The Fair 55 Tax Reform Plan (Part 7)

Michael Caryl Fair 55 Tax Reform

ENTERPRISE CONSUMPTION TAX (ECT)

In what, to some, may be the boldest aspect of the Fair 55 Tax Reform Plan©, it is proposed that, in an orderly and fiscally responsible manner, both the current Personal Income Tax (PIT) on individuals’ currently earned income, and the Corporation Net Income Tax (CNIT) on C corporations’ profits, would be repealed and replaced by the addition-method Enterprise Consumption Tax (ECT), imposed at the illustrated rate of 5.5%. The proposal does provide for the temporary imposition of a limited Deferred and Passive Income Tax (DPIT), to be applied only to non-social security/non-public employee retirement benefits such as deferred income, interest and dividends, received by higher-income individuals, but at the flat rate of 3%, which is the rate for the lowest bracket of the current state personal income tax.

This new consumption tax, on private for-profit and not-for-profit organizations engaged in economic activity would, in effect, function as a user fee for participation in the free enterprise system. Specifically, the substantive policy foundation of the ECT is that all private, non-government organizations with commercial receipts in excess of $100,000 (including larger non-profits), which use and enjoy the benefits of the free enterprise system, should contribute, through a simple and principled tax structure, the funds to help defray the government’s burden of providing the public goods and services on which the efficacy of that system fundamentally depends. Those public goods and services are public infrastructure, safety, education, health and the rule of law.

Reflecting the measure of the extent of an organization’s use of, and benefit from, the system, the base of the ECT would be the value of the labor and capital resources the organization devotes to that use, to-wit: compensation to employees, rents, royalties, interest and dividends paid, and profits retained. In addition, the annual use of capital assets (i.e. depreciation) would be included in the tax base, after allowing a deduction for the amount of their purchase in the year of acquisition (i.e. the reverse of the current income tax concept of periodically recovering, through annual tax base deductions for depreciation, the investment in such assets as they are used).

Because the underlying rationale of the tax is to defray the burdens of government expenditures, any direct donations (cash or in kind) or other expenditures, which are duly certified as directly relieving those burdens, would be credited, dollar-for-dollar against the donor organization’s pre-credit ECT liability. Those creditable expenditures would include payments of the healthcare provider tax, which is proposed to be retained due to the necessity of using it as a source of revenue to attract federal matching funds for the state’s Medicaid program.

Further, regular operational expenditures by an organization, which are certified as directly providing, in a manner subject to free market, private-sector discipline and efficiency, any particular public good, would be deductible by that organization from its ECT base. To illustrate the breadth of such a deduction, consider all the payroll of a private (profit or non-profit) accredited, degree-granting institution of higher education. To the full extent such an entity is providing one of the fundamental public goods, to-wit: higher education, it would be allowed to deduct all of the compensation paid its employees, and the other elements of its ECT directly employed for that purpose, thus, making it effectively exempt from the tax by having a zero tax base The same would be true of a hospital (for profit or not-for-profit) to the extent it directly renders in-kind charity healthcare.

In addition, the proposal will encourage expanded use of “public-private partnerships” whereby an organization, subject to the ECT, will apply for State government certification of a proposed infrastructure project as being “in the public interest.” An example would be a public access road to a new industrial site. If the project is so certified, the organization would then receive a credit against its ECT for a stated large percentage of its expenditures which are within the proposed cost of the project as certified. At the same time, by not giving a full dollar-for-dollar (100%) credit, the private benefit to the organization from the project is accounted for while the economic efficiencies and free market discipline will be leveraged to achieve important public infrastructure improvements. In other words, a far greater scale of useful infrastructure can be realized if the improvements are directly funded with private dollars and not with tax revenues, the value of the latter of which, due to bureaucratic inefficiency and the inherent “handling” cost of spending “someone else’s money,” is thus heavily discounted before the remainder of those funds are actually applied to the desired improvement.

When viewed as a revenue-generating replacement for much of the present income taxes on most individuals and C corporations, the ECT’s most extraordinary feature is that, due to the deductibility of ECT tax paid by any employer entity subject to federal income taxes, the net cost to the employer of the ECT (after the benefit of the employer’s federal income tax deduction) is such that, even if the employer took the truly unprecedented (and, ideally, illegal) step of shifting to its employees, by a wage reduction, the economic incidence of the net cost of the ECT on wages, the employees would still be economically better off due to their no longer having to pay the PIT on their compensation pursuant to its repeal under the Plan.

That is because, as long as the employee’s current effective state income tax rate is more than 3.575% (e.g. any married couple with taxable income over $25,000 or single person with taxable income over $12,500), the net, after-federal-tax cost of the ECT to the employer will (assuming the 5.5 % ECT rate in the accompanying Fair 55 Tax Reform Plan© Fiscal Scorecard) always be less than the current income tax otherwise payable by the employee. Moreover, if we can impose a minimum wage, regardless of its level, we can design effective prohibitions against any such pass-through of the ECT on wages to employees, particularly for the very low income wage earners in the bottom 3% bracket of our current income tax structure.

