Retirement and Social Security Reform
Good Intentions Do Not a Tax System Make
November 20, 1995
By Ernest S. Christian
Ernest S. Christian was the deputy assistant secretary
(tax policy) of the Treasury Department in the early 1970s.
He presented this testimony in a hearing before the National
Commission on Economic Growth and Tax Reform on September
6, 1995. He is also the author of "Description and Explanation
of the Unlimited Savings Allowance Income Tax System,"
Tax Notes, Special Supplement, March 10, 1995.
The current federal income tax is a national disgrace that
ought to be replaced immediately before it can do further
harm. It has characteristics that would be condemned in any
human personality. It is inexcusably class conscious, it is
hypocritical, it is meddlesome, it is overbearing, it is mean
and hurtful, it is covetous and, above all, it is downright
Reading the Internal Revenue Code (assuming anyone could actually
do it) is truly a journey into the absurd. There is a rule
for nearly everything that exists and some that do not --
including "passive activity."
Ridicule is too easy and beyond a point serves no constructive
purpose. The current federal income tax has few defenders.
Its long list of fundamental defects is well-known. I take
it as a given that it will be replaced (or, at least, radically
restructured) in the near future. Therefore, I will address
myself to the design of the new tax system for America's future.
Given the obvious defects of current law, replacing it with
a better one might seem an easy task. Unfortunately, reality
At this particular time in history, we definitely do have
a unique opportunity to succeed. To do it right, once and
for all. To design and enact into law a rational tax system
that will fairly and efficiently raise revenue in a way that
neither distorts behavior nor misallocates resources. But
we also face the prospect of failure -- by repeating in a
different context many of the same mistakes that underlie
the existing federal income tax or by making some new ones
of our own. Initial success also does not necessarily translate
into long-term success. The new tax system is likely to remain
stable only if it is built around self-reinforcing core principles
of enduring merit and, then, only if the American people truly
understand and agree with those principles.
Otherwise, lacking that firm foundation and as the prevailing
political winds shift in the future, what might have been
a fine new tax system at the outset can quickly be converted
into one as bad or worse than the one we now have. We already
have a long and recent history of tax instability. A succession
of congresses has for decades incessantly spewed forth a constantly
changing kaleidoscope of amendments to the existing federal
income tax. The American people are accustomed to that. If
we now further demonstrate that the entire tax system can
be repealed and replaced, we better get it right to start
with. Once started, what can be radically changed in one direction
today can also be radically changed in a very different direction
Success requires much more than good intentions. The present
and failed income tax is not the result of bad motives. Wrong
basic principles compounded by a succession of mistakes, yes.
Ideological biases, bad economics, parochial agendas, narrow
self-interests, political expediency, bureaucratic inertia,
and a large degree of plain old incompetence -- all very definitely
yes. A disgraceful abdication of their own responsibility
by elected officials who have relied more on the nostrums
of so-called tax "experts" than on their own common
sense -- also yes; but not evil intent. Only the result is
I would caution everyone to beware of "experts"
-- particularly the kind of expertise applied by the economists
and lawyers who are the real architects of the current federal
income tax. They are of the baroque school of tax design and
policy. Therefore, they are specialists in multifaceted intricacies
who, according to Mr. Webster, use convoluted, even gargoylian,
forms and other bizarre imagery. When applied to taxes, baroque
techniques make the simple complex and the complex incomprehensible
to everyone but the experts themselves. Witness the federal
income tax of today.
Writing in the American Tax Policy Journal a few years ago,
the very learned Emeritus Professor James C. Eustice probably
said it best of all and from the perspective of a lifetime
spent mastering and then remastering the constantly changing
intricacies of the income tax.
A definition of an expert is a person who avoids the small
errors as he sweeps on to the grand fallacy. Perhaps the
trouble with the tax law is that it has been written and
interpreted by so many 'experts'; that it has lost sight
of the fact that there are some people out there someplace
that have to function under this system.
