantially distorts the free market. A broad, simply applied, low rate tax reduces the impetus to modify behavior purely to minimize tax liability.

Attributes of a Tax System

In keeping with the above goals, here are the attributes of an improved tax system:

• Broad base—This is fundamental. If everything is taxed, the system is simple, the rate is low, and there isn't much reason to choose one course of action over another to save taxes.
  
  
• Implicit progressiveness—The system should treat everyone equally while still increasing the burden on wealthier individuals—no mean trick.
  
  
• Equal treatment—A simple, unambiguous tax without exceptions. As soon as you allow one exception, say exempting very low-income individuals from paying any tax, you open the flood gates for an endless stream of exceptions. In other words, our current tax system. The effect of any deduction or exemption can be precisely duplicated via an appropriation, except that you have to step up and say, "We're spending this much money on this."

A New Tax Regime

So what miracle tax fulfills all the above objectives? The Transaction Tax. It's embarrassingly simple, a single percentage rate, legislatively adjustable, paid by the recipient every time money changes hands. The key is its universal application, far beyond taxable sales, profits, or earnings. Every transaction is taxable. Major examples include purchases/refunds, loan proceeds/repayments, investment deposits/withdrawals/dividends, wages and fringe benefits, and gifts and inheritances.

Why Would It Work?

Applying it to every transaction keeps the rate low, removes tax as an important decision factor, forces replacing tax expenditures with appropriations, and allows most of the resources devoted to the tax industry—advisers, enforcement, adjudication, collection—to be redirected to productive uses. My crude estimate of the number of dollars that changes hands each year indicates a tax rate between 0.5 and 2 percent would generate the same tax revenue as currently collected by all levels of U.S. government. Even if it were substantially higher, the rate would compare very favorably with 35 percent payroll deductions and 8 percent sales tax.

Tax preparation and audit would consist of only two questions: How much money did you receive this period? Did you pay x percent of it as tax? As in the current system, barter, non-arms length, and international transactions would require monitoring, but the rest almost disappears. Profit vs. loss, business vs. personal expense, employment vs. contracting—all irrelevant. There's no tax subsidy for extravagant salaries, business entertainment, or overseas outsourcing. If everyone is paying on every transaction, the rationale for feeling abused or evading tax is tenuous, and enforcement is easy. Instead of the quarterly and annual tax return ordeals, you pay the exact tax due every day, week, or month. Since the tax is paid by the recipients of money, inability to pay is nonsensical.

Progressiveness is built in since low-wage, hand-to-mouth workers spend their earnings directly on necessities whereas the rich, who use their money to earn money, shuffle each dollar through several transactions before finally spending it.

Problems

Of course, there are perceived and actual problems to overcome. Space limitations prevent detailed discussion but here's an overview.

Some would argue the transaction tax discourages investment and finance. A low tax rate, though, would be dwarfed by investment returns. Any actual effect would be trivial compared to the massive economic distortion of the current system.

Replacing taxes at all levels is a thorny problem. A system of level per capita financing of states, counties, and cities—similar to a judicially evolving principle of school taxes—seems fair but would be a radical change. Per capita allocation also dodges the complex task of assigning a local jurisdiction to each taxable transaction. All that's needed is the simpler task of determining how many people live in or enter a given jurisdiction. Of course taking away local government power to determine tax revenue is a legislative revolution in itself. And remember, the federal government can still arbitrarily give money to anyone for any purpose—it just has to do so through explicit appropriations.

Legislation must also prevent replacing discriminatory taxes with new charges rationalized as fees for service (national defense fee, property owners' fee, employer fee, etc.).

The hardest part is enactment. Only a tidal wave of popular support in the name of fairness and simplicity could overcome diehard efforts of the current tax beneficiaries, some of whom derive great wealth from tax preferences.

Conclusion

The transaction tax concept is very attractive to anyone who considers our current tax system illogical, unfair, and corrupt. It has the potential to both garner broad public support and incite a fight to the finish by those who personally benefit from the current regime by shifting their tax burden to others. Like any revolutionary change in the U.S. today, implementing it would require a true crusade to generate sufficient momentum for passage.

Acknowledgments

Although I've been independently evolving my transaction tax concept since 1980, research for this article turned up two separate, similar proposals:

Feige, Edgar, Taxation for the 21ST Century: the automated payment transaction (APT) tax (10/00).

Fattah, Chaka, Transform America Transaction Fee Proposal (HR 1601, 4/29/05).

My ideas were referenced in:

Woehlke, James A., Trends in Taxation, The CPA Journal, 2/00.

About the Author John Gunther II '72 is the owner of Bucks vs. Bytes Inc. computer consulting in Rosendale, NY. He believes the time is right to implement the transaction tax and welcomes technical and political help to build a movement. He can be reached at mit@bucksvsbytes.com.

Published February 2007

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