I. Preface: Why the Income and Estate Taxes Are Unconstitutional.
II. The Wisdom of A) Replacing the Federal Income Tax With a Universal 8% Federal Sales Tax; and B) Unlimited Guarantee of Cash Deposits by the Federal Reserve.
III. Treasury Securities Held by the Federal Reserve Are Only Virtual Debt,Not Real Debt, and Can Be Cancelled at Any Time by the Fed.
I. Preface: Why the Income and Estate Taxes Are Unconstitutional.
Preliminarily, it must be understood why there are no federal real estate taxes and no state real estate taxes. There are only local real estate taxes, imposed by cities and towns. Why? Because of the fundamental principle expressed in the Constitution’s 5th Amendment, the “no taking of private property without just compensation” clause. Taxing property is thus unconstitutional, even as only a partial taking. The reason why local real estate taxes are constitutional is that they are not really taxes; rather, they are fees for services rendered to real estate, such as roads, sewers, schools, police and fire departments, etc. Being fees for services rendered, the total annual real estate taxes of a given city or town cannot exceed the annual costs of the services rendered.
The 1789 Constitution, in Article I, specifically lists sales taxes, imposts, duties, and excise taxes, all of which are indirecttaxes (i.e., paid to the government by sellers, the cost shifted onto purchasers when added to the sales price), as opposed to direct taxes (i.e., paid to the government by the person or entity charged directly by the government) such as the “capitation tax”. The capitation tax is the only direct tax mentioned in the 1789 Constitution and it has long been shelved as being primitive, associated with kingdoms. The Constitution of 1789 never envisioned an income tax, the reason why the 5th Amendment (1791) followed within two years to make that clear, prohibiting the “taking of private property without just compensation”, which is consonant with the sanctity of private property.
The income tax, introduced by the 16th Amendment of the Constitution in 1913, is a direct tax. Though the income tax has the endorsement of the 16th Amendment, the endorsement is incomplete and flawed, being contradicted by the 5thAmendment’s “no taking of private property” provision. Income, whether personal or corporate, is clearly property. Though the 16th Amendment (1913) is more recent than the 5th Amendment (1791), it is outweighed by the 5th because the 5th expresses a fundamental principle and the 16th does not. Also because the 16th tellingly ignores the 5th, while not ignoring the “apportionment” clause of Article I. The income tax is therefore unconstitutional, though it has not been successfully challenged as yet. Needing added revenues, the Congress purposely disregarded the conflicting amendments as an expedient.
As for the estate tax (1913), it is not supported by a constitutional amendment, but was intentionally crafted by the legislature so as to circumvent the 5th Amendment’s prohibition of government “taking of private property without just compensation” by explicitly stating that the estate tax is not a tax on private property, rather it is a tax on the transfer of estate assets. But the legislature was sloppy, betraying its fraudulent violation of the Constitution by having all references made to the date of death, and not to the date of transfer/transfers. If the estate tax were truly a tax on the transfer of estate assets, all references (such as the due date of the tax payment and the value of the assets transferred) would be to the date of estate asset transfer/transfers, not to the date of the decedent’s death. A parallel: retail sales taxes are due when a sale actually takes place, not when an item enters a seller’s inventory, and calculated on the sale price to the buyer, not on the cost to the seller. Also, if the estate tax were truly a transfer tax, it would be similar to a sales tax (though not commercial in nature) and its tax rate would be similar to sales tax rates (i.e., always under 10%), not similar to income tax rates (up to 40%). There is no logical justification to apply a higher tax rate to a non-commercial transfer than to a commercial one. The estate/gift tax also amounts to double taxation, as personal property is mostly acquired with after-tax income.
II. The Wisdom of A) Unlimited Guarantee of Cash Deposits by the Federal Reserve, and B) Replacing the Federal Income Tax With a Universal 8% Federal Sales Tax.
The collapse of Silicon Valley Bank is only the latest illustration of why two major financial reforms are urgently needed: 1) changing the way the Federal Reserve manages monetary policy; and 2) changing the system for protecting depositor cash accounts at banks (FDIC) and stock brokers (SIPC). Efficient, easy to implement reforms are available.
The current system of having monetary policy set by the Federal Reserve according to its discretion has repeatedly destabilized the economy, through investment bubbles due to excessively low interest rates; and through deep recessions and high unemployment, due to excessively high interest rates. Furthermore, alternating booms and busts have at times resulted in serious bank and brokerage failures. The fact is, properly calibrating interest rates and their rate of change is a difficult task, since interest rate variations have lagging effects in addition to immediate effects, making monetary policy a very imprecise tool for stimulating and braking the economy.
