The House of Representatives voted last week to hold Lois Lerner in contempt for her failure to testify about her actions involving misuse of the taxing authority to harass and delay the application by certain groups for tax-exempt status. These applicants were mostly those opposing big government, increased taxation, etc.  By the time all of this activity is uncovered by investigators, we may find that the IRS did additional questionable things and may have even influenced the 2012 election results.

This is undoubtedly not the first time the IRS has been used for political purposes.  The point to be made is that the IRS is a tempting and powerful weapon that might be used for political gain, and this activity may be hidden for a long time.

The Constitution as originally written would not have permitted an agency with the power of the IRS, or most of the taxes the IRS is supposed to collect.  Article I, Section 9 of the original Constitution provides: “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.”  The Census was and still is used to apportion the seats in the House of Representatives among the states.  Thus, the original Constitution provided for direct taxation only if it followed representation.  The federal government lived under this arrangement (with a few temporary and questionable diversions) from 1789 to 1913, when the Sixteenth Amendment was ratified on February 3 of that year.  The Sixteenth Amendment provides: “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

Taxation was divorced from representation.  This has predictably led not only to higher taxation and more government spending, but also to abuses of the taxing authority such as, but not necessarily limited to, those currently being investigated.

The founders were smart enough to limit the taxing power of the federal government to “Taxes, Duties, Imposts and Excises … but all Duties, Imposts and Excises shall be uniform throughout the United States[,]” and to “direct taxes … apportioned among the several States … according to their respective Numbers.”  (See here and here.)  This was undone by the Sixteenth Amendment.

After some experiments that generated questions concerning constitutionality, Congress enacted an excise tax on corporations based on income in 1909.  When the Sixteenth Amendment was ratified in 1913, this became the Corporate Income Tax, and the IRS was established to collect both the corporate and personal income taxes.

That is how the stage was set for abuse.  It is almost axiomatic that changes to the Founders’ prescriptions will upset some balance somewhere and create unforeseen results.  It is very hard to teach this to advocates of big government or members of Congress seeking to enact some change that will further the desire of the day.

The abuses discussed above are not the only problems with the personal income tax and the corporate income tax.  The byzantine tax code got that way because of lobbying and campaign donations that resulted in little changes to give this one or that one a small favor that might amount to a very good sum of money.  This practice continues.  The corporate income tax in particular accounts for more lobbying activity than any other statute passed by Congress.

Now, this is not only corruption; it is also massive inefficiency and a drag on the economy.  The personal income tax is so complicated that the average citizen cannot understand it.  He uses a tax service on the internet or in a storefront or an accountant to do his taxes.  This results in a cost of paying the tax that is sometimes more than the tax itself but in any case still an expense that the taxpayer should not have and would not have with another form of tax or even with a simple income tax.  This “cost of compliance” is even more pronounced in the corporate income tax.  The typical large corporation has a platoon of accountants to calculate and file the company’s income tax.  With this kind of compliance cost, hiring lobbyists to get tax favors makes good economic sense.  And lobbying success makes campaign contributions seem to be good policy.  How can any tax so inviting to corruption, so costly to administer, and so costly for the taxpayer to comply with be a good way to fund the government?

We are becoming concerned that our government knows too much about us.  The awareness of this has grown up around the activities of NSA and other intelligence-gathering arms of government.  But every year we tell the government (via the IRS) how much we made, where it came from, where most of it went, what investments we have, how many children we have, how much medical expense we had, and, soon, whether we have health insurance.  If we are indeed a free people, why do we, as individuals, give so much personal information to our central government every year?

It would be relatively easy to prevent further abuse of the taxing power and institute a more rational system of funding the federal government.  Repealing the Sixteenth Amendment, repealing the current federal tax code, and closing the current IRS are all necessary parts of this solution.

We should go back to the founder’s design for funding the federal government.  In the process, we can make the federal government smaller and much less intrusive in our lives.  The duties, imposts, and excises mentioned in the Constitution would still be the province of the federal government and only the federal government.  Uniformity throughout the country would still be required.  However, all other revenues of the federal government would come from levies upon the states in proportion to their population (that is, to their representation in Congress).  How the states collect this tax would be a matter for them to decide.  They could raise the money by taxing real or personal property; by taxing transactions (as in the sales tax); by taxing incomes and excises; or by any other form of tax that their legislatures would enact.  This would soon cause competition between the states to see which could have the lowest or most efficient tax system.  It would also permit individuals to vote with their feet and move from a high-tax or inefficient low-growth state to a low-tax or high-growth state.  The states would be interested in pursuing business-friendly high-growth policies because the federal levy would have to be by population, not state GDP.  The corporate tax could be levied only by states, and revenue therefrom could be used to satisfy the federal levy, just as any other tax the state could legitimately levy within its own territory.  However, states that want more corporate activity would tax corporations less, and those who don’t want corporate operations and jobs would tax them more.  This would shake out fairly quickly.  

Changing the way the federal government gets the bulk of its revenue would not necessarily change the way federal money is spent or what it is spent on.  However, it would tend to make that spending much more efficient and would tend to take the federal government out of several areas where it now funds activities managed by the states – like Medicaid.  Government activities now undertaken by both the federal government and the states would tend to move to one or the other, but not to both.  The efficiencies gained by such a system would probably save enough every year to reduce the federal debt without any greater burden on the taxpayer.  As a matter of fact, the individual’s tax burden and compliance cost would undoubtedly be reduced, and the corporate tax burden and compliance cost would probably also be reduced.  Most of all, the Congress would be reminded that they are spending the people’s money, which comes to them as representatives of those people, and they might wake up and be better stewards of the Treasury.

Jeff Scribner is president of ASI Enterprises, Inc. (www.asienterprises.com), an investment bank serving small and medium-sized businesses.  Contact him at jscribner@asienterprises.com.