To be certain, this uniquely beneficial consequence, of the interplay of the proposed ECT with federal income tax deductibility, will not help entities (or, indirectly, protect their employees) which have no federal income tax exposure due either to the absence of taxable profits or to exempt status. Admittedly, there is no tax disincentive for a non-income tax paying entity to not lower one otherwise deductible expenditure (wages) due to the added cost of another otherwise income tax deductible expenditure (the ECT on wages). However, the overall economic stimulus, expected to be demonstrated by the dynamic modeling necessarily preceding implementation of the Fair 55 Tax Reform Plan©, should go far to reduce the incidence of non-profitability in the for-profit organization community. Moreover, the significant credits and deductions for ECT purposes, available to the non-profit community for directly relieving the burdens of government, including, particularly for non-profit institutional healthcare providers, their payment of the healthcare provider tax, all should greatly mitigate the actual economic impact of the ECT on such entities.

Further, a small organization exemption from the ECT is proposed for independent entities with less than $100,000 of annual commercial receipts. By not counting any public or private grants, gifts or donations toward that taxable threshold, all religious and other primarily donor-supported charitable organizations will also avoid exposure to the ECT. Typical related-party rules, found in other business tax schemes, will then become necessary to prevent abuse of the small organization exemption by groups of related and commonly controlled economic interests.

Although, as explained in Section D. supra, in terms of avoiding taxation of many business inputs, the GCT would contain many of the typical exemption provisions (sale for resale, direct use in manufacturing, etc.), the same contentions about the folly of taxing those inputs can be expected to be raised against the ECT. However, just as with the taxation of contract labor under the GCT, the taxation of employee labor under the ECT still comports with well-known public finance principles. Thus, it cannot be disputed that, when it comes to the taxation of a business organization, it operates purely as a conduit to shift the ultimate economic incidence of the tax burden to one, two or each of three constituencies, to-wit: its customers, its employees or its equity owners. Thus, when the certain truth of that principle is recognized, the typical lamentations about taxing business inputs succumb to their own superficiality.

To be certain, a “pass-through” of the tax burden to customers is the essence of the design of broad-based consumption taxes like the current consumers sales tax or the proposed GCT. At the same time, it must be acknowledged that, when taxes are buried in higher prices to customers, lowered wages to employees or lower profits for owners, the aspirational goal of maximum transparency of taxation is compromised. Of course, either voluntary disclosure or a legal mandate requiring the listing of otherwise buried taxes would be one remedy. However, a far more meaningful way to honor the principle of transparency in taxation is to have the people, at its onset, to actually vote on the fairness of a simple, consumption tax system which expressly states how the immediate incidence of its burden is allocated. Then, any shifting to consumers will be apparent to each of them in each purchase they make. That is precisely what is contemplated for the Fair 55 Tax Reform Plan©.

Finally, in the case of multi-state organizations, to more precisely align their liability for the ECT, with the extent of their actual exploitation of the West Virginia market, and to stop penalizing such entities based on the extent of their employment and property investment in West Virginia, the proposal calls for a change of the method for apportionment of the base of the ECT from the present three-factor method (property, payroll and sales) to a single sales factor method.

To address the typical question, raised in response to any policy proposal, to-wit: “what do the other states do?” the ECT would be modeled in its structure, to an extent, on New Hampshire’s Business Enterprise Tax. However, unlike the Fair 55 Tax Reform Plan©, that state still also imposes, on a parallel track, a Business Profits Tax which is similar in structure to West Virginia’s present CNIT, the latter of which would be repealed here.

Despite its obvious merits, there will be those who reflexively oppose the ECT on the grounds that it would be labeled, by tax policy wonks, as being an addition-method value-added tax (VAT). A traditional VAT uses a subtraction-method impost whereby each party in the chain of commerce charges the tax to his or her customer measured by the sold merchandise’s selling price, less its cost to the selling merchant, and, thus, on the “value added” by the selling merchant via his or her mark-up over the cost of the resold item to him or her. .

Nevertheless, “VAT” is the tax category to which its opponents will readily relegate the ECT, because of (not, as you would assume, in spite of) the fact that traditional VATs are, by far, the most prevalent primary tax employed throughout the global economy. Before we go down that road of economic xenophobia, however, it should be remembered that nineteen (19) years after Michigan adopted its SBT (an addition-method VAT), and twenty-five (25) years before New Hampshire adopted its BET, West Virginia’s Legislature, in 1970, enacted its own VAT, based on what was then referred to as the “Papke Plan” developed by James Papke, an economist from Purdue University who the Legislature had hired for that purpose.

However, due to doubts about whether the new tax would have the same revenue-generating capacity as the business and occupation tax it was to replace, then-Governor Arch Moore vetoed the bill too late in the 1970 session for the Legislature to override his action. Today, however, nearly half a century later, as explained in Section J. infra, we have and will employ far superior economic modeling tools and time-tested methods, than those available to the Legislature and Governor Moore in 1970. As a result, we will be able to confidently predict (and cautiously phase in) the revenue-generating capacity of the ECT and of the entire Fair 55 Tax Reform Plan© until they can be fully implemented. Indeed, that was also true of the SBT and the rest of the 1999 tax reform proposal of the GCFT.


Have a tax question, contact Michael Caryl.

The Fair 55 Tax Reform Plan (Part 1)

The Fair 55 Tax Reform Plan (Part 2)

The Fair 55 Tax Reform Plan (Part 3)

The Fair 55 Tax Reform Plan (Part 4)

The Fair 55 Tax Reform Plan (Part 5)

The Fair 55 Tax Reform Plan (Part 6)

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