As for our cash deposit insurance system comprised of FDIC and SIPC, it has repeatedly failed due to insufficient dollar coverage, leading to runs on banks and brokers and imposing the impractical burden on depositors of opening accounts in multiple financial institutions to ensure full insurance coverage of large cash deposits. The current $250,000 coverage limit is very insufficient, considering the current level of earnings, profits, and wealth. The reason for limiting FDIC and SIPC coverage per account per bank/brokerage is two-fold: limiting the cost of funding such insurance, and avoiding “moral hazard”, i.e., excessive risk taking by financial institutions. Fortunately, there is a simple, very effective, practically cost-free alternative.
A) The proposal for cash deposit insurance reform is as follows. Instead of FDIC and SIPC cash deposit insurance, we should have an unlimited Federal Reserve guarantee of all bank and brokerage cash deposits. Whenever a bank or stockbroker became insolvent due to incompetence or fraud, the Fed would temporarily take it over, replace the top management, and make sure all cash balances were intact. That deposit guarantee would cost the Fed absolutely nothing since if customer cash were missing, the Fed would simply replace it electronically.
As for moral hazard, it would be practically eliminated by a well publicized legal provision that bank and brokerage failures due to incompetence, excessive risk taking or fraud would lead to 1) top management being fired and having their salaries and bonuses over the prior five years clawed back; 2) stock and bond holders of the failed bank/brokerage losing their entire investment; 3) depositors forfeiting all interest received during periods when the bank/broker paid an interest rate on deposits significantly exceeding the national average during the 5 years prior to insolvency.
B) The proposal for Federal Reserve policy reform and for a universal federal sales tax replacing the income tax is as follows. Given that monetary policy is an imprecise tool, the Federal Reserve would also be given a fiscal policy tool so it can rely less on monetary policy. Just as Congress has delegated monetary policy to the Fed, it could delegate a fiscal policy power to the Fed, consisting of raising and lowering federal income tax rates. That would be a fairly precise tool for braking and stimulating the economy with no side effects. It can be accurately calibrated with no major lag effect, contrary to monetary policy.
Furthermore, the Fed would not be limited to lowering federal income tax rates in order to stimulate a weak economy: it could distribute tax rebates (funded through QE) which have immediate effect.
Even better, an optimal fiscal policy would consist of having the federal income tax replaced by a federal sales tax. For two reasons. First a federal sales tax would greatly increase the efficiency and accuracy of fiscal policy. Second, it would be much fairer than income taxes which can easily be avoided by the wealthy through various legal tax shelters, which by the way distort capital allocation (a significant negative for the economy). Furthermore, since high-income citizens spend much more than low-income citizens, a sales tax is inherently very progressive. A federal sales tax can be made even more progressive by having the Fed send all low-income taxpayers an annual federal sales tax “prebate” every January 1, based on the sales taxes they would incur by spending their total annual income. For example, if the federal sales tax were 8% and it was desired that all taxpayers earning less than $20,000 should effectively pay no federal sales tax, such low-income taxpayers would receive a $1,600 check from the IRS each January.
A good case can be made that an 8% universal federal sales tax (that is on all sales, not just retail sales) would raise more revenues than current federal income taxes, fully covering federal spending, leaving no budget deficit. In fact, using 2019 figures (pre-Covid), GDP was $21 trillion; federal spending was $4 trillion; federal income tax revenues were $3 trillion; the federal budget deficit was $984 billion. Meanwhile, retail sales were $5.4 trillion; wholesale (B-to-B) sales $8.6 trillion; real estate sales $4 trillion; stock sales $23 trillion; and bond sales about $12 trillion. Total sales were therefore $53 trillion. An 8% universal federal sales tax would bring in $4.2 trillion ($53 trillion X 8%), thereby leaving a federal budget surplus of $200 billion. There would then be no more income taxes (including capital gains taxes), and no more unconstitutional estate taxes (around $27 billion in 2021). (Short-term traders could elect to have a special brokerage account dedicated to short-term stock, bond, option, and commodity trades, whereby ordinary income tax rates would apply to their capital gains, dividends and interest, in lieu of incurring the 10% sales tax which would be prohibitive for many short term investments.)
The effect of eliminating capital gains and estate taxes would unlock enormous amounts of “frozen”, stagnant investments (“frozen” due to the widespread reluctance to sell them and incur substantial capital gains taxes). That would lead to greatly increased spending on consumption and more productive investments, thereby raising GDP and retail and wholesale sales, and increasing federal sales tax revenues which could allow the federal sales tax rate to be reduced to 7% or 6%, if not lower. (By the way, long-term capital gains taxes are unfair when capital gains are solely due to inflation and do not represent real gains. Notoriously, many citizens selling their home in view of moving or trading down, end up after capital gains taxes with much less money than an equivalent new home would cost. That is incredibly unfair, apart from being unconstitutional. With the federal sales tax, home sellers would pocket the entire sales price, the buyers paying the tax.)
