The tax loophole financial problem

Part 1 of 2

One of the most crucial economic and political issues facing the current U.S. administration and Congress in 2017 is how to manage the U.S. national budget deficit ­— to correct the imbalance between revenues and expenditures.

The recent historical record is this: Under the George W. Bush administration (2001–08), the annual U.S. budget deficit rose by a factor of 5, from $300 billion to $1.5 trillion by the end of 2008. Under the Obama administration (2009–2016), the deficit was reduced, by a factor of 3, to $441 billion, and it is projected to decline further to $350 billion by the end of this fiscal year (2017). Let’s assume that $350 billion is the target imbalance to be corrected. What’s the solution?

The current debate in the U.S. Congress is whether (a) to reduce the size of government by reducing taxes and budget expenditures on social programs (such as health, education, infrastructure, job creation etc.), or (b) to raise tax bracket rates (perhaps to 35 or 40 percent) for the more wealthy among us, in order to increase revenues and restore equity in the tax system. 

Actually, neither approach (a or b above) is entirely satisfactory, sufficient or even necessary. The real problem is that the IRS is unable to collect sufficient taxes because of the growing use of perfectly legal means of tax avoidance (not to use the term “tax evasion”), euphemistically called “tax loopholes,” including the exemption from taxation of certain organizations and investment vehicles, and the use (or misuse) of foreign and domestic tax havens. Under these circumstances, the Trump administration’s promise to reduce overall tax rates, if achieved, would widen inequity and drive national budget deficits through the roof.

On the other hand, raising tax rates or brackets on the wealthy would not address the underlying problem, because those exploiting tax loopholes don’t pay taxes at any bracket rate anyway. Raising tax rates would most likely hit the so-called middle class most heavily, while encouraging still more billionaires to take advantage of hundreds of new tax loopholes skillfully drafted and hidden in some 50,000 pages of the U.S. Tax Code and judicial rulings.

Proposed alternative tax reforms such as replacement with flat taxes or national sales taxes, to give the impression of overall income tax reduction, would actually hit middle-class working Americans the hardest, and once again permit the billionaire oligarchs to pay a lower effective rate of tax, and thus contribute even less to covering the cost of running the country.

The U.S. Tax Code is larded with dozens of special-interest-designed loopholes, the elimination of any one of which could substantially reduce or eliminate the projected annual national budget deficit of $350 billion. Let’s look at just one of these loopholes and the potential solution. (There are dozens of potential solutions, but let’s look at one of the most promising yet least painful.)

When any of us ordinary Americans buys or sells any simple, needed commodity (such as a bottle of milk or a loaf of bread) we pay a typical state sales tax of 6 to 12 percent, depending on the product and the state of purchase/sale transaction. But when a billionaire investor (better described as a “speculator,” “flip trader,” or “hedge funder”) buys or sells a financial instrument (stock, bond, derivative, future, option, swap, or other security) he pays no sales tax at all — state or federal. Why? What is it about a financial trade transaction that deserves more protection than the purchase of a loaf of bread? 

We have no trouble asking the consumer to pay a 6 to 12 percent sales tax. What if we asked the billionaire to pay a mere one percent (1 %) or one dollar on every $100 buy/sell financial transaction? Would that be unfair? Would the billionaire investor, trader, short-seller even notice? What’s the nature and magnitude of the financial transaction market we are talking about? Do we even know? 

Here’s what we do know: Up to 40 percent of high-volume speculative trades on a given day can take place through dark sites outside the major regulated exchanges, and some 80 percent of these transactions are performed by high-speed computers using mathematical algorithms that have nothing to do with the long-term success or value of the investment. These calculations and automated buy/sell decisions (including short sales) are designed to make money on both the up and down sides of the cyclical free market, thus milking the economy without contributing to it.

Arguably, this kind of trading is not investing in the economy; it is exploiting the economy. It is unproductive gambling, doing next to nothing for concerned companies, products, employees, shareholders or customers. So, why should such activities deserve exemption from the sales tax we normally pay on a gallon of milk? 

The next question is, what’s the magnitude of the potential increase in revenue that a financial transaction tax could generate?

Part 2 next time


Sharon resident Anthony Piel is a former director and general legal counsel of the World Health Organization.