We are, indeed, an expert-afflicted society with an expert-
afflicted tax system, but before we either throw up our hands
in despair or start burning books and closing schools, let
us remember that there is another kind of expertise -- a higher
order of expertise that is perfectly suited to the design
of an ultimately rational, highly utilitarian, nonintrusive
tax system. This is the kind of expertise found in minimalism
-- the theory or practice in art or design of using the fewest
and simplest elements to achieve the greatest effect.
When applied to the design of a tax system that can actually
function in a highly complex economy where thousands of different
events and transactions must simultaneously be taken into
account, minimalism first involves a mastery of all details.
It then, if successful, cuts through to the heart of the matter.
The result should be a tax system with only a few precisely
honed rules that, when consistently applied throughout the
economy, automatically produce the correct and logical result
in all situations.
A tall order, to be sure, but such a highly desirable result
must be sought and must be achieved. In my view, that process
and that result is what The National Commission on Economic
Growth and Tax Reform is all about. To succeed in this endeavor
will require the highest order of expertise, but a very different
kind than is reflected in the existing tax system.
Obviously, designing a new tax system for America is not a
matter that has first arisen with your Commission. A great
deal of thought has been given to all these issues by a great
many people over many years. All the basic alternative tax
structures before your Commission are of the minimalist school
of design. Some are more perfect examples than others and
the best may be yet to come -- perhaps through some amalgamation
that takes the best parts from two or more.
The most well-known are the USA Tax by Sens. Pete V. Domenici,
R-N.M., and Sam Nunn, D-Ga., the Flat Tax by Rep. Dick Armey,
R- Texas, and Sen. Richard C. Shelby, R-Ala., and, in a general
sort of way, a national sales tax suggested by Sen. Richard
G. Lugar, R-Ind., and perhaps others. Of these three, the
most fully developed and articulated -- in all its operational
details -- is the USA Tax. In my opinion, and in the opinion
of many others, the USA Tax is, thus far, the high water mark
in the attempt to design a crisply efficient tax system of
the minimalist school (a) that will actually work in a complex
global economy, (b) that takes a balanced approach to correcting
all (not just some) of the deficiencies in current law, and
(c) that is sufficiently in-tune with the on-going political
ethic in this country to be enacted into law and to endure.
I highly recommend the USA Tax for your most intense and thorough
In brief, the USA Tax consists of a simple 11 percent tax
on corporations and other businesses that allows full expensing
of capital equipment and inventories, allows a credit for
the employer- paid payroll tax, and levels the international
playing field with respect to imports and exports. For individuals,
the USA Tax is a simple, progressive-rate system that allows
a full credit for the employee-paid payroll taxes and a full
deduction for saving. The USA Tax has very few moving parts.
It is written in a simple, understandable style. The entire
USA Tax code is a tiny, highly readable document compared
to the monstrous and incomprehensible Internal Revenue Code
of 1986. The USA Tax also has the right philosophy, which
is fully and well articulated in Title I of the statute itself.
The all-inclusive mandate of your Commission is for a "fair"
tax system. The USA Tax provides a correct definition of fairness
-- a fair opportunity to save, a fair opportunity to invest,
a fair opportunity to compete in international markets, and
a fair opportunity to achieve a better standard of living
through one's own work and thrift. The USA Tax does not stop
with rhetoric. It goes on to provide a fully articulated tax
structure that actually does what it says and that will actually
permit the American people to regain control over their own
income and taxes, and to plan and provide for their own future
well-being. It is hard to ask for more from any tax system.
The USA Tax is not perfect, but it is getting close. About
the only significant criticisms I have heard are (a) the false
impression that USA Tax is too complex and (b) the complaint
that its marginal tax rates are too high.
The USA Tax is not complex. In and of itself, it is quite
simple. It is the economy that is complex. The complexity
of the economy has been confused with the simplicity of the
USA Tax because its proponents have fully illustrated the
application of its few simple rules to a wide range of complex
domestic and international transactions which are themselves
not easy to understand. The proponents of other alternative
tax proposals have not done that. Unlike the USA Tax, they
also have not addressed the transition from the old tax system
to the new tax system. Thus, the USA Tax appears more complex
than it in fact is and other proposals appear simpler than
they in fact are.
