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Implementing an Electronic Taxation System to Replace the Income Tax

April 7, 2022, 8:45 AM

Entertain for the moment that the government funded a feasibility study to automate the system of taxation by essentially transitioning from an income tax-based system to a cash flow system of a unilateral electronic collection of a 5% tax on all cash withdrawals from banks—a withdrawals tax. The change would be likened to electronic toll collection, which is now widely accepted and trusted. The tax base would be upward of $9 trillion and be totally transparent within the banking system.

The first step in the process would be to offer an option to the taxpayer of having the annual amount collected electronically as their full tax burden or by computing their tax on the historical income tax method, then selecting the lower tax. The taxpayer could and should opt for the electronic collection of their tax in place of wage withholding and be the overall tax credit against either system. A study to quantify this could be easily accomplished by projecting the revenue based on electronic collection versus income tax collection and calculating the breadth of the tax on those affected. The problem with all this is that the tax perks distributed throughout the tax system, such as the earned income credit, child tax credit, energy credits, and tuition credits, would have to find another means of disbursement or merely get credited back to the taxpayer’s master account.

The U.S. system of taxation has long been on the government’s chopping block. In 1999, Rep. Steve Largent (R-Okla.) was able to get a bill through Congress to sunset the Internal Revenue Code. In 2004, President George W. Bush commissioned a panel challenging our brain trust of learned economists to offer new taxation systems. The panel was widely supplied with entries for consideration; many scholars espoused versions of a cash flow tax system. To the dismay of many, including myself, the presidential response was that the income tax system is “good,” but that it should be made simpler. That has not happened, and today’s system is costly to administer and just impossible for taxpayers to navigate without a degree in taxation.

Countries have made attempts to introduce a withdrawals tax system, namely Australia, Pakistan, India, and Brazil. Historically, economists have a knee-jerk reaction to such systems. However, the time has come to engage in a serious study of the implementation of a withdrawals tax.

Individual taxpayers and businesses should embrace this form of dedicated tax, which would eliminate the need for a FICA tax—the federal payroll tax that funds Social Security and Medicare obligations—by supplanting it. Instead of redistributing wealth, this withdrawals tax would distribute the government obligation for entitlements more fairly. It could even transform Social Security into a system that is economically viable.

The national debt is now more than $30 trillion (that is $30,000,000,000,000!) and growing. No matter how you state that amount, it has never been any higher in our history, and it will continue to grow despite predictions of increased revenue.

The national debt is increased by deficit spending, and the focus of debt solutions is the perennial lament that we have to stop spending money we don’t have. As long as we have a Congress that politicizes debt limits, nothing short of default will stop the debt junkies from raiding the legacy of our children. Management of the debt must encompass three elements: to whom we actually owe the debt, how much debt we really owe, and how to find a systematic way not only to service it but to reduce it. This must be done while finding the political leverage to keep the government focused on realistic fiscal goals.

Programs such as Social Security, Medicare and Medicaid, SNAP—commonly known as food stamps—and unemployment insurance take up about 60%of the total federal budget. They are funded by a 19th century income tax system that politically pulls us away from any real hope of finding a solution to the debt issue. There is just not enough available income to service the debt and entitlements, amounting to a tab that the American people have to pay to maintain our basic standard of living. Something has to change.

A withdrawals tax dedicated to funding all economic security payments would effectively depoliticize the broad spectrum of entitlements. This type of tax would be equalizing to the responsibility it funds, much like a bridge toll. The tax would support all economic security payments without ever having to expand the debt to maintain the whole system, which now directly impinges on national defense and other general government expenditures.

In a sense, a separate, dedicated withdrawals tax would function the same way as interstate highway maintenance, which is funded with the gasoline tax. It would relieve the income tax system from having to service such payments. Instead of redistributing wealth, this would more fairly distribute the government obligation for entitlements.

Given all of these reasons, a withdrawals tax would work very well. All we need is the guts to say so.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Patrick R. Colabella, CPA, is professor of accountancy at the Peter J. Tobin College of Business at St. John’s University and has been a practicing certified public accountant for more than three decades.

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