The Spirit of Reform

The Daily Reckoning PRESENTS:Tax season is upon us…and while most of us throw up our hands in frustration when we see nearly 50 percent of our income eaten up by the government, Steve Forbes takes the more proactive approach…

THE SPIRIT OF REFORM

“The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.”
– John Maynard Keynes

America considers itself the land of new ideas, and in many respects it is. Yet the truth is that by the time we embrace them, so-called new ideas are usually anything but new. Most were hatched decades before being adopted. They had to travel a long and winding road, enduring repeated examination, debate – and rejection – before finally winning acceptance and bringing about real change.

The flat tax is no different. When I ran for president in 1996 and 2000, I proposed that today’s monster federal income tax code be scrapped and replaced by a single tax rate for individuals and businesses. The flat tax would do away with all but a few basic exemptions and deductions, eliminating the confusion and complexity of the current tax code and letting you fill out your return on a simple postcard or sheet of paper. A simple proposal, but one that promises, as you’ll see in succeeding chapters, to transform not only the tax system but the nation as well, revitalizing the economy and changing our lives dramatically for the better.

Back then, this was portrayed as a new and radical idea. In fact, the flat tax has been around for decades. Some view it as a descendent of the “tithe” which exacted 10 percent off the fruits of men’s labor in biblical times.

Flat Tax Debate: History

Our earliest system of income taxation was a flat tax. Lincoln enacted a 3 percent tax on income in 1861 to help finance the Civil War. The idea of graduated tax brackets was considered unfair and contrary to our traditions. Graduated brackets then came, but only briefly. The income tax itself was scrapped not long after the war.

By the mid-twentieth century, however, our view of taxation had changed. In the 1940s and 1950s, Americans had come to believe that, as a modern country, we needed to swallow the medicine of catastrophically high tax rates. Like castor oil, they were supposed to be good for us. In much the same way that Americans in the 1950s trusted that “Father Knows Best,” the title of the classic television show of that era, we felt the government knew best about how to tax us and deploy our money. But it doesn’t. The federal tax code has grown into a 9-million-word, multi-headed hydra of countless brackets, deductions, and exemptions.

Rates have come down significantly in the past 25 years. Yet when all of Washington’s exactions – not just the income tax, but also Social Security and Medicare taxes and numerous excise taxes – are added together with state and local taxes, we annually surrender as much as 50 percent or more of our income to Uncle Sam and his equally voracious state and local kin.

Every April fifteenth – and for entrepreneurs, every quarter – we keep saying we’ve had enough. Like Howard Beale in the classic movie “Network,” we want to throw open the window and shout at the top of our lungs that we’re mad as hell and not going to take it anymore. But we don’t. We may be incensed at tax time and consider the federal tax code an unfair, excessive burden. But most of us accept today’s system as a fact of life, as immutable as lousy weather.

Flat Tax Debate: World Reform

Until recently, few people have been bold enough to suggest that we don’t have to take it, that the system can be changed – and that real change can work. But, as this book will show, reform is not only possible: It is essential – and inevitable. The flat tax has already produced results around the world – from Russia to Hong Kong and elsewhere. It is part of a new worldwide wave of tax simplification that has implications for America’s competitive position in the world economy. The flat tax movement is finally being recognized by media organizations that had once been skeptical, including the Economist magazine, which devoted an April 2005 cover story to the growing worldwide support for the flat tax.

America’s relative lateness to the table is ironic when you consider that the first calls for a modern flat tax system in this country began in the 1960s when in their groundbreaking book, Capitalism and Freedom (1962), economists Milton and Rose Friedman proposed a “flat-rate tax.”

The prime movers behind the flat tax movement in America have been Robert Hall and Alvin Rabushka, economists at the Hoover Institution. Their highly influential book, The Flat Tax, first appeared in the early 1980s and provided the impetus for a series of legislative proposals, the first serious attempts at reform. Throughout the 1980s, the flat tax was periodically discussed. It emerged as a national issue for the first time when former California governor Jerry Brown, campaigning for the 1992 Democratic presidential nomination, called for a 13 percent flat tax on all personal and business income. His plan did away with the Social Security tax, retaining exemptions for mortgage interest, charitable contributions, and adding a new one – a deduction for rent.

