Why the US should abolish income tax

America's unwieldy tax system hinders growth and hurts poorer Americans. With its complicated system of exemptions, it's time to ditch income tax for a value-added tax that could raise revenue more efficiently.

Americans desperately want a fairer tax system and relief from arbitrary treatment by the IRS. True reform requires simply junking the personal and corporate incomes in favour of a consumption tax.

House Ways and Means Committee Chairman Dave Camp estimates tax filing, recordkeeping and the like amounts to $US168 billion ($A186.6bn) a year -- a terrible waste exceeding 10 per cent of the taxes collected. Much of the personal information revealed is a terrible invasion of privacy, and the constant fear the IRS will audit taxpayers for their political activities is outright tyranny.

The tax code is riddled with special interest provisions that favour rich donors to political campaigns, distort business decisions and consumer choices, and handicaps economic growth and jobs creation.

Camp proposes to eliminate or modify many exemptions, deductions and other special provisions, but just the summary of those reforms takes 194 pages to explain in language only a tax expert could fully comprehend. Despite noble intentions, much of the morass would remain, and the biggest beneficiaries would be lawyers and accountants tasked by the rich and big corporations to game the new system.

The tax code would continue to heavily tax America’s biggest jobs creators -- small businesses who cannot afford those professionals to effectively compete with big corporations -- and to disadvantage American businesses in foreign markets where governments rely more on consumption taxes than levies on income.

In 2013, the Treasury collected $US1.6 trillion from corporate and personal income taxes. This could be replaced by a 12 per cent sales tax on all private purchases and other payments, be they computer equipment, college tuition or lunch at the corner takeout.

Businesses and institutions would then pay to Treasury the taxes they collected less sales taxes paid on purchases of materials and equipment, rent and the like. This subtraction would avoid the double taxation of materials and equipment businesses purchase and create a value-added tax often proposed by advocates of reform.

It would end forever all the headaches associated with valuing inventories, calculating depreciation on capital equipment and other work that cost billions in accounting and legal fees.

A VAT would favour no activity over another and, by taxing goods and services at the point of sale, it would end the problem of US firms parking profits abroad to avoid taxes.

Businesses and institutions would file a three-line return, how much tax they collected, how much they paid and the difference. Individuals would file no tax return at all!

Temptations would abound to exclude or exempt all kinds of activities, but that is the kind of thinking that gave us the current mess, as well as inequities, slow growth and exceeding complex tax returns.

Two problems remain. A VAT is not progressive: it taxes rich and poor consumers at the same rate. The elderly, who more or less live on savings, have already paid income taxes on those savings and would be taxed again.

A simple solution would be to raise the rate to 15 per cent, and award each parent $US4,000 for each child and pay similar amounts to each American over 65.

If Congress wants to spend more, it could raise the rate further. That would make transparent to all the cost of spending more on government activities. If conservatives on Capitol Hill want to cut programs, they could explain to voters how much those savings would lower the rate.

Elegant, egalitarian and efficient, such a value-added tax without exemptions would give Americans the tax reforms they want but privileged rich folks and big businesses spend a fortune avoiding.

The economy would grow faster, create more jobs and Americans would live better and in less fear. And that is what America is supposed to be about.

Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, and a widely published columnist. He tweets @pmorici1

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