The Tax Rate Fallacy

When anyone starts lecturing you that the US has the highest tax rate in the industrialized world, just turn around, walk away, and pretend you never heard of them. This person is either ignorant about this country’s taxation system, or is deliberately trying to deceive or mislead you.

According to a report released by the Internal Revenue Service, America’s tax collection agency, the top 400 individual tax returns filed in 2009 reported an average gross income of $358 million each. The average amount of tax paid by these individuals came to under 17%, less than half the maximum Federal rate of 35%, which kicks in on annual income over $372,950 (click here for the 2009 tax tables at ). This explains why Warren Buffet pays a much lower tax rate than his secretary. It really is true that in America, only the poor people pay taxes.

Look at any international comparison of taxes to GDP, and one can always find the United States at the bottom of the table. Low American taxes is one of the main reasons why I moved my company here from England 15 years ago. Take a look at the Fortune 500, where one third of the largest companies pay no tax at all, and many that dominate the top of the list, like the oil majors, pay only token amounts. However, if any politician wants to pander to voters during election time on a tax cutting platform he will only bluster on about “tax rates”, not actual taxes paid.

What the US has that other countries lack is the 100,000 pages of the Internal Revenue Code. It is a 97 year accumulation of deductions, accelerated depreciation rates, tax credits, and other tax breaks that are the end product of intensive lobbying efforts and bribes by special interest groups, corporations, unions, and even religious groups. Take a look at the oil industry again. The oil depletion allowance permits drillers to deduct a substantial portion of the cost of a new well in the first year (click here for its fascinating history at ). When I first got into the oil and gas business a decade ago, after reading the relevant sections of the tax code, I couldn’t understand why everyone wasn’t drilling for Texas tea.

I have a very simple solution to the country’s budget deficit problem. Hit the reset button. Eliminate the Internal Revenue Code. Just set it on fire. Keep the existing progressive, hockey stick tax rates on income, but eliminate all deductions. And I mean everything; deductions for dependents, home mortgage interest, medical expenses, the works. There are no sacred cows. My revised Form 1040 would have only three lines on it:

Tax Rate
Tax Due

The budget deficit would disappear overnight. Government spending would shrink dramatically, because you could ditch most of the 100,000 who work for the IRS. Some 1.3 million auditors and CPA’s would have to hit the road in search of new work too. The amount of money that is wasted on tax collection in this country is truly staggering. This is not some pie in the sky concept. This is how taxation already works in most countries, and they seem to get along just fine.

In fact, the whole scheme might even pay for itself.

To see the data, charts, and graphs that support this research piece, as well as more iconoclastic and out-of-consensus analysis, please visit me at . There, you will find the conventional wisdom mercilessly flailed and tortured daily, and my last two years of research reports available for free. You can also listen to me on Hedge Fund Radio by clicking on “This Week on Hedge Fund Radio” in the upper right corner of my home page.