Along with the flat tax, Brown proposed a Europe-like value added tax (VAT) of 13 percent. I loved Brown’s idea of the flat tax, but realized that his VAT would lead us down a perilous path toward European economic stagnation. Nonetheless, his flat tax idea was breathtaking and groundbreaking. Brown’s flat tax proposal rightly got him plenty of attention – making him a serious contender against frontrunner Bill Clinton. Even the New York Times was favorable to the idea of a flat tax back then. Brown was not the only Democrat to support what some see, incorrectly, as an exclusively Republican idea.

Few may recall now that no less a Democrat than former House Minority Leader Richard Gephardt once pushed a variation of the flat tax idea, a stance from which he later retreated. Other flat tax plans have been floated by Republicans, including former House Majority Leader Dick Armey (R-TX). I believe the stage is now set and that conditions are more conducive than ever to the introduction of a flat tax in this country. Our prior belief in a 1950s “government knows best” high-tax approach has been replaced by widespread recognition that a flat tax which combines stark simplicity with a tax cut, would generate more, not less, government revenue.

Flat Tax Debate: Effects of Tax Cuts

The salutary effects of tax reduction on the economy have been demonstrated. Starting with the Harding-Coolidge tax cuts in the 1920s and the Kennedy tax cuts in the early 1960s, we have seen how lower tax rates produce prosperity. (Amazing to think that the Democrats in the 1960s were the tax cutters and the Republicans thought such cuts were fiscally irresponsible, a total role reversal from today.) In the late 1970s, the Kemp-Roth tax cut proposal for an across-the-board 30 percent tax cut was adopted by Ronald Reagan when he became president and launched what became the then-longest economic boom in American history.

As our history chapter makes clear, Reagan’s dramatic reforms were undone by subsequent administrations. Today President Bush is attempting to revive meaningful tax reform with his call in 2001 for elimination of the death tax, and two years later, a similar call for doing away with the dividend tax. He also ushered in a cut in the capital gains tax and allowed more expensing of investments for business. Yes, there have been roadblocks. The president’s proposal for supersavings accounts was quickly dropped; the death tax expires in 2010 for just a year, to be reincarnated in 2011. And even the president’s 2005 panel on tax reform, which was formed as I wrote [my] book, The Flat Tax Revolution will base its recommendations on static analysis techniques believed by many experts to be highly inaccurate in predicting the impact of tax initiatives, especially tax cuts, on the economy.

And yet . . . the spirit of reform is in the air. The administration has proposed a host of free market initiatives – from taxes to tort reform to private Social Security accounts – that are causing us to reexamine how the government is structured and financed and how it provides services. At last many people are asking, just how much is the government entitled to take from what we earn? And how much is too much?

Meanwhile, ordinary citizens approach me at airports, TV studios, professional and social events, asking: Do you think that we will ever see a flat tax? There is a plaintive tone, a note of frustration in their voices. Small business people complain that, for all the smooth talk, the politicians don’t get it. All they care about, they say, is finding excuses to increase government spending and get as much money as they can without losing their jobs. They don’t understand that every dollar they take is one that we need to pay our people and stay in business. They don’t understand what we go through.

That’s why I wrote [my] book – to get beyond the sound bites, the political agendas that so often color day-to-day reporting and, instead, encourage a full and reasoned discussion of the issues during this critical period of national debate; to show in clear and compelling terms that the flat tax works. The evidence is there – in the historical facts, economic statistics, and the experiences of nations that have implemented a flat tax system.

Flat Tax Debate: On A Local Level

The need for a flat tax could not be greater at a time when tax reform overseas is helping to produce new global competitors – countries in Asia and Central and Eastern Europe whose low tax policies have spawned a gold rush of foreign investment. Even high-tax nations in Europe with their stagnant economies have awakened to the threat of these emerging dynamos. America needs to respond.

The flat tax is a reform of our federal income tax system. It does not affect, for example, state and local taxes. But, contrary to what some may fear, it will generate increased government revenue. And that powerful example will induce, I believe, similar reforms in state and local taxes.

Another fact that people seldom realize: the increased revenues and increased value of the nation’s assets that will result from the flat tax will certainly help us grapple with the fiscally challenged Social Security and Medicare programs. America has a great future. The flat tax will help us achieve it.