Things are not always as they may superficially appear. That
is also true with respect to the marginal tax rates under
USA. While higher than I personally would like and higher
than under the Flat Tax, the marginal rates under USA are
not as high as they may seem. Similarly, the actual marginal
rates under other proposals such as the Flat Tax are not as
low as they may seem.
Because the USA Tax allows a full credit for the nearly 8
percent employee payroll tax, the 8, 19, and 40 percent individual
rates include the payroll tax. /1/ The 20 percent rate under
the Flat Tax is in addition to the 8 percent employee payroll
tax. Therefore, to compare the two, the rates under the USA
Tax must be considered to be 0, 11, and 32 percent (or the
rate under the Flat Tax must be considered to be 28 percent).
The top marginal rate under the USA Tax could be lower. It
is set to achieve a revenue-neutral result. It is also set
to maintain the same progressive distribution of tax liabilities
by income class as under current law. If the Congress were
to decide to modify progressivity or not to be revenue neutral,
the tax rate could be lowered. The important and uniquely
valuable structure of the USA Tax can accommodate any rate
desired -- even a single flat rate. A single rate is not the
exclusive province of the Flat Tax, which has a quite different
and, in my view, less good overall structure.
The special and enduring value of the USA Tax lies in its
smoothly functioning, fully integrated structure where (a)
all income (labor and capital) is taxed and taxed alike, but
only taxed once, (b) a full deduction for saving is allowed,
and (c) all international transactions (including exports
and imports) are treated correctly. I find it hard to believe
that anyone could claim much credit for fundamental tax reform
if that new tax system did not allow a full deduction for
saving or if that new tax system continued to penalize U.S.
competition in foreign markets while granting a virtual "tax
holiday" to foreign companies in U.S. markets.
If your Commission should decide to recommend a new tax system
with a single flat rate of tax (or lower multiple marginal
rates), I very strongly urge that your Commission also recommend
that the rate (or rates) operate within the highly salutary
structure of the USA Tax.
Your Commission is a vital part of what I think of as the
American Tax Revolution. I understand you are near to completing
your fact-finding hearings and are about to begin your deliberations
looking toward making recommendations to the Majority Leader
and the Speaker before year end. Your task is going to be
very difficult. In preparation for it, let me share my favorite
quote from Dwight Eisenhower:
"I have one yardstick by which I test every major
problem -- and that yardstick is: Is it good for America?"
Further, let me also share with you a few other points of
advice that may be helpful.
- Resist over-concentration on achieving one or two goals
to the exclusion of others. Just as the current tax system
has many defects, the ideal tax system should have many
positive attributes. I assure you that it is possible to
design a simple and fair tax system that lowers rates, allows
a deduction for saving and investment, taxes all income
once and only once and the same, and treats all international
transactions correctly in a manner that is consistent with
international practice and the principles of free trade.
- Insist that any new tax system be simple, but be certain
that you correctly understand what are and are not the sources
of tax complexity. The fact that a tax has two or three
rates, instead of only one, is not the source of any material
tax complexity. Similarly, allowing a few personal deductions
(such as for home mortgage interest and charity) is also
not the source of significant tax complexity. The tax complexity
that afflicts the public today -- and wastes billions of
dollars and hours -- arises mostly from a multiplicity of
rules and from exceptions to those rules. Current law has
thousands of rules and thousands of exceptions. Specialized
deductions and credits have specialized eligibility requirements.
The remaining complexity under current law arises from prolixity
of writing and from the fact that savings is not deductible.
I have recently been amazed to find how much of the current
tax code exists solely because savings are not deductible.
- Resist the temptation, which we all face, of thinking
about the new tax system too much in terms of the old tax
system. Old issues that have occupied our minds and inflamed
our emotions under current law may have little to do with
the proper design of the new system. This is one case where
past experience may not be such a good guide to the future.
