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Death of Taxes

Death of taxes – Investigate Australia April 05

THE DEATH OF TAXES
As pressure builds on the Howard Government to cut taxes, IAN WISHART reports on moves in the United States that go one giant leap further, and which may yet impact on Australians: the possible abolition of income tax

There is nothing as certain, so the old joke goes, as death and taxes. But by the end of this decade, it could be income tax itself lying dead and buried in the graveyard of bright ideas that outlived their use-by dates. If it seems like a bold, even ludicrous, idea, that may be more reflective of the way we’ve been conditioned to think about income tax than the merits of the prediction.

At the heart of it all lies a “rolling thunder”-style tax revolt that’s been quietly sweeping across America since the 1990s. In places as diverse as local community halls, Washington, D.C. thinktanks, and plush resort hotels in offshore tropical tax havens, people have been quietly gathering to discuss ways of removing America’s cumbersome Internal Revenue Service (IRS) from their lives. Many of those meetings were instigated by so-called tax rebels who argued that the US Tax Code was invalid, and that people had a constitutional right, backed up by old Supreme Court judgments, not to pay the federal income tax.

Significantly, these tax rebels also took their arguments to Australians and New Zealanders in the late 1990s with a series of offshore “tax seminars” held in exotic locations like Vanuatu and Fiji. While the legal niceties of the Australasian tax codes were different to those in the US, the principles were the same and a tax revolt briefly flowered here in Australia as a result. But in America it actually took root.

Whether the arguments were right or wrong turns out to be immaterial, because as of 2005 the tax revolt has placed so much pressure on the US tax system that it’s cracking at the seams.

Just a few short weeks ago, President George W. Bush put the abolition of income tax firmly on his domestic agenda this term, with a special advisory panel due to report its recommendations by July 31st. And later in March, US Federal Reserve chairman Alan Greenspan added his voice to what is now a cacophony of calls for income tax to go, saying that individuals should be taxed on what they consume rather than what they earn.

You heard it right.

It is an issue that has barely touched the radar of most media in Australia or New Zealand, but the implications for Australasia if the United States abolishes income tax are huge. And the federal government in Canberra knows it.

Investigate understands Treasurer Peter Costello and his officials are keeping a close eye on developments in the US because – just like the old Vietnam War red peril theory – if one domino falls then other Western democracies may have no choice but to follow suit.

Most Australians born here probably cannot remember a time when income tax was not part of their lives, yet income tax is actually a very modern invention. While kings had the power to levy special taxes on ordinary citizens to pay the bills during times of war, income taxes were not permitted – and in fact had been expressly outlawed from the time of the Magna Carta. Contrary to popular belief, taxes on commoners were extremely uncommon throughout the Middle Ages and the Renaissance.

Britain was the first major nation to impose an income tax, between 1799 and 1816, to fund the Napoleonic Wars with France. The US Government imposed a special income tax in 1864 to fund the Civil War effort, but under the US Constitution the tax had to be repealed in 1872.

Having seen the benefits of a national tax on citizens, however, the governments of both Britain and America realised they could do so much more if they could find a way to permanently collect income taxes. In 1874, just two years after the US tax was repealed after the Civil War, Britain introduced sweeping legislation, including a partial repeal of aspects of the Magna Carta, and gave itself the power to impose a permanent income tax.

New Zealand and Australia followed soon after. News headlines from the time disclose considerable public disquiet about the idea, and warnings it would be “the thin end of the wedge”. But in pioneer lands like Australia and New Zealand where roads and infrastructure needed building, the income tax pill was largely swallowed whole by the public. Still, there were many who felt the tax burden, at one and a half pennies in the pound (a tax rate of about 0.75% in today’s terms), was onerous. Just what those first Australians would make of today’s 50 per cent tax rates is unclear, but history appears to have borne out the warnings that giving a government the power to levy income taxes – even at 0.75% – was indeed the thin end of the wedge.

Not to be outdone by the Mother Country and the Antipodes, US officials reintroduced a federal income tax in 1894, but it was struck down by the Supreme Court as unconstitutional. So in 1913, amid much lobbying from merchant bankers who saw the chance to make lots of money, the US reintroduced income tax by way of the Sixteenth Amendment to the Constitution. It is this document that lies at the heart of the US tax revolt after revelations in the past ten years that the Sixteenth appears never to have been properly ratified by the required number of state governments. Therefore, argue the protestors, income tax remains illegal under the US Constitution.

Either way, the protests over the past five years have seen hundreds of thousands – some commentators say it is into the millions – of American individuals and small businesses refusing to file their tax returns, and tying the IRS up in red tape and court challenges every step of the way. Adding insult to injury for the IRS, it has lost some cases in front of unsympathetic juries – fueling the perception that income tax might indeed be “voluntary” in the US.

In August 2001, Investigate was the first media organization in the southern hemisphere to report that the recently-elected President Bush was taking on board the protests and considering abolishing the federal income tax:

“The growing rebellion against income tax that’s sweeping New Zealand, Australia, the United States and Canada has just taken a major step towards achieving its goal: US President George Bush has confirmed he is considering the complete abolition of income tax in the United States.

