Presentation to the Presidents Advisory Panel on Federal Tax Reform Taxation for the 21st Century: T

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Presentation to the Presidents Advisory Panel on
Federal Tax Reform Taxation for the 21st
CenturyThe Automated Payment Transaction APT
TaxMay 11, 2005

• Edgar L. Feige
• University of Wisconsin-Madison

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The Problem Our Current Tax System

• Overly Complex Opaque
• Annual administration and compliance costs 200
  Billion
• Inefficient
• Annual misallocation costs - 300 Billion
• Inequitable
• System is perceived as unfair, non-progressive
  and riddled with loopholes favoring the wealthy
  and special interests.
• Tax Evasion
• Annual evasion costs 325 Billion

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The Challenge

• To design an alternative tax system that is
• Revenue Neutral
• Simple Comprehensible-Transparent-Stable
• Efficient Minimal allocation distortions -
  lowest possible tax rate - broadest possible tax
  base.
• Equitable treats all individuals fairly and is
  progressive.
• Relatively costless to administer and comply
  with.
• Growth promoting.

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The APT Tax Proposal

• Replace federal, state and local personal and
  corporate income taxes, excise, capital gains,
  import and export duties, gift and estate taxes
  with a single comprehensive revenue neutral flat
  rate tax on all voluntary transactions.
• Eliminate all deductions, exemptions, credits,
  exclusions and adopt zero tolerance policy on
  any form of tax expenditure.
• Collect the tax automatically at the source of
  payment, namely, through the banking/payment
  clearing system when financial accounts are
  credited and debited. Currency is taxed as it is
  withdrawn from and deposited to the banking
  system.

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Special Features

• Revenue Neutrality is achieved with a tax rate
  .6 on estimated tax base of 337 Trillion. The
  buying and selling party to each transaction pays
  .3 on each transaction.
• Highly progressive Since tax base is heavily
  skewed toward the wealthy who undertake the bulk
  of asset exchange transactions. Progessivity is
  automatically introduced through the tax base.
• Eliminates filing of all information and tax
  returns. Automated assessment and collection is
  the electronic financial equivalent of a highway
  EZ pass.
• Highly efficient lowest conceivable tax rate on
  largest conceivable tax base. Eliminates most
  costs of compliance and administration.
• A public brokerage fee assessed by government to
  pay for the provision, maintenance and use of the
  monetary, legal, military and political
  institutions that facilitate and protect free
  market trade and commerce.

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Benefits

• Elimination of current system promises potential
  annual savings 825 Billion in efficiency,
  compliance and evasion costs.
• Simple to understand, transparent, stable.
• Equitable progressive non invasive.
• Shifts tax burden away from wealth producing
  (positive sum activities) to wealth
  redistributing (zero sum) activities thereby
  stimulating economic growth.
• Lengthens holding periods for equity and debt,
  stabilizing markets and stimulating real long
  term investments.
• Stimulates home ownership because of low turnover
  of owner occupied housing.

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Potential Costs

• Every tax system introduces costs and distortions
  and the APT tax is no exception. These new costs
  require empirical documentation and must be shown
  to be of a magnitude approaching the 825 billion
  the gains in annual savings from scrapping the
  tax current system.
• New costs
• Transition costs.
• Costs of administration.
• Distortions introduced by cascading of
  intermediate payments.
• Costs of increased vertical integration.
• Costs of reduction in liquidity of asset markets.
• Costs of attempted evasion.

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Appendix

• Choice of tax base.
• Determination of revenue neutral tax rate.
• Equity Distribution characteristics of the tax
  base.
• Administration and compliance.
• Simplicity, transparency and privacy.
• Efficiency effects and distortions.
• Benefits and costs.

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Choice of Tax Base

• Most taxes are based on income or consumption and
  tax these transactions at rates between 5-40.
• Strange choice since societies would like to
  raise income and consumption standards but high
  tax rates reduce both.
• The voluntary transaction can be viewed as the
  fundamental element of economic activity.
• The APT tax proposes to expand the tax base to
  the largest conceivable base, namely to each and
  every transaction undertaken in the economy.
• Every transaction involves a voluntary exchange
  (trade or transfer of property rights to goods,
  services and assets) between a buyer and a
  seller. Therefore every transaction voluntarily
  undertaken must improve the perceived well being
  of both parties.

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Tax Rate Determination -Mechanics

• Single flat rate (t) to be determined.
• tR/T where R is required revenue (given) and
  T is the estimated volume of transactions (
  payments) that will be undertaken after the tax
  is imposed.
• 2001-2002 Required Revenue Simulation R1.821
  Trillion.
• Initial tax base is estimated to be 674
  trillion. We shall assume that total transactions
  fall by 50 so that the effective tax base will
  become 337 Trillion debits.

