Monday, November 19, 2012

Why Income Taxes are What We Have

I've been reading various Facebook "memes" and blog postings complaining that the "wealthy" do not pay their "fair share" in taxes. These posts reveal a basic misunderstanding of the United States' historical approach to taxation, and the limits imposed on the government by the Constitution. The basic issue is that the taxes Congress can enact and collect are limited by the United States Constitution.

The Sixteenth Amendment to the U.S. Constitution reads:
The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.
Notice what this simple, clear Amendment establishes as a Congressional power: "to lay and collect taxes on incomes." The Amendment is clear and concise. Congress can establish an income tax, in addition to its previous power to set and collect various import/export taxes. For much of this nation's history, the federal government survived on the duties collected at our ports of trade.

There are three major mentions of taxes in the Constitution. These mentions are all in Article I, the powers of Congress.
Article I, Section 2, Clause 3:
Representatives and direct Taxes shall be apportioned among the several States which may be included within this Union, according to their respective Numbers, which shall be determined by adding to the whole Number of free Persons, including those bound to Service for a Term of Years, and excluding Indians not taxed, three fifths of all other Persons.
Basically, the Constitution attempted to ensure that each state would collect and send revenues to the federal government based on the population of the state — with the caveats we all know based on ethnicity. How the taxes would be collected by the states, and which taxes might stay in the states, was not determined by the Constitution. Most states relied on some form of property taxes and special transaction taxes.

Historians debate the next section to address taxes. Section 8 reads:
Article I, Section 8, Clause 1:
The Congress shall have Power to lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States.
Article 1, Section 9, clarifies that all taxes were to be proportional to population, not income distribution.
Article I, Section 9, Clause 4:
No Capitation, or other direct, Tax shall be laid, unless in proportion to the Census or Enumeration herein before directed to be taken.
As you can read above, the Constitution sets clear limits on taxation. If the citizens (and politicians) wish to establish European-style wealth taxes on "the rich" of this nation, the United States Constitution would need to be amended. That is a difficult process. There are many other issues that should be considered long before we alter our traditional tax structure; I'd argue against any such proposal.

It is a shame that political activists, and some politicians, are promoting class envy by suggesting "the wealthy" don't pay a "fair" amount of taxes. The wealthy, generally, are following our tax code. Getting rid of deductions or capping deduction would be a huge step towards fairness and tax simplification. But, we are not going to shift away from an income-tax based revenue system.

We should tax income consistently, not giving special breaks to any group. I would consider capital gains to be income. Inheritance is more problematic: the income has already been taxed, but maybe there is a legal argument that inheritance should be included within that year's income and taxed accordingly. There is no reason inheritance should be taxed at a higher, or lower, rate than other income.

The income tax should apply to all income. I accept some progressive setting of marginal rates, but the top rate should be capped. I also oppose most deductions: any income is income, period. Our tax code is a mess, with too many special tax breaks for various groups. The home mortgage interest deduction, for example, is popular but serves the real estate market more than it does other individuals. Tax breaks distort behaviors and markets.

Instead of promoting envy, we should be asking why Congress won't clean up the income tax code. A simplified tax code might raise more revenues with less effort — and fewer attempts to avoid taxes.