- Beware of large exemptions that remove large numbers of
people and voters from the tax roles -- lest we quickly
end up with a situation where a majority made up of nontaxable
voters is deciding how heavily to tax a minority of voters
who have no recourse. Decoupling the fundamental obligation
of citizenship (paying taxes) from the fundamental right
of citizenship (voting) is not a good idea. Large exempt
levels of income are also unnecessary under a properly designed
tax system. It if is necessary to have high exemption levels,
the tax rate must be too high or too flat. If the large
exemption is designed to relieve large numbers of people
from having to fill out and file a tax return, the tax must
be too complicated. Moreover, large exemptions tend to grow
and to push tax rates higher. Low marginal rates and high
exemptions are inconsistent over the long term.
- Keep marginal rates as low as possible, but be certain
you have fully accounted for the payroll tax. Unless a credit
is allowed for the payroll tax, any stated marginal rate
must be increased by the nearly 8 percent payroll tax to
arrive at the real marginal rate. Otherwise, the supposedly
lower marginal rate is a gimmick -- reminiscent of current
law -- that will not fool the American people.
- Beware of leaving a vacuum. It will quickly be filled.
For example, we have a long history of taxing corporations
and, if properly done, it is not illogical to do so. But
some have proposed to you a "household-only" tax
where the tax would be collected only from individuals.
I suggest that the "gap" -- no corporate tax --
would quickly be filled in the future. It is better to occupy
the field from the outset with a properly designed corporate
tax. Similarly, some have suggested only taxing retail purchases
and having no income tax at all, but, again, we have a long
history of taxing income and that gap would quickly be filled
if left unoccupied. We could have a badly designed income
tax and a sales tax.
- Do not put much faith in labels such as "income tax,"
"consumption tax," "flat tax," "VAT,"
and so forth. They mean little, often mean different things
to different people and most often serve to confuse. Instead,
concentrate on the real substance of various tax designs
without regard to name. For example, do not be misled into
thinking that only a VAT (in the sense of a European-style
sales tax) can be correctly adjusted at the border for exports
and imports or be misled into thinking that any tax with
such adjustments is a VAT. It's not true. For example, the
USA Tax correctly adjusts for imports and exports, but it
is clearly not a sales tax.
- Look very carefully at the issue of multiple rates vs.
a single rate and do that from several perspectives. First,
neither a single rate nor multiple rates is the exclusive
province of any particular alternative tax proposal. For
example, the USA Tax can accommodate either. Second, do
not assume that rates are the sole source of progressivity
or that multiple rates are the source of "redistributive"
effects. Exemptions also produce progressivity, but large
exemptions cause other severe problems that should be avoided.
If progressivity is desired, it is best achieved primarily
- Beware of treating capital income differently from labor
income and further beware of appearing to do so. I include
within this caveat any proposal to exclude interest, dividends,
and gains from tax at the individual level.
- Insist on a deduction for saving and beware of theories
that suggest that allowing no deduction for saving but exempting
the earnings on saving is the same as allowing a deduction
for saving. As a practical matter and as a political matter,
they are not the same.
- Pay special attention to the transition from the old tax
system to the new, and, in doing so, beware of either creating
windfalls or appearing to do so. For example, exempting
the earnings on new saving is one thing, but exempting the
earnings on all existing capital is quite another.
- Avoid a parochial or insular perspective that focuses
only on the "domestic" economy. There really is
no such thing anymore. A global economy requires a global
tax perspective and a tax system that correctly takes into
account international transactions.
Finally, keep in mind the obvious. To have any effect, the
new tax system you recommend must be capable of actually functioning
in a complex economy and must be enacted into law. To be enacted,
it must be understood by the American people and be consistent
with the American political ethic. Therefore, avoid extreme
and unfamiliar approaches that may make sense to theoretical
economists but are counter-intuitive to the American people.
1. These are the permanent, revenue-neutral rates in S. 722
beginning in the year 2000. The transitional rates in 1996
are 19, 27, and 40 percent