Ever Heard Of The Neutral Tax?

I’ve always been a proponent of a flat tax, and particularly Steve Forbes’ plan in which the first $30,000-40,000 of individual income was exempt from income tax and an 18 percent rate was to kick in after that. I never could understand the objections to that plan and why it never got close to a serious hearing in Congress.

That said, I never really had a problem with the Fair Tax Mike Huckabee and others have been pushing for the last few years. Replacing the income tax system with a national consumption tax is a perfectly good idea which would spur economic growth. But the Fair Tax is an awfully heavy lift, because before it would ever garner any real support from economic conservatives you’d have to repeal the 16th Amendment. You can’t have an income tax in place at the same time as a consumption tax; that’s an invitation to even less fiscal discipline than we have now.

But there’s a third option which has just made its debut, and the more I look at this one the better I like it. It’s called the Neutral Tax, and while that name doesn’t particularly grab you by the throat the idea might.

The Neutral Tax would do away with the concept of the federal government taxing individuals at all. It would end the social engineering in the tax code, it would do away with the lobbying and loopholes, and it would eliminate class warfare at the federal level. All that would be gone from Washington politics.

Instead, the federal government would tax the states and local governments.

The Neutral Tax would be a flat tax on the gross revenues of those governments. How they generate the revenue to pay the Neutral Tax is entirely up to them.

Proponents of the Neutral Tax outline several features it offers

  • Eliminates the federal government’s micromanagement of tax policy
  • Compatible with most other tax reform proposals (implemented at the state level)
  • Enables each state to design its preferred tax structure
  • Eliminates the federal monopoly on tax policy
  • Eliminates all direct federal taxes on citizens
  • Eliminates the IRS as we know it
  • Makes repeal of the 16th Amendment (the federal income tax) practical
  • Eases future tax reform efforts — no more decades of debate
  • Integrates federal, state and local taxation policies
  • Makes the US more competitive internationally
  • Inherently non-partisan policy makes it easier to enact with bipartisan support

A few points of discussion here.

First, given the volume of the federal tax code and the incomprehensible character of it, you’ve got to agree that getting Congress – the people who have built that monstrosity over the years – out of the individual tax business is a good idea. What this does is reduces the federal role in taxation down to essentially telling states and local governments “Hey guys, we need x-dollars to run the federal government, and that’s why we’re looking for y-rate of tax from you this year.” Period. That’s it. No more games, no more debate about soaking the rich or “fair share” on one end or tax breaks for fat cats or supply-side economics on another. That’s all over in Washington.

Sure, that debate moves down to the state and local level, but it’s much better that we’d have it there. Because state and local governments have to be a lot more mindful than the federal government does of the mobility of their citizens. It’s very easy, relatively speaking, to move from Detroit to Grosse Pointe to escape taxation, or even from New York to Connecticut. It’s not as easy to move from the U.S. to Costa Rica or Singapore. And what that means is the city council, county commission or state legislature has to be mindful of the effect of their revenue policies on the local population, or else they’ll find themselves depopulating.

Which has already happened, of course, and giving an increased burden of responsibility to those local governments, like Detroit or New Orleans or Newark, who have already proven themselves capable of running off productive citizens under the current tax code is a legitimate source of uncertainty about the Neutral Tax. How do you trust Stockton, California, for example, to cover its Neutral Tax obligations when it can’t handle what it currently has on its plate?

The answer, of course, is that state governments will have to insure local compliance. And if that means local governments get forced into bankruptcy when they can’t manage their obligations under the new system, so be it. Many local governments are insolvent as it is. And with a new set of obligations in place, perhaps the fools who populate city councils in some of our lesser-performing localities will find their more totalitarian and wacky legislative desires constrained by the Neutral Tax.

Not that local governments are the only source of worry. The Neutral Tax would be a major cold splash of reality to a state government like California or Illinois. But remember – state governments would inherit not only the obligation to “kick up” to the federal government under this plan, they would also get the full power to tax that the feds currently have. And because the federal income tax would go away under this plan, states would be able to ratchet up their income tax rates to meet the burden. Or ratchet up sales tax rates. Or property tax rates. Or corporate taxes. Or put in consumption taxes. Or whatever else they could think of. It would be up to states to design whatever tax system they thought best, with the knowledge that they’d better insure they’re competitive, or else they’d see their revenues plummeting as they run off their productive citizens.

There’s a four-page white paper the Neutral Tax folks have put together which is well worth a read. Here it is…

Of all the potential tax reform plans out there, this one seems to contain the most wide-ranging benefits with the least partisan acrimony in Washington. It would restore the role of states and local governments to the prominence they enjoyed before the early 20th century Progressives destroyed that role with the 16th and 17th Amendments, and because of that you can expect the entrenched interests and petty tyrants on Capitol Hill to fight the devolution of power out of DC.

But that’s not particularly a partisan problem. If you’re a Democrat Congressman or Senator from a blue state you should be just as excited about getting a chance to set unfettered tax policy back home as a Republican from a red state; it’s the freedom to legislate both sides ought to embrace.

The opposition to this would likely be stringent, and certainly there would be obstacles to a transition from the current system to one based on a Neutral Tax. That said, it’s clear the current tax code doesn’t work and it’s also clear America is too diverse politically and economically for any federal-based tax system to satisfy all interests – which is why our current tax code is so full of exemptions, loopholes and disparate treatments. This is such a departure from that Rube Goldberg contraption that one can’t help but be intrigued; it deserves a full hearing and, potentially, passage.

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