“In a front page story in The New York Times on July 16, Bush’s chief economic advisor Lawrence Lindsey confirmed that the White House has adopted a Ground Zero approach to tax reform, and that all issues, including the scrapping of income and company tax altogether, are “in the discussion stage.”

“ ‘The facts are that one needs a broad consensus before moving on fundamental tax reform,’ Lindsey said. ‘The process of building that consensus takes time. That doesn’t mean you shouldn’t start the process’.

“If the White House does push ahead with ditching the century-old income tax, the newspaper reports a likely replacement is either a flat sales tax of between 20 and 30 percent, or an Australasian-style GST.

“Pressure’s been building in the United States for nearly a decade for the US Government to come clean on the constitutional status of the income tax. Lawyers, congress researchers and even former Internal Revenue Service agents are now saying the income tax is illegal – that its introduction in 1913 was not properly ratified by the states of the Union, and that ordinary Americans cannot be forced to pay it.
“The White House has also been sandwiched in a pincer movement between competing groups of tax rebels. One of them, the FairTax organisation, has congressional, bipartisan support and its cause is being championed by Congressman John Linder (R-Georgia) and Congressman Collin Peterson, (D-Minnesota).

“The two men, with a number of other politicians behind them, have introduced legislation to Congress clearing the way for the abolition of income tax in favour of the so-called FairTax.”

That was August 2001. A month later, the attacks on the World Trade Center took Bush’s attention away from domestic issues and agendas like the FairTax. But the Linder/Peterson proposal to totally reform America’s, and possibly the West’s, taxation system didn’t disappear.

Over the past four years, largely through an email blitz fired out from their website fairtax.org, the Congressmen have marshaled the support of more than half a million Americans and a large number of current and former politicians and business leaders. And, fresh from introducing democracy to the Middle East, George W. Bush now has the chance for a domestic legacy as well: becoming known to future historians as the President who killed income tax.

Bush can’t stand for re-election in 2008, so this term he’s largely unfettered by political considerations. And Bush has shown he’s a man who likes to pursue big visions.

Which is why the FairTax may return to centrestage this year.
In the form now being proposed in the US Congress, the FairTax would see the federal income tax abolished, the IRS disestablished, and the introduction of a 23% flat-rate sales tax imposed at the final point of sale to end users. Nothing particularly new in the idea of a sales tax, you might say. And critics of sales taxes are usually quick to suggest they are unfair to the low paid, because people on low incomes spend most if not all of their income on the necessities of life and have no way of avoiding a sales tax, while the wealthy can save their money or invest it and not be taxed.

It’s a simplistic argument at the best of times – the low paid haven’t generally been able to avoid income tax either – but in the case of the FairTax the argument fails at an even more basic level.

Recognising the need to ease the burden on the poor, the FairTax provides for regular tax rebates to every single household in America, so that a family of four on the poverty line, with a household income of just US$23,000 a year, will effectively pay zero tax. Under that $23,000 threshold, the tax system actually works in reverse, so that families under the poverty line will not only get all their tax back, they’ll get as much as 23% more of their income back on top of that. In real terms, say the FairTax proponents, for a family of four on a household income of US$45,000, the effective tax rate will be only 11.5%, and at $90,000 it is still only 17.2%, rising to 20% by the time you’re earning $180,000.

Compare that to Australia.

According to the ATO, a family of four in Sydney with a household income of $45,000 will be pinged almost 24% income tax on that sum, more than double the amount of tax an American family will be likely to pay under the FairTax. And over here, Australians still pay consumption taxes on top of the income tax.

President Bush has instructed a nine-member panel of
experts to conduct a series of public hearings on the idea of abolishing income tax, and they’re due to report back to the White House this coming July.

At one of the hearings in March, US Federal Reserve chairman Alan Greenspan threw his not-inconsiderable influence behind the idea of scrapping income tax and replacing it with a consumption tax. “As you know, many economists believe that a consumption tax would be best from the perspective of promoting economic growth – particularly if one were designing a tax system from scratch,” argues Greenspan, “because a consumption tax is likely to encourage saving and capital formation.”

A recent OECD report noted Australia’s marginal income tax rates are among the highest in the world. If America does indeed get rid of income tax less than a hundred years after it was introduced, it will undermine the philosophical foundations of income tax in other western democracies like Australia and New Zealand, where it has crept from 0.75 cents in the dollar when it was introduced to 48 cents in the dollar today.

Not only are the US, Australian and New Zealand tax codes huge and unwieldy – running to thousands of pages and requiring teams of Queens Counsel to interpret – the wastage in the collection system is also massive.

Most tax money taken from private citizens gets eaten by the large government bureaucracies set up to administer the system. In the US, the people behind the FairTax are quietly confident their proposal will get the green light from the White House, though it will still have to get through a string of congressional and senate committees and public hearings.

“Can you imagine,” writes one advocate, “what Joe Public will think when he wakes up one morning, five years from now, opens his paycheck and finds the government has taken nothing in tax? Suddenly, Joe is in charge of his own financial destiny.”

For Australians who, like Treasurer Peter Costello, will be watching how this plays out in the next few months, it won’t be too hard to do the math: simply punch your gross annual salary into a calculator, divide it by 52, and that’s how much take home cash you’d get every week. How much tax you’d pay would be determined entirely by how much you bought that week.