Wednesday, September 28, 2011

Flat Tax, Herman Cain, and Systemic Ignorance.

For years I have heard about the utopia called a “flat tax” nation, where everybody was taxed at the same "rate" with no deductions "and joy and fairness would spread throughout the land on the backs of unicorns". This shows a complete misunderstanding of how (and why) the tax system as we know it came to be. As a system designer, it is the first question I ask anybody paying me to upgrade or replace their current system. "How is it that you came to have the system you currently have, and why was that the best choice at the time?" Herman Cain’s 9-9-9 plan takes that to a new level where I am not sure if he is being ignorant of malice.

What do Herman Cain and porn stars have in common?
Before we get started I was roused to write about this because of the recent events. I hadn’t been taking it all that seriously. Since Cain won the Florida straw pole, he has gained a little recognition. If you don’t know him, his claim to fame is that he brought a pizza chain out of financial ruin. Now, if you know much about business (even just as a consumer), a pizza joint is a remedial business. Doing well is like being the fastest kid in the Special Olympics. In the small town I am from (approximately 8,000 people), there was 2 gas stations, a vet clinic, a McDonalds and a Rax, a greasy spoon, and 8 pizza shops. The top 6 were very successful. How often do you see pizza places on opposite corners of the same street? Because “Pizza is like sex, even when it is bad it is still pretty good.”. Thus brings me to the point, claiming being “successful in the pizza business” gives you insight into economic success of a nation is like saying being good as a porn star gives you successful insight into being a parent. Anybody can have sex. Porn stars are really good at doing something that anybody can do. But the systemic purpose, the function of sex, is only a small portion of the act of becoming a parent. So this is ludicrous to think just because a guy has financial success earning profit for a simple pizza business, he would make an intuitive economic policy maker. About the same claim rational as a porn star would make great parents.

That’s Gross (or Net)?
Like I mentioned, I have heard the idea of a “flat tax” sine at least the Ross Perot days. It has become the battle cry of the blissful but meaning well inside and outside the Tea Party. I too used to think that this made sense until I asked the question, if something so easy made so much sense, why hasn’t it happened? Which lead to the question, “why is our tax system as convoluted as it is?” (I can’t stop being s system troubleshooter.) Let us face it; what sounds more fair then everybody pays the same number, right?

My understanding of why it wouldn’t work came form my (way too long) 2 yr career as a ditch digger for the cable company working in a 1099 environment. (For those not familiar, this is a tax structure where you get all the liabilities of being a sole proprietorship but none of the advantages. Many illegals are employed under this because it requires little reporting from the employer, gets around minimum wage laws, and cuts way back on office red tape.) It was then I learned the difference between “gross” and net”.

When I hear somebody advocating a flat tax, my first question is, “on the gross or on the net income?” If they say, “gross” I explain how my years would go as a ditch digger. On paper it looked like I made in the area of $20,000 “gross” that year. My tools and equipment were things such as shovels, picks, sledge hammers, specialty crimpers, the cable, pvc piping, and various types of cloths, shoes and boots. Not to mention the computer used partly for mapping out routes and accounting for jobs. Those amounted to about $6000. Another nearly $3000 went into gas and maintenance for my Daewoo. Now, compare that to a friend of mine, a part time tax accountant that also made $20,000 whose overhead was about $1000 for computer, the maintenance, and the software. IF you tax us both 9% on our gross, we would both have to pay 1800. I worked 60 hours a week, and she worked 25 on the average. But the accountant was left with 19,000 in expendable income while I was left with $10,000. How is that fair? So, you say, “well then charge more for your services as a ditch digger.” There are so many reasons that logic fails if you are truly a champion of fixing the economy. Not the least as I mentioned before, this work is already appealing to those who don’t pay taxes. Continuing with this example, your cable bill would see a large increase if I had to chare 50% more for installation in order to compensate for the cost of doing business. As it stands now, it takes your first 2 months of cable at least to pay for the installation. However, the real inequality comes when you apply the sales tax on the tools and equipment. Why am I paying for taxes on stuff I already paid taxes on when I bought it. My accounting counterpart only paid 9% on the 20 grand. I pay 9% on the 20K and another 9% on $10,000 of it if you go with the 9-9-9 plan.