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Transaction Estimates for the US
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Revenue neutrality requirement

1 Budget of the United States government
Historical Tables Tables 2.1 and 2.5 2
Economic Report of the President 2005 Table B-86
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Table 2 Effective APT Tax Base and Required
Revenue Neutral APT Tax Rates - 2002 Data
Potential Percentage Reduction in Initial Total
Payments
Source Authors calculations
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Required revenue neutral tax rate

• A conservative estimate of the APT flat tax rate
  required to raise the same amount of revenue as
  the 2001-2002 tax system (federal and state) is
  roughly .6 percent per transaction. This
  calculation assumes that total transactions fall
  by roughly 50.
• This amounts to a public brokerage fee of .3
  paid by the buyer and seller to each transaction.

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Equity

• Most flat rate taxes are regarded as inequitable.
  Citizens desire an effective progressive tax
  structure.
• In APT tax, progressiveness is provided through
  the tax base rather than the structure of tax
  rates.
• Transactions are highly skewed toward the
  wealthy.
• Flat rate APT tax is progressive.

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Distribution of Net Worth and Transactions
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Distribution EffectsTransactions (Credits and
Debits) are highly skewed.
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Administration and Compliance Costs

• The APT tax exploits a natural discontinuity in
  the administration and compliance cost function.
• Compliance costs depend upon the need to
  distinguish between taxable and non taxable
  transactions and deductible and non deductible
  expenses.
• Taxing all transactions with no deductions or
  exemptions minimizes the cost function.
• Estimated to save 200 billion annually.

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Administrative collection features

• Tax is automatically collected by bank or
  financial institution via a tax escrow account.
• Software automatically and permanently links the
  tax escrow account to each account capable of
  settling a final payment.
• No deductions or exemptions are permitted.
• Currency is taxed as it enters and leaves the
  banking system. The tax rate on currency is a
  multiple (3 times) of the rate on bank debits to
  allow for the turnover velocity of cash between
  the time it leaves and reenters the banking
  system.
• This eliminates the tax evasion associated with
  the cash underground economy.

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Administration and Compliance

• New administrative costs -
• System conversion.
• Guarding against payment systems fraud.
• Defeat counterfeit payment systems.
• Compliance costs reduced to minimum.
• Automatic assessment and collection.
• No tax or information returns.
• If intermediate payments are allowed to be
  exempted through a net VAT collection system this
  will introduce new costs and greater complexity.

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Low costs for banks, individuals, firms and the
government

• Banks Banking system already collects all
  necessary information in the normal course of
  doing business
• Individuals Collection is automatic-No forms
  -Virtually costless compliance.
• Firms No more filing of information and tax
  returns.
• Federal Government Administration requires
  auditing of several thousand financial
  intermediaries instead of 100 million taxpayers.
• State Government Can piggyback APT tax
  collection on residents bank accounts.

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Simplicity, Transparency and Privacy

• Every taxpayer has real time record of all taxes
  paid.
• Government is paid from Escrow Account. Real time
  collection.
• Government can not monitor individual
  transactions.
• Government expenditures are explicitly in
  government budget, not in hidden tax
  expenditures.

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Efficiency Effects-1

• Shifts burden of taxation from wealth producing
  to wealth redistributing activities.
• Lowest marginal tax rate, lowest deadweight
  welfare losses.
• Cannot prevent currency and banking crises but
  will reduce short term speculative trading and
  hence reduce variance of exchange rate
  fluctuations and international capital flows.
• Incentives for ex ante investment in information
  rather than asset churning for short term gains.

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Efficiency Effects 2

• Shifts term structure of financial assets to long
  term investments.
• Favors home ownership since owner occupied
  housing represents a long term asset holding with
  an average turnover frequency of only once every
  ten years.
• May have negative effect of providing incentive
  for vertical integration.
• Introduces new distortions resulting from
  cascading effect on final products with many
  stages of production.
• Cascading issue can be eliminated by permitting
  producers (at their expense) to adopt net VAT
  collection procedure, but this will complicate an
  otherwise seamless system.

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Advantages

• Greatest benefit is elimination of current system
  with all attendant distortions.
• Greatly reduces collection, administration and
  compliance costs.
• Shifts political focus away from opaque taxation
  expenditures toward more transparent direct
  government expenditures.
• Promotes equity, simplicity , transparency and
  perception of comprehensibility and fairness of
  tax system.

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Special features

• Payment for state services via brokerage fee.
• Entry ticket to free market exchange.
• Government is not a party to exchanges, therefore
  longer participates in gains or losses of
  individuals or firms.
• Eliminates all tax expenditures.
• Improves transparency.
• Total burden of government expenditure is shifted
  to budget process.

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Summary

• APT tax is revenue neutral but not
  distribution neutral.
• Efficient and Equitable.
• Simple and Comprehensible.
• Transparent and Private.
• Low cost of administration and compliance.
• Increased level of compliance.

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Summary of potential benefits and costs

• Benefits Elimination of Current System
• Potential Estimated gains
• Allocation costs -------------- 300
  Bil.
• Compliance and administration - 200 Bil.
• Reduced evasion -------- 325
  Bil.
• Total estimated annual benefits -- 825 Bil.
• Costs To be empirically documented.
• Transition and administration costs.
• New allocation costs.
• Total costs are highly unlikely to approach
  expected benefits.