Taxation and International Trade

 

     There is another aspect to the economic effects of taxation not covered adequately in the 'Economics of Taxation 101' post: the impact on international trade. With President Trump reviving tariffs as a tool of international policy, the ramifications of that and other taxes are worth examining.

    Everyone has heard from time to time that a given country – ours or others' – is blessed with an abundance of natural resources. This is obviously a good thing, but if the inhabitants of the country merely sell off the non-renewable resources, a wealthy country can quickly be reduced to ruin and destitution. A few natural resources are not expendable, such as climate, access, etc., which can be lumped into the Realtor's favorite line – location, location, location. Virtually everything else can be exhausted or decimated for short term profit. Taxation can play a major role in either facilitating or discouraging the demise of a country's natural resources.

    Development of mineral resources can contribute positively to the wealth of a country, but not in the long term if they are liquidated in international trade. On the other hand, consumable resources such as fossil fuels can be depleted internally or externally if not given the proper respect as finite non-renewable assets. In either case, the fairly obvious policy a country should pursue with all non-renewable resources is to try to conserve them for posterity.

    So what should be the proper approach to international trade? Ideally one should export renewable assets, primarily labor, and strive for at least net zero export of non-renewables. In fact, a net positive import of non-renewables is desirable, with export profits being based on value added to imported raw materials by labor and manufacturing. This strategy, in fact, been responsible in a large part for the ascent of China in recent decades.

    The role of taxation for encouraging the principles described above is to discourage or restrict export of non-renewable raw materials; to NOT tax the contribution of labor to exported products; to discourage imports to the extent that they are primarily labor intensive; and to encourage to the extent possible the import of non-renewable raw materials. Tariffs can be useful for achieving the proper balance of types of imports, but should not interfere with obtaining raw materials.

    As usual, the Income Tax is perhaps the worst offender in achieving the desired trade objectives. It taxes the labor and value added of Americans at the source and throughout the supply chain, and therefore works diametrically opposite to the strategy outlined above. It does not tax exported non-renewable raw materials, but instead taxes any American labor involved in producing and shipping them. As this blog has repeatedly emphasized, THE INCOME TAX MUST GO!

    Sales Taxes, on the other hand, tax some or all goods and services consumed by the residents of a country. In this country State sales taxes are a levy on American goods and services, but also a levy on all imported goods. Unfortunately, they usually do not tax foreign services rendered by mail, telephone or internet. A National Sales Tax would treat domestic and foreign entities equally, and would also be more or less equivalent to an across-the-board tariff of the same rate. This would then make any additional targeted tariffs more advantageous to American producers and a more flexible tool for trade negotiations.

    It is worth noting that a tariff is essentially a sales tax levied on specific imported goods or on imports from specific countries. It is levied on imports at the time and/or place of import and not at the point of sale. This differs from what Americans are accustomed to, as sales taxes in this country are levied by each State at the time of sale as an add-on. Thus the tariff sales tax is buried in the price of the affected goods and as such goes more or less undetected by the consumer. A National Sales Tax could be implemented in a similar manner.

Income Tax Burden

     

The fact that a large number of current jobs are directly the result of the Income Tax is NOT a good reason to retain it. The argument that it provides work for these people is the same as the 'broken window' theory - that it is advantageous economically to have windows broken because it makes work for glaziers. Although a work force repairing windows that are accidentally broken is necessary, breaking windows to create more repair jobs is obviously insane. But that in effect is the Income Tax. There are several alternatives to the Income Tax to finance necessary government, and the gargantuan army of 'window repairmen' servicing the Income Tax monstrosity could be employed in much more productive efforts. The deleterious burden on business of the Income Tax is so great that putting the Federal Bureaucrats, lawyers, CPAs, bookkeepers, etc. that are required by the Income Tax on welfare and eliminating the Income Tax would be an economic gain for the country.

The total effect of the Income Tax on the economy is virtually impossible to determine. The word insidious is defined as working or spreading harmfully, subtle but treacherous, gradually but secretly causing harm. This describes the Income Tax, in that a graduated Income Tax appeals to the lower classes because it looks like it can tax the rich and not them. This is the sinister aspect of the Income Tax, in that the cost to the consumer of all the Income Tax paid by every worker and business in this country that is involved in bringing the product to the American consumer is included in the final price of the product. This includes not only the workers and businesses that contribute to the production and delivery of all goods and services bought by the consumer but also all those parasites that are required to do all the necessary bookkeeping and other paperwork involved in determining and remitting the Income Tax. In addition there is the completely indeterminate cost of the many economically negative decisions that are made because of the arcane Income Tax rules.

A word in passing on a related subject. There are morality aspects to the many forms of taxation that seem to be given little consideration in modern America. In particular, Income Taxs are essentially a statement that an American citizen is in fact a serf of the Governments, Local, State and Federal, that he/she lives under. The situation is no different than that of the King in medieval times requiring a percentage of the productivity of each peasant to support his opulent living style.