Meet The “Net” Plan, Same as the Old Plan
The other option is a person may answer “Tax the net” then. To which I just look at them blankly and say, “how do you think our system works now?” All of those write offs, loopholes, and tax shelters are created in the pursuit of determining ones “net pay”. I say that steel toed shoes are part of my business cost, while you say you had to take a client out to a day of golf and strippers as a cost of doing yours. Who is going to go over my return to make sure I am on the level with my reporting. If only we had an agency that would look over “internal revenue”. Next thing you know, people will be using the “rapid depreciation” clause to get the government to pay for their hummers. (The automobile kind)
Simply making a blanket minimized list of deductions is an impossibility, and anything but fair as all jobs have different overhead costs even thought they may have the same gross income. And that is how we got the system we have today. Economics of equality is complex and some even think subjective.

The Formula We All Work By (But Have Stopped Living By).
There is one formula every one of us who have ever been employed has come to know. Where (d)= dollars and (t)= time in hours, all offering can be broke down into d/t where “t” is almost always expressed as 1 for the first 40 hours worked of a week. That is the long version of saying, “your employer pays you in dollars per hour.” By moving us to this formula via the monetary system, we have forgotten what that “t” signifies. 1 hour of our life. Now, a “flat tax” on income as it is being earned (excluding the problems cited above) is fair enough. Let us take Mr. Cain’s 9% figure. You make a million dollars a year and you pay $90,000 in taxes (or 187 hrs of your life). If you make $25000 a year, you pay $2,2500 (or 187 hrs. of your life). That is the formula and unarguably fair in that perspective.

Sales Tax Are Inherently Unconstitutional
Wow, talk about an anxious statement. That challenges every thing we First, what people don’t seem to understand about the pizza kings proposal is that he is thinking about adding 9% in addition to your already existing city tax. So if your city has a 6% sales tax, that tax then will become 15%. That is a chunk of change, and with it buying power.

Now, I always get the same nonsensical response when I use “big screen TV’s” as an example when expressing he next point. “Well poor people shouldn’t be buying big screen TV’s” completely missing the concept of simplifying a point. So, let us use the example of a Ford Focus that they are buying which there is no denying having transportation to get back in forth to work or school is important to improving ones position in life AND the trade off between new car payments vs. used maintenance cost is one most Americans struggle with.

Let us say that the cost of a focus is $15,000. We apply the 15% to that cost as the local plus federal sales tax. Here is that number $2250 again. (It was the yearly income tax on $25,000) . So we know that is equivalent to 187 hours of the life of a person making $12/hr or $25,000 a year. However, compared to the guy making $480/hour (or a million per year) that is a total of 4.7 hours of his life. Now I thought our constitution promised us equality in “Life, liberty, and pursuit of happiness”? Sales taxes values a one persons life in this example nearly 40 times more valuable then another.

Conclusion and fear:
This type of policy “sounds” so fair on the surface. What could be more so then the same “rate” applied to everybody. Many smart people I know have fallen for believing it. But the story reminds me of the story of the emperor and the guy who invented chess. (look it up, it is a good story.) Here, the misunderstanding of the power of “terms” would have bankrupted the Chinese empire. People just hear marketing slogans; my fear is the average voter doesn’t have the depth of thought or tools to grasp just how much worse for the economy a proposal such as the “9-9-9” would be. Currently Warrant Buffet pays 17.4%. With this plane he would be taxed at a much lower rate of 9% which would amount to savings of millions of dollars, and in turn pay a higher “sales tax” on goods he purchases, which would amount to a few thousand dollars extra per year. All of this and we are not going to mention the affect on the equilibrium price of goods when the cost is driven higher and how that would dive more people out of work. If people can’t get this simple concept of tax rates, complex economics will sent them into comas. People seem not to be able to look at the entire system and because of it, they back the horse that bites them in the ass. Then they blame it on the horse.

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