A Payments Tax Sounds Too Good to be True - Why Hasn't This Been Done Before?

Whenever I present the idea of replacing income taxes with a Payments Tax the most common response is that there must be something wrong with the proposal—it sounds too good to be true. When that happens it reminds me of how the investment bankers on Wall Street reacted when I was promoting the idea of securitizing commercial mortgages in the early ’90s.

The idea seemed simple enough to me. Our nation was in the throes of the Savings & Loan crisis. Lenders had been instructed to steer clear of making new loans on commercial real estate. Double-digit interest rates prevailed and defaults were on the rise since lenders refused to renew any mortgages when they matured (commercial real estate mortgages typically balloon in five to ten years). As a consequence, commercial real estate values plummeted, only making the losses greater.

It was in this environment that I envisioned a better way to make commercial real estate loans. I had followed Lewie Ranieri’s methodology for securitizing residential loans at Salomon Brothers in the ’80s, and I felt there was a way to fund commercial real estate mortgages based upon his principles. The gap between what Ranieri had done and what had to be done to securitize commercial loans in the ’90s was substantial though, and it was a challenge to get the investment bankers on Wall Street to see how the gap could be bridged.

The same arguments prevailed back then about the prospects for securitizing commercial mortgages that I hear today about taxing payments instead of income. “If what you are proposing could work, we would have done this a long time ago. There must be a catch. It’s too good to be true!”

Ranieri was able to rate pools of residential mortgages by getting the S&L that originated a loan that went bad to buy the loan back. That option didn’t exist for conduit financing, nor would the government guarantee the performance of the bonds as it did with FNMA or the RTC (the Resolution Trust Corporation, a precursor to TARP, the Troubled Asset Relief Program, that was used in the latest financial crisis). Instead, we needed a stand-alone structure for the pools that would provide the credit necessary for a rating, which is what I came up with.

If I were right, the impact on the industry would be profound. Mortgage rates would drop to five percent or less and there would be an influx of new money in the market so loans could be refinanced, which would put an end to maturity defaults and falling real estate values. And to top it off, Wall Street could earn some nice profits.

It turned out that I was right, and the ’90s enjoyed a booming economy in part because of the new approach to lending that I helped pioneer. So I smile when I hear the comment that a Payments Tax is too good to be true. The truth is that the best ideas always arise from the grassroots of America and not from our institutions.

As I’ve pointed out already, we have changed our tax base many times in the past. It is only in the last couple of decades that financialization has grown the monetary economy to the point that a Payments Tax could work, so we have only recently entered into an era in which we could consider an alternative to income taxes.

Essentially it is the proliferation of new technology that makes the proposals in the book possible, just as it was technology that allowed securitization or high speed trading to emerge. And the greater truth is that there is no magic panacea for taxation. Just as Wall Street abused securitization when it ignored the principles of solid underwriting, which led to the last financial crisis, politicians can abuse a Payments Tax. Remember in the Introduction I said that this book is part utopian vision, part cautionary tale.

One way to think about the feasibility of a Payments Tax is to compare it to the feasibility of what we are doing today. If there were already a small Payments Tax in place, our national budget were balanced, and there were no federal debt, think of how you would react to the proposal that you should start paying 40% of your income in taxes, an extra 8% in sales taxes for everything you bought, and a third more in excise taxes for gas, phone service, and travel. And if the suggestion was topped off with the projection that your government would end up with a half-a-trillion dollar deficit each year and $20 trillion in outstanding debt, it’s likely you would see that as an awful idea. So which is the greater stretch—what I am proposing, or our current system?

 

Wouldn't it be Difficult to Implement a Payments Tax?

Implementing a Payments Tax would be easy. We are not talking here about any need for new government agencies, nor would it require 73,954 pages of tax code as our current system does.

The Payments Tax would involve a single adjustment to the clearing process for financial institutions. If you deposited a check for $1,000 into your bank account, the bank would automatically deduct the standard tax on payments and credit you $999.

It would not matter whether money was paid into a bank, a non-bank such as a credit union, or a securities clearinghouse—a small portion of each payment would be an automatic part of the clearing process. Since every payment would be taxed, enforcing fair and consistent taxation would be easier for the government to manage, and a more difficult system to game for those who try to avoid paying their fair share of taxes. Of course, there would be less incentive for individuals to try to avoid paying taxes. Whereas today federal income taxes might take up to 39% of your personal income, the Payments Tax would be miniscule. It’s not likely that many would object to paying one tenth of one percent.

 

How Would a Payments Tax Be Collected?

One would think the Payments Tax should be collected the same way we collect income taxes, but there’s a better way. Instead of taking the money deducted from a payment and crediting it to an account for transfer to the Treasury Department, as we do with income taxes, it would be better not to credit the money to any account at all. The idea of not crediting money to an account may be a bit challenging to conceptualize, but it actually would serve an important purpose. It would effectively delete the money collected under the Payments Tax from the money supply, while from the taxpayers’ point of view it would appear as a discount applied to the electronic clearing process.

If we implemented the Payments Tax in this way, we could utilize the Federal Reserve to create the money that the government spends. The money created by the Fed would then enter the economy via government spending and essentially replace the money deleted by the Payments Tax, which would balance the money supply, or more accurately, mitigate inflation.

There are several economic advantages to this way of implementing the Payments Tax. First, it would be highly efficient, since it would eliminate the overhead associated with having to aggregate tax revenues and transfer them to the Treasury. Second, it would eliminate the need for and the cost of financing to bridge the inevitable gaps between the processes of collecting revenue and spending. And third, it would enable the Payments Tax to be utilized as an economic stabilizer.