Regards,

Steve Forbes
for The Daily Reckoning
February 8, 2006

Editor’s Note: The above essay has been adapted from Steve Forbes’ latest book, Flat Tax Revolution. To order your copy, click on the link below:

Flat Tax Revolution: Using a Postcard to Abolsih the IRS

Steve Forbes is president and chief executive officer of Forbes and editor-in-chief of Forbes magazine. Forbes is also chairman of the company’s American Heritage division and publisher of American Heritage magazine. In both 1996 and 2000, Forbes campaigned for the Republican nomination of the presidency. Key to his platform were a flat tax, medical savings accounts, a new Social Security system for working Americans, school choice, term limits, and a strong national defense. Forbes continues to promote this agenda. He lives with his wife and family in New Jersey.

Flat Tax Debate: The Spirit of Reform
by Steve Forbes
The Daily Reckoning
Wednesday, February 8, 2006

Tax season is upon us, and with it, Steve Forbes is rekindling the Flat Tax Debate. While most of us throw up our hands in frustration when we see nearly 50 percent of our income eaten up by the government, Steve Forbes is taking a more proactive approach.

“Record sales of sleeping pills,” heralds a NY Times headline.

What worried us, we reported recently, was that we were the only ones worrying. Now, it looks like others are beginning to do their share. More and more of them toss and turn at night, according to the press report. No visions of cherry plums dance in their heads, we would guess. Instead, they are plagued by nightmares of a financial variety.

While we here at The Daily Reckoning worry for fun and profit, others fret for a more practical reason: they’re going broke. Of course, we don’t really know that for sure. Nor can we know what tomorrow will bring them; for all we know, they really will get rich by leveraging their homes and going to work for Wal-Mart. After all, we don’t get to read tomorrow’s headlines any sooner than any one else.

But today, we make an exception. “Boom in Going Broke,” is tomorrow’s headline on MoneyWeek’s cover story. We say that because we just wrote it.

MoneyWeek is a London-based magazine. Its editor is out this week, so we offered to help, promising not to lower the editorial quality. The lead story is on debt, or to be more precise, the effects of debt.

Let us pause here and check our five Big E’s for context. Among them we find the world’s Experiment with paper money. Hardly had the experiment begun in 1971 when it looked as though it would soon be over. By the middle of the decade, consumer prices in America had begun to soar. “Inflation” was in almost every financial headline. We remember friends from the time who were hoarding pennies to capture the copper content. Silver dimes were precious. Desperate, President Nixon did something so lame and stupid it had not been seen in a major empire since the days of Diocletian – he imposed wage and price controls! Naturally, these made the situation worse.

Finally, it took big Paul Volcker to step into the Fed and impose order. It was into that nascent order that our recently retired, dearly beloved and not-yet-forgotten Alan Greenspan crept. Like a sailor on leave sneaking into the sultan’s harem, our man Greenspan found himself in paradise. He cast his eyes left. He cast them right. Everywhere he looked he saw something to make his mouth water: falling rates of inflation, falling interest rates, and rising prices for stocks and bonds Unbelievably, gold was going soft and declining in price, but his own currency, the pure Experimental paper money, was swelling with every passing moment. The dollar was going up!

As long as the dollar stayed up, the chairman of the Fed could enjoy himself. All he had to do was not get caught. He could emit as much new money as he wanted. Other nations had to follow his lead. They either had to match it, or their own currencies would become expensive and their export industries would suffer.

And so, the whole world was caught up in the grand experiment, and a good time was had by all.

We have not checked, but we wouldn’t be surprised to find that sleeping pill sales are strong here in Britain, too. Yesterday’s headlines told of record bankruptcy rates. The figure topped 70,000 last year, of which, 45,000 declared bankruptcy under a new, gentler legal proceeding.

“The debt that is feeding this new boom market [in bankruptcy] is staggering,” Brian Durrant tells us in MoneyWeek. “British consumers have run up two-thirds of all credit card borrowing across the entire European Union. Outstanding household debt now stands at a record high of 1.13 billion pounds (about $2 billion), well over 140% of post-tax annual income.”

Durrant even recommends shares in a company that makes money by helping people go broke. We thought that was what all finance companies did in the first place, but Durrant is way ahead of us. He’s not looking at lenders, but at companies that actually help to organize bankruptcy reorganizations and workouts.

Which made us think: Who really pays when people go broke?

We guess that the popular vision of money extinction is as puerile as the popular vision of money creation. “Easy come, easy go.” Surely, if the Fed can conjure money “out of thin air,” a bankruptcy court can make it vanish into thin air too, right?