As for criticisms that this fiscal reform would benefit the wealthy, not the poor, everyone must realize that poverty has not been solved for over 50 years since LBJ proclaimed the “War on Poverty”, under the regime of income and estate taxes, both of which the wealthy largely avoid through legal tax shelters. The wealthy would generally pay more in federal sales taxes than they do with income taxes. Furthermore, since poverty is the result of a very inadequate education, the solution is not soaking the rich; rather it is greatly upgrading all our public schools so that every single youth gets a truly excellent education. That requires public schools to be run as the best private schools, with strict discipline; lots of homework/study hall; individual attention for students having academic or psychological difficulties; and, of crucial importance, an enlightened curriculum. Eliminating poverty would then lead to a very low federal sales tax rate, under 5%, to widespread economic and social prosperity, and political harmony. There would be no class warfare. It should also be universally understood that without many wealthy citizens and profitable businesses, no nation can have strong, sustained investment and economic growth. Furthermore, it should be understood that whatever the wealthy do with their money is good for the nation. If they spend on consumption, that’s good for the economy and employment. If they invest, that’s good for economic growth, employment, and technological advances.
What would be an enlightened high school curriculum? One which includes four years of the following courses: 1) psychology (taught in conjunction with group therapy and good parenting workshops); 2) economics/finance/investing, putting mainstream theories to the test of statistical correlation and rigorous logic; 3) detailed, analytic 20th Century world history; 4) history of art/architecture/design; 5) history of music; 6) the United Nations’ Charter and its Universal Declaration of Human Rights; 7) the world history of human rights violations; 8) comparative religion studied through direct, analytic readings of the holy books along with the history of the major religions; 9) logic, critical thinking, and media literacy, with case studies; 10) ethics and empathy, with case studies; 11) foreign languages and cultures; 12) introductory and Constitutional law; 13) Latin; 14) the major mistakes in economic, social, and foreign policy of the past 100 years in the United States, Latin America, Europe, Africa, and Asia, and which would have been the correct policies. (I personally would have greatly benefited from such a high school curriculum, getting an invaluable head start in understanding the world in all its complexities.) For uniformity of public school excellence nationwide, we need an enlightened, ambitious national public school core curriculum along with a prestigious national high school graduation exam.
Had the above public high school reform been implemented fifty years ago, today we would have hardly any poverty, addiction, violence (including gun violence), crime, social strife, political strife, racism and other violations of human rights, dishonesty, unwanted pregnancies. We would have very few mentally disturbed citizens. With educational parity at a uniformly high level, integration would have progressed naturally and not been met by the widespread resistance which occurred with government enforced integration. We would have no budget deficits or accumulated federal debt. We would have much lower tax rates. We would have widespread economic and social prosperity. There would have been no January 6. Our politicians would be much more qualified.
The political choice and commitment to make sure every single public school provides a truly excellent education to every single youth should be unanimously understood as the right choice. So should having the federal income and estate taxes replaced by a universal federal sales tax (initially of 8%, but soon to be much lower); having the Fed use fiscal policy tools instead of monetary policy to stimulate or brake the economy (the fed funds rate would be put on automatic pilot, updated monthly at the 3 or 6 month trailing CPI rate); and having FDIC/SIPC insurance for cash deposits replaced by an unlimited Federal Reserve guarantee combined with effective incentives to ensure prudent risk taking. What rational, informed arguments against these measures could there possibly be, by Democrats and Republicans? We shouldn’t continue to be stuck in the mud with outdated and ineffective economic, social and educational policies.
III. Treasury Securities Held by the Federal Reserve Are Only Virtual Debt, Not Real Debt, and Can Be Cancelled at Any Time by the Fed.
It’s important to understand that all Treasury bills, notes, and bonds held by the Fed, as opposed to those held by investors, are only virtual debt, not real debt which must be repaid by citizens through taxes. The Fed is an agency of the federal government, and upon maturity the Fed could cancel those Treasuries and not require the Treasury to redeem them using tax payer dollars. There would be no negative side effects. The result would only be a reduction in the federal debt, at no cost. All Fed funding of our enormous budget deficits since 2009 was done with QE, and all that Treasury debt can be eliminated at will. Canceling that debt would not be inflationary since it would not increase the money supply, which would remain unchanged, whereas the money supply would be reduced if the Fed were to require the Treasury to redeem that debt. The Fed’s incipient QT is a big mistake. The upshot: with the right policies, we have no federal debt problem.
© Edward Sonnino 2023
April 20, 2023