 

How Would a Payments Tax Affect Me?

What would the Payments Tax mean for you personally? What could be the benefits for individual citizens?

Today, a single, self-employed person earning $30,000 per year pays around $6,000 in income and social security taxes. With the Payments Tax, their tax bill would plummet from $6,000 to a mere $30. Quite the pay raise indeed!

Compare this to a single, self-employed person earning $50,000 per year who pays around $12,000 in income and social security taxes. With the Payments Tax, their tax bill would fall to just $50.

Are you married? A married, self-employed couple with two children and a combined income of $100,000 pays around $22,000 in income and social security taxes. With the Payments Tax, their tax bill would be only $100. The extra $22,000 per year would be a game changer for a family raising children.

 

How Would a Payments Tax Affect our Nation's Economy?

Because a Payments Tax would put more money in our pockets, consumer spending would increase and our nation’s GDP would skyrocket. Since businesses would no longer pay corporate or FICA taxes, they’d have more money to expand and hire new employees. In addition, the cost of complying with our complex tax code would be eliminated, so businesses could put that money to productive use. And without a deficit, our national debt would no longer increase. Together, these factors would propel our economy to new heights. But the benefits of the Payments Tax go even beyond this.

Under the Payments Tax, companies would no longer use foreign nations to hide from U.S. taxes. Foreign tax rates are higher than the Payments Tax, so the problem of “inversions,” or companies moving their headquarters offshore, would be solved. Instead, we’d see a return of the dollars that multinational companies currently stash offshore, which would increase the volume of payments in our nation. Eliminating income taxes would also bring a flood of money from foreign corporations and individuals into our country, resulting in increased investment in our economy and even more payments.

Finally, the Payments Tax would save Social Security. According to current estimates by the Social Security Administration, the trust funds supplementing the payment of benefits will soon be exhausted. At that time, benefits to retirees will need to be cut and/or FICA taxes increased. In other words, the Social Security program is already insolvent with expenditures exceeding receipts; the program is in its final stages of unraveling. The Payments Tax would eliminate this ticking time bomb, bringing solvency to our Social Security program.

Balancing the budget would be simple with a Payments Tax. At a rate of just one tenth of one percent, the Payments Tax would generate a surplus. This would stop the growth of the national debt in its tracks, and the government would no longer have to borrow money to cover its spending.

Notably, balancing the budget with the Payments Tax does not require financial austerity. In fact, the Payments Tax is so efficient we could use it to fund programs we cannot afford today. In The Economist’s Tale I outline several such programs that would dramatically improve the quality of your life while benefitting our nation’s economy as well.

 

Wouldn't People Try to Avoid a Payments Tax?

Because a Payments Tax is such a disruptive technology, it would affect many aspects of the economy, each of which would influence the volume of payments. Thus, in order to gauge the net effect of the Payments Tax, one must assess the combinatorial effect of the Payments Tax on the total economy.

Let’s agree that the mere implementation of the Payments Tax would chase away some settlements. In terms of the volume of payments, that would represent a downward vector of a certain magnitude. At the same time, however, the elimination of personal income taxes would fuel a boom in consumer spending, producing vigorous growth in the economy. A strong bull market would be an upward vector of significant magnitude in terms of the volume of payments.

The elimination of corporate income taxes would also serve to bolster stock prices, adding fuel to a bull market. In addition to this upward vector, the end of corporate taxes would result in a flood of money coming into our economy as companies move the capital they have stashed overseas into domestic accounts. The tax rate of the Payments Tax would be much lower than the tax rates of the countries where that money is now domiciled, and the influx of this capital would be a strong upward vector, fueling growth in the volume of payments.
 

Just as the Payments Tax would incentivize U.S. companies to move their overseas cash into domestic accounts, it would provide the same incentive for foreign companies and wealthy individuals to move their assets into our country. With the PT, therefore, we’d create an economic environment with a net effect of rewarding participation in our markets rather than chasing away transactions. Basically, the Payments Tax would result in a surging economy, which would mean net positive growth in the volume of payments.

 

Wouldn't a Payments Tax Reduce the Volume of Payments?

One aspect of the Payments Tax that we need to consider is whether it would negatively impact the volume of payments. Because the Payments Tax is such a disruptive technology, it would affect many aspects of the economy, each of which would influence the volume of payments. Thus, in order to gauge the net effect of the Payments Tax, one must assess the combinatorial effect of the Payments Tax on the total economy.

Let’s agree that the mere implementation of the Payments Tax would chase away some settlements. In terms of the volume of payments, that would represent a downward vector of a certain magnitude. At the same time, however, the elimination of personal income taxes would fuel a boom in consumer spending, producing vigorous growth in the economy. A strong bull market would be an upward vector of significant magnitude in terms of the volume of payments.

The elimination of corporate income taxes would also serve to bolster stock prices, adding fuel to a bull market. In addition to this upward vector, the end of corporate taxes would result in a flood of money coming into our economy as companies move the capital they have stashed overseas into domestic accounts. The tax rate of the Payments Tax is much lower than the tax rates of the countries where that money is now domiciled, and the influx of this capital would be a strong upward vector, fueling growth in the volume of payments.

Just as the Payments Tax would incentivize U.S. companies to move their overseas cash into domestic accounts, it would provide the same incentive for foreign companies and wealthy individuals to move their assets into our country. With the Payments Tax, therefore, we’d create an economic environment with a net effect of rewarding participation in our markets rather than chasing away transactions. Basically, the Payments Tax would result in a surging economy, which would mean net positive growth in the volume of payments.