Replacing (absolutely NOT in addition to) the Income Tax with tariffs, sales taxes, excise taxes, etc., should be a no-brainer. The problem is to educate the public to the total cost of the Income Tax, direct and hidden, and thus to the resulting loss of competitiveness of American made goods in both domestic and foreign markets. Adding tariffs on imports to offset the embedded cost of the Income Tax may help domestic producers for sales in this country (mostly paid by the American consumer), but it does nothing to make American goods more competitive in foreign markets.

Lastly, the fact that citizens of the U.S. are no more free than the medieval peasant should be galling to every hard working American. We fought the Revolutionary War in part over a tea tax. Let's hope we don't have to repeat over a serf tax.

Why The Income Tax Must Go

Rahm Emanuel is known in part for his adage "never let a serious crisis go to waste".  The unprecedented crisis in the United States that the coronavirus COVID-19 has brought upon us may be an opportunity to correct a glaring problem with the U.S. tax structure.

One of the corrections needed in U.S. overall philosophy that most have been made painfully aware of because of the coronavirus is the need to reduce our dependence on foreign sources of critical needs, especially on countries that have overtly stated their hostility to America. The general wisdom on the subject is that it is the greed of large corporations that has led to so much outsourcing of the goods and services that we consume. Where less than a century ago the US was the undisputed leader in production of most goods and services, today we don't even produce much of our medical or military needs. This is insane and dangerous.

The rarely mentioned factor in the impetus for the outsourcing and offshoring of production is the U.S. tax structure. In particular, the Income Tax is a huge contributor to the reason that the American Worker cannot compete with low cost foreign labor. The added costs to every product made in the USA due to income taxes paid by both the worker and the business that he works for make his product less competitive both in the domestic market and in foreign markets. Any superiority in the efficiency and productivity of the American worker is canceled by the income tax burden that must be included in the price of American goods.

There are many ways to view the undesirability of the Income Tax. On the philosophical side, the Income Tax is a tax on productivity and investment, both of which one should want to encourage, not penalize. The Income Tax is a tax on labor, not product, and thus can be viewed as penalizing the American worker relative to not only the foreign worker, but also illegal 'under the table' workers and even automation.

The costs of maintaining the infrastructure that is necessary for the free market to exist in this country is paid by the citizens of the country, but not by foreigners that participate in our markets for nothing. Instead of foreign interests paying their fair share, that cost is shouldered by U.S. citizens, primarily with the Income Tax. and in effect makes their products more expensive in both domestic and foreign markets.

Another downside of the Income Tax is the detrimental effect that it has on business economic decisions. How many times have you heard someone say "I have to consider the tax implications", or "I need a loss". This is magnified by the many special rules that the lobby driven political class has embedded in the tax code. One wonders if the productivity of American businesses wouldn't explode if the stupidities of the Income Tax were purged.

Then there is the problem of whether to tax gross or net income. It's pretty obvious that taxing gross income would be a total disaster, since anyone that was in the business of reselling a product would have to have a markup greater than the tax rate to make any net profit. But that leaves the problem of defining net income, a task beyond mere mortals, and especially those that try. And even if it could be done fairly, it requires massive bookkeeping to compute net income to tax. This bookkeeping burden further adds to the cost to the American producer.

One last indictment of the Income Tax in the U.S. Since we have a fiat currency that our unscrupulous government is inflating at a non-trivial rate, the Income Tax treats any increase in currency based value as a taxable capital gain. Return on investment in the form of interest or dividends are taxed at the marginal rate such that one must get a return of more than the inflation rate plus the tax on that fictitious gain to not be losing value. Inflation and income taxes are not compatible and the one that is worse is the Income Tax.

Instead of taxing and therefore penalizing labor and investment with the Income Tax, it makes much better sense to tax the product with a retail consumption tax. It taxes foreign products at the same rate as domestic products, thus taxing a $30,000 car made in Japan, Mexico or Detroit the same. It has the same effect on foreign goods as a tariff, without the appearance of a punitive penalty. At the same time, the exported domestic goods are not burdened with the US consumption tax and therefore are more competitive in foreign markets.

Thus in the midst of a health and economic disaster Americans have a historic opportunity to at least try to improve their government. The income tax, a treachery so heinous that it required amending the Constitution (the 16th Amendment) to be legal, could be temporarily eliminated. One could further hope that the wisdom of such an improvement was sufficiently apparent to promptly re-amend the Constitution to eliminate the possibility of it reappearing.

The 'Fair Tax' bill (H.R.25 - Fair Tax Act of 2019) does an excellent job of laying out the case for a sales tax to replace the disastrous income tax. But it's not going to happen unless the rank and file citizen becomes sufficiently convinced that it's not only a good thing, but that it's virtually required to avoid an untimely demise of the United States as the world economic leader. One of the unfortunate characteristics of the average American is that his/her response to everything is "what's in it for me". This is despicable, but it is a fact of life that must be faced. Every American needs to study the problem, convince himself that there is something in it for them (unless they're politicians or tax lawyers), and then help get the word out.

The Internet is deluged with jokes and other garbage passing from coast to coast like wildfire. Let's make use of this phenomena to pressure Congress to pass the single most important piece of legislation that's come along since the ill considered stupidity that proposed the 16th Amendment in the first place.