In Britain, America, and much of the rest of the world, bankruptcies, seizures, foreclosures and workouts are bound to increase. But whither goes the money? Does it go to money heaven? Does it just get written off of balance sheets as easily as it was once written on? If we had a million dollars and we lent it to the U.S. government (buying a U.S. Treasury note), we are still a millionaire. And when the Department of Defense gives the money to a hustler who offers advice on how to kill people, now the world has two millionaires. And then, the fellow buys a $2 million house with a $1 million mortgage. Now, the guy who sold the house also has more money (he bought it for only $1 million), and all of them start throwing money around all over town. We began with one guy with $1 million. Now, we have three millionaires, at least, all spending money at a jumped-up pace.

Is there no end to it? And what happens when the hustler loses his contract and cannot pay his mortgage? What happens if his asset – the house – declines in price? Will that unpaid mortgage simply vanish, no harm done?

We are about to find out, dear reader.

More news from our currency counselor…

————–

Chuck Butler, reporting from the EverBank world currency trading desk in St. Louis:

“Yes, the base metals got taken down, too. This looks all too much like hedge funds and speculators taking profits, and then turning it into a rout. I think that in the long run, this will prove to be a blessing.”

For the rest of this story, and for more market insights, see today’s issue of The Daily Pfennig

————–

Bill Bonner, back in London with more observations…

*** Here in London, the property market has sprung a distinct leak. But still, there are places where the good earth might make a healthy addition to a diversified portfolio, only you’ll have to turn your eyes far, far south of El Norte…to the land of sultry tangos and solitary gauchos.

Our friend, Barb Perriello, writes to us that great investment opportunities still abound in Argentina for the careful investor. In Buenos Aires, capital of the fiery dance, property prices in the best areas are no longer sizzling, but they are still a tenth of comparable prices in Paris or London…and in the more bohemian neighborhoods, bargains can still be had.

And there are many other possibilities. With the mushrooming of Chinese demand for wood, Argentinean hardwoods, which grow nearly 65% faster than hardwoods here and re-sprout on their own after harvesting, look like they might make a recession-proof investment.

Or there is bargain wine terroir close to Mendoza, Patagonian ski country bungalows, or in nearby Uruguay, the glamorous beaches of Punta del Este, the Latin Monte Carlo, to choose from. With the peso still weak as the country pulls itself out of a slump – “briskly,” according to Credit Suisse – your money might be more secure south of the Rio de la Plata than north of the Rio Grande.

We offer no guarantees, but for some time now, Argentina has been of interest to us. This spring, we are planning to take the whole family down there to have a closer look. If you’d like to do the same, Barbara is leading a 12-day tour.

*** Gold was hit hard yesterday. We’ve been waiting for a correction for such a long time we’ve forgotten what we expected the price to correct to. Below $550? Below $500? We don’t know how low the price will fall, but when it gets there we hope we remember to buy.

*** Here’s an interesting tidbit to get you in the mood for tax season…a recent report conducted by the federal National Taxpayer Advocate Service shows that the IRS froze 120,000 refunds last year, citing suspicion of fraud – and never let the taxpayers know why they didn’t receive their refund.

The taxpayers in question? Working parents and those who applied for the earned-income tax credit, two groups of people whose median income ranges between $13,330 and $11,956. To add insult to injury, the report showed that 80 percent of these people in question deserved either a full or partial refund of the amount they had originally claimed, which they received over eight months later.

When asked for comment, IRS Commissioner Mark Everson said that the agency would reconsider stalling tax refunds without notifying filers. And, he continued, the IRS would “minimize the number of taxpayers whose refunds are frozen unnecessarily.”

Geez…that’s nice of him. Of course, Steve Forbes, would counter that this problem could be “minimized” if the Flat Tax were to take effect. Because there would be no IRS. And because, as he outlines in his latest book, The Flat Tax Revolution, he proposes that no one who makes less than $36,000 a year would pay any tax at all.

“When we met in his well-appointed offices on 5th avenue in NYC,” writes Addison about Steve Forbes, “he was visibly flummoxed about the confusion over this part of his proposal. He said his 1996 bid for the presidency was torpedoed by then governor of New Hampshire, Steve Merrill.

“Mr. Merill apparently went around giving speeches to the effect of: ‘Sure you won’t pay any taxes under the income level of $36,000 a year, but once you make $37,000 you’ll get whacked with a $6,000 tax bill.’ But that’s not how the proposal works. Under Steve’s plan you would only be taxed on the money you make above and beyond $36,000. Effectively giving everyone a tax holiday on the first $36,000 of their income.”

The devil is in the details. More from Steve Forbes below…